BOOK REVIEW--AFTERSHOCK by Robert Reich

Reviewed by Bill Breakstone, October 2, 2010


THE AUTHOR

Robert B. Reich is Chancellor’s Professor of Public Policy at the University of California, Berkeley. He served as Secretary of Labor under President Bill Clinton, and has written twelve books. His articles have appeared in the New Yorker, the Atlantic, the New York Times, the Washington Post, and the Wall Street Journal. He is also co-founding editor of The American Prospect magazine and provides weekly commentaries on public radio’s Marketplace, as well as appearing regularly on MSNBC, CNBC, CNN and NPR. In 2003, he was awarded the prestigious Vaclav Havel Foundation Prize for pioneering work in economic and social thought. He holds an MBA and PhD in economics from Harvard University, where he taught for many years prior to and after his career in public service.

His most recent book, Aftershock, is both an economic and sociological treatise, brief in length but concise, penetrating and filled with, from this reviewer’s point of view, insightful commentary on our present economic malaise and some of its sources. Times Op-Ed columnist Bob Herbert quoted from it extensively in one of his pieces early last week, and the book was reviewed yesterday in The New York Times Sunday Book Review Section, to less than outright enthusiastic support, by Sebastian Mallaby, a Senior Fellow at the Council on Foreign Relations. This review, though laudatory in part, did no justice to what I consider to be an important contribution to the present economic literature.

As his fellow colleagues in economics such as Ben Bernancke, Joseph Steiglitz, Paul Krugman, Nouriel Roubini and others have closely studied and analyzed public policy in the aftermath of the Great Depression, so has Reich. However, this author brings a fresh perspective to the table, and that is one of a sociologist.

In addition, he focuses in part on the work of Merriman Eccles, who served as Federal Reserve Board Chairman from November 1934 through April of 1948, under Presidents Franklin Roosevelt and Harry Truman. As Reich states: “While Eccles is largely forgotten today, he offered critical insight into the great pendulum of American capitalism. His analysis of the underlying economic stresses of the Great Depression is extraordinarily, even eerily, relevant to the Crash of 2008. It also offers, if not a blueprint for the future, at least a suggestion of what to expect of the coming years.”


DEALING WITH THE GREAT DEPRESSION
Merriman Eccles, a conservative banker by nature, was a reluctant adherent to Keynesian economic thought. In the aftermath of the Depression, Reich relates, “economists and the leaders of business and Wall Street sought to reassure the country that the market would correct itself automatically, and that the government’s only responsibility was to balance the federal budget.” Sound familiar? “Lower prices and interest rates, they said, would inevitably ‘lure natural new investments by men who still had money and credit and whose revived activity would produce an upswing in the economy.’ Entrepreneurs would put their money into new technologies that would lead the way to prosperity. But Eccles wondered why anyone would invest when the economy was so disabled.”

The answer, so said our conservative brethren, was that economic downturns were a natural phenomenon, part of the economic cycle, a Darwinian view that here, as in Nature, the fittest would survive and the economically strong would move on. This trend of thought harked back to the works of Austrian economist Joseph Schumpeter, who Roubini states in his excellent recent book Crisis Economics “developed a powerful theory of entrepreneurship that is often distilled down to a pair of powerful words: creative destruction. In Schumpeter’s worldview, capitalism consists of waves of innovation in prosperous times, followed by a brutal winnowing in times of depression. This winnowing is to be neither avoided nor mineralized. It is a painful but positive adjustment, whose survivors will create a new economic order.”

Reich goes on: “They further explained that we were in the lean years because we had been spendthrifts and wastrels in the roaring twenties. We had wasted what we earned instead of saving it. We had enormously inflated values. But in time we would sober up and the economy would right itself through the action of men who had been prudent and thrifty all along, who had saved their money and at the right time would reinvest it in new production. Then the famine would end.” Now keep in mind that we are here talking about the Great Depression, not the Great Recession. Yet the parallels could not be more vivid.

In any case, as Reich recounts, “Eccles thought this was nonsense.” As a leading banker in the national arena, Eccles testified before the Senate Finance Committee in February 1933, just weeks before Roosevelt was sworn in as president. “Others had advised the Committee to reduce the national debt and balance the federal budget, but Eccles had different advice. Eccles told the senators that the government had to go deeper into debt in order to offset the lack of spending by consumers and businesses. Eccles went further. He advised the senators on ways to get more money into the hands of the beleaguered middle class. He offered a precise program designed ‘to bring about by Government action, an increase of purchasing power on the part of all the people.’ ” It should be noted that this advice was given three years before John Maynard Keynes’ similar theories were first published in his famous General Theory of Employment, Interest and Money.

Eccles biggest and most important insight was this: the major cause of the Depression had nothing to do with excessive spending during the Roaring Twenties. It was, rather, the vast accumulation of income in the hands of the wealthiest Americans, which siphoned purchasing power away from most of the rest. “As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth to provide men with buying power equal to the amount of goods and services offered by the nation’s economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-1930 drawn into a few hands an increasing portion of currently produced wealth.”

Without adequate financial resources, consumers had to borrow to fund purchases. The borrowing took the form of mortgage debt on homes and commercial buildings, consumer installment debt, and foreign debt. Eccles understood that this debt bubble was bound to burst. And when it did, consumer spending would shrink. And so it did. Debtors were then forced to curtail their consumption, which naturally reduced the demand for goods and services of all kinds and brought higher unemployment. Unemployment further decreased consumption, which further increased unemployment. For Eccles, widening inequality was the major culprit.

Eccles realized back in 1933, and Reich and other economists are repeating now in the wake of another severe economic downturn, that recovery will be dependant on increasing aggregate demand, and that will be impossible to accomplish without the participation of middle class Americans. The inequality that Eccles saw regarding income distribution in 1930 is being repeated today, and that inequality must be re-balanced.


DECLINE OF THE AMERICAN MIDDLE CLASS
Reich goes on to detail the decline of middle class purchasing power over the period from roughly 1975 to the present. The New York Times Bob Herbert, in that Op-Ed piece, summarized the present plight: “Analysts have tracked the increasing share of national income that has gone to the top 1 percent of earners since the 1970s, when their share was 8 percent to 9 percent. In the 1980s, it rose to 10 percent to 14 percent. In the late-’90s, it was 15 percent to 19 percent. In 2005, it passed 21 percent. By 2007, the last year for which complete data are available, the richest 1 percent were taking more than 23 percent of all income. The richest one-tenth of 1 percent, representing 130,000 households, took in more than 11 percent of total income in 2007. That does not leave enough spending power with the rest of the population to sustain a flourishing economy. This is a point emphasized in “Aftershock.” Mr. Reich, a former labor secretary in the Clinton administration, writes: ‘The wages of the typical American hardly increased in the three decades leading up to the Crash of 2008, considering inflation. In the 2000s, they actually dropped. A male worker earning the median wage in 2007 earned less than the median wage, adjusted for inflation, of a male worker 30 years earlier.’ A typical son, in other words, is earning less than his dad did at the same age. This is what has happened with ordinary workers as the wealth at the top has soared into the stratosphere.”

Reich continues, drawing a parallel between government action to alleviate the effects of the Great Depression and current attempts to create a sustainable recovery after the Great Recession. Government policies in the wake of the Depression led to a new economic order, including many of the programs that Marriner Eccles proposed on the eve of Roosevelt’s inauguration—social insurance, improvements in the nation’s infrastructure, and improved educational opportunities, including an expansion of public universities, all initially financed by government borrowing. They made the American middle class vastly more secure, prosperous and productive.

“The Great Recession that started at the end of 2007, however, has produced no new economic order. Instead, the government stepped in quickly with enough money to contain the downward slide. . . . . . But little was done to reduce the underlying, cumulative problem of widening inequality—Eccles’s insight into what caused the Great Depression. After the stimulus and loose money wear off, therefore, it is unlikely that growth can be sustained. . . . . . This will constitute the Great Recession’s aftershock. From it will emerge either a political backlash—against trade, immigration, foreign investment, big business, Wall Street, and government itself—or large-scale reforms that reverse the underlying trend.”

We are already witnessing the former—the Obama Administration is suffering greatly in the polls as the mid-terms approach. Incumbents have fallen by the wayside in droves, Congress may fall into the hands of the opposition party, the Tea Party movement is attracting more and more followers, there is outrage among congressmen over China’s currency manipulation, Wall Street and big business have become targets of voter anger. On the other hand, there are no signs of the type of reforms that will aid the vast majority of Americans. And the clock is ticking. Time is running out. Unemployment remains high, with little signs that it has peaked. Although American corporations are making record profits once again, GDP is stagnant at best.

The middle chapters of “Aftershock” trace economic policy from the end of the Depression and World War II, through that period Reich names The Great Prosperity, encompassing the years 1947 through 1975, and finally the three-decade long period from 1980 through the current crisis. It was during those years that economic policy was reversed through deregulation, privatization, reduced public services, reduced aid to higher education, restriction on unemployment benefits, and reduced taxes, especially for the wealthiest Americans. At the same time, income taxes were greatly increased for the less advantaged among us, sales and payroll taxes were boosted, both actions taking a bigger chunk out of the middle class and poor.

“Significantly, Washington deregulated Wall Street while insuring it against major losses, in doing so turning finance—which until then had been the servant of American industry—into its master, demanding short-term profits over long-term growth, and raking in an ever larger portion of the nation’s profit.” In essence, the basic bargain between American business on the one hand and the public welfare on the other was broken.


FROM THE GREAT PROSPERITY TO THE GREAT RECESSION
Reich rhetorically asks how the pendulum could have swung back in the opposite direction of social progress. He proposes three answers:

First, there grew a consensus that there was simply no need for government intervention. The proof lay in the great expansion of the 1980s; the long recovery of the 1990s; the wildly exuberant bull market of the era. And Reich states: “This argument is bunk. It equates the stock market with the economy, and turns a blind eye to the revocation of the basic bargain. The argument does not acknowledge the consequences for an economy when the middle class lacks the means to buy what it produces.”

Second, the reversal could be viewed as the inevitable result of declining confidence in government. “The tax revolts that thundered across America starting in the late 1970s were not so much ideological revolts against government . . . . . as against paying more taxes on incomes that had fattened. When government services consequently deteriorated and government deficits exploded, the public’s cynicism was confirmed.

Third, the more important cause of the pendulum reversal had to do with power. People with great economic power have an undue influence in making the rules of the economic game. “The rich and powerful also have substantial influence in conditioning the attitude taken by people as a whole toward rules. “They generously finance think tanks, books, media, and ads designed to persuade Americans that free markets always know best. Ronald Reagan, Margaret Thatcher, Alan Greenspan, Milton Friedman, and other apostles of free-market dogma reiterated a simple story: The choice was between free market and big government. Government was the problem. Free markets were the solution.”

“But how could the public have been so gullible as to accept this story? After all, America had gone through a Great Depression, suffering the consequences of an unfettered market and unconstrained greed. . . . . . America had also experienced the Great Prosperity, which depended so obviously on public improvements, safety nets, and public investment. Now that the basic bargain was coming apart once again, the need for them was even greater.”

One way to understand the paradox is loss of generational memory. . . . . . . When the latest generation became adults (from around the end of the 1970s onward), all they recalled was the failure of government and the success of the market. This made them particularly susceptible to the seductive rants of the free marketeers, who wanted to blame government for the economy’s failings. Moreover, they had no clear memory of a society whose members were all in it together. They witnessed instead an economy in which, increasingly, each of us was on his own.”

Personally, this writer has an alternative explanation: government had simply over-reached. The tide turned against the Great Society because it had gone too far. Unions had become too powerful. Handouts became too many. The social net became too wide. When civil riots broke out, public revulsion set in. Then, along came “Ronnie.” The new conservatives from the South and others flocked to him and his apostles with their simplistic solutions: decrease the role of government; deregulate industry and the markets; bust the unions. And the public bought it!

The middle class struggled on. “Starting in the late 1970s, the American center honed three coping mechanisms, allowing it to behave as though it was still taking home the same share of total income as it had during the Great Prosperity, and to spend as if nothing substantially had changed.”

Number 1: Women moved into paid work in greater and greater numbers;

Number 2: Everyone started working longer hours. What families failed to get in wage increases, they made up for in work increases;

Number 3: Middle class workers drew down on savings and borrowed up to the hilt.

After exhausting the first two coping mechanisms, the only way Americans could keep consuming as before was to save less and go deeper into debt. Americans borrowed from everywhere—credit card debt exploded; student loans increased dramatically; mortgage debt increased exponentially; auto loans were easy to obtain. “And, as housing values continued to rise, homes doubled as ATMs. Consumers refinanced their homes with even larger mortgages and used their homes as collateral for additional loans. As long as housing prices continued to rise, it seemed a painless way to get money. Between 2002 and 2007, American households extracted $2.3 trillion from their houses, putting themselves ever more deeply into the hole.” All these borrowings were aided by the Federal Reserve’s easy money policy, as Greenspan and the Fed did everything they could on the monetary side to prolong economic prosperity from 2000 through the onset of the Great Recession, when the credit and housing bubbles burst. When that happened, the last of the coping mechanisms disappeared.

Paul Volker thought the underlying cause of the Great Recession was that Americans had been living beyond their means. But Laura Tyson, the former chair of Bill Clinton’s Council of Economic Advisors, disagreed: “The real problem was their means hadn’t been growing.”

Reich comments: “The fundamental economic challenge ahead is to lift the means of middle-class Americans and reconstitute the basic bargain linking wages to overall improvements—providing the vast American middle class with a share of economic gains sufficient to allow them to purchase more of what the economy can produce.”
“The Great Recession accelerated the structural change in the economy that began in the late 1970s. More companies have found means of cutting their payrolls for good. Consequently, large numbers of Americans will not be rehired unless they are willing to settle for lower wages and fewer benefits. . . . . . . Nor will households be able to borrow as before. . . . . . Housing values will not regain their speculative peak for a long time, which means homeowners cannot use their homes as sources of easy money through home equity loans and refinancing deals. . . . . . . Americans are paying off, paying down, or walking away from trillions of dollars of outstanding loans—in a vast “deleveraging” of household finances that is likely to continue for years. Even as the economy returns, people won’t want to be burdened by much additional debt.”

“All this means relatively less middle-class consumption than before the Great Recession. . . . . . . Where will sufficient demand come from without a buoyant American middle class? . . . . . . Government can fill the gap for a time, but government cannot continue indefinitely to stimulate the economy with deficit spending or by printing money.”

“It should be apparent that there will be no return to ‘normal,’ because the old normal got us into our present predicament and can’t possibly get us out. So what comes next?

“Economic gains are so meager that the wealthy fight harder to maintain their share. The middle class, already burdened by high unemployment and flat or dropping wages, fights ever more furiously against any additional burdens, such as tax increases to support public schools or price increases resulting from regulations limiting carbon emissions. It’s a vicious cycle.”

The question, then, is how to move from a vicious cycle to a virtuous one—how to restore the widespread prosperity needed for growth, and how to get the growth necessary for widespread prosperity. The challenge is both economic and political. A fundamentally new economy is required—the next stage of capitalism. But how will we get there? And what will it look like when we do?”

Leaders throughout history have learned the hard way how inextricably bound together are politics and economics. Just look at what fate bestowed on many of our presidents over the past 35 years. Jimmy Carter lost his reelection bid because the economy had been suffering double-digit inflation. George H. W. Bush suffered the same result when Alan Greenspan raised interest rates to ward off inflation, which also raised unemployment. As James Carville said: “It’s the economy, stupid.” George W. Bush eventually took the blame for the latest economic catastrophe, and that blame also spilled over to John McCain. “All that can be said with confidence is that jobs and the economy are almost always at the forefront of voters’ minds.”

Reich moves on to examine the source of voter dissatisfaction and anger. He concludes: “Given the chance, most members of the middle class want to join the ranks of the rich and gain all the perks that come with great wealth. The real frustration, and the final straw, will come if and when they no longer feel they have a chance because the dice are loaded against them.”

That is happening right now. Presidents Bush and Obama may have saved America, and the world, from falling off the economic cliff. However, they did so partly by favoring the rich, the powerful, and the most advantaged among us. Namely, the banks, the large corporations and Wall Street. “The giant bailout of Wall Street [and corporate America] was sold to the American people as a way to save Main Street and jobs. But it appeared to do neither. . . . . . . Little or nothing trickled down to Main Street. Small business could not get loans. Few homeowners were able to renegotiate their mortgages, and large numbers lost their homes. Wall Street lobbied successfully against a proposal to allow homeowners to declare bankruptcy rather than forfeit their homes. The proposal would have given distressed homeowners more bargaining leverage with the banks that owned their mortgages. . . . . . . The whole thing began to look like a giant insider deal.”


TWO PATHS FORWARD
Reich believes there are two alternatives available to address the diminished role and opportunities of middle-class Americans, and, in turn, the future health of the American economy. The first way forward is illustrated by the following hypothetical scenario that Reich lays out:


NOVEMBER 3, 2020
The newly formed Independence Party pulls enough votes away from both the Republican and Democratic candidates to give its own candidate, Margaret Jones, a plurality of votes, an electoral college victory, and the presidency. A significant number of Independence Party members have also taken seats away from Democrats and Republicans in Congress.

The platform of the Independence Party, as well as its message, is clear and uncompromising: zero tolerance of illegal immigrants; a freeze on legal immigration from Latin America, Africa, and Asia; increased tariffs on all imports; a ban on American companies moving their operations to another country or outsourcing abroad; a prohibition on foreign “sovereign wealth funds” investing in the United States. America will withdraw from the United Nations, the World Trade Organization, the World Bank, and the International Monetary Fund; end all “involvements” in foreign countries; refuse to pay any more interest on our debt to China, essentially defaulting on it; and stop trading with China unless China freely floats its currency.

Profitable companies will be prohibited from laying off workers and cutting payrolls. The federal budget must always be balanced. The Federal Reserve will be abolished.

Banks will be allowed only to take deposits and make loans. Investment banking will be prohibited. Anyone found to have engaged in insider trading, stock manipulation, or securities fraud will face imprisonment for no less than ten years.

Finally, but not least: In order for the government to balance the budget, provide for national defense, guard our borders, and pay down the national debt, all personal incomes will be capped at %500,000 per year; earnings in excess of that amount will be taxed at 100 percent. Incomes above $250,000 are to be taxed at 80 percent. The capital gains rate will be 80 percent. All net worth above $100,000 will be subject to a 2 percent annual wealth tax. Any American found to be sheltering his income in a foreign nation will be stripped of his U.S. citizenship.

In her victory speech, president-elect Jones is defiant:

“My fellow Americans: You have voted to reclaim America. Voted to take it back from big government, big business, and big finance. To take it back from the politicians who would rob us of our freedoms, from foreigners who rob us of our jobs, from the rich who have no loyalty to this nation, and from immigrants who live off our hard work. (Wild applause.) We are reclaiming America from the elites who have rigged the system to their benefit, from the money manipulators on Wall Street and the greed masters in corporate executive suites, from the influence peddlers and pork peddlers in Washington—from all the privileged and the powerful who have conspired against us. (Wild applause and cheers.) They will no longer sell Americans out to global money and pad their nests by taking away our jobs and livelihoods! (Wild applause and cheers.) This is our nation, now! (Wild applause and cheers that continue to build.) A nation of good jobs and good wages for anyone willing to work hard! Our nation! America for Americans! (Thunderous applause.)

Her opponents concession speeches are bitter. George P. Bush, the Republican candidate, is irate. “I cannot stand before you and congratulate my opponent, who based her entire campaign on fear and resentment,” he tells his supporters.

Chelsea Clinton, the Democratic candidate, is indignant. “I would very much like to offer Margaret Jones my best wishes for the future. But I have to be honest: She and the Independence Party pose a grave danger to this nation.”

Foreign leaders try to be respectful but cannot hide their anxieties. The British prime minister issues a terse statement “wishing Americans well.” The German chancellor offers “condolences,” but the German ambassador to the United States insists the chancellor’s remark has been mistranslated and is best understood as “commiserations.” The president of China appears before news cameras and says, simply, “The United States has committed a grave error.”

The presidents of the U.S. Chamber of Commerce and the Business Roundtable issue a joint statement warning that Margaret Jones and the Independence Party “will push America into another Great Depression.” The CEOs of the four remaining giant Wall Street firms predict economic collapse.

On November 4, the day after Election Day, the Dow Jones Industrial Average drops 50 percent in an unprecedented volume of trading. The dollar plummets 30 percent against a weighted average of other currencies. Wall Street is in a panic. Banks close. Business leaders predict economic calamity. Mainstream pollsters, pundits, and political consultants fill the airways with expressions of shock and horror. Over and over again, they ask: How could this have happened?


The second alternative Reich proposes is to face head-on the currently existing inequities and remedy them through legislative and executive actions. His specific suggestions are enumerated at the end of this review.

Reich next examines the power and influence of lobbyists, and here, here he is getting to one of the underlying systemic roots the dilemma. No one will deny the corrupting influence of money. It drove, in part, the bank rescues, and the “people” were left behind holding the bag. It funds politicians’ campaigns, who then cow tow to contributors’ interests rather than the public welfare they swore to protect. Thus, the cause of the problem is political, and that will require a political solution. If our elected officials didn’t need so much money, their vulnerability to its corrupting influence would diminish. Could the answer lie in having fewer elections at more infrequent intervals? Why do members of the House of Representatives need to face reelection every two years, while across the aisle, senators serve six year terms. It’s obscene! Why do presidents have to run for reelection every four years? It severely limits their effectiveness as leaders—they in essence have a two-year period after being elected to put their programs to work, and then spend the following two years running for reelection. Why not, as many have suggested, have a six-year term for our presidents?

Both of these changes would encounter fierce resistance from exactly those whose undue influence such changes would address, i.e., the lobbying industry itself. But it’s a fight worth taking on. Reich does not advocate anything in this regard, and that is the first fault I find with his work. The following is the second:

Reich proposes nine steps to restore the balance between middle-class opportunities and the rich and powerful—restore what he refers to as the “bargain”—that intellectual or ideological agreement giving workers a proportionate share of the fruits of economic growth. I will simply state his proposals without elaboration.

First, a reverse income tax. Instead of money being withheld from workers paychecks to pay taxes to the government, money would be added to their paychecks by the government, according to a graduated or progressive formula; second, a carbon tax; third, higher marginal tax rates on the wealthy—up to 55%--and elimination of the capital gains exemption; fourth, a reemployment system rather than an unemployment system, including wage insurance; fifth, school vouchers based on family income; sixth, college loans linked to subsequent earnings, to be repaid during the first ten years of a student’s gainful employment; seventh, Medicare for all; eighth, a sizeable increase in public goods such as transportation, public parks, recreational facilities, public museums and libraries, with free public transportation, including high speed rail; and, finally, the removal of money from politics.
Reich maintains “This is not an unrealistic agenda. It is practical and doable.”

It is said that one of the dangers of an academic life can be isolation from reality. Living in the ivory tower of academia can blur a person’s reasoning powers. If Reich thinks his nine-step program is doable, he is deceiving himself. To end such a brilliant study of our economic and political systems with these kinds of proposals is a true shame.


CONCLUSIONS
I have seldom read a book as thought-provoking as this one. I regularly read 25 pages or so before bedtime, and found myself awakening hours later and writing notes to myself about one insight or another that Reich had brought to mind. I have also found the many quandaries that the author describes to be deeply troubling, for no one seems to be addressing the underlying causes of our economic malaise. Rather, all things seem to be pointing to a breakdown in effective government, in our national leaders’ ability to overcome political rancor in order to solve our nation’s problems.

Is there a basic flaw in our political system? Our founding fathers created a lasting document over 240 years ago, our Constitution. It has served the nation well for a long, long time. However, those founders never conceived that effective leadership would be so compromised by political parties totally unwilling to cooperate and put the common good ahead of partisanship and the striving for power. In fact, the party system did not even exist at the time of the Constitutional Convention. But the Signers did bequeath to future generations the ability to modernize the document through the passage of Constitutional Amendments. It is in that direction that we must proceed. As mentioned above, the contentious effect of our party system must be corrected, and the only way this can be accomplished is to reduce party and lobbying influences; reduce the predominance of special interests, and put the reins of government back in the hands of our elected officials, allowing them to represent both their constituents and their own conscience.