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Excerpt from Morgan Stanley economist Richard Berner's October 27th essay:

One might have thought that angst over the plight of the typical U.S. wage-earner -- and by extension, his and her downbeat assessment of the economy -- might have subsided with the recent acceleration in real wages....

But... economic worries continue. The war in Iraq is obviously the critical issue on voters' minds. But with less than two weeks to go before the mid-term elections, a USA TODAY/Gallup Poll released this week suggests that the economy is running a close second. And low unemployment, improving incomes, falling gas quotes, and rising stock prices just aren't resonating with voters; 55% of those polled say the economy is "fair or poor," and 54% think it is getting worse...

The real reason for the sour mood, as I see it, is that significant cuts in employee benefits -- pensions and healthcare -- signify the breakdown of the postwar 'social contract' between employers and employees and have created anxiety about the future... Employers and employees both look at total compensation including benefits when reckoning pay packages, so soaring benefit costs often squeeze take-home pay... With healthcare costs rising rapidly, the "give" in compensation could only come in wages as employers forced employees to accept smaller pay gains. And to keep their benefits, workers accepted them...

The acceleration in healthcare costs over the 1995-2003 period and the private pension crisis of the past few years brought benefit costs to nosebleed levels, and employers are cutting back. Consequently, worker confidence in the future of the total compensation package likely has weakened. Despite the improvement in market conditions that has narrowed DB pension funding gaps, for the beneficiaries, pensions are still at risk... Healthcare benefits are more broadly offered and are even more at risk. Companies are aggressively shifting their cost to employees...

The financial market implications of these developments will depend heavily on the policies implemented and consumer behavioral responses to them. There is a benign scenario: The loss of employee benefits might finally trigger bipartisan support for genuine retirement saving, healthcare, and entitlement reform -- the holy grail of economic policy. Moreover, abetted by policy changes that give consumers carrots and sticks to take responsibility for their future needs, the shrinkage in employer-paid benefits could accelerate a gradual rebirth of personal saving. Financial markets would celebrate the prospect of a sustainable fiscal policy and a better balance between personal thrift and future needs. But there's also a darker alternative: If the loss of benefits promotes a wave of protectionism designed to protect old jobs and old benefits, and if consumer anxiety turns into consumer retrenchment, both the economy and risky assets would suffer.

Source: Richard Berner: How Escalating Health Costs Might Affect the Economy