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8 Things That Must Happen Now to Salvage the Economy -- and the Country

The U.S. is no longer merely in crisis; it is in a state of emergency. And it will take more than re-regulating Wall Street to fix it.

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According to their economic model, budget deficits reduce the nation's savings, push up interest rates and undermine long-term growth. Deficits must therefore be restrained. Meantime, the high dollar fortunately attracts foreign funds to compensate for the minimal savings, making borrowing at low rates still possible. A second component of this model is that rising wages are a cost that weakens profits and encourages businesses to raise prices. Resulting high inflation induces the Federal Reserve to step on the brakes. Modest, even tepid, wage gains, even when less than gains in productivity, are thus interpreted as healthy; they are less inflationary and the Fed then has the leeway to lower interest rates still more.

But there is another model. It suggests that deficits are often necessary to stimulate and maintain high rates of growth, and the higher wages that result in turn create the savings required for investment. Raising savings rates in the short run, on the other hand, often does just the opposite of what is intended. By reducing demand, it ultimately leads to slow growth, smaller incomes and less savings. Keynesian demand stimulus in an underperforming economy will not crowd out private investment due to federal borrowing but rather crowd it in by creating business opportunities due to more sales and prospective buying power. Strong sales are what generate capital investment.

If the stimulus is spent on domestic investment in infrastructure, energy alternatives and green investment, especially after so many years of decay and neglect, it will also create domestic jobs, often good ones, all the while improving the nation's productivity.

As for the question of tolerating higher wages that may bring about a return of inflation, the higher wages themselves may stimulate growth by encouraging demand without, it is important to emphasize, pressuring financial markets with ever higher levels of debt. The demand in turn stimulates capital investment -- the source of productivity growth -- and may generate greater economies of scale. It is Henry Ford paying his workers up to $5 a day to make sure they could afford his cars.

The latter was always the American way. It is conclusively true, notes Peter Lindert, economist at the University of California, Davis, in a working paper for the centrist National Bureau of Economic Research, that America paid the highest wages in the world from 1800 to the 1980s. How did we grow so rapidly then?

If and when the ship is righted, including intelligent re-regulation of finance, the nation must again develop imaginative and aggressive policies to raise wages. How? Through institutional effort and a recognition that labor markets are hardly perfect. As economic historian Peter Temin and economist Frank Levy, both of MIT, argued in a recent paper, it is increasingly obvious that institutional protections for workers matter, and indeed worked in the 1950s and '60s to raise the standard of living for workers at all income levels.

Briefly, then, America must:

  • Raise the minimum wage still higher and on a regular basis. It has fallen far behind increases in inflation since the 1970s, and that affects higher level wages as well.
  • Encourage living-wage programs by local governments. Governments can demand that their contractors and suppliers pay well above the minimum wage. There is substantial evidence that this does not result in an undue loss of jobs.
  • Enforce the labor laws vigilantly. Minimum-wage and maximum-hour laws are violated to a stunning degree. American workers shouldn't be forced by their employers to understate the number of hours worked or be locked in the warehouse so they can't leave on time. Workers often make only $2 and $3 an hour.
  • Unions are not seeking a free pass to organize secretly when they advocate for open check-offs on cards to approve of a union vote. They are seeking to organize without persistent and often illegal management interference. Penalties for illegally deterring such organizing are so light, it makes little sense for management not to pursue strategies to stop organizing even at the cost of prosecution.
  • Request that trading partners develop serious environmental standards and worker-protection laws. This is good for them, bringing a progressive revolution and a robust domestic market to their countries. It is good for America, which will be able to compete on a more level playing field.
  • Demand that the president, governors and mayors speak up about unconscionable executive salaries and low wages. The influence from the top cannot be underestimated. A president who looks the other way sends a strong signal to business. A president who demands responsible treatment of workers will get a response. Business does not like such attention.
  • These measures should be accompanied by serious investment in modernized infrastructure and energy alternatives, which can create millions of domestic jobs that pay good salaries. It should also be accompanied by a policy that supports a lower dollar -- contrary to Rubinomics -- in order to stimulate manufacturing exports again. Accomplishing this may require a new system of semi-fixed currencies across the globe. The unabashed high-dollar policy of the past twenty years has led to imbalances around the world that have contributed fundamentally to US overindebtedness.
  • And finally, the nation needs more balance on the part of the Federal Reserve between subduing inflation and creating jobs. Americans can live with inflation above 2 percent a year. There is no academic evidence to support a 2 percent annual target, although the Fed has made this its informal target.

These are the components of a restored social contract that's suitable to America's aspirations and values and that promotes prosperity.