Bankruptcy

Is Borrowing a Substitute for Getting Paid??

By Kevin Leicht

Many thanks to the organizers of Credit Slips for inviting me to blog this week.

Henry Ford had a good idea.

In January, 1914 he announced to the world that his workers would be paid five dollars a day. The five-dollar day doubled the average wage for auto workers, produced long lines outside of the factory gates, and helped to create a mass market for the Model T and other consumer durables.

For the next 60 years, this basic formula spread. An entire consumer economy was built on steady middle class jobs that paid slowly rising wages from productivity gains. Wage earners accumulated debts when they were young (mortgages, perhaps car loans, small installment loans for other durable goods), and paid those debts off over their working lives with inflation-discounted dollars from slowly rising paychecks. One was supposed to retire owning a house and not owing the world a cent.

By the middle of the 1970s, this system was fraying at the edges. By the start of the recession in 1981, the patient that produced steady jobs at rising wages was dead. U.S. Federal Reserve Chairman Paul Volcker turned his attention to fighting inflation. Interest rates rose, credit and banking was deregulated, investment became more dynamic, and economic recovery started in the late 1980s. Economic growth through the 1990s and up until 9/11 was very impressive, as were productivity gains in the U.S. economy.

But something was gravely wrong, and by the middle of the 1990s some observers were getting worried.  The economy was growing. Real wages and earnings were not. In fact, median before tax family income in 2001 dollars peaked in 1976 ($42,000) and has been nowhere near that level since. Layoffs, job instability, and family income volatility all rose to near record levels. Yet spending and consumption rose almost continuously from 1992 to now as household revolving debt grew from essentially zero in 1976 to over $9,000 per household by 2005. Total consumer debt outstanding went through the roof and has only tailed off in the past 18 months or so.

Slowly but surely In the U.S. we substituted borrowing and lending for getting paid.

There are a variety of reasons why this happened and I?m not accusing anybody of anything (as Uncle Cecil from Texas would say). Productivity rose in the United States during the 1990s and the benefits of those gains did not filter into most people?s paychecks (They were paid to executives). Financial deregulation (which occurred at almost the exact same time as wages stagnated for the average worker) loosened consumer credit markets considerably and produced a secondary market for securitized consumer debt. Outsourcing, downsizing, and the threats of these put a quiet end to the orderly work career and its steadily rising wages and steady employment. Bankruptcies soared.

More importantly, Henry Ford?s original idea (that workers should be treated well in part because they spend money as a consumer outside the office door) was discarded as a quaint old-fashioned notion.  ?Let the other guy treat people well, I can?t afford it? seemed to be the individual response of employers around the country and, for a long time anyway, Wall Street loved it. In the business section of the newspaper major downsizing on the front page was accompanied by major jumps in stock prices on the back page.

Over the long term this exposed a classic public goods problem ? U.S. consumer purchasing power is something everyone has an interest in but no one has any concrete incentive to contribute to themselves. There are so many alternatives to paying people a decent wage that virtually any alternative is more acceptable than paying people more money or even paying people what they?re worth.

Is this sustainable?? It is difficult to see how. After all, if someone told you that we were going to base the largest developed economy in the world on (a) treating the mass of employees badly, (b) producing many products and services that are consumed offshore and  then (c) loaning these same employees  money to buy the basic goods and services to keep the entire economy afloat,  I would say that someone just walked off a postbellum Southern plantation to sell us on the virtues of sharecropping(!) . 

The current economic downturn gives us an opportunity to think hard about this entire I-borrow-because-I-can?t-get-a-decent-wage system. Simply restoring the ability of banks to loan money is not enough. Instead, the actual real earnings-based purchasing power of the American consumer must be restored.  This is a much tougher task. Loaning people money is not a perfect substitute for paying them, but it is the easy way out. It produces real differences in political and economic power that can?t be ignored. It also isn?t economically sustainable.

Full post as published by Credit Slips on July 11, 2009 (boomark / email).