How to Rebuild U.S. Incomes

President Obama deserves at least two cheers for his recent economic address.

In an unusually clear-eyed assessment of how the economy has shaped our current politics and national mood, he traced most people’s disillusion with government to their “daily battles to make ends meet.”

The “defining challenge of our time,” he declared, is to make “sure our economy works for every working American.” For his part, the President pledged to devote the remainder of his second term to restoring upward mobility and reducing inequality.

To make progress on these fronts, the President and many progressives should first step back from some common populist myths.

35-year squeeze?

In his address, for example, the President stressed the populist trope that the median income today is only 8% higher than it was in 1979. The clear implication is that middle-class Americans have been caught in an economic squeeze for nearly 35 years and Washington should turn away from the policies of the 1980s and 1990s.

This view, at best, is only partly right.

It is true that today’s extraordinary inequality began in the late 1970s. In 1976, the share of national income claimed by the top 1% of Americans fell to less than 9%, its lowest point in the 20th century. Since 1977, however, their share of the economy’s rewards has grown steadily and sharply, reaching more than 23% in 2008, its highest level since 1928.

Nevertheless, most people’s incomes continued to grow at reasonable rates through the 1980s and 1990s. If that strikes many Americans as implausible from today’s vantage, it’s only because much of those income gains were swept away over the last decade. The challenge of restoring upward mobility comes mainly from what has happened economically since 2002.

What really happened

Here is what has really happened to incomes, based on data released recently by the Census Bureau. Across all households — all ages, races, and both genders — the inflation-adjusted median income increased by an average of 1.7% per year from 1983 to 1989, or by nearly 12% over the course of the Reagan expansion.

The recession of 1990–91 took back about one-third of that progress, leaving a typical middle-class household with net income gains of just under 8% from 1983 to 1991. Those gains were followed by more income growth through the Clinton expansion, averaging another 1.4% per year after inflation.

The recession of 2001 took back one-fifth of those gains, leaving a typical middle-class household with net income growth of more than 10% from the 1990s and 18% from 1982 to 2002. Nor did upward mobility stall out in this period: Throughout the 1980s and 1990s, those who had long lagged behind achieved the greatest gains — namely, households headed by African-Americans and by women.

A bad decade

The income squeeze most Americans feel today owes its bite almost entirely to the developments of the last decade. Through the Bush expansion of 2002 to 2007, household income growth rates plummeted to just 0.2% per year. Moreover, those meager gains were followed by the Great Recession, which cost the average household an unprecedented 5% of its incomes.

Those losses wiped out not only all of the income growth from 2002 to 2007, but also 40% of the net gains of the 1990s. Even worse, the economic damage from the 2008–09 crisis, on top of some new problems, continued to eat away at incomes. In 2010–11, American households gave back, on average, another 4% of their incomes.

Those losses finally stabilized in 2012, when household incomes were virtually unchanged. All told, the median income of American households declined nearly 10% from 2002 to 2012.

Getting out of the hole

To get out of this hole, policymakers have to confront the two new dynamics that largely define the last decade economically — globalization and technological change.

There is no possible retreat from the historic advance of globalization, which has drastically reduced poverty across much of the world and driven innovation and cost savings here at home. But the intense competition generated by globalization also produces unprecedented pressures on businesses to cut their costs, and then directs those pressures to jobs and wages.

Policymakers can help relieve some of those cost pressures, starting with a stronger commitment to contain health care costs for both employers and workers. They also could help jumpstart stronger job creation with financial reforms that link a bank’s access to the Fed’s virtually free funds to its willingness to provide capital for newer businesses.

Washington also can help tens of millions of Americans to upgrade their skills for an economy that now provides few rewards for those without the training and skills to operate effectively in workplaces dense with information and Internet technologies.

For a modest cost, for example, the federal government can provide grants to hundreds of community colleges to keep their computer labs open and staffed on weekends and evenings, so any adult can walk in and receive free training in information and Internet technologies.

What the government got right before

The economic record also tells us that the government got a number of things right in the 1980s and 1990s. As in the 1950s and 1960s, usually sensible macroeconomic policies tempered the business cycles, especially after dealing with the oil-shock inflations of the 1970s.

Successive presidents and congresses also continued to liberalize trade in the 1980s and 1990s, encouraging businesses and workers to shift their resources to areas where they held powerful advantages even as Germany, Japan and other advanced countries began to compete actively again.

And from the late 1970s onward, Washington reinforced those advantages by deregulating transportation, telecommunications, and other sectors — including finance, where policymakers went too far in the late 1990s.

Public investments in infrastructure remained generally robust until the 1990s, and even then the private sector sunk tens of billions of dollars into new information and telecommunications infrastructure.

Higher education programs helped tens of millions of Americans expand their human capital, building on the GI Bill of the 1950s and 1960s with major expansions in student assistance in the 1980s and 1990s.

And science and technology policies continued to promote innovation by aggressively funding government research institutes and through technology competitions sponsored by the Pentagon (including the Internet).

Building for the future

To restore income gains and upward mobility, Washington also needs to revisit what works.

• Recommit macroeconomic policy to healthy growth by ending mindless austerity and doubling down on public investments in infrastructure and basic research and development.
• Further expand the markets for innovative American goods and services by completing the current trade liberalization talks with the European Union and much of Asia.
• Help millions of young people complete their higher education by reforming student assistance — for example, by replacing most current loan and grant programs with federally-funded free tuition at public institutions that limit their future cost increases to overall inflation.

There is no iron-clad guarantee that these approaches will restore the reasonable income gains of the 1980s and 1990s, much less the stronger progress seen in the 1950s and 1960s. Nevertheless, they provide a credible place to begin, one based on the real economic record and the actual nature of our economic problems.