The Great Recession and its aftermath are at the forefront of Americans' concerns right now. But wages were in trouble long before the economic crisis hit in 2008. After rising steadily for a generation following World War II, the wages paid to Americans in the lower half of the earnings distribution have barely budged since the 1970s.
That isn't because the US economy has failed to grow. It's because growth of wages no longer tracks growth of the economy. Economic growth and wage growth have become decoupled.
This is worrisome. Rising income, even more than the opportunity to go from rags to riches, is at the core of the American dream. And people who feel they are better off than before tend to be more generous, altruistic, and participatory. If wage stagnation continues, America risks heightened frustration, alienation, and selfishness.
Moreover, given that pay and incomes have been growing rapidly for those at the top, the country has experienced a sharp increase in polarization. At some point this could engender serious societal friction.
Maxing out on two-income households
According to one view, though, household living standards have been improving without wage growth, and they can continue to do so.
It's true that incomes in households with two adults have risen in spite of stagnant wages. But that's due largely to the steady increase in second earners. America is approaching the end of its ability to use rising household employment as a substitute for rising wages. And in any case this isn't a solution for single adults.
It's also true that during the past few decades, Americans have benefited from improvements in product quality and the invention of new gadgets – new medical technology, personal computers, cellphones, the Internet, MP3 players, e-readers, and so on. These enhance quality of life. Maybe this trend will continue, but it doesn't seem wise to assume it will. Nor would that be enough. iPhones are great, but owning one won't help pay a mortgage or college tuition.
In the 1990s and 2000s, borrowing helped to substitute for rising wages and household incomes. With home values appreciating, middle-class families could take on more and more debt in order to fund rising consumption. But for many, that option is now foreclosed.
A second view holds that wage stagnation actually is healthy, because low wages spur job creation. This seems plausible in the abstract; low wages should make it more attractive for employers to hire. Is it true in practice?
If it's correct, the lack of wage growth over the past three decades should have resulted in increasingly strong job growth. But that hasn't happened. The rate of employment growth has slowed in each successive business cycle from the 1980s to the 1990s to the 2000s. Job growth was especially lackluster during the 2000-07 business cycle; the country's employment rate did not increase at all.
Wage growth unlikely to return
A third approach is to hope that wage growth will return. Alas, I suspect that's unlikely.
The key to rising wages prior to the 1980s was that many firms faced limited global competition, little pressure from shareholders to maximize short-run profits, and significant pressure from unions to pass a "fair" share of profits on to employees. These three features of America's postwar economy are gone, and it's unlikely that they will return.
Meanwhile, additional developments now push against wage growth: computerization, stagnant educational attainment, the shift of employment from manufacturing to services, a more general trend away from middle-paying jobs, a rise in less-skilled immigration, a shift toward pay for performance, and a declining real minimum wage.
Inflation-adjusted wages in the bottom half of the earnings distribution did rise briefly in the late 1990s. This was helped by a low unemployment rate ("full employment"), which forced companies to compete more with each other for employees. But I suspect that if and when America again nears 4 percent unemployment, the Federal Reserve, ever obsessed with lurking inflation, will head off wage growth by stepping on the monetary brakes.
What, then, can be done?
Some of the key contributors to wage stagnation, such as technological change, global trade, and immigration, also yield benefits that would be a shame to forgo.
One often-overlooked contributor to living standards is public goods and services. Government provision or subsidization of safety, schools, health care, roads, and so on expands consumption.
Improving educational attainment might help. Only 75 percent of young Americans graduate from high school, and just 35 percent complete a four-year college degree. An especially valuable addition would be good-quality, affordable early education. But boosting school completion rates is difficult, and the payoff is likely to come only in the long run.
A fast-acting solution
To get household incomes rising sooner, I suggest expanding the Earned Income Tax Credit to make it a full-blown middle-class earnings supplement. In its current form, the EITC rises with household earnings up to about $13,000 (for a family with two children), then stays at a flat level, and then begins to decrease, reaching zero at earnings of about $40,000. The maximum EITC benefit amount is around $5,000.
It's a very good program, boosting the incomes of households with low earnings while encouraging employment. It could be revised to better help working Americans without children and to reach households further up the income distribution.
Tying the benefit level to average earnings would ensure that it rises over time in inflation-adjusted terms, helping to narrow the gap between growth of the economy and growth of household incomes.
This proposal is unlikely to get much of a hearing in today's political climate. But politics can shift quickly and in unexpected ways. With wisdom and public pressure, we may find our way back to reliable income growth for ordinary Americans.