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We Need A New Economic Model…

because the one we have is broken.  Consider this: over 70% of GDP (gross domestic product) depends on consumer spending and 80% of business/economic activity starts in the service sector.  A report by Dr. Thomas Palley, an economist, entitled “American’s Exhausted Paradigm: Macroeconomic Causes of the Financial Crisis and Great Recession” supports this claim that our current economic system is broken.  The arguments he makes are pretty convincing. 

(hat tip: Robert Oaks @ The Economic Populist)

The subprime mortgage crisis, the collapse of Lehman Brothers and Bear Stearns, and bailing out of financial conglomerates are symptoms to a much larger problem - a terribly flawed economic growth model.  In my opinion, it is this current economic model that is destroying the middle class.  Dr. Palley identifies two key flaws in the economic growth model (which he calls the Neo-Liberal Growth Model) that he says were adopted in the 1980s:

Flaw 1: Reliance on Debt and Asset Price Inflation

Prior to 1980s, economic policy focused on full employment and wages grew with productivity.  Rising wages meant rising GDP which contributed to full employment.  Full employment in turn provided an incentive to invest, which raised productivity, thereby supporting higher wages.

All this changed after 1980 when economic growth model shifted from focusing on full employment to focusing on controlling inflation.  Full employment was actually deemed inflationary and policies and strategies were implemented to break the productivity growth/wage growth link.  But something had to replace full employment and wage growth as an economic driver.

Borrowing/leverage and asset price inflation replaced full employment and wage growth.  The tactics employed by those carrying out this flawed economic policy included globalization for the purpose of lower wage competition and off-shoring employment, and constant attacks on unions, minimum wage laws and other worker protections.  The result was the destruction of the mechanisms for rising middle class incomes.

Flaw 2:  The U.S. Engagement in the Global Economy

Our current growth model depends on financial booms and cheap imports.  Cheap imports attempt to compensate for the impact on stagnate wages - making things cost less.  The global engagement has undermined our economy in two ways.  First, it has accelerated the erosion of household incomes particularly as a result of the decline in manufacturing employment.  Second, it accelerated the accumulation of unproductive debt - debt that generates economic activity elsewhere rather than in the United States (ex. China).

This flawed economic engagement has created a “triple economic hemorrhage”.  First hemorrhage, household income and borrowing was significantly spent on imports, creating incomes offshore rather than in the United States. As a result, borrowing left behind a debt footprint but did not create sustainable jobs and incomes at home.  Second hemorrhage, The second hemorrhage was the leakage of jobs from the U.S. economy as a result of offshore outsourcing, made possible by corporate globalization.  This leakage of jobs, particularly higher paying manufacturing, negatively effected household incomes.  Third hemorrhage concerned new investment. Not only were corporations incentivized by low foreign wages, foreign subsidies, and under-valued exchange rates to close existing plants and shift their production offshore, they were also incentivized to shift new investment offshore. That did double damage. First, it reduced domestic investment spending, hurting the capital goods sector and employment therein. Second, it stripped the U.S. economy of modern industrial capacity, disadvantaging U.S. competitiveness and reducing employment that would have been generated to operate that capacity.

This is a pretty powerful report by Dr. Palley.  I strongly encourage and beg people to read it, understand it and spread the word.  Our elected officials are focusing on treating symptoms of this terribly flawed economic model and not curing the disease.  We need a new economic growth model but the attention of our elected officials is focused elsewhere.  If we don’t change this economic model we are doomed to experience more violent bubbles in the future and continued destruction of the middle class. 

Let me conclude with this incredible and very interesting points that Dr. Palley makes:

The logic of the neo-liberal growth model [our current growth model] rests on redirecting income from lower- and middle-income households to corporate profits and upper-income households. Asset prices are bid up by a host of measures, including higher profits, savings by the super-rich that are directed to asset purchases, borrowing to buy assets, and such institutional changes as the shift from traditional defined benefit pension plans to defined contribution—such as 401(k)—pension plans. Consumption is maintained by lower household savings rates and by borrowing that is collateralized by higher asset prices. The reduction in savings rates is partly a response to squeezed incomes and partly rationalized on the grounds that households are wealthier because of higher asset prices (including house prices).

Good luck.