Long read: The Great Compression and How to Get It Back

Tony Scaramucci runs an investment firm in New York called SkyBridge. In this thought-provoking piece on the US economy, he explains why America had it so good for a generation or so post-World War II, why things went south for the American working class thereafter and what can be done to put the US working class back on track. This piece appeals to us because we have been using a similar framework to explain why the Indian middle class has been under the pump over the past decade.

Mr Scaramucci correctly says that the US economy and the working American had a great time from the mid-1940s until the end of the 1960s. To a significant extent, this was true for Western Europe as well. The Swinging 60s were indeed a time of unprecedented economic prosperity. He writes:

“From the late 1940s to the early 1970s, the period economists call the Great Compression, labor claimed a historic share of national income, hovering in the low-to-mid sixties percent, with gains flowing from the bottom up. Productivity roughly doubled, and worker pay doubled right alongside it. The two lines moved together like a couple that actually liked each other.

Here’s the part people forget: this wasn’t just the unionized factory worker. The postwar bulge was just as much a white-collar story: the clerks, the analysts, the managers, the engineers, who were also labor, also not owners, riding the same escalator. The organization man in the gray flannel suit didn’t own Du Pont; he worked for it. The genius of the era was that it treated a vast swath of people who owned no productive assets as if they had a stake in them. For a while, society treated labor itself as a form of equity.”

Mr Scaramucci identifies two decisive factors behind this extended post-WW II boom. Firstly, World War II had obliterated productive economic capacity in the rest of the world barring the USA. As a result, America could boom with very little competition. “America had no competition. Nobody wants to say this out loud. In 1945, every other industrial economy on earth was a smoking crater. Germany, Japan, Britain, and the Soviet Union were bombed flat, bled dry. The United States emerged with roughly half of the world’s manufacturing capacity and an intact continent. When you’re the only factory still standing, you can pay your workers extraordinarily well, because no one’s undercutting your prices. The postwar wage was, in part, a monopoly rent, and labor got to split it. That’s the uncomfortable foundation of the golden age: it was built on everyone else’s rubble, and rubble gets rebuilt.”

In such circumstances, American labour and capital were rewarded handsomely in the two decades following the end of WW II. “Labor was scarce and organized. Capital was relatively scarce, labor was relatively scarce, and a third of the private workforce was unionized. That gave workers real bargaining power, the credible threat to walk, which is what every paycheck negotiation actually runs on.”

Secondly, he points out that the 1950s and 60s were decades characterised by fixed exchange rates and the gold standard (as agreed in Bretton Woods at the end of World War II). As a result, capital was NOT internationally mobile – it could not roam around the world looking for the best return.

“The money was anchored, and so was the game. Under Bretton Woods, currencies were pegged, capital couldn’t slosh freely across borders, and finance was a sleepy utility, not the main event. A company couldn’t easily offshore production or chase yield around the planet. Money stayed put, which meant it stayed invested in the people standing nearby. The capitalist of 1955 earned his return by building a better refrigerator with American hands, because he didn’t have a thousand more lucrative places to put the cash.”

The magical combination of factors broke in the early 1970s as oil prices surged exponentially through the decade, as USA went off the gold standard in 1971 and as the Bretton Woods compact fell apart by 1973 and currencies became ‘floating’.
Most importantly, from the point of view of the US worker, from the 1970s onwards “Finance grew from a utility into the dominant force in the economy.”

With floating exchange rates and with monetary policy now free to focus on national priorities (as opposed to being disciplined by the gold standard), the whole game changed. Mr Scaramucci describes it thus: “It untethered money from any hard anchor and opened the door to the era of financialization, in which capital became mobile, global, and far more interested in assets than in wages. Money that used to be stuck building refrigerators next to American workers could now earn more, faster, somewhere else, or in nothing physical at all.

Once capital could roam, the bargaining power that built the bulge drained away. You can’t credibly threaten to strike against a factory that can move to Guadalajara. Unionization fell from a third of private workers to about one in sixteen. Productivity kept climbing — but pay flatlined, and the gap between the two became the central economic fact of the last half-century. The gains didn’t vanish. They got redirected, from the people who worked to the people who owned. That’s the whole ballgame.”

So, what can be done now to bring back the glory days? Mr Scaramucci proposes three interesting ideas: