The Economy Isn't Broken

Middle-class wage stagnation is the biggest economic fact driving American politics. Over the past many years, so the common argument goes, capitalism has developed structural flaws. Economic gains are not being shared fairly with the middle class. Wages have become decoupled from productivity. Even when the economy grows, everything goes to the rich.

This account of reality, which I’ve certainly repeated, explains why the Democratic Party has moved from the Bill Clinton neoliberal center to the Bernie Sanders left. It explains why the Republicans have moved from the pro-market Mitt Romney right to the populist Donald Trump right.

On both left and right, movements have arisen to fix capitalism’s supposed structural flaws, either by radically interfering in the marketplace (Bernie) or by clamping down on global competition (Trump).

But what if there are no structural flaws? What if the market is working more or less as it’s supposed to?

That’s certainly the evidence from the last two years. Over this time, the benefits of economic growth have been shared more widely.

In 2015, median household incomes rose by 5.2 percent. That was the fastest surge in percentage terms since the Census Bureau began keeping records in the 1960s. Women living alone saw their incomes rise by 8.7 percent. Median incomes for Hispanics rose by 6.1 percent. Immigrants’ incomes, excluding naturalized citizens, jumped by over 10 percent.

The news was especially good for the poor. The share of overall income that went to the poorest fifth increased by 3 percent, while the share that went to the affluent groups did not change. In that year, the poverty rate fell by 1.2 percentage points, the steepest decline since 1999.

The numbers for 2016 have just been released by the Census Bureau, and the trends are pretty much the same. Median household income rose another 3.2 percent, after inflation, to its highest level ever. The poverty rate fell some more. The share of national income going to labor is now rising, while the share going to capital is falling.

In a well-functioning economy, workers are rewarded for their productivity. As output, jobs and hours worked rise, so does income. Over the past two years, that seems to be exactly what’s happening.

The evidence from the past two years strongly supports those who have argued all along that income has not decoupled from productivity. A wide range of economists, including Martin Feldstein, Stephen Rose, Edward Lazear, Joao Paulo Pessoa, John Van Reenen, Richard Anderson of the St. Louis Fed and a team from Goldman Sachs, have produced studies showing wages tracking very predictably with productivity.

If anything, as Neil Irwin of The New York Times’ Upshot has noted, wages are a little higher than you’d expect from looking at the productivity and inflation numbers alone.

The problem of the middle-class squeeze, in short, may not be with how the fruits of productivity are distributed, but the fact that there isn’t much productivity growth at all. It’s not that a rising tide doesn’t lift all boats; it’s that the tide is not rising fast enough.

For those interested, Shawn Sprague has a good summary of the data at the Labor Department’s “Beyond the Numbers.” He shows conclusively that during this recovery we’ve endured a historically low labor productivity growth rate of 1.1 percent. By some estimates if productivity increases had kept pace with the mid-20th-century norm, median incomes would be $40,000 higher than they are today.

If productivity itself is the problem, not distribution, radically different politics is demanded than we’re seeing today. If productivity is the problem, we need more dynamism, not less, more openness, not less, more growth-oriented policies, not more dirigiste and redistributive ones.

There are a few things government can do to help boost productivity: Increase market competition with more antitrust enforcement and fewer licensing regulations; admit more skilled immigrants; invest more in human capital; deregulate urban land usage back to the 2008 levels; introduce more market incentives into the low productivity sectors, like health care and education; fund more research into promising technologies like new energy storage systems.

Today, politics is polarizing to the populist left and the populist right. But if productivity is the problem, what we need is a resurgence of the moderates. The moderate-left policies of Barack Obama must have had something to do with the middle-income gains of the last two years. Moderate Democrats can plausibly argue that government should not be interfering in the markets, but it should be addressing the inequalities that are the result of deeper social forces. There is still a yawning gap dividing the median Asian-American household, which makes $81,000 a year; the median white household, which makes $65,000; and the median African-American household, which makes $39,490.

Moderate Republicans can argue that while government should be active in boosting human capital, and in helping rural America, most of what’s needed is more dynamic capitalism — more trade, more immigration, more free competition, fewer regulatory burdens, more growth.

Right now moderates are in retreat. The populist extremes are on the march. But the fact is they are basing their economic and political agendas on a story that is fundamentally untrue.

David Brooks is a columnist for The New York Times.