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What accounts for the rise in income inequali-ty since the 1970s? According to most economists,the answer lies in structural changes in the econo-my—in particular, technological changes thathave raised the demand for highly skilled workersand thereby boosted their pay. Opposing this pre-vailing view, however, is Princeton economist andNew York Times columnist Paul Krugman, winnerof the 2008 Nobel Prize in economics. Accordingto Krugman and a group of like-minded scholars,structural explanations of inequality are inade-quate. They argue instead that changes in eco-nomic policies and social norms have played amajor role in the widening of the income distribu-tion.

Krugman and company have a point. For thequarter century or so after World War II, incomeswere much more compressed than they are today.Since then, American society has experiencedmajor changes in both political economy and cul-tural values. And both economic logic and empir-ical evidence provide reasons for concluding thatthose changes have helped to restrain low-end

income growth while accelerating growth at thetop of the income scale.

However, Krugman and his colleagues offer ahighly selective and misleading account of the rel-evant changes. Looking back at the early postwardecades, they cherry-pick the historical record in away that allows them to portray that time as anenlightened period of well-designed economicpolicies and healthy social norms. Such a rosy-col-ored view of the past fails as objective historicalanalysis. Instead, it amounts to ideologically moti-vated nostalgia.

Once those bygone policies and norms areseen in their totality, it should be clear that nos-talgia for them is misplaced. The political econ-omy of the early postwar decades, while it gener-ated impressive results under the peculiarconditions of the time, is totally unsuited toserve as a model for 21st-century policymakers.And as to the social attitudes and values thatundergirded that political economy, it is franklyastonishing that self-described progressivescould find them attractive.

_____________________________________________________________________________________________________

Brink Lindsey is vice president for research at the Cato Institute and author of The Age of Abundance: HowProsperity Transformed America’s Politics and Culture.

Executive Summary

Introduction

“The America I grew up in was a relativelyequal middle-class society. Over the past gen-eration, however, the country has returned toGilded Age levels of inequality.”1

So sighs Paul Krugman, the Nobel Prize–winning Princeton economist and New YorkTimes columnist, in his recent book TheConscience of a Liberal. The sentiment is noth-ing new: political progressives like Krugmanhave been decrying the trend toward greaterincome inequality for many years now.

Yet Krugman has added a novel twist to thelong-running inequality debate. In seekingexplanations for the widening spread ofincomes since the 1970s, researchers havefocused overwhelmingly on broad structuralchanges in the economy: in particular, techno-logical change, demographic shifts, and therise of “winner-take-all” or “superstar” mar-kets. But Krugman argues that these structur-al explanations are insufficient. Instead, or atleast in addition, he points the finger at poli-tics. “Since the 1970s,” according to Krugman,“norms and institutions in the United Stateshave changed in ways that either encouragedor permitted sharply higher inequality. Where,however, did the change in norms and institu-tions come from? The answer appears to bepolitics.”2

To understand Krugman’s argument, wecan’t just start in the 1970s. Instead, we have toback up to the 1930s and ’40s—when, he con-tends, the “norms and institutions” thatshaped a more egalitarian society were created.“The middle-class America of my youth,”Krugman writes, “is best thought of not as thenormal state of our society, but as an interreg-num between Gilded Ages. America before1930 was a society in which a small number ofvery rich people controlled a large share of thenation’s wealth.”3 But then came the twin con-vulsions of the Great Depression and WorldWar II, and the country that arose out of thosetrials was a very different place. “Middle-classAmerica didn’t emerge by accident. It was cre-ated by what has been called the Great

Compression of incomes that took place dur-ing World War II, and sustained for a genera-tion by social norms that favored equality,strong labor unions and progressive taxation.”4

The “Great Compression” to which Krug-man refers is a term coined by economistsClaudia Goldin of Harvard and Robert Margoof the Massachusetts Institute of Technology todescribe the dramatic narrowing of the nation’swage structure during the 1940s.5 According toKrugman, the real wages of manufacturingworkers jumped 67 percent between 1929 and1947, while the top 1 percent of earners saw a 17percent drop in real income.6 These egalitariantrends can be attributed to the exceptional cir-cumstances of the period: precipitous declinesat the top end of the income spectrum due toeconomic cataclysm; wartime wage controlsthat tended to compress wage rates; rapidgrowth in the demand for low-skilled labor,combined with the labor shortages of the waryears; and rapid growth in the relative supply ofskilled workers as high school graduation ratesroughly doubled from 29 percent in 1930 to 57percent in 1950.7

But here’s the puzzle: the return to peace-time and prosperity did not result in a shiftback toward the status quo ante. Instead, thenew, more egalitarian income structure per-sisted for decades. Why? “This persistence,”Krugman argues, “makes a strong case thatanonymous market forces are less decisivethan Economics 101 teaches.”8 In support ofthis claim, he cites economists Thomas Pikettyof the Paris School of Economics andEmmanuel Saez of the University of Californiaat Berkeley, authors of widely discussed stud-ies of changes in the income distribution.According to Piketty and Saez, “this pattern ofevolution of inequality is additional indirectevidence that nonmarket mechanisms such aslabor market institutions and social normsregarding inequality may play a role in settingcompensation.”9

What were the egalitarian institutions andnorms that supposedly held income extremesin check? Here Krugman leans heavily on apaper by MIT economists Frank Levy and PeterTemin.10 They argue that postwar American

4

Krugman hasadded a novel

twist to the long-running

inequality debate.

history has been a tale of two widely divergentsystems of political economy. First came the“Treaty of Detroit,”11 characterized by heavyunionization of industry, steeply progressivetaxation, and a high minimum wage. Underthat system, median wages kept pace with theeconomy’s overall productivity growth, andincomes at the lower end of the scale grewfaster than those at the top. Beginning around1980, though, the Treaty of Detroit gave way tothe free-market “Washington Consensus.”12

Tax rates on high earners fell sharply, the realvalue of the minimum wage declined, and pri-vate-sector unionism collapsed. As a result,most workers’ incomes failed to share in over-all productivity gains while the highest earnershad a field day.

This revisionist account of the fall and riseof income inequality has important implica-tions for public policy. Under the convention-al view, rising inequality since the 1970s hasbeen understood as a side effect of economicprogress—namely, continuing technologicalbreakthroughs, especially in communicationsand information technology. Consequently,when economists have supported measuresto remedy inequality, they have typically shiedaway from structural changes in market insti-tutions. Rather, they have endorsed moreincome redistribution to reduce post-taxincome differences as well as various socialpolicies designed to raise the skill levels oflower-paid workers (e.g., remedial educationand job retraining programs).

By contrast, Krugman and his fellow revi-sionists see the rise of inequality as a conse-quence of economic regress—in particular, theabandonment of well-designed economicinstitutions and healthy social norms thatpromoted widely shared prosperity. Such anassessment leads to the conclusion that weought to revive the institutions and norms ofPaul Krugman’s boyhood—in broad spirit atleast, if not in every specific detail. I suggesttherefore that “nostalgianomics” is a handyterm for this revisionist challenge to prevail-ing interpretations of inequality.

So, what to make of nostalgianomics? Letme start by giving its proponents their due.

Their historical argument makes a good dealof sense—at least as a supplement to, if not awholesale substitute for, conventional ac-counts. As I will review, there is good evidencethat changes in economic policies and socialnorms have contributed to a widening of theincome distribution. Blinkered by ideologicalcommitments, however, the partisans of nos-talgianomics give a highly selective account ofwhat the relevant policies and norms actuallywere and how exactly they changed.

Once those bygone policies and norms areseen in their totality, it should be clear thatnostalgia for them is misplaced. The politicaleconomy of the early postwar decades, while itgenerated impressive results under the pecu-liar conditions of the time, is totally unsuitedto serve as a model for 21st-century policy-makers. And as to the social attitudes and val-ues that undergirded that political economy, itis frankly astonishing that self-described pro-gressives could find them attractive.

Specifically, the economic system that Levyand Temin call the Treaty of Detroit was builton extensive cartelization of markets, limitingcompetition to favor producer welfare overconsumer welfare. And those restrictions oncompetition were buttressed by entrenchedprejudices concerning race and the role ofwomen in society, as well as the prevailingpostwar conformism of the “OrganizationMan.” Those social norms were swept away inthe cultural tumults of the 1960s and ’70s, asmore liberal and individualistic values dis-placed traditional mores. Restrictions on com-petition in product and capital markets werethen substantially reduced during the 1970sand ’80s, to the applause of economists acrossthe ideological spectrum. These salutary devel-opments may have contributed to the rise ofincome inequality, true enough. But onlythrough the distorting lens of nostalgia canwhat came before be seen as the “good olddays.”

Serious and challenging issues are raisedby increased economic inequality, but thenostalgianomics of Krugman et al. obscuresrather than clarifies them. A gauzy sentimen-talism about the lost world of one’s child-

5

The partisans ofnostalgianomicsgive a highlyselective accountof what the relevant policiesand norms actually were andhow exactly theychanged.

hood is an understandable temptation as weage—but it has no place in sound social sci-ence or policy analysis.

Income Inequality’sMany Causes

At issue here is the rise in income inequal-ity since the 1970s. Let’s start by clarifyingexactly what that means.

First of all, it means we aren’t talking aboutwealth inequality. To be sure, that is anotherimportant element of differences in overall eco-nomic well-being. And, obviously, wealthinequality can contribute to income inequality,and vice versa. But the trends in wealth inequal-ity and income inequality have been quite dif-ferent. According to economists EmmanuelSaez of Berkeley and Wojciech Kopczuk ofColumbia University, wealth inequality (at leastas measured by the share of total wealth held bythe wealthiest 1 percent of Americans) hastrended up slightly since the 1970s, but wealthremains considerably less concentrated than itwas during the 1950s and ’60s—and dramati-cally less so than back in the 1920s.13

Even when we restrict our focus to incomedifferences, we still have a lot of sorting out todo. How do we go about measuring those dif-ferences? The most comprehensive measure isthe so-called Gini coefficient, which quantifiesthe deviation of the overall income distribu-tion from equal incomes for all. Trends in theGini coefficient, however, do not tell us abouthow particular groups within society aredoing. For example, overall income inequalitycould be rising because incomes at the bottomare stagnant or falling, or because incomes atthe top are soaring, or because of a decline inthe number of people in the middle ranks. Toget a more detailed look at income trends, weoften look at the share of total incomeaccounted for by particular segments of theincome distribution: for example, the bottomquintile, the top 10 percent, the top 1 percent,etc. Or we compare ratios of incomes: forexample, 90/10 (income in the 90th percentileof the distribution compared to income in the

10th percentile), 95/50, or 50/10. In addition,we might want to look at other ratios—blackincome to white income, say, or female incometo male income—or at Gini coefficients forparticular groups within society (e.g., incomeinequality among blacks or among women).For something as complex as changes in thepattern of millions of incomes over time, nosingle measure is capable of revealing thewhole picture. And over a given period of time,some indicators of inequality may be risingwhile others are holding steady or falling.

Consequently, when we talk about a rise inincome inequality, pinning down what wemean by “inequality” is actually fairly tricky.And pinning down what we mean by “income”turns out to be tricky as well. Income includesnot only money earned in the workplace orfrom investments, but also employee benefits(e.g., health insurance) and government trans-fers (e.g., Social Security checks). Also, ofcourse, pre-tax income and post-tax income aretwo very different things. If we focus only onworkplace earnings, or only on money income,or if we exclude the effects of taxes and govern-ment transfers, we’re not getting the completepicture.

Furthermore, income statistics are kept onan annual basis, but people’s incomes tend tofluctuate from year to year. If we measure peo-ple’s income over a longer period, differencesin incomes will appear somewhat reduced asthose year-to-year differences get washed out.If temporary fluctuations in people’s income,also known as income volatility, are increasingover time, income inequality will appear to riseeven when there is no change in the pattern ofincomes over the longer term. Indeed, accord-ing to a paper by Peter Gottschalk of BostonCollege and Robert Moffitt of Brown Univer-sity, some one-third of the measured increasein earnings inequality between the periods1970–78 and 1979–87 is due to an increase inthe volatility of earnings.14

An additional complication arises becausethe size of the economic unit whose income isbeing measured has changed over time. We typ-ically measure the annual income of “house-holds,” but with increasing numbers of single-

6

Over a given period of time,

some indicatorsof inequality may

be rising whileothers are

holding steady or falling.

parent families and people living alone, the sizeof the average American household has shrunksince the 1970s. As a result, a significant por-tion of the rise in measured income inequalityis due to these demographic changes ratherthan to any changes in the workplace. We canget around this wrinkle by looking at wageinequality—although, of course, trends in indi-vidual earnings miss the fact that people actu-ally do live their economic lives as members ofhouseholds (in particular, they combine theirearnings with those of their spouses).

In view of all these complications, what canwe say about changes in the pattern ofAmerican incomes? Here I want to look at pre-tax income, as my focus is on divergent trendsin the way the marketplace rewards work andthe underlying causes of those trends. First,overall income inequality as measured by theGini coefficient is up since the 1970s: from0.395 in 1974 to 0.470 in 2006. Over that sameperiod, the 95/50 household income ratio(household income at the 95th percentile com-pared to median household income) rose from2.73 to 3.61—an increase of nearly a third.15

Looking at wages as opposed to householdincome tells a similar story. According to ananalysis done by Terry Fitzgerald of the FederalReserve Bank of Minneapolis, between 1975and 2005 real wages at the 90th and 95th per-centiles grew twice as fast as median wages.16

Meanwhile, earnings at the very top of thescale have grown by leaps and bounds overthe past generation. Often this phenomenonis discussed in terms of the growing share oftotal income accounted for by the top 1 per-cent, or top 0.1 percent, of earners. All ofthese statistics, though, are based on incometax data; and income reported for tax pur-poses, especially by high-income taxpayers, isextremely susceptible to changes in the taxcode. Thus, analyses that track incomes overdecades and multiple major changes in taxpolicy are highly problematic.17

Nevertheless, anecdotal evidence aboundsthat top performers in their fields—in sportsand entertainment as well as business—haveenjoyed huge gains in recent decades. To takeone particular example, I recently re-read Jerry

Kramer’s account of his 1967 season as rightguard for the Green Bay Packers. Coming off anappearance in the Pro Bowl, he earned $27,500that season (or about $171,000 in 2007 dol-lars).18 By comparison, the 2007 salaries of theguards who started in the previous Pro Bowlaveraged $3,187,000.19 That works out to morethan an 18-fold increase over 40 years; by com-parison, median real household income roseonly 29 percent between 1967 and 2007, andeven real income at the 95th percentile in-creased only 72 percent.20

The nation’s corporate elite has profited insimilarly spectacular fashion. According to along-term historical study of top corporateexecutives in large publicly traded firms con-ducted by Carola Frydman of the MIT SloanSchool of Management and Raven Saks of theU.S. Federal Reserve, median compensation(in 2000 dollars) averaged $930,000 duringthe 1970s, but jumped all the way to $4.08million in 2000–2005. Between 1970 and2005, the ratio of median executive compensa-tion to average earnings per full-time-equiva-lent worker rose from under 30 to 110.21

There is now enormous scholarly as well aspopular literature on the possible causes ofincreased income and wage inequality.22 With-out attempting any kind of comprehensivesynthesis of that literature here, I will brieflydescribe the most plausible structural expla-nations currently on offer—that is, explana-tions that link changes in the income distrib-ution to broad changes in the economy andthe workforce.

The leading explanation that emerges fromthe literature is one of “skill-biased technicalchange” (SBTC). The idea here is that, with theexplosive growth of information technologyin recent decades, rising relative demand forhighly skilled “knowledge workers” has result-ed in a growing pay gap between those work-ers and their less-skilled counterparts.23 Animportant refinement of the SBTC hypothesisemphasizes not only rising relative demandgrowth for skilled workers but also lagging rel-ative supply growth.24 According to Harvardeconomists Claudia Goldin and LawrenceKatz, college-educated workers as a percentage

7

Earnings at thevery top of thescale have grownby leaps andbounds over thepast generation.

of the total workforce increased by only 2.0percent a year from 1980 to 2005—down fromthe 3.8 percent increase per year between 1960and 1980.25 The result of these interactions ofsupply and demand has been a big increase inthe “college wage premium.” Goldin and Katzestimate that the difference between the aver-age weekly wages of college graduates andthose of high school graduates rose from 24percent in 1979 to 63 percent in 2005.26

An obvious challenge for the SBTC hypoth-esis is the fact that income inequality withinskill groups has also been on the increase. Ofcourse, unobserved skills may vary within thosegroups as well. But Thomas Lemieux of theUniversity of British Columbia contends thatthe major explanation of so-called “residual”inequality is another structural change: namely,the changing demographics of the Americanworkforce. Americans today are both older andbetter educated than they were in the 1970s,and it turns out that income dispersion increas-es with both age and education—which makessense. Younger and less-skilled workers tend tobe concentrated at the low end of the pay scale,while older and highly educated workers canfan out over a much broader range. Accordingto Lemieux’s estimates, the overwhelming bulkof the increase in residual inequality can beexplained by these “composition effects.”27

Another distinctive aspect of the inequali-ty picture that seems to need special explana-tion is the whopping increase in incomes atthe very top of the pay scale. How to explainthe rise of so-called “superstar” markets? Oneexplanation goes back to technology: peoplewill pay top dollar to see the very best per-formers; and as technology (e.g., television,the Internet) expands the audience that thoseperformers can reach, top performers profitaccordingly.28 But in other cases (e.g., chiefexecutive officers, investment bankers, elitelawyers), big increases in remuneration havecome without any corresponding expansionof the “audience” or customer base.

Patterns of wages and incomes are extreme-ly complex phenomena that reflect the con-fluence of untold millions of factors. Not sur-prisingly, the leading structural explanations

of increased income inequality are less thanfully satisfactory. Even if these explanationsare correct as far as they go, they are doubtlessincomplete. In other words, while the evidencedoes support a strong connection betweenstructural changes in the economy and a widerincome distribution, almost certainly otherfactors are at play as well.

Paul Krugman and company are welladvised to search for additional causal con-nections in the realms of politics and culture.The fact that dramatic changes in both pub-lic policy and social norms have coincidedwith a marked change in income trends sug-gests that links between the two are a possi-bility worth considering.

What in particular should they consider?For changes in economic policies and socialnorms to contribute to the rise in incomeinequality, the changes would need to eitherrestrain wage and income growth at the low-er end of the income spectrum or accelerateits growth at the top end. Which is to say,they should look for changes that intensified(a) competition among less-skilled workersfor employment and/or (b) competitionamong employers for highly skilled workers.

When put that way, and knowing a little his-tory, it quickly becomes apparent that changesin economic policies and social norms very like-ly have made significant contributions to therise in income inequality. As I will detail below,the political economy of the postwar decadeswas characterized by a general suppression ofcompetitive forces—a suppression that was aid-ed in important ways by prevailing socialnorms. The changes in economic policies thathave occurred in recent decades, buttressed byparallel changes in social norms, have workedto intensify competitive pressures in wide-rang-ing ways. And in so doing, they worked in con-cert with changes in economic structure tostretch the income distribution.

Stifled Competition

The economic system that emerged fromthe New Deal and World War II was markedly

8

Changes in economic policiesand social norms

very likely havemade significantcontributions to

the rise in incomeinequality.

different from the one that exists today. Andthe contrast between past and present is high-lighted when we focus on one critical dimen-sion: the degree to which competition is eitherencouraged or thwarted by public policy.

The postwar economic order was charac-terized by a host of laws and regulatory insti-tutions that systematically limited competi-tion—not only in product markets, but incapital markets and labor markets as well. Thepolicies identified by Levy and Temin as keyprovisions of the Treaty of Detroit—highlyprogressive tax rates, a relatively high mini-mum wage, and a strong policy bias in favor ofunionization and collective bargaining—werecertainly part of the story. But the story wentfar beyond these limited elements.

Let’s begin by looking at product markets.First and most obviously, the transportation,energy, and communications sectors were sub-ject to pervasive price and entry regulation.Railroad rates and service had been under fed-eral control since the Insterstate Commerce Actof 1887, but the Motor Carrier Act of 1935extended the Interstate Commerce Commis-sion’s regulatory authority to cover truckingand bus lines as well. In 1938, the CivilAeronautics Act put airline routes and faresunder the control of the Civil AeronauticsBoard. After the discovery of the East Texas oilfield in 1930, the Texas Railroad Commissionacquired the effective authority to regulate thenation’s oil production in the name of main-taining price stability. Rates for the interstatetransmission of natural gas were regulated bythe Federal Power Commission under theNatural Gas Act of 1938, and a 1954 SupremeCourt case expanded the commission’s controlto include setting wellhead prices for naturalgas. The Federal Communications Commis-sion, created by the Communications Act of1934, allocated licenses to radio and later televi-sion broadcasters and also regulated the ratescharged by the AT&T telephone monopoly. Itsregulatory power also extended to the emergingcable television and microwave-based long-dis-tance telephone industries.

Limits on competition in product marketsweren’t restricted to these so-called “regulated

industries.” Beginning with the AgriculturalAdjustment Act of 1934, the prices and produc-tion levels of a wide variety of farm productswere controlled by a byzantine complex of fed-eral controls and subsidies. Manufacturers andother goods producers were shielded frominternational competition, not just by the dev-astation of World War II, but by high importtariffs. Although rates fell during the 1930s and’40s from their dizzying Smoot-Hawley highs,average tariffs on dutiable goods remainedabove 10 percent throughout the 1950s and’60s.29 And in the retail sector, aggressive dis-counting was countered by state-level “fairtrade laws,” which allowed manufacturers toimpose minimum resale prices even on non-consenting distributors.

Comprehensive regulation of the U.S.financial sector in the wake of the GreatDepression served to restrict competition incapital markets in a variety of ways. The Glass-Steagall Act, part of the Banking Act of 1933,erected a wall between commercial and invest-ment banking, thereby effectively brokering amarket-sharing agreement under which com-mercial banks and investment banks were pro-tected from each other.30 The McFadden Act of1927 added a federal ban on interstate branchbanking to widespread state-level restrictionson intrastate branching. “Regulation Q,” insti-tuted under authority of the Banking Act of1933, prohibited interest payments on de-mand deposits and set interest rate ceilings fortime deposits. Provisions of the Securities Actof 1933 worked to limit competition in under-writing by outlawing pre-offering solicitationsand undisclosed discounts.31 These and otherrestrictions amounted to a significant dose offinancial repression—or the artificial stuntingof the depth and development of capital mar-kets. Consider, for example, the striking factthat the ratio of U.S. stock market capitaliza-tion to gross domestic product fell from 0.75in 1929 to 0.33 in 1950—and did not reach andthen surpass the 1929 mark until the 1990s.32

The relative underdevelopment of the financialsector, meanwhile, likely muted the intensity ofcompetition throughout the larger “real” econ-omy. New entrants are much more dependent

9

The postwar economic orderwas characterizedby a whole hostof laws and regulatory institutions thatsystematicallylimited competition.

on a well-developed financial system than areestablished firms, since incumbents can self-finance through retained earnings or use exist-ing assets as collateral.33 It follows, therefore,that a hobbled, less-competitive financial sec-tor acts as a barrier to entry and therebyreduces established firms’ vulnerability tocompetition from entrepreneurial upstarts.34

The highly progressive tax structure of theearly postwar decades may have further damp-ened competitive forces throughout the econ-omy by discouraging entrepreneurship. Thetop marginal income tax rate shot up from 25percent to 63 percent under Herbert Hoover in1932, climbed as high as 94 percent duringWorld War II, and stayed at 91 percent duringmost of the 1950s and early ’60s.35 In theory,the effects of progressive rates on the decisionto become an entrepreneur can cut both ways.On the one hand, by reducing the risk ofincome shocks, progressive rates could act as akind of income insurance policy that encour-ages potential entrepreneurs to be less risk-averse. Also, higher rates could increase thevalue of the tax avoidance opportunities creat-ed by business ownership or self-employment.Empirical research by economists WilliamGentry of Williams College and Glenn Hub-bard of Columbia University, however, findsthat these possible benefits are more than out-weighed by the costs imposed by progressiverates. In their analysis, a progressive rate struc-ture acts as a “success tax” that reduces theupside of possible entrepreneurial venturesrelative to the wages of continued employ-ment. The result is to discourage possibleentrepreneurs from striking out on theirown.36

Finally, competition in labor markets wassubject to important restraints during the ear-ly postwar decades. Levy and Temin have iden-tified two of those restraints: governmentencouragement of unionization and collectivebargaining, and the imposition of an above-market minimum wage. The Wagner Act of1935 provided a major boost to the surgingindustrial unionism movement. Membershipin labor unions as a percentage of total non-agricultural employment (otherwise known as

union density) jumped from 13 percent theyear the law was passed to 28 percent in 1938,more than doubling in just three years.During World War II, the strongly pro-uniontilt of the National War Labor Board helped topush union density above 30 percent, where itremained until the early 1960s.37 In particular,roughly three-quarters of blue-collar workersbelonged to unions during this period.

The triumph of collective bargaining meantthe active suppression of wage competition incovered industries—especially through the prac-tice of “pattern bargaining,” in which a laboragreement negotiated with one target employerbecomes the model for a whole industry. And inthe interest of boosting wages, unions some-times worked to restrict competition in theirindustries’ product markets as well. Thus, gar-ment unions connived with trade associationsto set prices and allocate production amongclothes makers. And coal unions attempted toregulate production by dictating how manydays a week mines could be open.38

Meanwhile, a relatively high federal mini-mum wage imposed another significantrestriction on wage competition. Establishedunder the Fair Labor Standards Act of 1938,the federal minimum wage was originally setat $0.25 per hour. According to Levy andTemin, that wage floor equaled 27 percent ofaverage output per hour in the nonfarm busi-ness sector. Throughout the 1950s and ’60s,that ratio of minimum wage to averagehourly output generally stayed between 25and 30 percent.39 As a result, workers whoseskills were worth less than this thresholdwere priced out of the labor market in indus-tries subject to the wage floor.

Although not mentioned by Levy andTemin, highly restrictive immigration policiesprovided another significant brake on labor-market competition. With the establishmentof country-specific immigration quotas underthe Immigration Act of 1924, foreign-born res-idents of the United States plummeted from13 percent of the total population in 1920 to 5percent by 1970.40 As a result, competition atthe less-skilled end of the U.S. labor market wassubstantially reduced compared to what

10

Highly restrictiveimmigration

policies providedanother

significant brakeon labor-market

competition.

would have been the case if liberal immigrationpolicies had continued.

Interestingly, the immigration quota systemdid not apply to the western hemisphere.Consequently, inflows of workers from Mexicosurged as restrictions on the rest of the worldtightened. Between 1907 (when the “Gentle-men’s Agreement” between the United Statesand Japan stopped emigration from the lattercountry) and 1929, the number of Mexican-born residents of the United States soared from178,000 to 739,000. The Great Depression,however, precipitated a harsh crackdown:between 1929 and 1937, the Mexican popula-tion was halved as some 458,000 Mexicans—including native-born children who were U.S.citizens—were arrested and summarily deport-ed. Labor shortages during World War IIbrought on another wave of Mexican immigra-tion—some of which occurred officially underthe “Bracero Program” for temporary agricul-tural workers, but much of which did not.Another crackdown followed, as “OperationWetback” apprehended over one million Mexi-cans in 1954 alone. Through the rest of the1950s, the Bracero Program was expanded topermit between 400,000 and 450,000 immi-grants a year, and unofficial immigration sub-sided. Through these cycles of openness andrepression, wage competition from Mexicanswas held more or less in check during the earlypostwar decades.41

The political economy of the early post-war decades was thus distinguished by its sys-tem of extensive and mutually supportingrestrictions on competition. Though some ofthat system dated back as far as the late 19thcentury, most of it was slapped together dur-ing the frenzied improvisations of the 1930s.The New Deal was the product of many con-flicting impulses, but one clear theme was apush to limit competition—and, in particu-lar, to protect incumbents from outside chal-lengers—in virtually every sector of the econ-omy. As the historian Ellis Hawley concludedin his landmark study of the New Deal:

Most New Deal planning was in thenature of government cartelization. It

came at the behest of organized eco-nomic interest groups intent uponstrengthening their market positionthrough legal sanctions or governmentsupports. . . . And its purpose, althoughthis was often disguised as somethingelse, was to help individual industries orparticularistic pressure groups to pro-mote scarcity and thus balance theiroutput with demand, regardless of thedislocations that such action mightbring in other areas of the economy.42

The drive toward cartelization began with acomprehensive approach: the NationalIndustrial Recovery Act of 1933. When thatact’s system of industrial codes foundered onconflicts among rival interest groups and thenwas toppled by the Supreme Court, a patch-work arrangement of industry-specific pro-duction and price controls took its place.Combined with price supports and produc-tion limits in agriculture, far-reaching finan-cial regulation, pro-union labor legislation,and a dramatic increase in top marginal taxrates, the overall effect was to imbue Americaneconomic institutions with a decided tilt infavor of established producer interests(including producers of capital and labor aswell as goods) at the expense of consumer wel-fare. That tilt would persevere until the 1970s.

The catastrophe of the Great Depressionwas the primary catalyst for the shift towardcartelization. It was widely believed at the timethat the economic collapse had been broughtabout by unsustainable overproduction andconsequent falling prices. Accordingly, restrict-ing output and propping up prices seemed likethe obvious strategy for reversing the down-ward spiral. More broadly, since the late 19thcentury, the clear trend in elite opinion hadbeen toward the view that unregulated marketswere an anachronism and that modern condi-tions required broad government control ofeconomic life. The spectacular implosion ofthe market economy seemed to provide deci-sive vindication for such thinking. As theprominent New Dealer Rexford Tugwell put it:“The jig is up. The cat is out of the bag. There

11

The catastropheof the GreatDepression wasthe primary catalyst for theshift towardcartelization.

is no invisible hand. There never was. . . . Wemust now supply a real and visible guidinghand to do the task which that mythical,nonexistent agency was supposed to perform,but never did.”43 In such an intellectual cli-mate, the conditions were highly favorable forindustries and other economic interest groupsto justify limits on competition in the name ofthe public interest.

Solidarity and Chauvinism

The anti-competitive effects of the Treatyof Detroit were reinforced by the prevailingsocial norms of the early postwar decades.Just as there were clear and relevant differ-ences between the policies of that era andthose of today, likewise the values and atti-tudes that dominated during that time standin distinct contrast to contemporary norms.

Krugman and company focus in particu-lar on changing norms with respect to execu-tive pay. Krugman quotes wistfully fromJohn Kenneth Galbraith’s characterization ofthe corporate elite in his 1967 book The NewIndustrial State: “Management does not go outruthlessly to reward itself—a sound manage-ment is expected to exercise restraint.”44

According to Krugman, “For a generationafter World War II, fear of outrage kept exec-utive salaries in check. Now the outrage isgone. That is, the explosion in executive payrepresents a social change . . . like the sexualrevolution of the 1960’s—a relaxation of oldstrictures, a new permissiveness, but in thiscase the permissiveness is financial ratherthan sexual.”45

Krugman is on to something. But chang-ing attitudes about the seemliness of lavishcompensation packages are just one smallpart of a much bigger picture. In a whole hostof wide-ranging ways, American cultural val-ues have undergone dramatic shifts sinceWorld War II. Of particular relevance togrowing income inequality, during the earlypostwar decades, the combination of in-group solidarity and out-group hostility wasmuch more pronounced in certain key

dimensions. By contrast, contemporary cul-ture is decidedly more individualistic, so thatloyalty to other members of the same groupand discrimination against outsiders haveboth weakened.

The more group-minded mores of the“Treaty of Detroit” era worked in concertwith the economic policies of the time tokeep competition in check. First, the prevail-ing racism of the era supported the restrictiveimmigration policies that excluded foreign-born workers from competing for jobs in theU.S. labor market. In addition, traditionalattitudes about the role of women in societysuppressed female labor force participationand kept women from competing in a widevariety of jobs considered to be men’s work.Furthermore, a distinctive social ethos thatflourished in the years after World War II fos-tered a sense of solidarity within businessenterprises that probably restrained competi-tion among enterprises for top talent.

Consider, first of all, the transformationin attitudes about race. Open and unapolo-getic discrimination by whites against otherethnic groups was widespread and sociallyacceptable in the America of Paul Krugman’sboyhood; it no longer is today. Contrast theoppression of Jim Crow with the affirmativeaction policies of the past generation; com-pare the mass internment of Japanese-Americans during World War II with theextreme hesitancy to engage in anything thatlooked like “racial profiling” of Muslims inthe wake of 9/11.

How does racial progress fit into the storyof income inequality? Not the way we mightexpect. Of course, the most dramatic mani-festation of that progress was the disman-tling of institutionalized discriminationagainst African Americans during the 1960s.More relevant to the rise in income inequali-ty, though, was the fact that more enlight-ened attitudes about race also encouraged amajor reversal in the nation’s immigrationpolicies. The effect of that reversal has beento increase considerably the number of less-skilled workers and thereby intensify compe-tition among them for employment.

12

The more group-minded

mores of the“Treaty of

Detroit” eraworked in

concert with the economic policies

of the time tokeep competition

in check.

Under the system that existed between1924 and 1965, immigration quotas were setfor different countries on the basis of the per-centage of people with that national originalready living in the country (though immi-gration from East and South Asia was bannedoutright until 1952). The explicit purpose ofthe national-origin quotas was to freeze theethnic composition of the United States—thatis, to preserve white Protestant supremacy andprotect the country from “undesirable” races.“Unquestionably, there are fine human beingsin all parts of the world,” said Senator RobertByrd in defense of the quota system during thedebates on the 1965 immigration act, “butpeople do differ widely in their social habits,their levels of ambition, their mechanical apti-tudes, their inherited ability and intelligence,their moral traditions, and their capacity formaintaining stable governments.”46

But the times had passed the formerKlansman by. With the triumph of the civilrights movement, official discrimination onthe basis of national origin was no longer sus-tainable. Just two months after signing theVoting Rights Act, President Lyndon Johnsonsigned the Immigration and Nationality Actof 1965, ending the “un-American” system ofnational-origin quotas and its “twin barriersof prejudice and privilege.”47 Although neitherJohnson nor the bill’s backers in Congressrealized it at the time, the act would inaugu-rate a new era of mass immigration: foreign-born residents of the United States havesurged from 5 percent of the population in1970 to 12 percent as of 2005.48 That influxhas expanded significantly the ranks of low-skilled workers competing in the American jobmarket.

Changing attitudes about the role ofwomen in society have also served to open upcompetition in the labor market. Here again,in-group solidarity (among working males)had expressed itself in a concerted refusal toextend opportunities to (female) outsiders.Just as racism helped to keep foreign-bornworkers out of the U.S. labor market, sexismkept women in the kitchen and out of the paidworkforce. As of 1950, the labor force partici-

pation rate for adult women stood at only 31percent; by 1970, it had climbed to 42 percent,and as of 2005 it had jumped to 59 percent.49

Meanwhile, the range of jobs open to womenexpanded enormously. Prior to the women’smovement of the 1960s and ’70s, workingwomen were largely confined to a “pink col-lar” ghetto consisting of teaching, nursing,and secretarial and clerical jobs. Elite, high-paying managerial and professional occupa-tions were almost completely off limits.

Racism and sexism are two ancient andwidespread forms of group identity. Anotherform, more in line with what Paul Krugmanhas in mind, was a distinctive expression of U.S.economic and social development in the mid-dle decades of the 20th century. Here I am talk-ing about the phenomenon that sociologistDavid Riesman, in his classic 1950 work TheLonely Crowd, described as the “other-directedpersonality.” Journalist William Whyte wasreferring to much the same thing when hewrote about the prevailing “social ethic” in his1956 book The Organization Man.

Riesman summed up the situation towhich the American character was adapting atmid-century: “Increasingly, other people are theproblem, not the material environment.”50 Forone thing, Americans were emptying out ofthe countryside and small towns and pouringinto cities and suburbia. In 1900, 60 percent ofAmericans lived in rural areas; by 1960, 70 per-cent of the population was urban.51 At thesame time, more and more people were work-ing, not with nature on farms or with machin-ery in factories, but with other people inoffices. As of 1900, only 18 percent of theworkforce was in white-collar occupations; by1960, that figure had climbed to 40 percent.52

Meanwhile, the descendants of the great waveof immigration from the turn of the centurywere progressively assimilating into the main-stream of American life, and thus large num-bers were joining the white-collar middle classand leaving big-city ethnic enclaves for thesuburbs. Learning how to get along with oth-er people of all kinds of different back-grounds—in the meeting room, at the watercooler, and at the weekend block party—was

13

Changing attitudes aboutthe role ofwomen in societyhave also servedto open up competition inthe labor market.

indeed a major and novel challenge in theyears after World War II.

That challenge was surmounted by theemergence of a new sensibility that defineditself in studied contrast to old-style “ruggedindividualism.” The prevailing mores of, inparticular, the 1950s put an extraordinaryemphasis on fitting into the group and being“well-adjusted.” When contemporary criticsscorned the era for its conformism, theyweren’t just talking about the ranch housesand gray flannel suits. “In the Social Ethic Iam describing,” wrote Whyte, “man’s obliga-tion is . . . not so much to the community ina broad sense but to the actual, physical onearound him, and the idea that in isolationfrom it—or active rebellion against it—hemight eventually discharge the greater ser-vice is little considered.”53

A few anecdotes from The Organization Manillustrate Whyte’s point:

“These men do not question the sys-tem,” an economics professor says of[college seniors], approvingly. “Theywant to get in there and lubricate andmake them run better. They will be tech-nicians of the society, not innovators.”54

One recruiter went through three hun-dred interviews without one senior’smentioning salary, and the experience isnot unusual. Indeed, sometimes seniorsreact as if a large income and securitywere antithetical. As some small compa-nies have found to their amazement, theoffer of a sales job netting $15,000 at theend of two years is often turned down infavor of an equivalent one with a largecompany netting $8,000.55

“Any progressive employer,” said onepersonnel director, “would look a-skance at the individualist and would bereluctant to instill such thinking in theminds of trainees.”56

“We used to look primarily for bril-liance,” said one [company] president.

“Now that much-abused word ‘charac-ter’ has become very important. . . . Wewant a well-rounded person who canhandle well-rounded people.”57

From company to company, traineesexpress the same impatience. All thegreat ideas, they explain, have alreadybeen discovered and not only in physicsand chemistry but in practical fields likeengineering. The basic creative work isdone, so the man you need—for everykind of job—is a practical, team-playerfellow who will do a good shirtsleevesjob. “I would sacrifice brilliance,” onetrainee said, “for human understandingevery time.”58

Times have certainly changed. But al-though these passages sound jarring to con-temporary ears, the sensibility they highlightwas doubtless useful in helping people adaptto the new surroundings of an urbanized,highly organized, and culturally pluralisticworld. And it seems entirely reasonable to con-clude that the prevalence of this social ethicdid help to limit competition among businessenterprises for top talent. Secure membershipin a stable organization was more importantrelative to maximizing one’s individual posi-tion than it is today, and consequently themost talented employees were less vulnerableto the temptation of a better offer elsewhere.Even if they were tempted, a strong sense oforganizational loyalty made them more likelyto resist and stay put.

The heavy emphasis on group cohesionwas further strengthened by the experiencesof the Great Depression and World War II.According to social psychologists, our senseof group identity is heightened when mem-bership in that particular group is especiallysalient—as it is when, say, the group is facedwith an external threat. Under those condi-tions, we feel strong pressures (both externaland internal) toward assimilation—that is,reducing the differences among members ofthe group. By contrast, when a group isn’tfaced with some external challenge, the nat-

14

The prevailingmores of the1950s put an

extraordinaryemphasis on

fitting into thegroup and being“well-adjusted.”

ural tendency is toward differentiation—aseverybody seeks some niche in which he haspower, influence, and status.59

The successive cataclysms of economiccollapse and total war engendered a strongsense of shared national identity and result-ing group cohesion. We experienced some-thing similar in the wake of the 9/11 terroristattacks: for weeks and months thereafter thevisceral feelings of patriotism and “we’re allin this together” were both powerful andwidespread. In the 1930s and ’40s, circum-stances conspired to keep national solidarityhighly salient, not just for weeks or months,but for 15 years.

Thus, the young office workers and sub-urbanites of the early postwar years were fac-ing novel social challenges that put a premi-um on group-mindedness. And they facedthose challenges with outlooks shaped by ahistorical era uniquely suited to suppressingindividualism. It is no wonder that the cul-ture of the 1950s was so strongly marked byan emphasis on fitting in, getting along, andnot rocking the boat.

Increased Competition,Increased Inequality

The proponents of nostalgianomics arecertainly correct that American political econ-omy has undergone dramatic changes sincethe 1970s. Let’s start with the economic insti-tutions that Krugman and company focus on:unions, the minimum wage, and income taxrates. Union density, which remained above 30percent into the 1960s, fell to 12 percent by2006. In the private sector, only 7 percent ofworkers belonged to unions by 2006.60 Thefederal minimum wage, just before the recenthike, stood at $5.15 in 2006—down nearly 45percent in real value from its 1968 peak of$9.27 (in 2006 dollars).61 Annual earnings atthe minimum wage, expressed as a fraction ofaverage output per worker, have fallen fromthe 25–30 percent range during the 1950s and’60s to under 15 percent in the 2000s.62 Thetop income tax rate, which stood at 70 percent

as of 1980, was reduced to 50 percent under1981 legislation, fell all the way to 28 percentunder the 1986 Tax Reform Act, rose to 31percent under a 1990 budget agreement, wasincreased again to 39.6 percent in 1993, andwas reduced to 35 percent in 2001.63

These changes were part of a much broad-er shift toward greater reliance on marketcompetition. Price and entry controls in theairline, trucking, and railroad industries wereeliminated. Oil and natural gas prices werederegulated. The AT&T monopoly was bro-ken up, and competition in long-distance tele-phone services was permitted. Cable and satel-lite television were allowed to compete withbroadcasting. Interest rates were deregulated,limits on branch banking were lifted, and theGlass-Steagall wall between commercial andinvestment banking was lowered. Barriers tointernational trade have continued to fall, andthe trade-weighted average tariff rate nowstands at under 2 percent.64

Meanwhile, social norms have been trans-formed by the cultural upheavals of the 1960sand ’70s. The “social ethic” of the “Organi-zation Man” is long gone, as are a whole host oftraditional attitudes about race, sex, and muchelse besides. As a result, Americans today pur-sue more individualized conceptions of per-sonal integrity and personal fulfillment. Theyare less committed to group-oriented normslike racial solidarity, traditional gender roles, orloyal submission to corporate or other bureau-cratic hierarchies.65

These dramatic changes in political econ-omy and social norms have brought about abroad-based intensification of competitionin American economic life. Of particular rele-vance to the distribution of income, thechanges in question have simultaneouslyincreased competition among less-skilledworkers for employment and increased com-petition among employers for highly skilledworkers. The logical consequence of suchdevelopments should be to hold down low-end wages while boosting the earnings ofpeople at the top. In other words, the logicalconsequence should be to reinforce andamplify the structural changes in the Ameri-

15

The proponents of nostalgia-nomics are certainly correctthat Americanpolitical economyhas undergonedramatic changessince the 1970s.

can economy that have increased incomeinequality.

That, at any rate, is the logic of the situa-tion. What about the facts? A review of empir-ical economic research does provide evidencethat changes in economic policies and socialnorms have contributed to the rise in incomeinequality since the 1970s. To be honest, how-ever, much more research is needed before anyconfident assessment of the size of the contri-bution can be made.

A number of economists have identified thedeclining real value of the minimum wage as asignificant factor in the rise of income inequal-ity.66 In particular, the nominal value of theminimum wage stood unchanged at $3.35 anhour from 1981 to 1990, during which timeinflation eroded the purchasing power of thedollar by 30 percent.67 That real decline coin-cides closely with a sizeable jump in 90/10 and50/10 income inequality, and statistical analy-sis supports a connection as well.

An important caveat is in order, however.The fact is that only a small fraction of theworkforce earns the minimum wage. As of1988, during the midst of this sharp decline,only an estimated 6.5 percent of hourly wageworkers—or under 4 percent of all wage andsalary workers—were being paid the legal mini-mum. Moreover, a full 36 percent of minimum-wage workers at that time were teenagers.68 It isdifficult to see how a policy that directly affectssuch a small percentage of adult, full-timeworkers could have played more than a modestrole in boosting inequality.

Solid evidence also shows a connectionbetween declining private-sector unions andrising inequality. Although unions do appar-ently reduce inequality, they do not do so byincreasing labor’s overall share of nationalincome. True, collective bargaining has result-ed in a wage premium of 15 percent or morefor unionized workers.69 However, above-mar-ket wages in organized sectors tend to result inlower employment, and the resulting diver-sion of labor to other sectors may depresswages there. In any event, labor’s share ofnational income has held remarkably steadyover the decades regardless of the changing

fortunes of the labor movement. According toone estimate, that share actually rose slightlyfrom 72 percent to 73 percent between 1950and 2007.70

So how do unions reduce inequality if notby wresting a greater share of the pie for work-ers? It turns out that the wage structure inunionized sectors is generally more com-pressed than in nonunionized sectors. In oth-er words, the pay gap between highly skilledand less skilled, or senior and junior, workersis generally smaller when wages are set by col-lective bargaining. As a result, high union den-sity results in lower income inequality becausemore workers’ wages are bunched in a relative-ly narrow band. Focusing on this dynamic,economist David Card of the University ofCalifornia at Berkeley estimated that theshrinking percentage of unionized workersaccounted for 15–20 percent of the rise inoverall male wage inequality between the early1970s and the early 1990s.71

But did policy changes play a role in the fallof union power? Yes, they did; but the theoriesof nostalgianomics notwithstanding, the rele-vant changes were not in labor law. The onlysignificant reduction in the Wagner Act’s pro-union bias occurred with the Taft-Hartley Act,which, among other things, outlawed “closedshops” (contracts requiring employers to hireonly union members) and authorized state“right-to-work” laws (which ban contractsrequiring employees to join unions). But thatpiece of legislation was enacted in 1947—threeyears before the original Treaty of Detroitbetween General Motors and the United AutoWorkers. It would be a stretch to argue thatthe Golden Age ended before it even began.

Scrounging about for a policy explanationfor declining unionization, Levy and Teminpoint to the failure of a 1978 labor law reformbill to survive a Senate filibuster.72 They mightas well have added the failure in any year topass legislation requiring all employees to beunion members. In any event, maintenance ofthe policy status quo is not a policy change.Levy and Temin, joined by Krugman, alsoblame President Reagan’s 1981 decision to firestriking air-traffic controllers as a signal to

16

Solid evidence shows

a connectionbetween declining

private-sectorunions and rising

inequality.

employers that the government no longer sup-ported labor unions.73 It is true that Reagan’shandling of that strike, along with his appoint-ments to the National Labor Relations Board,made the policy environment for unions some-what less favorable. But the effect of thosemoves was marginal.

As economist Henry Farber of Princetonand sociologist Bruce Western of Harvardhave pointed out, the main cause of decliningunionization has been a dramatic difference inemployment growth between unionized andnonunionized workplaces. Between 1973 and1998, employment at unionized firms de-clined on average by 2.9 percent a year, whilejobs at nonunion firms grew at an average rateof 2.8 percent a year. To counteract this differ-ential and hold union density constant wouldhave required torrid rates of organizing newworkers. Yet organizing rates have been inlong-term decline since the early 1950s. Onlyorganizing rates at early-1950s levels wouldhave sufficed to prevent the drop in uniondensity experienced since the early 1970s.74

Meanwhile, it is important to understandthe reasons for the differences in employmentgrowth that are at the root of unions’ problems.One contributing factor is the structural shift inoverall employment away from industries inwhich unionization was historically most preva-lent (in particular, manufacturing industries).However, such structural changes are not themain reason for falling union density. Between1983 and 2002, union density fell from 16.5 per-cent to 8.6 percent. Yet according to TrinityUniversity economist Barry Hirsch, even ifindustrial structure had remained unchangedover this period, union density would still havefallen to 10.2 percent. Thus, some 80 percent ofthe decline in unionization was due to fallingunion density within industries.75

The major reason for the fall in unionizedemployment, according to Hirsch, “is thatunion strength developed through the 1950swas gradually eroded by increasingly compet-itive and dynamic markets.” As he elaborates:

To the extent that high union laborcompensation is not offset by greater

productivity or higher product prices,union gains can be thought of as a“tax” on firm profits. The competitive-ness of the product market affects theability of the unions to acquire gainsfor their members. When much of anindustry is unionized, firms may pros-per with higher union costs as long astheir competitors face similar costs.When union companies face low-costcompetitors, labor cost increases can-not be passed through to consumers.Factors that increase the competitive-ness of product markets—increasedinternational trade, product marketderegulation, and the entry of low-costcompetitors—make it more difficultfor union companies to prosper.76

Accordingly, the decline of private-sectorunionism was indeed abetted by policychanges. The changes in question, however,were not specific shifts in labor policy, butrather the general reduction of trade barriersand elimination of price and entry controls.With the unleashing of competitive forcesunder the Washington Consensus, unionizedfirms, saddled with above-market wages andrestrictive work rules, found themselves at acritical disadvantage.77 They shrank accord-ingly, and union rolls along with them.

In addition to helping undermine union-ization, trade liberalization has also affectedinequality directly by reducing relativedemand for less-skilled workers in import-competing industries. According to a num-ber of studies done in the 1980s and ’90s,however, the magnitude of the effect appearsto have been quite modest. For example, in a1995 paper, Paul Krugman estimated thattrade with poorer countries led to about a 3percent increase in the ratio of skilled tounskilled wages, and thus accounted forroughly 10 percent of the increase in wageinequality since 1980.78 (Note that the effecthere is for all trade, not just increased tradedue to lower barriers.) More recently, though,Krugman has argued that the rise of low-wage China and the increased ability to send

17

The main causeof decliningunionization hasbeen a dramaticdifference inemploymentgrowth betweenunionized andnonunionizedworkplaces.

offshore specific parts of the productionprocess have magnified the downward pres-sure of trade on low-end wages. He con-cludes, however, that data on trade flows arenot sufficiently detailed to permit a reliablequantitative estimate.79

The huge wave of immigration over thepast generation, the result of a policy changecatalyzed by changing social norms, has alsoexerted mild downward pressure on thewages of native-born low-skilled workers.Most estimates show a small effect: at thehigh end, Harvard economist George Borjasfound that immigration between 1980 and2000 depressed the wages of high-schooldropouts by around 9 percent.80

The more dramatic impact of immigra-tion on measured inequality, however, hascome from its effect on the composition ofthe American workforce. Specifically, immi-gration has substantially increased the num-ber of less-skilled workers, thereby increasingapparent inequality by depressing averagewages at the low end of the income distribu-tion. According to American University andUrban Institute economist Robert Lerman,excluding recent immigrants from the analy-sis would eliminate roughly 30 percent of theincrease in adult male annual earningsinequality between 1979 and 1996.81

Interestingly, although the large influx ofunskilled immigrants has made Americaninequality statistics look worse, it has actuallyreduced inequality for the people involved.After all, immigrants experience large wagegains as a result of relocating to the UnitedStates, thereby reducing the wage gap betweenthem and top earners in this country. Accord-ing to Lerman, if trends in inequality are recal-culated to include, at the beginning of the peri-od, recent immigrants and their native-countrywages, a very different picture emerges. Insteadof the 90/10 wage ratio increasing by 16.6 per-cent between 1979 and 1996, it actually fell by4.7 percent. Thus, the result of immigration hasbeen to reduce human inequality while increas-ing national inequality.82

Changing social norms led, not only to alarge infusion of foreign-born workers into

the labor force, but to a large infusion ofAmerican women as well. How did the trans-formation of social attitudes about the roleof women in society affect the inequality pic-ture? The massive expansion of opportuni-ties for women resulted in significant gainsfor gender equality: the female-male earningsratio shot up from 0.30 in the mid-1960s to0.57 in 2002.83

In terms of overall income inequality,though, gains for women have ended upwidening rather than narrowing income dif-ferences. Since women’s incomes have beenrising faster than men’s in recent decades, theshift from one- to two-earner householdsmight have reduced inequality by supple-menting lagging male earnings with morerapidly increasing female earnings. But be-cause of the prevalence of “assortative mat-ing”—that is, the tendency of people to choosespouses with similar educational and socio-economic backgrounds—the rise in dual-income couples has actually exacerbatedhousehold income inequality. Between 1979and 1996, the proportion of working-age menwith working wives rose by approximately 25percent among those in the top fifth of themale earnings distribution, and their wives’total earnings rose by over 100 percent.84

According to a 1999 estimate by Gary Burtlessof the Brookings Institution, this unanticipat-ed consequence of the women’s movementaccounted for about 13 percent of the totalrise in income inequality since 1979.85

What about rapidly rising incomes at thetop of the pay scale? Is there any evidencethat changes in policy and social norms havecontributed to the rise of “winner-take-all” or“superstar” markets?

Economic logic suggests that the generalthrottling of competitive pressures during theTreaty of Detroit era probably did suppresshigh-end earnings by reducing competitionamong employers for the most talented execu-tives and other key employees. After all, to theextent that trade barriers abroad and price andentry controls at home weakened the connec-tion between firms’ productivity and their bot-tom line, the importance of attracting and

18

Although the large influx

of unskilledimmigrants hasmade American

inequality statistics look

worse, it has actually reduced

inequality for thepeople involved.

keeping the best personnel was correspond-ingly diminished.86 At the same time, extreme-ly high top marginal tax rates discouragedfirms from bidding against each other for themost valuable employees, since even sizableraises would produce only paltry increases inactual take-home pay. Accordingly, it makessense that policy changes that unleashed com-petitive forces simultaneously unleasheddemand for the most productive employees.

Meanwhile, the “Organization Man” ethosof the early postwar decades likely contributedto the dampening of the market for top talent.If stability and security were valued aboveshort-term rewards, and if loyalty to one’semployer was widely considered to be animportant part of being a good person, thenlateral moves from one company to anotherwould have been discouraged—on both thesupply and demand sides. As a result, prevail-ing mores may indeed have helped to keep alid on top salaries. Furthermore, concernsabout the effects on employee morale of lavishpay packages at the top were probably takenmore seriously in a more group-minded age.Consequently, there are good reasons forthinking that the cultural shift since the 1960sto a more individualistic ethos helped to heatup of the market for highly skilled workers.

Unfortunately, I am not aware of any stud-ies that have attempted to quantify the effectsof greater competition on high-end incomes.Some data, however, are at least suggestive.Consider, first of all, the effect of free agencyon sports salaries. For example, averagesalaries in Major League Baseball increased0–2 percent in real terms during 1973–75; in1976, when free agency was first instituted,salaries jumped 10 percent; in 1977, 38 per-cent; in 1978, 22 percent. Between 1974 and1982, salaries as a share of team revenues sky-rocketed from 17.6 percent to 41.1 percent.87

Arguably, the combination of increased prod-uct-market competition, declining top taxrates, and changing social norms has amount-ed to some kind of analog of free agency forelite managers and professionals—in whichcase one would expect to see an analogousboost to their earnings.

Along these lines, the recent study byFrydman and Saks of long-term trends inexecutive compensation shows somethingextremely interesting. Their data indicate thatthe median real compensation of top execu-tives was virtually flat from the end of WorldWar II to the mid-1970s, notwithstanding thepostwar boom and related growth in firm size.From the 1980s forward, however, executivecompensation and firm size grew at nearly thesame rate.

These findings pose serious problems forthose who argue that soaring executive payreflects (in Frydman and Saks’ words) “man-agers’ ability to extract rents from the firm.”After all, they point out, pay remained basi-cally flat from the 1950s to the ’70s “eventhough corporate governance was arguablyweaker” during that period. Yet, similar prob-lems confront those who argue now that thebig run-up in pay reflects (again, according toFrydman and Saks) “firms’ competition forscarce managerial talent . . . leading to highercompensation in larger firms.”88 If that argu-ment is true, then why didn’t executive com-pensation rise with firm size in the early post-war decades?

The dramatic change in the trend lineseems baffling—until one considers the pos-sibility that changes in economic policies andsocial norms came together by the late 1970sto inaugurate an era of something like freeagency for corporate executives. That expla-nation remains untested, admittedly, but itsfit with the long-run pay data is striking.

So what can we say about empirical sup-port for the hypothesis that changing policiesand norms have contributed to incomeinequality? Various studies of the effects ofspecific policies suggest a combination ofmodest to significant effects. No effort hasbeen made, however, to assess the overall effectof the relevant changes—or the relative signifi-cance of that effect compared to the variousstructural explanations of increased inequali-ty. More work thus remains to be done. Fornow, though, we can at least say that changesin policies and norms are definitely part of thestory of increased income inequality.

19

It makes sensethat policychanges thatunleashed competitiveforces simultane-ously unleasheddemand for themost productiveemployees.

Progressives versus Progress

As the above review of the historical recordand economic literature attests, Paul Krug-man and his fellow proponents of nostalgia-nomics deserve credit for calling attention tothe role that changes in economic policies andsocial norms may have played in the rise ofincome inequality. They fail, however, to offera full accounting of the relevant changes;instead, they have cherry-picked particularpolicies and norms from the past that allowthem to portray the early postwar decades as amodel of enlightened social order. AndKrugman compounds that failure by offeringa completely wrongheaded explanation ofhow the relevant changes came about.

What did cause the sweeping changes in pol-icy and social norms that made the economymore competitive and the culture more individ-ualistic? According to Krugman, the rise ofincome inequality is due to the rise to politicalpower of the modern conservative movement.Specifically, conservatives were able to exploit“white backlash”89 in the wake of the civil rightsmovement to hijack first the Republican Partyand then the country as a whole. Once in pow-er, they duped the public with “weapons ofmass distraction”90 (i.e., social issues and for-eign policy) while “cut[ting] taxes on the rich,”91

“try[ing] to shrink government benefits andundermine the welfare state,”92 and “empow-er[ing] businesses to confront and, to a largeextent, crush the union movement.”93

Alas, Krugman’s account is a crude carica-ture of historical analysis. To be sure, the riseof the conservative movement has con-tributed in important ways to the policy andcultural shifts of recent decades. But the realstory of those shifts is more complicated, andmore interesting, than Krugman lets on. Thefact is that influences from across the politi-cal spectrum have helped to shape the morecompetitive, more individualistic, and lessequal society we now live in.

Indeed, the relevant changes in socialnorms were led by movements associated withthe political left. The great civil rights cam-

paigns of the 1950s and ’60s exposed the ugli-ness of traditional racial bigotry and provokeda widespread move toward more enlightenedattitudes about race and ethnicity. One resultof that racial progress was the elimination ofnational-origin quotas in the Immigrationand Nationality Act of 1965, a piece of legisla-tion spearheaded by a young Senator EdwardKennedy. Meanwhile, the women’s movementof the 1960s and ’70s mounted a frontalassault on traditional notions about the sexu-al division of labor. And the counterculture ofthe 1960s, whose influence spread through-out American society in the “Me Decade” thatfollowed, upended the social ethic of group-minded solidarity and conformity with astampede of unbridled individualism and self-assertion.94 It seems likely that, with the gener-al relaxation of inhibitions of all kinds, talent-ed and ambitious people felt less inhibitedabout seeking top dollar in the marketplace.In that case, yippies and yuppies were simplytwo sides of the same coin.

As for changes in economic policies, theydid happen and they were dramatic. But con-trary to Krugman’s vast-right-wing-conspiracytheory, liberals and Democrats joined withconservatives and Republicans in pushing forthose changes. In addition to his role in liberal-izing immigration, Edward Kennedy was aleader in pushing through both the Airline De-regulation Act of 1978 and the Motor CarrierAct of 1980 that deregulated the truckingindustry—and he was warmly supported inboth efforts by left-wing activist Ralph Nader.President Jimmy Carter signed these two piecesof legislation, as well as the Natural Gas PolicyAct of 1978 (which began the elimination ofprice controls on natural gas) and the StaggersRail Act of 1980 (which deregulated the rail-road industry).

The three most recent rounds of multilat-eral trade talks were all concluded by Demo-cratic presidents: the Kennedy Round in 1967by Lyndon Johnson; the Tokyo Round in 1979by Jimmy Carter; and the Uruguay Round in1994 by Bill Clinton. And although the slash-ing of the top income tax rate from 70 percentto 50 percent was one of President Ronald

20

Krugman’saccount is a crude

caricature of historical analysis.

Reagan’s signature accomplishments, the TaxReform Act of 1986, which pushed the toprate all the way down to 28 percent, was spon-sored by two Democrats, Senator Bill Bradleyand Rep. Richard Gephardt.

And what about unions? Krugman isright that policy changes contributed to theirdecline, but his ideological blinkers lead himto identify the wrong ones. The real culpritwasn’t conservative anti-union bias in laborpolicy: the effect of Republican administra-tions on union fortunes has been minimal.What really mattered, instead, was the bipar-tisan effort to unwind restrictions on domes-tic and foreign competition in goods and ser-vices markets. In the new, more competitiveenvironment, employment losses in union-ized sectors made declining union member-ship all but inevitable.

Krugman’s conspiracy theory may offer anemotionally satisfying tale for ideologicalopponents of modern conservatism, but as anobjective historical account it doesn’t even passthe laugh test. How then should we character-ize the dramatic changes in economic policiesand social norms over the past generation?

With all the appropriate caveats thatshould attend any sweeping historical general-ization, I submit that these changes representa broadly successful response to the challengesof social and economic development. To putthe matter more plainly, they representprogress.

The move toward a more individualistic,less group-minded, less tradition-minded cul-ture is not unique to the United States. Aspolitical scientist Ronald Inglehart has docu-mented in dozens of countries around theworld, this shift toward what he calls “post-modern” attitudes and values is the pre-dictable cultural response to rising affluenceand expanding choices. “In a major part of theworld,” Inglehart writes, “the disciplined, self-denying, and achievement-oriented norms ofindustrial society are giving way to an increas-ingly broad latitude for individual choice oflifestyles and individual self-expression.”95

The increasing focus on individual fulfill-ment means, inevitably, less deference to tradi-

tion and organizations. “A major componentof the Postmodern shift,” according toInglehart, “is a shift away from both religiousand bureaucratic authority, bringing declin-ing emphasis on all kinds of authority. Fordeference to authority has high costs: the indi-vidual’s personal goals must be subordinatedto those of a broader entity.”96 Paul Krugmanmay long for the return of self-denying corpo-rate executives who declined to seek betteropportunities out of organizational loyalty,but they are creatures of a bygone ethos—anethos that also included uncritical acceptanceof racist and sexist traditions and oftenbrutish intolerance of deviations from main-stream lifestyles and sensibilities.

What is the connection between economicgrowth and cultural individualism? In Ingle-hart’s view, the key is the freedom to shift one’sattention from physical survival and securityto other needs and goals. “This shift in world-view and motivations,” he states, “springs fromthe fact that there is a fundamental differencebetween growing up with an awareness thatsurvival is precarious, and growing up with thefeeling that one’s survival can be taken forgranted.”97 As Inglehart elaborates:

Individuals under high stress have aneed for rigid, predictable rules. Theyneed to be sure what is going to happenbecause they are in danger—their mar-gin for error is slender and they needmaximum predictability. Postmodern-ists embody the opposite outlook:raised under conditions of relative secu-rity, they can tolerate more ambiguity;they are less likely to need the security ofabsolute rigid rules.98

The emergence of a more individualisticethos thus represents a case of cultural adap-tation to new social conditions. The adventof American mass prosperity in the yearsafter World War II was a new social realitythat called for the development of a new, cor-responding set of social norms. That devel-opment occurred, however messily, in thecultural upheavals of the 1960s and ’70s.

21

The emergence of a more individualisticethos representsa case of culturaladaptation tonew social conditions.

Following quickly on their heels were theeconomic upheavals of the 1970s and ’80s: theoil shocks of 1973 and 1979; the “GreatInflation,” combined (to the consternation ofthe prevailing Keynesian macroeconomic con-sensus) with the recession of 1973–75; theabrupt slowdown in productivity growth; andthe harsh, disinflating recession of 1980–82.These crises provided the political impetus fora reorientation of American political economytoward greater reliance on entrepreneurshipand market competition—in other words, theshift from the Treaty of Detroit to the Wash-ington Consensus. In particular, much of thesweeping economic deregulation during thatperiod was justified at the time as a means ofcombating inflation. More generally, just asthe Great Depression moved public opiniontoward acceptance of greater governmentinvolvement in economic affairs, the stagfla-tion of the 1970s created popular support forthe idea that government intervention hadnow gone too far.

As happened in the 1930s, the swing inpopular sentiment and political rhetoric wasguided by an underlying shift in the intellec-tual climate—a shift that had been in the off-ing for many years. In the decades after theinstitutions of the Treaty of Detroit were hur-riedly slapped together, advances in econom-ics knocked major holes in many of theassumptions on which those institutions rest-ed. Consider, for example, the work of threecelebrated Nobel Prize–winning economists.Milton Friedman demonstrated that mone-tary policy failures, not the free market’s sup-posed tendency toward overproduction, lay atthe root of the Great Depression. GeorgeStigler’s studies of economic regulation re-vealed that “government failures” (in particu-lar, the phenomenon of “regulatory capture”)regularly foiled government attempts toaddress real or imagined market failures. AndF. A. Hayek’s insights illuminated the role ofmarket prices in coordinating the use ofknowledge dispersed throughout society—afunction that, even with the best of inten-tions, government officials lack the capacityto carry out.

During their careers, these men (and theUniversity of Chicago, with which all were affil-iated) were figures of considerable controversy.But today their achievements are recognizedthroughout the economics profession. Theyled economists, and well-informed opiniongenerally, to put a healthy respect for thewealth-creating power of market competition,and a healthy wariness of government effortsto second-guess markets, beyond serious intel-lectual dispute. “Milton Friedman . . . was thedevil figure of my youth,” recalled Harvardeconomist Lawrence Summers, who served asBill Clinton’s Treasury secretary and is nowdirector of President Obama’s National Eco-nomic Council. “Only with time have I come tohave large amounts of grudging respect. Andwith time, increasingly ungrudging respect.”99

The change in American political econo-my, with its greater emphasis on competitionand entrepreneurship, thus represented—inbroad brush at least, if not in every particu-lar—a distinct improvement in economic pol-icy that reflected an improved understandingof economic affairs. Future Supreme CourtJustice Stephen Breyer, then a professor atHarvard Law School (and formerly an aide toSenator Edward Kennedy who worked on air-line deregulation), offered this intellectualobituary for the old order back in 1982:

The most persuasive general theory ofregulation, popular among economistsand political scientists until the late1950s, held that regulation grew out ofa need for a regulatory program tosecure the “public interest” and that reg-ulators sought, to the best of their abili-ty, to secure the public interest asdefined in their enabling statutes. Thisview has been discredited by historiansand economists, who have argued thatmany forms of regulation, such astrucking or airline regulation, injure thegeneral public.100

To be sure, debate over the proper scope ofthe regulatory state still rages, especially at pre-sent in the wake of a serious financial crisis. Yet

22

The change in American

political economy,with its greater

emphasis on competition and

entrepreneurship,represented a

distinct improve-ment in economic

policy that reflected an

improved understanding ofeconomic affairs.

even now, there is no serious suggestion that weshould return to the days of financial repres-sion with controlled interest rates, branchingrestrictions, and a separation of commercialand investment banking. Even less conceivablewould be a resumption of regulated airline ortrucking or railroad rates, or across-the-boardtariff hikes, or a re-creation of the AT&Tmonopoly.

Although the defenders of old-style eco-nomic regulation have all but vanished fromthe scene, a great deal of acrimonious wran-gling over tax rates continues. Even here,however, interest in turning back the clockhas its limits. The Bush tax cuts are certainlycontroversial, but nobody is seriouslyproposing that top marginal rates should goback to their stratospheric, pre-Reagan levelsof 70 or 90 percent. And that is because thecentral insight of supply-side economics—that sufficiently high tax rates can have dele-terious effects on incentives to work andinvest—is now generally accepted. “Onceyou’re below the 40 percent range, peoplearen’t that sensitive,” observed the Harvardeconomist Lawrence Katz, who served in theClinton administration. “And once you’rewell above 50 percent people are sensitive.”101

It is telling that Katz’s first point is muchmore hotly debated than his second.

Let me turn now to an important but con-fused question: if the economic institutions ofthe Treaty of Detroit were really so flawed,how did they produce such great results? And,make no mistake, America’s economic perfor-mance during the early postwar decades wastruly wonderful. Not only were incomes con-verging, but they were rising smartly across theboard, thanks to sustained, vigorous growthin productivity. Between 1947 and 1973, out-put per worker in the nonfarm business sectorrose at an average annual rate of 2.9 percent—compared to 2.0 percent between 1980 and2006.102 Don’t those numbers show that thepolicies of the Treaty of Detroit were betterthan those of the Washington Consensus—not only from the standpoint of equity, butfrom the standpoint of efficiency as well?

This is Paul Krugman’s argument. “The

Great Compression, far from destroyingAmerican prosperity,” he writes, “seems if any-thing to have invigorated the economy. If thattale runs counter to what textbook economicssays should have happened, well, there’s some-thing wrong with textbook economics.”103

Krugman’s analysis here rests on a crudeconflation of correlation and causation. It istrue that, all thing being equal, we shouldexpect better economic policies to generatebetter economic performance. But in the realworld, all things are seldom equal; thusstrong performance is not always reliable evi-dence of good policies.

For example, countries can achieve highgrowth for a time by unsustainable means—by borrowing heavily or inflating the curren-cy, for example. Furthermore, relatively back-ward countries, notwithstanding seriouslyflawed institutions, can often grow fasterthan more advanced countries. Such “catch-up growth” is possible because it is easier toadopt technologies or organizational tech-niques developed elsewhere than to come upwith them on your own. Institutions that donot hinder catch-up growth, or that are evenconducive to it, can nonetheless becomeproblematic as a country approaches thetechnological frontier. Meanwhile, for coun-tries at that frontier, the specific challengesof economic growth change over time as acountry moves through different stages ofeconomic development. Institutions thatmay serve well enough at one stage can leadto difficulties later on. What works in the ear-ly stages of industrialization, for example,may work much less well in a postindustrial“knowledge economy.”

Untangling exactly why a country grew ata given rate during a given period of time isthus devilishly difficult. Not surprisingly,there is no generally accepted explanation forwhy the U.S. economy did so well in the earlypostwar decades. But several factors wereespecially conducive to strong performanceat that time. There was a pent-up demand forgoods and services after the privations of theGreat Depression and the mobilization ofWorld War II. There was also a pent-up sup-

23

If the economicinstitutions ofthe Treaty ofDetroit were really so flawed,how did they produce suchgreat results?

ply of new products that couldn’t be broughtto market during the depression and waryears. That pent-up supply was augmentedby technological and organizational break-throughs accelerated by the imperatives oftotal war. Big advances in transportation,communications, and air conditioning stim-ulated catch-up growth in the underdevel-oped South and underpopulated West. Andrapid upgrades in human capital (first explo-sive growth in high school graduates, thenexplosive growth in college graduates) doubt-less helped to spur productivity gains.

We will probably never have a fully satisfac-tory account of why the postwar decades weresuch banner years for the American economy.What we do have is very strong economic evi-dence that the elimination of barriers to com-petition beginning in the 1970s has, on thewhole, been good for productivity and growth.Analysis of specific deregulation initiativesshows sizable welfare gains for consumers andproductivity gains for producers;104 a volumi-nous literature documents the general con-nection between trade liberalization and fastereconomic growth as well as static efficiencygains;105 and a large body of research showsthat financial liberalization promotes overalleconomic growth.106

Let me focus here on one area where someeconomists have argued that restricting compe-tition can actually be good for productivity. Thearea is labor markets, and the restrictions takethe form of unionization and collective bar-gaining. Richard Freeman of Harvard, amongothers, has claimed that the collective voice pro-vided by unions, along with their bargainingpower, can create conditions that allow workersto do their jobs more effectively.107 Someresearch findings do support a positive connec-tion between unions and productivity, butthere are many contrary findings as well. Over-all, as Barry Hirsch has concluded, “my assess-ment of existing evidence is that the averageunion effect is very close to zero, and as likely tobe somewhat negative as somewhat positive.”108

What is beyond serious debate is thatunions in the United States reduce firms’ prof-itability. The hit to firms’ bottom lines doesn’t

just come at the expense of monopoly profitsin concentrated industries; in addition, itreflects a union “tax” on returns from long-term investments. As a result, and as the evi-dence clearly shows, the effect of unions is toreduce firms’ research and development, otherinvestment, and employment growth.109

All of which sets up a nasty dilemma. If orga-nized firms dominate a domestic industry andare relatively immune from foreign competi-tion, then unionization imposes a significantdrag on long-term economic dynamism. If, onthe other hand, organized firms face real com-petition from nonunionized firms at home andfrom foreign firms, union density will suffer aninevitable and ongoing decline over time.

The story of the rise and fall of private- sector unionism in this country is the story ofhow this dilemma was ultimately resolved: infavor of the country’s overall economic health,and against heavy unionization of industry.Perhaps, in the great wave of union organizingduring the 1930s and ’40s, firms’ acquiescencein unionization was the profit- and productiv-ity-maximizing move, at least in the shortterm. In the face of a highly aggressive labormovement stirred to militancy by the GreatDepression, buying labor peace with above-market wages and restrictive work rules mightwell have been cheaper than protracted strikesand ongoing workplace acrimony. Over time,though, the burdens of the union “tax” ledunionized firms to open plants in parts of thecountry less hospitable to union organizing—and led to the emergence of new firms in thoseparts of the country. Concurrently, the grad-ual rise of competition from Europe, Japan,and later less developed countries in thedecades since World War II—a phenomenonabetted by the ongoing fall of U.S. trade barri-ers—proved devastating for less competitiveunionized firms. Private-sector unionism hasthus been a victim of economic progress.

Conclusion

Paul Krugman is a brilliant economistwho has made important contributions to

24

There is verystrong economicevidence that the

elimination ofbarriers to

competitionbeginning in the

1970s has, on thewhole, been good

for productivityand growth.

his field. He has won, deservedly, the highestawards his profession can bestow. Yet ininterpreting America’s economic and socialhistory since World War II, he has allowed hisideological commitments to cloud his judg-ment. In lieu of objective analysis, he offersrosy-tinged nostalgia.

Krugman looks back to the America of hisboyhood and sees a society that combinedenergetic, activist government management ofeconomic affairs with vigorous growth andconverging incomes. Entranced by that vista,he imagines a Golden Age—not just of eco-nomic performance, but of economic policiesand social norms as well. “During the thirtiesand forties,” he writes, “liberals managed toachieve a remarkable reduction in incomeinequality, with almost entirely positive effectson the economy as a whole. The men andwomen behind that achievement offer today’sliberals an object lesson in the difference lead-ership can make.”110

The actual historical record is not nearly soneat and tidy. It is true that the quarter-centu-ry or so after World War II was a period of glit-tering economic growth and widely sharedprosperity. It is also true that the distinctivepolitical economy of that period contributedat least to some extent to the concurrent nar-rowing of the income distribution—and thatthis political economy was reinforced by a setof social norms now out of fashion.

But when that distinctive political econo-my is reviewed comprehensively and dispas-sionately, the conclusion that its effects were“almost entirely positive” becomes impossibleto sustain. On the contrary, what made theTreaty of Detroit distinctive was its pervasiverestrictions on competition in product, capi-tal, and labor markets. Consider high tradebarriers, farm price supports and productionlimits, price and entry regulations in trans-portation and energy, interest rate caps andbranching restrictions, national-origin immi-gration quotas—does Paul Krugman reallywish to defend such things? Yet all of thosepolicies—along with the labor laws, high min-imum wage, and progressive tax rates thatKrugman does celebrate—were constituent

elements of the postwar economic order. Allshared the same bias in favor of producer wel-fare at the expense of consumer welfare. And itwas that pro-producer, anti-competition biasthat served to promote income convergence:first, by limiting competition among less-skilled workers; and second, by limiting com-petition for the highest-skilled workers.

Meanwhile, the social norms that rein-forced the Treaty of Detroit were hardly onesthat a 21st-century progressive would beexpected to endorse. The social ethic that putdownward pressure on the paychecks of cor-porate executives also promoted conformismand groupthink. And it went hand in handwith the traditional racism and sexism that, intheir own ways, supported the GreatCompression. The social ethic fostered in-group solidarity, which Krugman lauds in thecorporate context. But that context was by nomeans the only one in which in-group solidar-ity among white males used to prevail. Thencame the convulsions of the 1960s, which ush-ered in a new, more individualistic ethos—withdramatically different attitudes regardingrace, sex, sexual orientation, the permissiblescope of cultural expression, the role of reli-gion in public life, the nature of Americannational identity, respect for authority gener-ally . . . and, let’s not forget, loyalty to one’sboss and the seemliness of fat paychecks.

Here, stripped of nostalgia, is the actualstory of the connection between incometrends and changes in political economy andsocial norms. Economic policies were alteredto give wider scope to entrepreneurship andcompetition, in accordance with advances ineconomics. Social norms shifted away froman emphasis on loyalty to the group andtoward a greater emphasis on personal ful-fillment (including through elective mem-bership in groups of our own choosing). Theupshot of these changes was to add to theincrease in income inequality over the pastgeneration through the following channels:

• Increasing the supply of less-skilledworkers (through increased immigra-tion)

25

Krugman has allowed his ideological commitments to cloud his judgment. In lieuof objectiveanalysis, he offers rosy-tingednostalgia.

• Decreasing the relative demand for less-skilled workers (through increased im-ports of labor-intensive products)

• Decreasing the ability of less-skilledworkers to command above-marketwages through minimum wage laws

• Decreasing wage compression throughcollective bargaining

• Increasing competition among employ-ers for the most-skilled workers (becauseof a stronger connection between firmproductivity and firm performance, andreduced barriers to moving from firm tofirm)

• Amplifying underlying income trendsthrough assortative mating and thegrowing prevalence of two-earner house-holds

There is no morality tale here. Economic insti-tutions improved, and social norms improved,but as a result incomes diverged.

The rise in income inequality does raiseissues of legitimate public concern. And rea-sonable people disagree hotly about what canand ought to be done to ensure that America’sprosperity is more widely shared. But the cari-cature of postwar history put forward byKrugman and other purveyors of nostalgia-nomics won’t lead us anywhere. Reactionaryfantasies about the good old days never do.

Notes1. Paul Krugman, The Conscience of a Liberal (NewYork: Norton, 2007), p. 244.

2. Ibid., p. 149.

3. Paul Krugman, “For Richer,” New York Times,October 20, 2002.

4. Paul Krugman, “Losing Our Country,” NewYork Times, June 10, 2005.

5. Claudia Goldin and Robert A. Margo, “TheGreat Compression: The Wage Structure in theUnited States at Mid-Century,” Quarterly Journalof Economics 107, no. 1 (February 1992): 1–34.

6. Paul Krugman, “Wage, Wealth and Politics,”New York Times, August 18, 2006.

7. For high school graduation rates, see U.S.Census Bureau, The Statistical History of the UnitedStates from Colonial Times to the Present (New York:Basic Books, 1976), p. 379. The graduation rate isestimated as the ratio of high school graduates ina given year to the number of 17-year-olds in thatsame year.

8. Krugman, Conscience of a Liberal, p. 137.

9. Thomas Piketty and Emmanuel Saez, “IncomeInequality in the United States, 1913–1998,”Quarterly Journal of Economics 118, no. 1 (February2003): 1–39, http://elsa.berkeley.edu/~saez/pikettyqje.pdf.

10. Frank Levy and Peter Temin, “Inequality andInstitutions in 20th Century America,” NationalBureau of Economic Research Working Paper no.13106, May 2007.

11. This turn of phrase was used by a youngDaniel Bell, then the labor editor of Fortune, todescribe the landmark 1950 deal between GeneralMotors and the United Auto Workers. “TheTreaty of Detroit,” Fortune, July 1950.

12. Here Levy and Temin put a new spin on econ-omist John Williamson’s well-known term for thereform package generally prescribed to develop-ing countries during the 1980s and ’90s. See JohnWilliamson, “What Washington Means by PolicyReform,” in Latin American Adjustment: How MuchHas Happened? ed. John Williamson (Washington:Institute for International Economics, 1990).

13. Wojciech Kopczuk and Emmanuel Saez, “TopWealth Shares in the United States, 1916–2000:Evidence from Estate Tax Returns,” National TaxJournal 57, no. 2, part 2 (June 2004): 456, Fig. 2,http://elsa.berkeley.edu/~saez/estateshort.pdf.

14. Peter Gottschalk and Robert Moffitt, “TheGrowth of Earnings Instability in the U.S. LaborMarket,” Brookings Papers on Economic Activity 25,no. 2 (1994): 217–72.

15. U.S. Census Bureau, Income, Poverty, and HealthCoverage in the United States: 2007 (Washington:Government Printing Office, 2008), Table A-3, pp.40–41, http://www.census.gov/prod/2008pubs/p60-235.pdf.

16. Terry J. Fitzgerald, “Has Middle America Stag-nated?” Federal Reserve Bank of Minneapolis TheRegion, September 2007, pp. 15–59, http://www.minneapolisfed.org/pubs/region/07-09/wages.pdf.

17. See Alan Reynolds, “Has U.S. Income InequalityReally Increased?” Cato Institute Policy Analysis no.

26

586, January 8, 2007, http://www.cato.org/pubs/pas/pa586.pdf.

18. Jerry Kramer, Instant Replay (New York: SignetBooks, 1968), p. 23.

19. The guards in question are Alan Faneca, SteveHutchinson, and Larry Allen. The other startingguard from the 2007 Pro Bowl, Will Shields,retired before the 2007 season. For 2007 NFLsalaries, see http://content.usatoday.com/sports/football/nfl/salaries/playersbyposition.aspx?pos=122.

20. Census Bureau, Income, Poverty, and HealthCoverage in the United States: 2007, Table A-3, pp.40–41.

21. Carola Frydman and Raven E. Saks, “Exec-utive Compensation: A New View from a Long-Term Perspective, 1936–2005,” National Bureauof Economic Research Working Paper no. 14145,June 2008, Table 3, p. 40; Figure 1, p. 47.

22. For the sake of convenience, I will use the term“income inequality” to refer generally to incomeand wage inequality.

23. For a solid defense of the SBTC hypothesis, seeAaron Steelman and John A. Weisberg, “What’sDriving Wage Inequality?” Federal Reserve Bank ofRichmond Economic Quarterly 91, no. 3 (Summer2005): 1–17, http://richmondfed.org/publications/research/economic_quarterly/2005/summer/pdf/steelmanweinberg.pdf.

24. Another related issue that has received com-paratively little attention in the inequality litera-ture is the possibility that skills at the low end ofthe socioeconomic spectrum have actually de-clined. For a brief discussion of this possibility,see William A. Niskanen, “Creating Good Jobs atGood Wages,” in Reflections of a Political Economist:Selected Articles on Government Policies and PoliticalProcesses (Washington: Cato Institute, 2008), p. 65.

25. Claudia Goldin and Lawrence F. Katz, The Racebetween Education and Technology (Cambridge, MA:Belknap Press of Harvard University Press, 2008),Table 3.2, p. 101.

26. Ibid., note 18, p. 391.

27. Thomas Lemieux, “Increasing Residual WageInequality: Composition Effects, Noisy Data, orRising Demand for Skill?” American Economic Re-view 96, no. 3 (June 2006): 461–98.

28. See Sherwin Rosen, “The Economics of Super-stars,” The American Economic Review 71, no. 5(December 1981): 845–58.

29. See Bruce Bartlett, “The Truth about Trade inHistory,” in Freedom to Trade: Refuting the New Pro-tectionism, ed. Edward L. Hudgins (Washington:Cato Institute, 1997), Figure 1, p. 13.

30. William F. Shughart II, “A Public ChoicePerspective of the Banking Act of 1933,” Cato Journal7, no. 3 (Winter 1988): 595–613.

31. Raghuram G. Rajan and Luigi Zingales, SavingCapitalism from the Capitalists: Unleashing the Power ofFinancial Markets to Create Wealth and SpreadOpportunity (New York: Crown Business, 2003),pp. 220–22.

32. Raghuram G. Rajan and Luigi Zingales, “TheGreat Reversals: The Politics of Financial Develop-ment in the Twentieth Century,” Journal of FinancialEconomics 69, no. 1 (2003): 5–50, Table 3.

33. Ibid., pp. 18–19.

34. For empirical evidence in support of thispoint, see Raghuram G. Rajan and LuigiZingales, “Financial Dependence and Growth,”The American Economic Review 88, no. 3 (June1998): 559–86.

35. For a history of U.S. income tax rates, seehttp://www.taxfoundation.org/publications/show/151.html.

36. William M. Gentry and R. Glenn Hubbard,“Tax Policy and Entrepreneurial Entry,” AmericanEconomic Review 90, no. 2 (May 2000): 283–87. Seealso William M. Gentry and R. Glenn Hubbard,“‘Success Taxes,’ Entrepreneurial Entry, and Inno-vation,” unpublished working paper, draft datedApril 30, 2004, http://www.williams.edu/Economics/gentry/6_08_04_Success_Taxes.pdf; WilliamM. Gentry and R. Glenn Hubbard, “Tax Policy andEntry into Entrepreneurship,” unpublished work-ing paper, draft dated June 8, 2004, http://www.williams.edu/Economics/gentry/Tax%20Policy%20and%20Entrepreneurial%20Entry_6-10-04.pdf.For a contrasting view, see Julie Berry Cullen andRoger H. Gordon, “Taxes and EntrepreneurialActivity: Theory and Evidence for the U.S.,”National Bureau of Economic Research WorkingPaper no. 9015, June 2002.

37. Census Bureau, Statistical History, p. 178.

38. Daniel Bell, “The Capitalism of the Proletariat:A Theory of American Trade-Unionism,” in TheEnd of Ideology (Glencoe, IL: Free Press, 1960), p.210.

39. Levy and Temin, p. 17.

40. Census Bureau, Statistical History, pp. 12, 14.

27

41. Douglas S. Massey, Categorically Unequal: TheAmerican Stratification System (New York: RussellSage Foundation, 2007), pp. 120–28.

42. Ellis W. Hawley, The New Deal and the Problem ofMonopoly: A Study in Economic Ambivalence (NewYork: Fordham University Press, 1995 [1966]), p.270.

43. Quoted in John M. Jordan, Machine-Age Ideology:Social Engineering and American Liberalism, 1911–1939(Chapel Hill: University of North Carolina Press,1994), p. 250.

44. Quoted in Krugman, “For Richer.”

45. Ibid.

46. Quoted in Roger Daniels and Otis L. Graham,Debating American Immigration, 1882 to the Present(Lanham, MD: Rowman & Littlefield, 2001), p. 201.

47. Lyndon B. Johnson, Remarks at the Signing ofthe Immigration Bill, October 3, 1965, http://www.lbjlib.utexas.edu/Johnson/archives.hom/speeches.hom/651003.asp.

48. Census Bureau, Statistical History, pp. 12, 14;U.S. Census Bureau, The 2008 Statistical Abstract,Table 40, http://www.census.gov/compendia/statab/tables/08s0040.pdf.

49. Census Bureau, Statistical History, p. 128;Census Bureau, 2008 Statistical Abstract, Table 570,http://www.census.gov/compendia/statab/tables/08s0570.pdf.

50. David Riesman, with Nathan Glazer andReuel Denney, The Lonely Crowd (New Haven, CT:Yale University Press, 1989 [1950]), p. 18.

51. Census Bureau, Statistical History, p. 11.

52. Ibid., p. 139.

53. William H. Whyte, The Organization Man,(Garden City, NY: Doubleday Anchor Books, 1956),p. 8.

54. Ibid., p. 74.

55. Ibid., p. 77.

56. Ibid., p. 150.

57. Ibid.

58. Ibid., p. 152.

59. See, for example, Judith Rich Harris, TheNurture Assumption: Why Children Turn Out the WayThey Do (New York: Touchstone, 1999), pp. 123–45.

60. CensusBureau, 2008 Statistical Abstract, Table642, http://www.census.gov/compendia/statab/tables/08s0642.pdf.

61. For nominal values of the federal minimumwage since 1938, see http://usgovinfo.about.com/library/blminwage.htm; for conversion to realdollars, see http://data.bls.gov/cgi-bin/cpicalc.pl.

62. Levy and Temin, p. 17.

63. For a history of U.S. income tax rates, seehttp://www.taxfoundation.org/publications/show/151.html.

64. For total customs duty revenue in 2006, seeOffice of Management and Budget, Historical Tables,Budget of the United States Government, Fiscal Year 2008(Washington: Government Printing Office, 2007),Table 2.5, http://www.whitehouse.gov/omb/budget/fy2008/pdf/hist.pdf; for total merchandise im-ports in 2006, see Census Bureau, 2008 StatisticalAbstract, Table 1272, http://www.cen sus.gov/compendia/statab/tables/08s1272.pdf.

65. For an in-depth account of these changes innorms, see Brink Lindsey, The Age of Abundance:How Prosperity Transformed America’s Politics andCulture (New York: Collins, 2007).

66. See, for example, David S. Lee, “Wage In-equality during the 1980s: Rising Dispersion orFalling Minimum Wage?” Quarterly Journal ofEconomics 114 (August 1999): 997–1023; DavidCard and John DiNardo, “Skill-Biased Technol-ogical Change and Rising Wage Inequality: SomeProblems and Puzzles,” National Bureau of Re-search Working Paper no. 8769, February 2002.

67. For nominal values of the federal minimumwage since 1938, see http://usgovinfo.about.com/library/blminwage.htm; for conversion to realdollars, see http://data.bls.gov/cgi-bin/cpicalc.pl.

68. Steven E. Haugen and Earl F. Mellor, “Estimat-ing the Number of Minimum Wage Workers,”Monthly Labor Review, June 1990, pp. 70–74, http://www.bls.gov/opub/mlr/1990/01/rpt1full.pdf.

69. See Barry T. Hirsch, David A. Macpherson, andEdward J. Schumacher, “Measuring Union andNonunion Wage Growth: Puzzles in Search ofSolutions,” in The Changing Role of Unions: NewForms of Representation, ed. Phanindra V. Wunnuva,(Armonk, NY: M. E. Sharpe, 2004), pp. 115–47.

70. Robert J. Gordon and Ian Dew-Becker, “Un-resolved Issues in the Rise of American Inequality,”paper presented at Brookings Panel on EconomicActivity, Washington, September 7, 2007, p. 5,http://www.people.fas.harvard.edu/~idew/papers/BPEA_final_ineq.pdf.

28

71. David Card, “Falling Union Membership andRising Wage Inequality: What’s the Connection?”National Bureau of Economic Research WorkingPaper no. 6520, April 1998. Among women, bycontrast, union density fell for less-skilled workerswhile rising for higher-skilled workers during theperiod in question, with little net change overall.

72. Levy and Temin, p. 33.

73. Levy and Temin, p. 34; Krugman, Conscience ofa Liberal, p. 151.

74. Henry S. Farber and Bruce Western, “Round Upthe Usual Suspects: The Decline of Unions in thePrivate Sector, 1973–1998,” Princeton UniversityIndustrial Relations Section Working Paper no.437, April 2000.

75. Barry T. Hirsch, “Sluggish Institutions in aDynamic World: Can Unions and IndustrialCompetition Coexist?” Institute for the Study ofLabor (IZA) Discussion Paper no. 2930, July 2007.

76. Ibid., p. 6.

77. For an interesting account of unions’ declinealong similar lines, see Michael Wachter, “TheRise and Decline of Unions,” Regulation, Summer2007, pp. 23–29, http://www.cato.org/pubs/regulation/regv30n2/v30n2-2.pdf.

78. Paul Krugman, “Growing World Trade: Causesand Consequences,” Brookings Papers on EconomicActivity 26, no. 1 (1995): 327–62.

79. Paul Krugman, “Trade and Wages, Recon-sidered,” draft paper for the Spring 2008 BrookingsPanel on Economic Activity, Washington, February2008, http://www.princeton.edu/~pkrugman/pk-bpea-draft.pdf.

80. George J. Borjas, “The Labor Demand Curve IsDownward Sloping: Reexamining the Impact ofImmigration on the Labor Market,” QuarterlyJournal of Economics 18, no. 4 (2003): 1335–74.

81. Robert I. Lerman, “U.S. Wage-Inequality Trendsand Recent Immigration,” American Economic Re-view 89, no. 2 (May 1999): 23–28.

82. Ibid.

83. Massey, Figure 2.5, p. 44; p. 230.

84. Gary Burtless and Christopher Jencks, “Ameri-can Inequality and Its Consequences,” in Agenda forthe Nation, ed. Henry Aaron, James Lindsay, andPietro Nivola (Washington: Brookings InstitutionPress, 2003), p. 65.

85. Gary Burtless, “Effects of Growing Wage

Disparities and Changing Family Composition onthe U.S. Income Distribution,” Brookings Insti-tution Center on Social and Economic DynamicsWorking Paper no. 4, July 1999.

86. See Robert H. Frank and Philip J. Cook, TheWinner-Take-All Society: Why the Few at the Top Get SoMuch More Than the Rest of Us (New York: PenguinBooks, 1996), pp. 45–60. In their discussion of thegrowth of “winner-take-all” markets in which topperformers earn disproportionately more thanothers in their field, Frank and Cook mentionderegulation and trade liberalization as factors inraising the market value of top performers.

87. Lawrence M. Kahn, “The Sports Business as aLabor Market Laboratory,” in The Business of Sports,ed. Scott R. Rosner and Kenneth L. Shropshire(Boston: Jones and Bartlett, 2004), p. 246.

88. Frydman and Saks, pp. 2–3.

89. Krugman, Conscience of a Liberal, p. 106.

90. Ibid., p. 173.

91. Ibid., p. 158.

92. Ibid.

93. Ibid., pp. 114–15.

94. See Lindsey.

95. Ronald Inglehart, Modernization and Postmod-ernization: Cultural, Economic, and Political Change in43 Societies (Princeton, NJ: Princeton UniversityPress, 1997), p. 28.

96. Ibid., p. 39.

97. Ibid., p. 31.

98. Ibid., p. 40.

99. Quoted in Daniel Yergin and Joseph Stanislaw,The Commanding Heights: The Battle between Govern-ment and the Marketplace That Is Remaking the ModernWorld (New York: Simon & Schuster, 1998), p. 151.

100. Stephen Breyer, Regulation and Its Reform(Cambridge, MA: Harvard University Press, 1982),p. 10.

101. Quoted in Daniel Gross, “Marginal Bene-fits,” Slate, June 3, 2003.

102. See Bureau of Labor Statistics, “Productivityand Costs,” http://www.bls.gov/lpc/prodybar.htm; 2008 Economic Report of the President,Table B-49, http://www.gpoaccess.gov/eop/2008/B49.xls.

29

103. Krugman, Conscience of a Liberal, p. 56.

104. See, for example, Alfred E. Kahn, “Airline De-regulation,” The Concise Encyclopedia of Economics, 1sted., http://www.econlib.org/library/Enc1/AirlineDeregulation.html; Thomas Gale Moore, “Truck-ing Deregulation,” The Concise Encyclopedia of Eco-nomics, http://www.econlib.org/library/Enc/TruckingDeregulation.html.

105. For a recent analysis of the effects of tradeliberalization on growth, see Romain Wacziargand Karen Horn Welch, “Trade Liberalization andGrowth: New Evidence,” World Bank EconomicReview 22, no. 2 (June 2008): 187–231.

106. See, for example, Ross Levine, “Financial Devel-opment and Economic Growth: Views and Agenda,”Journal of Economic Literature 35 (June 1997):688–726; Raghuram Rajan and Luigi Zingales,

“Financial Dependence and Growth,” American Eco-nomic Review 88, no. 3 (June 1998): 559–86.

107. See Richard B. Freeman and James L. Medoff,What Do Unions Do? (New York: Basic Books, 1984).

108. Barry T. Hirsch, “What Do Unions Do forEconomic Performance?” Institute for the Studyof Labor (IZA) Discussion Paper no. 892, October2003, p. 21.

109. See Hirsch, “What Do Unions Do forEconomic Performance?” Note that even RichardFreeman accepts these findings. See Richard B.Freeman, “What Do Unions Do? The 2004 M-Brane Stringtwister Edition,” National Bureauof Economic Research Working Paper no. 11410,June 2005.

110. Krugman, Conscience of a Liberal, p. 56.

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