The American Middle Class Was Destroyed by Design: How to Make It Strong Again

Once upon a time in a faraway land—the United States following World War II—workers reaped what they sowed. From 1947 through 1973, their income rose in lockstep with increases in productivity. Their median compensation (wages plus benefits) increased by 95 percent as their productivity increased by 97 percent. Then, abruptly, the rewards for greater productivity started going elsewhere—to shareholders, financiers, and top corporate executives. Today, for the vast majority of American workers, the link between their productivity and their compensation no longer exists.

As economists Robert Gordon and Ian Dew-Becker have established, the gains in workers’ productivity for the past three decades have gone entirely to the wealthiest 10 percent. The portion of the nation’s economy that went to workers’ pay and benefits—which had held remarkably steady from 1947 through 1973 at 66 percent or 67 percent—last year fell to a record low of 58 percent, while profits reached a postwar high.

Today, the drive to restore workers’ share has been narrowed down to the campaign to raise the minimum wage. That raise is long overdue. The real value of the federal minimum wage of $7.25 an hour is less than two-thirds of its level in 1968, which, in current dollars, would be $10.71. But even raising that wage wouldn’t do much for most workers; they make well more than the minimum, but their own wages have been stagnating or shrinking for decades as well.

What, then, do we do for American workers more generally? How do we raise their wages? How do we re-create a growing and vibrant middle class?

For many business leaders, politicians, and commentators, workers’ declining share is the inevitable result of globalization and technological change—forces of nature that nations, much less individuals, are powerless to stop. They also tend to blame the victim: According to conventional wisdom, workers lack the education and training to fill the new high-tech jobs the economy now demands.

Globalization and technological change have indeed played key roles in weakening workers’ bargaining power, and a more educated workforce surely commands better pay than workers without the requisite skills. Nonetheless, the business leaders and their apologists are fundamentally wrong in both their diagnoses and prescriptions.

To begin, at least one major nation every bit as subject to globalization and technological change as ours hasn’t seen the evisceration of its middle class and the redistribution of income from labor to capital that we’ve endured. Germany has a greater level of foreign trade than the U.S. and a comparable level of technological change, but it has managed to retain its best manufacturing jobs, because of the greater power that its workers exercise and the diminished role its shareholders play. In Germany, law and custom have enabled labor and required management to collaborate on making sure that the most highly skilled and compensated jobs remain at home.

The claim that American workers lack the skills they need is belied by workers in low-skilled jobs (those that pay two-thirds or less of the median wage) having much more education than equivalent workers four decades ago: 46 percent of low-skilled workers today have attended college; in the 1960s, just 17 percent had. Moreover, the incomes of many professionals, including lawyers and college teachers, have declined in recent years as well.

What corporate apologists won’t acknowledge is that workers’ incomes have been reduced by design. American business has adamantly opposed workers’ efforts to organize unions. Millions of jobs have been outsourced, offshored, franchised out, reclassified as temporary or part-time, or had their wages slashed, in a successful, decades-long campaign to increase the return to capital. Indeed, the only way to explain the soaring profit margins and stock values of recent years despite anemic increases in corporate revenues is that profits have come at the expense of labor. In forecasting the continued rise of profits in 2014, the chief economist for Goldman Sachs, Jan Hatzius, wrote: “The key reason is the continued slack in the U.S. labor market and the resulting weakness of nominal wage growth …. The subdued growth of unit labor costs has supported profit margins even in an environment of low price inflation.”

The transfer of income from labor to capital, then, is chiefly the consequence of capitalists’ design. But precisely because that transfer has been so thorough, reversing it will be exquisitely difficult. Traditionally, American workers were able to raise their wages by collective bargaining or through the clout they could wield in a full-employment economy. But the ability of private-sector workers to bargain collectively has been destroyed by the evisceration of unions, which now represent just 6.7 percent of private-sector workers. The labor movement has tried during each of the past four Democratic presidencies—those of Johnson, Carter, Clinton, and Obama—to strengthen protections for workers in organizing campaigns. Each time, however, the unions failed to surmount the Senate’s supermajority threshold. Until they can, the most direct way to raise workers’ wages will remain a dead letter.

Re-creating the other avenue for bolstering workers’ leverage—a full-employment economy—looks just as remote. Historically, workers won some of their biggest wage gains when the unemployment rate dipped beneath 4 percent, as it did during World War II, the late 1960s, and the 1990s dot-com boom. But low consumer demand (itself largely the result of the diminished spending power of underpaid workers) and the continuing rise of machines that can do people’s jobs have combined to diminish the workforce. The future may even be bleaker: Google’s self-driving car doesn’t augur well for the millions of Americans employed in transporting goods and people.

During the New Deal, the federal government embarked on massive public-works and employment programs. Now, confronted with a growing share of working-age Americans who have given up on finding employment, government needs to take up that task again. Such a project should combine a program to rebuild the nation’s sagging infrastructure with increased public investment in home care, child care, and preschool. But such a project also requires far greater public belief in the necessity and efficacy of governmental endeavors and the election of a president and a sufficient number of legislators who share that belief. However devoutly progressives may wish it, this is not likely to happen any time soon.

In a nation where workers have lost the power they once had to raise their incomes, what can be done to make those incomes rise?

Here are eight proposals, beginning with some that have already been enacted in regions where labor-liberal coalitions hold sway, moving on to some that require legislative changes that are not possible today but could be tomorrow, and concluding with those that involve a fundamental reorganization of our economic system. Rebuilding America’s middle-class majority will likely require them all.

1. Legislate Wage Hikes in States and Cities

In poll after poll, raising the federal minimum wage emerges as one of the most popular policy options on the political landscape, supported by an overwhelming majority of Democrats, a sizable majority of independents, about 50 percent of Republicans, and an increasing number of major retailers. Nonetheless, such is the influence of small business (of restaurants, especially) and the Tea Party that prospects for getting a raise through Congress remain dim.

In the 14 of the 50 states where Democrats control the governor’s office and both houses of the legislature, however, the odds on increasing the minimum are brighter. In a number of these states, the wage already substantially exceeds the federal minimum, and some have raised their standard even more in the past year (in California, to $10). Cities and counties in certain states have the right to set their own minimum wage higher than that of their state. In Maryland, the two counties bordering the District of Columbia recently increased the wage, in tandem with the District, to $11.50. In Washington state, which has a minimum wage of $9.32, Seattle’s mayor has called on the city council to boost the wage within the city to $15.

Governments, though, can also legislate raises for workers who make more than the minimum wage or who work in a place where a broad minimum-wage hike isn’t likely. Since the late 1990s, local progressive governments have been able to lift wage levels for private-sector workers in government-owned facilities (such as airports or museums) and projects that receive government assistance (such as property-tax abatements or infrastructure improvements) or require special governmental approvals (such as sports arenas). Advocates of these “living wage” ordinances argue that governments should not be using taxpayer dollars to subsidize poverty-wage jobs.

The Los Angeles Alliance for a New Economy (LAANE), an advocacy group that helped form the movement for the living wage, also pioneered community-benefit agreements, convincing municipal governments to condition their approval of major projects on the developer’s commitment to meet local-hiring and living-wage standards not just for construction workers but also for the service workers to be employed within the development. LAANE also persuaded voters in Long Beach, California, to enact by initiative a $13 hourly wage for hotel employees in the city’s downtown development zone and is currently lobbying the Los Angeles City Council to approve a $15 minimum wage for workers in all L.A. hotels with 100 or more guest rooms.

LAANE’s initiatives have been widely copied. Currently, at least 150 cities have established living-wage ordinances or community--benefit agreements. In 2007, San Francisco created a municipal health-insurance program for the city’s uninsured, funded in part from assessments on employers who didn’t provide their own workers with insurance. Unlike the Affordable Care Act, the city’s program covers undocumented immigrants.

The demographic changes that have transformed America’s big cities have turned them into a Brandeisian laboratory for progressive economic initiatives. Their populations having been swelled by waves of immigrants and young people, 26 of the nation’s 30 largest cities today have Democratic mayors—the most lopsided partisan alignment since the 19th century. That makes cities the most propitious terrain for legislation that would raise not just minimum wages but also wages for workers higher up the economic ladder. 

2. Link Corporate Tax Rates to Worker Productivity Increases

Later this year, the Securities and Exchange Commission, complying with a mandate in the Dodd-Frank financial-reform act, will require corporations to publish the ratio between the pay of their CEOs and the median pay of their employees. Since this process will make public the information on a company’s median wage, Congress could create a lower tax rate for those corporations that increased their median wage in line with the annual national productivity increase. So far, the discussions of rising inequality and corporate tax reform have progressed as though they’re on separate planets. The Senate Finance Committee, under its new chair, Oregon Democrat Ron Wyden, should combine them. Lowering corporate tax rates for those companies that institute annual employee productivity increases would probably be the most effective way, short of labor-law reform, to boost workers’ incomes.

Absent elections that give Democrats control of both the legislative and executive branches of the federal government, this proposal won’t be enacted anytime soon. (There’s no guarantee it will be enacted even with wall-to-wall Democratic control.) Until it is, though, states could pass laws that link their own corporate tax rates to workers’ receiving productivity increases. At the state level, it would probably be prudent to exempt those businesses that could move out of state, while applying the tax rate to service, retail, construction, and transportation businesses that can’t relocate.

Constructing a tax code that gives corporations an incentive to pass on productivity increases to their employees is admittedly a complex task. The tax break would have to be big enough to be attractive to the companies’ directors and managers. The break would also have to be withheld from corporations that game the system by initially cutting their workers’ pay to reduce the median wage, then restore it through a productivity increase. Devising a process for monitoring and assessing corporate conduct would not be easy. But with unionization—the straightforward means of linking employee pay to productivity gains—off the table, complexity is the price we’d have to pay to create a more prosperous economy.

3. Link Corporate Tax Rates to CEO-Employee Pay Ratios

If congressional liberals want to diminish economic inequality, they should also promote legislation that would link corporate tax rates to the ratio between CEO pay and the firm’s median pay: the lower the ratio, the lower the tax. This is sure to elicit a backlash from corporate elites and the financial sector, but it should gain popular support. A poll conducted this February showed that 66 percent of the public believed that “executive pay is generally too high”—an assessment shared by 79 percent of Democrats, 61 percent of independents, and 58 percent of Republicans.

The rise in the ratio of CEO to median-worker pay began about the time that workers’ compensation was detached from increases in productivity. In 1978, CEOs made 28 times the pay of their median-paid employee; by 2012, CEOs made 273 times the median.

Were this proposal to become law, CEOs and their boards would face a fundamental choice: They could persist in excessive executive compensation at the expense of forcing their company to shell out considerably more in corporate taxes. Or they could reduce executive pay to levels the American people see as a more legitimate reflection of executive worth. They would also have a self-interest in raising their workers’ wages. Indeed, if enacted in conjunction with the proposal linking the median worker’s pay to productivity increases, this proposal would limit corporations’ incentive to game that system by reducing workers’ pay before the median is calculated.

What kind of ratio should progressives set as an appropriate valuation of a CEO’s worth? In 1977, the celebrated management guru Peter Drucker wrote in The Wall Street Journal that a ratio of 15 to 1 seemed right for a small or midsize business, and 25 to 1 for a large business. By that standard, a CEO at a sizable firm where the average employee makes $60,000 a year would make $1.5 million.

4. Make Corporations Responsible for All Their Workers

Many of the problems American workers encounter in making a decent wage stem from a confusion about who employs them. In recent decades, companies have routinely shifted the production and delivery of their goods and services and other tasks needed to run their businesses from their own employees to workers employed by contractors, subcontractors, franchisees, or temporary job agencies or to workers who are labeled independent contractors. In many cases, these workers are the same workers the parent company once employed. In most cases, they could be employed directly by the parent company, but they’re not, chiefly because having the labor done by nonemployees saves the parent company money.

Inevitably, all this reduces the workers’ wages and benefits. By outsourcing work, Boston University economist David Weil explains in an important new book, The Fissured Workplace, an employer trades a wage-setting problem for a pricing problem. Rather than pay his own employees a low wage, he can choose from a range of contractors, who compete with one another on price—a process that advantages the contractor with the lowest labor costs. In 2009, the five most profitable electronics firms, among them Apple, had profit margins of 35 percent, while their five biggest contract manufacturers (led by Foxconn, the giant industrial contractor, which employs more than 1 million Chinese workers) had profit margins of 3.8 percent.

This dynamic explains why security guards employed by the company they’re guarding make 17 percent more than those employed by contractors. It explains why truckers who move imports from harbors to warehouses and who are employed directly by trucking companies make on average $35,000 a year, while the median earnings of the truckers whom the same companies classify as independent contractors are $28,800.

These varied forms of outsourcing have become the norm in a wide range of industries. Where once auto companies directly employed the men and women who made their cars, Nissan now has thousands of workers employed by temporary employment agencies making cars in its Tennessee and Mississippi factories. Where once major retail chains staffed their warehouses with their own employees, Wal-Mart has thousands of warehouse workers unloading the containers brought in by the port truckers, repacking and loading them onto Wal-Mart trucks for delivery to Wal-Mart stores across the nation. Yet these workers are not Wal-Mart employees; they, too, are employed by temp agencies.

Nissan’s temp workers do the same jobs as the Nissan employees next to them on the line, only for a good deal less. Wal-Mart, master of the logistics universe, specifies which products are to be moved through its warehouses and sent to which destinations, at which times, and at what cost.  Most of the “independent contractors” who move goods from the port rent their trucks from one company, drive exclusively for that company, with orders and routes set by that company. But neither Nissan, Wal-Mart, nor the trucking companies directly pay these workers, who, of course, are not eligible for any of the parent companies’ benefits. If these workers put in uncompensated overtime to complete their work, or are paid less than the minimum wage, or are injured on the job, their parent company is held harmless, though the parent company dictates the conditions of their work and the amount they are paid.

In some states, this has begun to change. In California, Labor Commissioner Julie Su has ruled that a number of port truckers who have lodged complaints with her office have been misclassified as independent contractors. In the 19 cases in which the Labor Department has rendered judgments, it has ordered the trucking companies to compensate their workers with a settlement averaging $4,266 for every month they’ve been underpaid. In New York, Governor Andrew Cuomo signed legislation in January banning the misclassification of commercial truckers.

As for employees working for contractors, Weil cites West Virginia’s Wage Payment and Collection Act as a model for making parent companies assume responsibility for any violations of employment laws. The act was passed in response to public outrage at the repeated violations of wage and safety laws at mines that the Massey Energy Company had subcontracted out to small companies. Those contractors, most of them barely solvent, frequently failed to pay their workers. The act made anyone who’d benefited from a mining operation responsible for compliance with wage and safety laws and subject to litigation for any violations of those laws.

Such a law, applicable to all companies, should be enacted on the federal level, but until then, states with progressive governments should enact their own versions of parent-company responsibility statutes. Wal-Mart should be held liable for the workers who labor off the clock in the company’s warehouses. As for the private-equity firms that own multiple companies—Blackstone, for instance, owns companies that employ 600,000 workers and delegate work to thousands more under contractual arrangements—they, too, should be regarded as the employers of record for employees-at-six-removes.

A radical amendment to the radical reforms I proposed in the preceding section: Count the parent company’s contract workers as employees in calculating corporate tax rates.

5. Help Create Benefit Corporations, and Don't Tax Them So Much

Boosting workers’ interests and incomes within the corporate framework ultimately requires changes to the framework itself. A new model that shifts the balance of power within the corporation away from shareholders and—probably but not definitely—more toward workers is something called a “benefit corporation.” Under its charter, the directors and management are legally required to weigh the social and environmental impact of their decisions. Nineteen states offer corporations the option of chartering themselves as benefit corporations rather than conventional corporations; Delaware, where most American corporations are chartered, joined the list of states with this option last year. Roughly 550 corporations have chosen this route, among them such worker- and enviro-friendly firms as Patagonia.

None of these corporations, however, offers shares that are publicly traded, and it’s hard to imagine any publicly listed corporation choosing to go this route. Delaware requires corporations to win the approval of shareholders holding 90 percent of the company’s stock to change their charters, and the probability of that happening—of the mutual, retirement, and hedge funds opting to diminish shareholders’ primacy—starts at zero and goes down from there. But socially conscious entrepreneurs forming new companies should be encouraged to go the benefit-corporation route, and one way to do that would be to set the federal and state tax rates on such corporations significantly lower than the rates on conventional ones.

6. Help Workers Claim Their Share of Capital Income

While—and because—labor income has lagged, capital income has soared. Last year, the share value of the Standard & Poor’s 500 companies rose by 30 percent. Americans’ real disposable income grew by 0.7 percent. Since Americans’ real disposable income includes income derived from those soaring stocks, that 0.7 percent conveys how few Americans derive significant income from investments.

Why, then, can’t more American workers take their payment at least partly in the form of profit sharing or stock? In fact, 11 million workers are currently employed by the roughly 12,000 U.S. companies with employee stock option plans, and one survey has concluded that 47 percent of American workers have access to some form of profit sharing. Yet these plans have had little appreciable effect in boosting workers’ incomes, for the reason that the existing plans don’t share a lot of the profits or vest a lot of the stock with their employees.

Last year, Rutgers management professors Joseph Blasi and Douglas Kruse and Harvard economics professor Richard Freeman wrote The Citizen’s Share: Putting Ownership Back into Democracy. They argued that worker ownership had a long history in the American economy and a long history of bipartisan and cross-ideological support, with advocates ranging from Ronald Reagan to liberal Democratic senators Amy Klobuchar of Minnesota and Debbie Stabenow of Michigan. Companies with profit sharing benefit from greater levels of worker involvement and innovation, while workers benefit from their profit sharing—but only modestly. To boost productivity and re-establish its link to workers’ incomes, the authors call for revising those plans so that workers can receive a larger share of their employer’s profits.

It’s particularly poignant that Freeman is making this case. More than any other of the nation’s leading economists, Freeman has devoted his career to demonstrating the need for and utility of unions. Having concluded, however, that unions have become too weak to champion employees’ interests, his new plan for helping workers comes down to “If you can’t beat ’em, join ’em.” One proposal to implement his strategy would be to have state and federal governments link corporate tax rates to the extent of the companies’ profit sharing: The more that’s shared, the lower the rate. 

7. Raise Taxes on Capital Income and Redistribute It to Labor

Another solution to the rise of investment income and the decline of income from work would be to use the tax code to explicitly redistribute capital income to labor. The current tax code comes close to doing the reverse. Capital income—income from qualified dividends and capital gains—can be taxed at a rate no higher than 20 percent, while income from wages and salaries is subjected to a progressive tax that tops out at 39.6 percent. As Warren Buffett frequently notes, upper-middle-class and middle-class Americans sometimes pay more taxes on their wages and salaries than billionaires pay on their investments.

The justification for the low rate on capital—that it boosts the American economy by promoting domestic investment—has been rendered absurd by the globalization of American businesses. The disparity between capital and labor tax rates also means that the government has diminished its take from that part of the national income that is growing, while maintaining a higher rate on that part of the nation’s income that is shrinking.

For all those reasons, the tax rates on capital should be raised to the level of the rates on labor; indeed, given that taxable labor must be domestic while taxable capital can be derived from anywhere, the rate on capital should be higher than that on labor. But what to do with this new revenue? As shareholder capital comes more and more at labor’s expense, it should be taxed for the purpose of boosting labor income. One option would be to devote some of it to increase labor income through a major expansion of the Earned Income Tax Credit, a tax rebate that supplements the income of the working poor.

8. Change the Governance of Corporations

Now, the most fundamental change of all.

Boosting workers’ power within the corporate framework requires more than expanding profit sharing or altering the company’s charter. It requires altering the corporate structure—in particular, the structure of its governing body. A myriad of reasons explain why German workers have fared better than their American counterparts in an era of offshoring and technological change, but the most decisive is the law mandating that the supervisory board of any German company with at least 1,000 employees be divided between management and worker representatives. Germans call this arrangement “co-determination.” (The CEO is selected by management and has the authority to break tie votes.) This sharing of power explains why Germany retains a manufacturing sector proportionately almost twice as large as its American counterpart, why Germany’s exports-over-imports trade balance is greater than any nation’s but China’s (and sometimes greater than China’s), and why German industrial workers’ compensation is one-third higher than Americans’ without diminishing the sale of German goods.

Co-determination is both a cause and consequence of the diminished role that equity markets and shareholders play in the German economy. German firms tend to receive their funding from bank loans and retained earnings; shareholders and bondholders play a small part, if any, in financing most businesses. That’s one reason the composition of corporate boards encounters little opposition within Germany. The other reason is that it has helped create an economy in which prosperity is broadly shared.

Here, then, is another proposal for those who favor raising workers’ incomes: Compel corporations through legislative mandate or encourage them through corporate tax reform to adopt co-determination. Putting worker or public representatives—not selected by shareholder voting—on corporate boards is not without precedent in the United States, but it has only occurred in response to extraordinary situations and never resulted in the seating of more than one or two non-shareholder--selected members. (United Auto Workers President Douglas Fraser served on the Chrysler board in the late 1970s and early 1980s as part of a wage-concession deal the union made with the company and the federal government to keep Chrysler from going into bankruptcy.)

This proposal would surely trigger an avalanche of business and establishment criticism prophesying the end of civilization, but the advantages of co-determination to most Americans would be real. A serious campaign on its behalf, contrasting its merits with those of the shareholder-dominated version of capitalism, would at minimum expose the price we pay for maintaining our current economic arrangements and could lead to less sweeping reforms. At maximum—and that would likely require the kind of political upheaval we haven’t experienced since the 1930s—it could change the form of American capitalism into one that once again rewards workers’ endeavors.


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