Book Review: Saving Capitalism By Robert Reich

by: Philip Mause


Robert Reich, Secretary of Labor under Clinton, has written an insightful book focused on the trend toward the capture of a higher percentage of income by the top 1%.

Partly as a consequence of this, median income has stagnated and the middle class has declined.

Reich sees the free market/government regulation debate as a false one and points out that the government necessarily sets rules for contract enforcement, property definition and bankruptcy.

He argues that the super-rich have manipulated and changed these rules to their advantage since 1980 and that this largely explains their increasing share of the national income pie.

There are other factors which much more plausibly explain the reasons that 1980-2015 was strikingly different from 1945-1980.

Robert Reich is always insightful and interesting, and his heart is in the right place. His new book, Saving Capitalism - For the Many, Not the Few, focuses on the change in income distribution which occurred starting around 1980. He correctly points out that a much larger share of pre-tax income has been captured by the top 10%, 1%, and .01% than had been the case in the past. More importantly, he notes that, although median income increased rapidly in the early period, median income has basically stood still for the last 25 years even though gross domestic product has increased substantially. Corporations - and their top executives and shareholders - are taking a bigger and bigger slice of the slowly growing pie. At some point, this may threaten to undermine public support for capitalism. Reich offers to "save" capitalism by reversing this trend.

Reich argues that we have become blinded by a spurious "free market" versus socialism debate. In fact, he argues, the capitalist system depends on things like the enforcement of contracts, the definition of property, and the operation of bankruptcy - all of which necessarily involve government action. So the question really is not WHETHER the government will get involved but HOW the government will get involved. Reich argues that - over the past 30 years or so - moneyed interests have spent huge amounts of money on lobbyists to twist the rules governing these areas to their advantage by, for example, extending copyright protection, easing restrictions on monopolies, permitting mandatory arbitration provisions in contracts of adhesion, and tightening bankruptcy requirements for individual debtors. These manipulations are a large factor causing the ever worsening income distribution.

He hearkens back to the 1950s and 60s as kind of golden age in which a hard working American could earn enough to support his children and a stay-at-home mom, make mortgage payments on a comfortable residence, and pay for college. He laments that these days are over and proposes myriad changes to enable us to go back to the golden age. He wishes we could go back to an era in which corporate executives served the interests of all "stakeholders" (employees, customers, communities, the country as a whole, the world, the environment) rather than just the interests of shareholders.

Reich ignores some extremely important macroeconomic factors which much more plausibly account for the changes we seen since 1980. Here are four of them.

The Aftermath of World War 2

From 1945 at least until 1970, we were living in the shadow of World War 2. The Axis Powers had been devastated but a number of countries on the winning side (France, China, the Soviet Union, the Netherlands) had been battered as well having been bombed, invaded, occupied, reinvaded, and stripped of industrial as well as agricultural resources. Many of our big companies had virtually no foreign competition and didn't have to worry about imports during the years in which virtually all the other industrial powers were engaged in rebuilding, retooling and barely surviving. Our steel, auto, rubber, aviation, and consumer electronics industries were fat and happy and faced little pressure to cut costs by holding down wages or trimming payrolls.


Between 1945 and 1980, the general pattern, admittedly with fits and starts, was gradually increasing inflation. While extreme inflation is devastating to the entire economy, slowly increasing inflation actually benefits the home owning middle class. During this period, the typical middle class household's balance sheet featured one highly leveraged piece of real estate securing a long-term fixed interest loan. Inflation dramatically increased the value of the owner's equity while the subsidized (by Fannie Mae) fixed rate mortgage became less and less burdensome as it was being paid off with progressively less valuable dollars. Middle class households could stretch to buy a house they could barely afford and then watch it increase in value so that, after living there 25 years, a very sizeable financial asset became available. Since 1980, we have had the opposite pattern with disinflation and finally deflation leading (since 2007) to a collapse in the housing market. Disinflation has driven up the value of "paper assets" (stocks and bonds) by creating a higher present value for a discounted future stream of cash. These paper assets are owned disproportionately by those in the top 10% or even 1% of the income distribution.


Reich does focus on globalization and reveals that he had misgivings about the Clinton Administration's initiatives in this area. But he misses several inexorable trends. Even without trade agreements and lower tariffs , our competitiveness was undermined by the fact that 1. transportation costs declined enormously, 2. the United States - virtually uniquely - did not have a value added tax, 3. technology created very valuable items like semiconductors for which shipping costs were trivial, and 4. the dollar, as the global reserve currency, was fated to be enormously overvalued - especially at times of financial stress - which turned out to be the very worst times in terms of the labor market. Once the rest of the world recovered from the conflict which had devastated the Eurasian land mass, we were fated to be deluged with cheap imports. A worker in the United States competing with a worker in Asia who is willing to work for 16 hours in exchange for a warm bowl of rice is not going to be able to support his family, own a home and pay for sending two kids to college.


Birth rates were depressed between 1930 and 1945 due to the Depression and World War 2. I was born in 1944 and was one of the "fortunate few"; college admission was easy, jobs were plentiful, and things were good. Starting in 1946, the "baby boom" occurred and lasted until 1964 when my tiny generation started to dominate the child production years. So the young men and women entering the job market from 1950 until 1965 were few and highly prized. At the very time that American companies faced no foreign competition, they also faced a shortage of new workers. Labor could command a bigger share of the pie simply due to supply and demand.

Where Do We Go From Here?

Reich outlines a series of proposals - a higher minimum wage, a return to corporate concern for all "stakeholders", stronger unions, less money in politics, restrictions on the big banks, and, perhaps, a kind of negative income tax. He doesn't really prioritize and I have misgivings about many of these. It was in the era of "stakeholder"-oriented management that we lost most of our steel industry, almost all of our consumer electronics industry and nearly half of our auto industry to foreign competition. Managements which were more focused on shareholder interests couldn't have done much worse. Reich spends a good deal of time on the advantage that "too big to fail" banks have in attracting deposits (on the theory that the government will always bail the bank out and make depositors whole) in competition with smaller banks. Reich cites sources for the proposition that the annual value of this subsidy to big banks is $83 billion and argues that it is the source of the high compensation we see on Wall Street. He doesn't discuss Federal Deposit Insurance nor does he really suggest a plausible solution. In fact, the limit on Federal Deposit Insurance is currently $250,000 so that on all deposits up to that amount there is no risk regardless of the depository institution. The $83 billion subsidy (and unfair advantage of the big banks) could easily be reduced by increasing the limit on deposit insurance. An increase to $10 million would, I am sure, put a big dent in the subsidy and allow middle-sized businesses to sleep more soundly holding deposits in smaller banks.

More fundamentally, we have to become more competitive in international markets. It is absolutely essential that we institute a value-added tax and restructure our obsolete corporate tax system. We must also recognize that the "game" of international trade has changed. It is no longer a matter of tariffs and explicit trade barriers. Instead, it is a matter of exchange rates and currency strategy. Germany has prospered by creating a common currency with weak and risky, overleveraged economies. The prohibitively high valuation that the Deutsche mark would have had has been replaced by a relatively weak Euro - allowing Germany to be competitive around the World. Japan has embarked an aggressive reflation program aimed at weakening the yen. And I am not even going to start talking about China. At a time like this, with the dollar at 1.36 loonies and 120 yen, we should be absolutely flooding the World with dollars to get back to competitive levels. This may bring some inflation but, as pointed out above, inflation is not the worst thing for the middle class.

These fundamental macroeconomic forces - and not manipulation of the "rules" of capitalism - are the real reasons for the change in income distribution. Many of Reich's proposals are sound as far as they go, but they will only put a small dent in the problem. His book is a good read, contains many sound insights and gives a reader a solid understanding of the economic reasoning underlying many political proposal we are likely to see coming from the Democratic Party. I hope we are able to address the fundamental problems with more systemic solutions but Reich has, at least, made a start at framing the problems.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.