The United States was turbulent in the 1960s. The Civil Rights Movement roiled the South and led President Johnson to lobby Congress to pass the Civil Rights Act of 1964, which forbade discrimination in employment and public accommodations, and the Voting Rights Act of 1965, which authorized the federal government to ban state barriers to African American voting under the Fifteenth Amendment. These acts should not have been necessary, since the constitutional amendments passed just after the Civil War granted African Americans full citizenship. Americans of European descent, however, opposed this sudden equality, and the Civil Rights Movement of the 1960s was an effort to gain full citizenship for blacks. The backlash from this movement was one of the pillars of the subsequent policies, as will become clear later.
At the same time as he fought for these bills, Johnson dramatically expanded American expenditures and forces in Vietnam. Reluctant to raise taxes soon after the Kennedy tax cut of the previous year and lacking congressional support as well, he overheated the economy and put great pressure on the value of the dollar, fixed at that time by the Bretton Woods system that regulated international commerce after the Second World War. The postwar dollar shortage turned into a dollar glut.1
President Nixon set himself up in opposition to Johnson. He won election to the presidency through a Southern Strategy that appealed to Southern racism and opposition to the Civil Rights Movement. He abandoned Johnson’s War on Poverty and declared a War on Drugs in 1971. He also abandoned the fixed exchange rate of the Bretton Woods system to deal with the strain on the dollar exerted by the expanding war in Vietnam.2 Nixon switched the United States to a floating exchange rate, transferring responsibility for the domestic economy from the federal government, which controls fiscal policy, to the Federal Reserve System, which controls monetary policy. The Fed had been securing the exchange rate for the previous quarter century, and it had to learn how to fulfill its new role. This process was complicated greatly when the Organization of Petroleum Exporting Countries (OPEC) quadrupled the price of oil in 1973. The resulting “Oil Shock” sent many prices—including exchange rates—in motion.3
Anticipation of the Oil Shock led President Nixon to propose “Project Independence” in November 1971. Nixon’s emphasis was on domestic production and consumption, and his policy implied that the United States was to remain passive in the face of OPEC provocation. This idea was transformed over the next few years into a more active stance that would seek steady supplies of oil from the Middle East. Nixon also replaced the ailing draft for Army soldiers with the volunteer army at this time, a plan he also started before the Oil Shock. The draft had become difficult as the Vietnam War dragged on, and conservatives argued against the idea of forced service. This was an early step in the privatization of the military.4
The Oil Shock also raised the question of how the members of OPEC were going to hold their newly acquired wealth. The highly regulated financial system established at Bretton Woods in the 1940s could not easily absorb this large inflow of cash, and the cash found a temporary home in the arrangement for dollar deposits outside the United States. These dollar deposits in European banks were known as Eurodollars, and they were not heavily regulated by either the United States or Europe. Much of the cash went to Switzerland, where banks were willing to preserve the anonymity of the depositors. The combination of changing prices and large amounts of money seeking a safe home led to demands to deregulate the financial system that stimulated a general push for deregulation and affected policy decisions in the following decades.5
The Fed did not know how to contain the price shocks of the 1970s, and “stagflation”—both inflation and unemployment—was the result. President Carter tried to end this monetary chaos by appointing Alfred Kahn to head the Council on Wage and Price Stability and promote deregulation and then, under pressure, Paul Volcker to chair the Federal Reserve System and rein in inflation. Kahn, banned from using the term “recession,” famously said, “Let’s call our condition a banana.” Volcker dramatically raised interest rates sharply and slowed the growth of money. The result was a sharp recession in 1981–1982 with massive unemployment followed by stable prices. Exchange rates fluctuated widely, putting strain on many industries. Banking problems led the government to deregulate Savings and Loan Associations (S&Ls), leading to excessive borrowing and failures of one third of the S&Ls in the 1980s.
In retrospect, the S&L crisis anticipated the financial crisis of 2008. Deregulation led to excessive speculative activity that eventually went bad. It took a decade for the federal government to raise taxes to pay off the $100 billion debt it incurred in paying for guaranteed deposits. It was not seen as a cost of deregulation at the time, even though raising taxes may have cost the first President Bush his job.
The S&L crisis instead was seen as a bump in the road to economic deregulation that would come to be called “neoliberalism.” That is one term for it, but its adherents call themselves “conservatives.” Both labels reveal their desire to return to the world as they imagine it before the wars and depression of the early twentieth century. Some of them go back even further, starting from the states’ rights position of the slave-owning South before the Civil War.
Lewis Powell, a successful corporate attorney, crystalized this ideology and presented a plan of action—a call to arms—in a secret memorandum to the United States Chamber of Commerce contemporaneous with Nixon’s actions changing American society. The coincident events of 1971 were tied together when Nixon appointed Powell to the Supreme Court later that year.
The Powell Memo opened: “No thoughtful person can question that the American economic system is under broad attack. This varies in scope, intensity, in the techniques employed, and in the level of visibility.” It stated: “The overriding first need is for businessmen to recognize that the ultimate issue may be survival—survival of what we call the free enterprise system, and all that this means for the strength and prosperity of America and the freedom of our people.” It argued that business should defend itself vigorously in the press, academically and in Congress and the courts.6
The Heritage Foundation was formed in 1973, shortly after Powell’s memo. It was supported initially by Richard Mellon Scaife, principal heir to the Mellon banking and oil fortune. Its mission is stated on its website: “The Heritage Foundation is a research and educational institution—a think tank—whose mission is to formulate and promote conservative public policies based on the principles of free enterprise, limited government, individual freedom, traditional American values, and a strong national defense.”7 Charles Koch, owner of a privately held oil firm that has made him and his brother among the wealthiest people in the country, was galvanized by the Powell Memo and formed the Cato Institute, a more academic conservative think tank, a few years later.
The references to “the freedom of our people” by Powell and “individual freedom” by The Heritage Foundation were code words for opposition to unions. They harked back to a mythical past where individual and small factory owners bargained equally about pay and working conditions. This view of the past is totally inaccurate as a description of early industrialization. Laws at that time put workers at a great disadvantage by making it a criminal act to leave a job to search for a better one. Destroying unions in the modern world puts workers again in a grossly inferior position when confronting employers.8
The language also harked back to the Declaration of Independence, notably “We believe all men are created equal.” Our forefathers may have said “all men,” but they really meant all white men. It would not be until the Civil War was fought over this issue that the idea of expanding the idea of equality was even possible. Today, while the appeal to individual freedom has economics as its source, this appeal to an iconic American ideal also has a racial overtone.9
Powell also wrote that “few elements of American society today have as little influence in government as the American businessman.” Organized lobbying of Congress began at this time, stimulated in part by this statement. Lobbying is expensive to initiate but cheap to maintain, leading to declining average costs and the growth of large lobbying firms. The growth of lobbying firms has made it very difficult for small firms to be heard and for Congress to pass coherent legislation. The overpowering clout of lobbyists led to their being more than 300,000 words in both the Affordable Care Act and the Dodd-Frank Financial Reform Act. These important bills are filled with definitions, qualifications, and exceptions to satisfy not only Congress but also the lobbyists.10
In addition to lobbying, businesses and industry associations began to support specialized think tanks. The Heritage Foundation and the Cato Institute were joined by a plethora of think tanks that reflect corporate interests in many fields. The think tanks are tax exempt and need to be careful about explicitly championing government policies. They can, however, support points of view by choosing who to hire and retain in return for tax-exempt contributions by corporate interests. This kind of influence extends from general think tanks like the Brookings Institution, which supports corporate efforts to rebuild damaged cities, to the United States Institute for Peace, which supports defense spending here and abroad.11
The conservative American Legislative Exchange Council, known as ALEC, was formed in 1973 in order to influence state legislation. Charles and David Koch founded and funded ALEC as a nonprofit corporation to advance conservative principles of free market, limited government, and individual liberty. ALEC drafts model legislation to achieve these ends and distributes them to state legislation. Around one-fifth of its proposed legislation gets passed somewhere in the country.
ALEC has about two thousand Republican state lawmakers as members. Its task forces recommend model bills to reduce the regulation of business, privatize public services, cut taxes—particularly for wealthy individuals and large companies—and restrict the efforts of unions. ALEC also organizes meetings for members to learn about specific issues along these lines and provides a network where members can meet other political leaders and business representatives.
State legislatures passed 231 ALEC bills in 1995. Almost every state passed at least one ALEC bill, and Virginia passed twenty-one bills that year. The median state passed three ALEC bills, and the mean was five. A statistical analysis showed that the time and resources available to legislators had a large effect on how many ALEC bills were passed. Legislators with the least time to spend passed a dozen more ALEC bills than legislators who had the most time. The most conservative legislature passed five more ALEC bills than the most liberal legislature, and legislatures with the most business-friendly members were able to pass three more ALEC bills than the legislatures that were the friendliest to organized labor. ALEC is one of the ways that the Koch brothers and their supporters affect political outcomes. Started soon after Powell wrote his secret memo, ALEC remains the only well-funded national legislative organization, and its success shows that there are other ways to affect public policy than to elect favorable representatives.12
Limited government was first expressed in the deregulation of finance and airlines in the 1970s, and “individual freedom” was code for the destruction of unions. The failure of a bill to reform labor law in 1978 reveals the change in opinion under way. The bill proposed a set of technical changes in labor law that would have preserved the legal framework in which the U.S. labor system operated. Despite the small scale of the bill, business groups mounted a large, inflammatory public campaign against it. The bill passed the U.S. House of Representatives by a vote of 257 to 163 and undoubtedly would have passed the Senate as well, but employers arranged to have it stopped by a filibuster.13
The sharp recession started by Volcker’s contractionary monetary policy compressed a generation of normal change into a few years. Durable manufacturing firms—pillars of private-sector unionization—were hit first by recession in the 1970s and then by a high dollar in the 1980s that crippled export sales. The Rural Renaissance of the Midwest in the 1970s became a Rust Belt in the 1980s as the low dollar during 1970s stagflation was succeeded by a high dollar in the 1980s.14
Unions were left behind as public policy changed. African Americans moved north in preceding decades to join unions to better their wages and working conditions. This long process, known as the Great Migration, lasted from 1915 to 1970, involved about six million migrants, and produced large black populations in the North and West. It began during the First World War when Northern manufacturers were supplying war goods to the Europeans and trying to expand their production. They needed more labor to produce more goods, but immigration was cut off by the war. They encouraged blacks to move from the South to take these jobs.
The process continued after the war when an isolationist reaction led to immigration restrictions. Northern employers needed workers, and blacks were hired. But all was not rosy for the migrating workers. The Great Migration was both a geographic change and a move from the country to the city. As noted by Lewis in his model, this was a big change, and not all new residents in industrial cities fared well. The mixed results are described in The Warmth of Other Suns, Isabel Wilkerson’s magisterial description of the Great Migration.15
But as African Americans tried to join unions in the North, they found that the members of established unions did not want to give them full status in their unions and they were not willing to acknowledge unions of black workers as equals. The sources of this opposition to black workers were many and complex. They started from racial prejudice and the fear of losing their superiority to another group. They also included the difficulty of absorbing rural Southerners into Northern cities as cultures clashed. White Northerners moved out of cities as African Americans moved in during the Great Migration, and the position of union members was part of this enduring American problem.16
Lawyers representing the new African American workers shifted their efforts from labor law to constitutional law to get more traction. They supported federal legislation like the Civil Rights Act of 1964 that banned discrimination. And because unions were excluding African Americans, the lawyers supported open shops, not the union shops preferred by unions where everyone was represented by and paid dues to one dominant union. In the 1980s business supporters of open shops drew on these precedents, but they abandoned the quest for labor equality.17
Right at this time, in the middle of the economic disturbances of the 1970s, the real wages of workers stopped growing. As shown in figure 2, the economy continued on its upward trajectory while the average wage stagnated. No one noticed this in the 1970s in the midst of both inflation and unemployment. Even if some people saw what was happening, they could not tell immediately if this was only a temporary aberration during stagflation.
Powell’s call to arms for business cohered into what is now called a neoliberal philosophy. It is useful to see this new policy direction in terms of the New Federalism that Nixon proposed in 1969 and the Washington Consensus formulated for developing countries in the 1990s. The New Federalism proposed to counter federal control of Roosevelt’s New Deal by converting specific grants to states into block grants, that is, shifting control over federal money from federal to state governments where state officials could preserve racial discrimination. Among the recommendations in common with the Washington Consensus are the desire for fiscal discipline in place of Keynesian polices, low marginal tax rates, low tariffs, privatization of state enterprises, and deregulation of private markets. Neoliberals added freedom of contracts, by which they typically mean opposition to labor unions, and they abandoned the postwar mandate to maintain full employment.18
Modern conservatives fear the power of the federal government that grew in the world wars and Great Depression, and they oppose the redistribution in a welfare state. They oppose the New Deal and unions as an “excess of democracy,” whatever that phrase means. They believe that the free market is equivalent to freedom itself and that regulating markets means surrendering political liberty. They draw their inspiration from Friedrich Hayek and Ayn Rand. There is an implicit political theory there that will be described in more detail in part II.19
This conservative philosophy represented a change in the intellectual legacy of the preceding thirty years of war and depression from John Maynard Keynes to Hayek. Keynes championed the role of government in achieving prosperity and well-being for the citizens of a democracy. Hayek focused on individual activity as the source of prosperity, and he rejected government in his most popular book, The Road to Serfdom. American economists rejected Keynes in the turbulent 1970s in favor of individual initiatives, and Keynesian macroeconomics was relegated to undergraduate courses. Professional publications amplified Hayek, while economic policymakers still rely on Keynes.20
As noted in the introduction, Ronald Reagan announced his 1980 presidential candidacy in Philadelphia, Mississippi, where three young civil-rights workers were murdered in 1964. He did not have to say a word to communicate his opposition to full citizenship of black Americans. His announcement illustrates the shift in political discourse from overt racism to codes in actions and words. Reagan continued this indirection through the implementation of Nixon’s New Federalism, which allowed Southern states to continue to exploit the legacy of slavery.
The Reagan administration often is seen as ushering in the neoliberal policy stance because he began his presidency by announcing in his inaugural address that “government is not the solution to our problem; government is the problem.” This anarchist position was the result of the arguments from the Heritage Foundation and the Cato Institute. It signaled a sea change in politics that had been engineered by corporate leaders responding to Powell’s secret memo. Reagan destroyed the flight controllers’ union—the Professional Air Traffic Controllers Organization (PATCO)—at the start of his administration, even though PATCO was the only union that had supported him, signaling his intent to continue the war on unions. But deregulation and the privatization of government functions like the military and prisons started earlier than when he began his first term in 1981 and continued after he left office in 1989.
Reagan lowered top marginal income tax rates for the rich in two tax cuts. He expanded military spending at the same time to threaten the Soviet Union. This combination led to large government deficits despite Reagan’s promise to balance the budget. And it confirmed the exception to the small government that he was proposing. The true conservative position was a government that supported the military and did not otherwise care for its citizens.
The second tax cut in 1986 coincided with the beginning of the rise in the share of income going to the top 1 percent of the population shown in figure 3. This rise also was a consequence of the wage stagnation revealed in figure 2. Stagnant wages were not maintaining workers’ share of the growing national income, and some other group’s share had to rise. As shown in figures 1 and 3, it was the share of the rich that rose. Reagan’s tax reforms emboldened corporate leaders to claim their part of this rise.
The Congressional Budget Office summarized the result: “For households in the top 1 percent of the income distribution, inflation-adjusted after-tax income grew at an estimated average rate of 3.5 percent per year. As a result, inflation-adjusted after-tax income was 200 percent higher in 2011 than it was in 1979 for households in that group. In contrast, households in the bottom quintile experienced inflation-adjusted after-tax income growth of 1.2 percent per year, on average. Consequently, inflation-adjusted after-tax income was 48 percent higher in 2011 than it was in 1979 for that income group.”21
The most important part of the new program was the deregulation of finance. Instead of bringing the Eurodollar system into the Bretton Woods system, new policies made American finance more like the Eurodollar system. There was a great need for financial help as the gyrations of prices and exchange rates in the 1970s and early 1980s took a fearsome toll on American industry. Resources needed to be shifted from one industry to another, and finance was needed to buy and sell companies in this process. Financial people argued that the great needs of finance required free hands to manage the economic transformation.
The nation’s financial sector grew dramatically during the 1980s. Reagan’s twin policies of low taxes and high military expenditures meant large government deficits. High interest rates and large international deficits coming from the high dollar stimulated trading in government securities and corporate takeovers, expanding the demand for financial traders, investment bankers, and corporate legal services. After stagnating in the 1970s, the Dow Jones Industrial Index tripled in the 1980s, attracting people to the brokerage industry.22
The rising demand for financial services increased the size of the financial sector and the returns to those employed in it. As deregulation created more need for finance as well as more scope for financial innovation, more educated people were attracted to the field. During the Bretton Woods period, banking was highly regulated and did not attract highly educated people. This changed in the tumultuous 1970s, and more educated people entered the financial sector. The increasing human capital in finance explains most of the rise in financial incomes in the 1980s. Wages in finance professions exceeded the educational premium in other industries after that, perhaps because of increasing risks in finance. This part of the economy accounted for one-seventh of the increase in the incomes of the richest people shown in figure 1.23
These high returns to people in finance have now become a matter of public concern. Hedge fund managers are handsomely paid whether the returns to their hedge funds are good or lackluster. The top earners made about $1 billion apiece in 2014 and again in 2015 even though their funds did not fare well. These incomes are lightly taxed due to the carried interest exemption, a tax loophole that taxes the income of hedge fund managers as capital gains instead of labor income, as shown dramatically by presidential candidate Mitt Romney’s tax returns. He paid taxes of less than 15 percent of his high income (which was smaller than the financial superstars’ incomes just described).24
The carried interest loophole is only one of the ways that members of the FTE sector reduce the taxes they pay. As congressional leaders were completing a massive tax and spending bill in late 2015, lobbyists descended from those that started in the early 1970s added fifty-four words that preserved a loophole for real estate and Wall Street investors that enabled them to put real estate in trusts to avoid taxes. The carried interest exemption and real estate trust provision are only two examples of tax loopholes initiated and maintained by lawyers and lobbyists for wealthy people.25
The rapid growth and high returns in finance raise questions about the role of finance in economic growth. The great changes in trade and production after the end of Bretton Woods clearly required active finance to accommodate, and there is no reason to deny the importance of finance in allowing economies to adapt to new conditions. But the continuing inflation of financial incomes suggests that private gains to financial activity may be exceeding social gains. We may be attracting bright, educated people to finance when their productivity for economic growth would be better employed elsewhere. This suggestion of diminishing returns to finance may only be answered after we have accumulated more evidence.26
The highest paid CEOs of nonfinancial corporations earned an order of magnitude less—dropping one zero—than those in finance, around $100 million in 2014. They represent top earners in the technology and electronics part of the FTE sector. The annual earnings limit for the top 1 percent of earners shown in figure 1 is about three orders of magnitude below this—dropping three zeros—at $330,000, and the wealth limit for the top 1 percent is $4 million.27
The FTE sector includes the top 20 percent of American earners, including almost all college graduates even though a BA does not provide automatic access to the FTE sector. The top 10 percent of American earners earn incomes in six figures of $100,000 and above.28 That is a high enough income to live in a good school district, own your house, and drive a new car. It is what we used to call a good middle-class living, although the term “now evokes anxiety, an uncertain future and a lifestyle that is increasingly out of reach.”29 The median worker earns around $40,000, and the dividing line between the FTE and low-wage sector lies in the gap between these two figures.30
Workers in this gap struggle to maintain their middle-class life style. The median college teacher of economics, for example, earns around $100,000, which places him or her comfortably in the FTE sector. The median college teacher of English Language and Literature earns only around $60,000, putting him or her perilously close to the median worker in the low-wage sector.31
College graduates who are not clearly in the FTE sector may be idealistic or artistic. For example, “John-David Bowman, who teaches Advanced Placement history and a class called Theory of Knowledge in the International Baccalaureate program at Westwood High School in Mesa, AZ, has not had a raise since he was hired, in 2008. He has two bachelor’s degrees and a master’s degree, and was voted Arizona’s Teacher of the Year for 2015.” The honor allowed him to shake hands with President Obama at the White House. Still, Bowman said, “I could retire in 20 years, under $50,000.”32 This distinguished high school teacher is and will remain in the low-wage sector if he continues teaching in this setting.