The Low-Wage Puzzle

When America's most recent economic boom ended in 2001, the economy was turning out $7 trillion worth of consumer goods and services a year -- enough to provide every man, woman and child with almost $25,000 worth of food, housing, transportation, medical care and other things every year. If all that stuff had been divided equally, the typical American household, which now has three members, would have gotten about $75,000 worth. Yet as we see in this issue of the Prospect, based on new research by the Russell Sage and Rockefeller foundations, a lot of Americans had to scrape by on far less than that. Almost one American worker in five reported having been paid less than $8 an hour in 2001. That works out to less than $17,000 a year even if you work full time. And many low-wage workers earned considerably less than $17,000 because they were unemployed for part of the year, worked less than 40 hours a week or earned less than $8 an hour.

Some of those low-wage workers were teenagers who didn't have to pay most of their own expenses, much less support anyone else. For them, $8 an hour was a pretty good wage. But many of America's low-wage workers were single mothers trying to support a family. Others were married men whose wives stayed home with their children. These workers are eligible for the Earned Income Tax Credit, but most of them still find that making ends meet is a constant challenge. Most Americans think they deserve a better deal and tell pollsters that the minimum wage (currently $5.15 an hour) should be raised. But a market economy is not designed to ensure that workers get paid what other people think they deserve. The logic of a market economy is that we should all be paid the smallest amount that will ensure that our work gets done, and that is what low-wage workers generally receive.

American economists and business leaders have long argued that the best way to improve low-income families' standards of living was to make the economy more productive. At times economic growth really has benefited almost everyone. When World War II dragged the United States out of the Great Depression, unskilled workers and their families gained proportionately more than most other Americans. Even after the war ended, the rich and the poor enjoyed roughly similar percentage gains in income until the early 1970s. So when John F. Kennedy said that "a rising tide lifts all boats," he was describing the experience of his generation. Since 1973, however, things have been very different. Productivity and national income have increased but wages have diverged.

Measuring changes in purchasing power is complicated and contentious, but the best historical measure is probably what the Commerce Department's Bureau of Economic Analysis calls the chain price index for personal consumption expenditure. Using this measure, the nation's output of consumer goods per worker rose 58 percent between 1973 and 2001. Yet if we use the same price index to measure the mean weekly earnings of nonsupervisory workers, we find that they rose only 3 percent. Wage stagnation was not confined to the worst-paid fifth of the labor force, many of whom are now immigrants. According to The State of Working America, published by the Economic Policy Institute, the median American worker's real hourly wages rose only 7 percent between 1973 and 2001.

Among men without any college education, real wages have actually fallen since 1973. Workers and immigrants now do many of the jobs that these men might once have filled, and this competition has driven down wages. As a result, male high-school graduates and dropouts are having more trouble supporting a family. Meanwhile, more women have entered the labor force, and their tolerance for men who cannot pay the bills has diminished, especially if these men are also hard to live with, as they often are. Marriage rates have fallen, and divorce rates exceed 50 percent among couples with below-average earning power. More than half of all mothers without college degrees now spend some time as a single parent. Most married couples now feel that they need two breadwinners rather than one. Partly for that reason, the number of workers has grown more than the adult population while the number of children has grown less than the adult population.

The net result of all these changes is that while the economy grew dramatically between 1973 and 2001, most of the benefits went to those who needed them least: affluent, college-educated couples. The best trend data on household income now come from the Congressional Budget Office (CBO), which pools data collected by the Census Bureau with data on similar individuals collected by the Internal Revenue Service. These data, which are available from 1979 through 2000, allow the CBO to calculate households' total income, including capital gains and noncash benefits like food stamps, and also to subtract out taxes. Mean household income rose 40 percent between 1979 and 2000. But in sharp contrast to the situation between 1940 and 1973, more than a third of the total increase since 1979 has gone to the richest 1 percent of all households, and another third has gone to the next richest 19 percent. That hasn't left much for the bottom 80 percent. While the incomes of the top 1 percent tripled between 1979 and 2000, the income of the median household rose only 15 percent and the incomes of those in the bottom quintile rose only 9 percent. These gains almost all came between 1994 and 2000.

The moral of this story seems clear: while economic growth is almost always a necessary condition for improving the lives of those in the bottom half of the income distribution, America's experience over the past generation shows that growth alone is not sufficient. So what makes the difference? Why are the benefits of growth sometimes widely shared and sometimes not? If you ask economists and business leaders why households in the bottom half of the distribution have benefited so little from economic growth since 1973, they tend to talk about impersonal forces like globalization, computers and skill deficits. But if these explanations were sufficient, we should see the same pattern in every rich country, and we don't.

The Luxembourg Income Study (LIS) now provides roughly comparable measures of how household income is distributed in most wealthy democracies. Data on Britain, Canada, France, Germany, Sweden and the United States are available back to the 1970s. Even then the United States was the most unequal of the six nations. Sweden was the most equal. But at that time, Canada, Britain, France and Germany all looked more like the United States than like Sweden. Since then the distribution of household income has grown substantially more unequal in both Britain and the United States, but it has hardly changed at all in Canada, France, Germany or Sweden. The LIS has data going back to the 1980s on a number of other rich democracies. These data also tell a mixed story. Household income inequality increased somewhat in Australia, Austria, Belgium, Finland and Norway, but it has hardly changed in Denmark, Ireland or the Netherlands. Today the United States is by far the most unequal rich democracy in the world.

Impersonal forces like globalization, computerization and skill deficits are not promising explanations for these differences. Most countries with stable income distributions are even more dependent than the United States on the global economy. Computer use and sales spread faster in the United States than in most other countries, but by the end of the 1990s, computers had permeated every affluent society. Thus if the skills required to use computers or interpret their output were in short supply, and if this explained the run-up in inequality, we should now see the same pattern in every technically advanced society. The International Adult Literacy Survey does suggest that workers' reading and math skills are somewhat more unequal in the United States than in the other wealthy countries, but because the correlation between these skills and workers' earnings is quite modest, the distribution of such skills cannot explain why inequality is greater in the United States. A somewhat more credible story points to faster growth in post-secondary enrollments in Europe than the United States, which could have kept the price of skilled labor lower in Europe. But European workers still have less schooling than their American counterparts, and educational change cannot easily explain why European workers' pay is more equal than ours.

So why do ordinary American workers get to keep less of what they produce than ordinary workers in other rich countries? And why is this form of American exceptionalism becoming more pronounced? The answer turns out be pretty simple: "It's politics, stupid." Political scientists have been churning out papers on this question for more than a decade, and while the details differ, they mostly tell a broadly similar story. At least in rich democracies, differences in income distribution seem to be traceable to differences in constitutional arrangements, electoral systems and economic institutions. Those differences in turn affect the political balance between left and right, the level of spending on the welfare state and a wide range of economic policies.

Economic inequality is less pronounced in countries where the constitutional system has few veto points, allowing the government of the day to make fundamental changes. Rules that favor a multiparty system rather than a two-party one also produce more equal economic outcomes. So does proportional representation. Such arrangements apparently make it more likely that a ruling coalition will seek to protect labor unions, raise the minimum wage and centralize wage negotiations, all of which tend to reduce wage inequality. Such coalitions also tend to expand the welfare state.

If you think all of this sounds very different from the United States, you are right. The men who drafted the U.S. Constitution were property holders. Most of them worried about the possibility that democratic governments might be tempted to appropriate their property, or at least impose very high taxes in order to provide benefits to less affluent voters. The Founders wanted a system of government that would make such populism easy to resist, and to a large extent they got what they wanted. Despite the subsequent spread of cultural egalitarianism, both federal and state legislators have remained remarkably solicitous of property holders' rights. Legislators have also shown a persistent preference for relying on private markets rather than public institutions to make economic decisions.

These legislative priorities enjoy broad popular support. Americans are less likely than Europeans to tell pollsters that income differences are too large. Americans are also more suspicious of government than Europeans, which means that Americans are less likely to endorse most policies for reducing wage inequality that involve government "meddling" in the marketplace. But these attitudes are not built into Americans' DNA, nor are they an inescapable legacy of our history. In part, of course, they reflect the public's tendency to endorse the institutional status quo, which most Americans think has served the nation well. The pro-market consensus also reflects the influence of journalists and political pundits, most of whom seem to be even more skeptical about government than about private enterprise, as well as the current influence of the business elite. This consensus also owes something to the absence of a political party that questions it. The absence of such a party derives both from rules that make third parties extremely difficult to organize and a system of campaign finance that makes every party dependent on rich contributors.

But none of these obstacles to redistribution is insuperable. Americans are not as unhappy as Europeans about economic inequality, though most Americans still say that income differences are too large. Large majorities also favor increasing the minimum wage. Furthermore, while there are certainly institutional obstacles to redistribution, most of those obstacles also existed between 1940 and 1970, when the distribution of income became more equal.

The New Russell Sage book, "Low-Wage America," which provided grist for this special supplement to The American Prospect, describes a complex mosaic of different occupations and industries that pay low wages. Many face relentless competitive pressures to cut costs, and they respond by battering down wages or shipping work overseas. But if there is one common theme to the 535-page volume with its dozens of case studies, it is that executives in most industries have a fair amount of discretion about how they structure and reward work. It defies common sense, as well as economic logic, to believe that a poorly skilled and badly paid American workforce should be the key to global competitiveness, never mind an attractive society.

The articles in this special section of the Prospect describe the considerable leeway that employers have in deciding how to respond to competitive threats. Some take the "low road" and squeeze their front-line workers, driving down wages and working them harder. Others take the "high road," adopting new technologies that keep their operations competitive, upgrading workers' skills and reorganizing the way work gets done.

Which road a firm chooses depends on the social context in which its managers operate. They are more likely to take the high road if they are connected to institutions, public and private, that promote such alternatives. The U.S. system for connecting highly skilled work to advanced technology, unfortunately, is rudimentary and fragmented. Managers are also more likely to choose the high road if they face a strong progressive union that can make abusing workers costly while simultaneously making collaborative efforts between workers and managers easier. But American business is almost uniquely hostile to unions. Further, experience in other countries suggests that managers will be more inclined to choose the high road if there is a higher minimum wage, which sets a floor below which wages cannot be pushed and forces them to think more inventively about how to keep the firm competitive. Perhaps most important of all, managers are more likely to choose the high road when the national culture treats driving down wages as discreditable behavior -- instead of rewarding such managers by bidding up the value of their stock options.

None of these alternatives is likely to become commonplace in the present political climate, but all have been common in the not-so-distant past. The articles that follow take a deeper look at several industries and suggest some of the ways that we could revive the social norms and the sense of solidarity that made more equal earnings possible.