Over the last 50 years or so, the concept of free trade has expanded around the globe, as economists (particularly U.S. economists) and policymakers have extolled its economic benefits. There is little doubt that free trade has lifted millions out of poverty around the globe and has made countries richer and more prosperous. However, it has also been extremely disruptive in wealthier countries (especially the U.S.) as the middle classes in those countries have seen their living standards stagnate, or only increase incrementally over the last 30-40 years or so.

The reason this has happened is not hard to guess. If a company or an industry or a country is suddenly exposed to competitive pressures that it was not exposed to before, then it must either A.) improve the quality of its product to justify its higher cost, or B.) lower the price of its product to meet the competition, or C.) go out of business. While industries and job opportunities have expanded in lesser developed countries as a result of free trade, the result has been the offshoring of U.S. jobs overseas.

But why was this allowed by our policymakers to happen? Some might argue that the captains of industry were able to “capture” politicians to push free trade agreements through that would improve the value of their stock price, but this doesn’t explain why professors, economists, and policymakers not obviously monetarily influenced by special interests would be proponents of free trade. The reason is, quite simply, that free trade does benefit the GDP numbers. Trade is not a zero-sum game, and both countries can be made ‘numerically’ better off with increased trade.

The problem is that the academic theories assume that the labor disruption from free trade will be minimal over the long term as workers move into new, more efficient, industries. The academic theories often assume no cultural clashes as workers move from one country into another, and are accused of “stealing” jobs from the local population. The academic theory doesn’t account for the fact that jobs today (in the U.S.) are highly complex requiring substantial training and experience. Whereas a middle class manufacturing job on an assembly line 2 generations ago only required a basic education and a strong back, the middle class jobs that replaced it require general computer knowledge (which most have), but also specific job knowledge that can often only be gained by experience, and company specific knowledge that often only be gained by experience within that specific company. In short, labor use is not as flexible as theories have assumed. A manufacturing worker 2 generations ago laid off at one company could either wait for the factory to re-open, in which case he would be rehired, or he could go to another manufacturing facility, many of the jobs of which would be similar to the one he just left. Over the last generation or so, so many manufacturing jobs were shipped overseas that there was nothing for the displaced worker to do but start over in another industry, usually for a much lower salary than what he was getting before.

It is hardly then surprising that there has been a nagging feeling for a long time, a feeling that has intensified over the last 8 to 10 years or so, that something in the U.S. has gone wrong. The trust in public institutions has deteriorated over the last 40 years, and part of it is that people feel that the institutions are only bringing value to the “insiders” and the “connected”, and not people “like them”. The feeling that government and institutions aren’t working for your benefit and don’t have your back inevitably leads to a sense of alienation, which can be seen in declining participation in the political process and of civic engagement. While certainly no trade (aka North Korea) leads to an impoverished population, too much free trade can lead to economic and social disruption as well. Policymakers should bear in mind that free trade is not ALWAYS a ‘good thing’ the next time they are considering signing a free trade agreement.

‘When you go home, tell them of us and say, for your tomorrow, we gave our today’ – Enshrined on the Kohima war memorial in Nagaland, built to commemorate soldiers of the British Empire who laid down their lives to repel a Japanese assault in 1944 during World War-II.

On Memorial Day, part of the country will simply take another day off to enjoy time with family & friends. The other part will take a brief moment to think about those who died, and then go about taking the day off with family & friends. But few will truly stop and ask themselves what those who sacrificed gave up, and whether what this country has become is what they truly died for. Nor will they likely give much thought as to why it is that this country doesn’t really seem to give anything more than lip service at best to Memorial Day.

Imagine the life of a hypothetical 20 year old who was killed at Normandy in 1944. What might his short life have been like, and what would he have seen? Being born in 1925, he would have just become aware of the world around him as the stock market was crashing 1929. There is a decent chance that he would have probably grown up in a smaller town, away from big cities. He would have experienced the Depression personally, either as his immediate family struggled, or as extended family/friends struggled. Good economic times would merely have been something that heard existed before he was born. He would have heard the call to enlist as WWII became a truly national project for the entire population, with basic goods being rationed. He would have seen that roughly 1/3 of those who tried to enlist were rejected as being unfit for military service. He likely would have left the love of his life behind, with promises that they would start a family when he returned; promises that would never be fulfilled. He experienced the terror of combat, felt the pain as a bullet tore him apart. And then he died. He never knew what marriage was. He never saw his kids grow up. He never grew old with a very special person. He never saw his grandkids. He never experienced television. He never experienced the massive increases in living standards that occurred from 1950-2000 (he might never have even experienced indoor plumbing until he went in the Army). He never experienced life. This is what he gave up.

And what are we today as a country? If our hypothetical 20 year old, who would now be 90, could see us today, would he be happy? Or would he feel that he had died for nothing. Would he like that only half the country sacrifices to federal income taxes, while the other half receives tax benefits? Would he like the fact that there are so many regulations that a person who wants to cut hair for a living needs permission? Would he think that we had advanced socially when a large segment of our youth (many of whom are older than he was when he died), are little more than narcissistic spoiled brats who think that the world should conform to them? Would he think that sending the IRS to harass people for political views was a good thing? How about that average taxpayers are left bailing out big financial institutions, some of whose employees made (and continue to make, thanks to the bail out), more in salary and bonus in 2 or 3 years than those average taxpayers will see in their entire lifetimes? Would he like the universities today where many of the political views of the taxpayers aren’t represented? Would he think it a good thing that college graduates, far from being able to rationally consider different points of view as those in his day were, lack basic critical thinking skills and are content to demonize their political opponents as basically being Nazi’s, something that he fought against. Would he think that these people are even intellectually serious? Would he worry that a segment of our political elite think that it is acceptable to force people to violate their consciences as a condition of employment? How about that the NSA listens scoops up phone records and listens into private conversations without anything remotely approaching adequate safeguards? In short, would he ask himself whether his sacrifice was even worth it?

And would he feel appreciated on Memorial Day; a holiday that often gets only lip-service from the population?  Would he feel understood by a population in which very few have ever served in the military or even know someone who has? How about what sacrifices his own family made? As civilians, we were not called upon to curtail our consumption or accept rationing, as the WWII generation was. We have a generation reaching adulthood which never really knew that generation, nor heard the experiences first-hand. Today, “grandpa’s war” was Vietnam, and most of the population didn’t experience that at all. And our war in Afghanistan & Iraq? Short of that one horrible day in September when we really did experience war on mainland America of a sort not seen since the Civil War, we haven’t really had to experience it (No, taking our shoes off in airport security lines doesn’t count). If we don’t watch the news, we don’t even have to hear about it. It hasn’t dominated our conversation. Our mothers don’t ask their friends if they have heard from John at the battlefront recently. Unlike the generation of which our hypothetical 20 year old came from, war isn’t real to us or our families (thankfully). And because it isn’t real, we don’t really appreciate the sacrifices made. The 20 year old who died in 1944 likely wouldn’t feel understood and appreciated today. And because of that, it is hard to make the case that we are truly keeping faith with those who died.

Recently, there has been some wringing of hands and puzzlement in policy circles regarding the fact that while the unemployment rate is down, wages and consumer spending don’t seem to be increasing and contributing to economic growth the way certain pundits and policy wonks think that they should. The economic policy world has faced these conundrums before. In the 1970’s, economic theory, using the Philips Curve, said that low unemployment leads to high inflation and vice-versa. Pundits then were shocked to see a situation with high unemployment AND high inflation; something that came to be known as stagflation (caused by OPEC raising oil prices). In the late 1990’s, we had the reverse which was low unemployment, rising wages, and low inflation. Again, this was puzzling (the theory regarding the cause of this happy confluence of factors was improved productivity due to the computer revolution), but nobody was really complaining.

Today, we have a situation where the economy is not behaving in ways that theory and experience says that it should. We had a deep recession that statistically ended in 2009, and yet the recovery has been sluggish (unlike prior recoveries). And now, with unemployment finally down, wages (and inflation) aren’t increasing like we expect. What is going on??

While nobody knows the entire answer, one explanation is likely that the statistics (the popular unemployment statistic in this case) simply aren’t honest. Or rather, they don’t capture the economic reality that they once did. In earlier times, an unemployment rate of 5.4% would have meant that the economy was forging ahead and workers could expect raises as the supply of labor was becoming scarce. This is not what is currently happening, creating confusion. The problem is that the statistic simply doesn’t capture the fact that more people than normal have dropped out of the labor force. In earlier time periods, someone dropping out (or not being counted) in the labor force likely meant that either a.) they were never part of the labor force (think “stay-at-home” moms), b.) became permanently disabled or c.) retired. In other words, they could have 500 open jobs sitting in front of them and still would not take a job because they couldn’t (disabled) or didn’t want one.

Today, however, people are dropping out of the labor force because they are discouraged. This is not the same thing as the a.), b.) or c.) options in the prior paragraph. They want work, presumably they have some skills that would give them work, but they can’t find work and give up. These people are as unemployed as the people who are actively looking for work. That the government has decided not to count them as unemployed doesn’t change that fact any more than if the government were to decree that George Washington never existed.

With a real unemployment rate significantly higher than 5.4%, pundits wouldn’t be wondering why wages aren’t increasing, why consumer spending is sluggish, etc. etc.In order to make the best policy decisions, policymakers have to have relevant and accurate information. If the unemployment statistic is no longer relevant given the economic structure of today, then it needs to be changed. Otherwise, pundits and policymakers will continue to be confused when they economy doesn’t respond in ways that they expect. To paraphrase Fezzik in The Princess Bride, pundits should stop using the unemployment statistic as currently constructed; I don’t think it means what they think it means. The sooner everyone accepts this reality, the better.

As someone who has observed the domestic political landscape for over 30 years, one theme that has kept recurring is the word ‘Reform’. We hear about tax reform, Social Security reform, Medicare reform, financial reform, spending reform, welfare reform, etc. etc. However, with the exception of welfare reform (passed two decades ago), any reform that is passed (assuming that anything is passed at all) tends to be watered down and ineffective. The end result largely appears to the public as if nothing was passed at all. The question is, how is it possible that so many smart people, most of whom know and admit that this system or that system badly needs reform, be so unable to produce any meaningful reform?

The first thing to remember is that no matter how idiotic a situation may seem, it makes sense to somebody. This is true in a macro political system like the U.S. or in a smaller political system like the company that you work for. Any system that exists anywhere is benefiting enough people to sustain it. So no matter how ridiculous a rule, regulation, tax, or policy may seem, someone with more power and influence than you is benefitting from it.

The second thing to remember is that any reform is going remove something that is currently benefitting someone. And that someone isn’t going to like it, and will resist it, either with money, or through other measures. For all of the talk about money in politics, this isn’t the only problem. Normally when we think of money in politics, we think of powerful interest contributing money to political campaigns. While this is certainly a major factor, sometimes the influence is more basic than that. Politician X isn’t just going along with Special Interest Y because Special Interest Y gives money to his campaign or will give money to his opponent if Politician X doesn’t play ball. Sometimes it is that Politician X and Special Interest Y are friends outside of office hours, attending the same parties, seeing the same people. Maybe even their wives are friends. Under these conditions, if Politician X ticks off Special Interest Y, it is going to be personally awkward for him.

If we look at attempts at reform over the last 6 years, we see either major resistance and/or watered down reform to point of being nearly meaningless. I am speaking of ‘healthcare reform’, ‘financial reform’, and what the Tea Party might call ‘spending reform’.

In the case of healthcare reform, we are still seeing major resistance 5 years later. Part of this is because of the way it was designed to force people to do things not in their perceived best interest. Part of it is because it ignored really much input from 1 of the 2 major political parties. But the main reason for the resistance is that it proposed to fundamentally alter a system that affects everyone (everybody needs healthcare) and a system in which 70% of the public had health insurance AND liked what they had.

Financial reform doesn’t look like it has had much of an effect or will have much of an effect in preventing the next crisis because it hasn’t fundamentally altered the system. The reason for this is, yes, due to the money that Wall Street gives Washington. But the resistance to reform is simply caused by the fact that a fundamental alteration of the system would result in a LOT less money going to Wall Street. According to CNN, the average bonus this year on Wall Street is $173k!!. That is a BONUS, not a salary. The average pat on the back, “you did a good job, kid”, “way to go” money is 3.4 x’s the average household income in the U.S.  I wouldn’t want to change this system either.

Finally, the Tea Party wasn’t able to achieve spending reform. However, it was, for a brief moment, able to succeed in actually cutting spending by an insignificant amount (in terms of the whole federal budget). I say “actually cutting spending” because most “spending cuts” in Washington are not true “cuts” as in, “I spent $100 last year and I will spend $50 this year”. But rather they are a reduction in the increase of spending as in “I spent $100 last year, I was going to spend $120 this, but I will ‘cut’ this to $110”. The Tea Party was able to get a real reduction in spending, but what they had to do get it was to essentially threaten (and appear to really mean it) to crash the U.S. credit rating.

This last example illustrates more than anything the practical impossibility of real reform taking place. That cutting what amounted to a rounding error in the federal budget would effectively require the figurative taking of hostages is not a system that is capable of any meaningful reform. The proposal of reducing discretionary spending from 2013 levels to around 2010 levels was met by the bureaucracy with the shutting down of monuments and generally trying to make cuts as visible and as painful as possible for the general public. As the government was somehow able to function in 2010 without inflicting this pain on the general public, these actions were clearly punitive and deliberate. The hysteria that emanated from some quarters was to the extent that one would have thought that the proposal on the table was a repeal of the New Deal. These actions illustrate the resistance that can and will be brought to bear if any real reform is attempted.

One can only conclude that if fundamental reform in various areas is needed and necessary (and it is becoming increasingly clear that it is), this system is probably not capable of providing it.

It is difficult today to pick up an economics publication, political publication, or visit a website covering either of those subjects without seeing an article lamenting the demise of the American middle class. While the articles throw around charts with multitudes of numbers and, in the case of the political journals, presume to offer policy prescriptions for what ails us (usually the same policies that they have been offering for the last 30-40 years), nobody seems to have a good grasp on what it means to be middle class nor do they seem to have a really compelling idea for what has gone wrong.

So what has gone wrong? Before we can answer that, we need to ask ourselves what was this mythical middle class Eden from which we have supposedly descended? If one looks at tables on Wikipedia (http://en.wikipedia.org/wiki/Household_income_in_the_United_States), one sees that the 50^th percentile (or median) of real household income in the U.S. has risen from $45,595 in 1976 to $50,054 in 2011 (in 2011 dollars). While stagnating real wages have been spoken of for some time, the key word in that expression is ‘real’. The middle is keeping up with inflation (or even a little better than inflation), so in theory it should not feel like it is falling behind. So why does it feel that way?

While this is a subject too complex for one blog post to do it justice, I suspect the reason stems in large part from expectations that have been disappointed, increased economic insecurity that now exists, the effort that must now be expended to maintain a middle class lifestyle, the lack of visible improvement, the sense that upward mobility is increasingly difficult and sub-standard public services all contribute to the sense of unease. To take a simple example, a fellow who has nothing and wins $2,000,000 in the lottery after taxes and a rich fellow who lose 80% of his wealth and is left with $2,000,000 are both objectively at the same spot financially, but one is much happier than the other.

So what has caused the disappointment in expectations? To understand this, we have to accept that what it means to be middle class was largely defined for us in the 1950’s: a secure job, a family (complete with 2.5 kids), a house, a car, good schools, and a secure retirement. One could add to this the sense that tax dollars were being used wisely, and that you could, with enough hard work, get ahead if you wanted to.

So what changed? The short answer is that the external conditions that allowed this world to exist have changed irrevocably and with it likely contributed to the sense of unease now being felt. In the 1950’s, the U.S. accounted for nearly 70% of all manufacturing, roughly half the world was communist and insular (meaning that U.S. workers weren’t having to compete with those workers), Europe was still recovering from the war, Latin America, Africa, and the Middle East were unstable (meaning nobody was going to be offshoring jobs to those locations), trade protection was still high, along with transportation costs. Add to this the fact that the workforce was being populated by the generation born in the 1930’s (a baby bust generation), along with high rates of private sector unionization (something that can only happen in protected industries), and you had a worker who was largely insulated from global competition and could work 8 hours, provide for his family, and have weekends off to enjoy himself.

This world no longer exists. Today, the U.S. accounts for 18% of the world’s manufacturing, trade barriers have gone down, transportation has become easier (and less costly), manufacturing has become more automated (costing jobs), the world has become a more stable place (meaning more inviting for off-shored jobs), communism has collapsed (meaning that U.S. worker have to compete with these workers) and unionization (in the private sector) has weakened as a globalized world has eroded the bargaining position of U.S. workers.

These effects on U.S. households have been somewhat offset by women entering the workforce. It is important to remember that the median household income of $45k in 1976 was in a world populated by a large share of single breadwinner households whereas the $50k median household income in 2011 consists of a large share of two breadwinner households. So while the numbers may look similar, the quality of life that they represent is not. The 1976 family was likely to have mom at home with the kids, while the 2011 family is not. If the 2011 kids are young, the family may have to spend money for daycare resulting in more money going out the door (in real terms) than what the additional breadwinner is bringing in, thereby leaving the 2011 family in worse shape financially and socially than the 1976 family. In addition, building restrictions in many areas have driven up the cost of housing. In 1970, the median home price was 1.72 x’s the median household income, while the same number was 3.4 in 2009. Although the average house built in 2009 is around 50% larger than one built in 1970, the expectation of having a house hasn’t changed (also adjusting the 1970 number for the larger house would, all things being equal, result in 2.58 x’s, still significantly lower than 3.4 x’s nearly 40 years later). Meanwhile, the average price of a car has gone up relative to median household income from 33% in 1970 to 50% in 2009.

To this one also needs to add that pensions were more prevalent in 1970, whereas today a large share of the labor force (outside of government) is on their own where retirement is concerned (meaning that the pressure to save is greater leading to either a lower lifestyle in the present or a lower expected one in the future), and the fact that jobs are not as stable as they once were. Take all of these factors together, and you have a situation in which the middle class feels less affluent than it once did. If both husband AND wife now have to work to achieve a lifestyle roughly similar to what a husband could provide a generation ago, and retirement and jobs are less secure than before, then it is no wonder that the middle class ain’t what it used to be.