Economist Ravi Batra. (Photo: Vishal Malhotra)
Maverick Southern Methodist University economics professor Ravi Batra says the financial crisis is just one symptom of a long-festering economic disease - a disease caused by neglecting basic economic principles over the past 30 years. Comments made by President Obama seem to echo Dr. Batra's understanding of a domestic economy choked by consumer debt.
"Even as we're focused on the financial system and the credit markets, we are laying the foundation for what I'm calling a post-bubble economic growth market," Obama said Friday afternoon, adding "the days when we are going to be able to grow this economy just on an overheated housing market or people spending - maxing out on their credit cards, those days are over."
Dr. Batra insists that pursuing economic policies that begin to reverse a decline in the real wages of individual consumers is the only way to heal the limping economy. Changes in the "wage-productivity gap" - or the difference between how much consumers earn and the value of goods and services an economy produces - can explain the current situation and can help guide policy-makers out of it.
I spoke with Professor Batra about the current meltdown and how it can be viewed through the lens of the wage-productivity gap.
Matt Renner: What is the wage-productivity gap and how does it affect the health of an economy?
Dr. Ravi Batra: The wage-productivity gap is the gap between the real wage and labor productivity. The real wage is the purchasing power of the average salary. If productivity rises fast and the real wage rises slowly, then a wage-productivity gap develops and grows.
MR: When there is production and wages don't keep pace, what is the result?
RB: Productivity is the main source of supply, whereas wages are the main source of demand. If this wage-productivity gap keeps rising over time, supply will rise faster than demand and then we face the problem of overproduction.
Many like [former Federal Reserve Chairman Alan] Greenspan and other economists love the productivity rise, but if it leads to overproduction, that leads to high unemployment such as we are seeing now. Overproduction is a disaster and it leads to depressions.
If businesses don't sell what they produce, they lose money, and when they lose money, they have to lay off people.
MR: In the United States, how did the recent wage-productivity gap begin to rise?
RB: It started off with [President Ronald] Reagan. The wage-productivity gap started to develop in 1981. Reagan's economic policies increased productivity while restraining wages. One example is "free trade," which increased productivity but also reduced the real wage in the United States.
Also, the policy of regressive taxation. Reagan raised every tax that burdens the poor, but sharply reduced the income tax; all this caused a fall in consumer demand. Economic growth fell after Reagan's policies were introduced. Slow economic growth leads to pressure on wages because low growth means low demand for labor relative to labor's supply, so wages fall.
The third reason the wage-productivity gap grew as a result of Reagan was the "merger mania." Big firms were permitted to merge with each other. Each time there was a merger, there were layoffs, which also exerted downward pressure on wages. Mergers also increase productivity, further widening the gap. Reagan's anti-union policies were also responsible for the falling wages.
MR: If the wage-productivity gap was widening, how did policy-makers prevent the inevitable overproduction and economic contraction?
RB: Each time the wage-productivity gap goes up, the economy will contract because of overproduction. What they did was come up with a scheme to create debt in the economy because, by creating debt, they could raise demand to the level of supply.
Initially they started off with increased government debt. The deficit went up under Reagan, which raised demand to the level of supply. Then Greenspan took over as Federal Reserve chairman and whenever there was the threat of overproduction, like when the stock market crashed in 1987, he brought interest rates down sharply. By bringing interest rates down, he lured people into borrowing. This began to create private debt on a larger scale.
This really postponed the wage-productivity gap problems for the future because under these policies, productivity rose every year, so debt had to increase every year unless wages were to rise. Since productivity rises exponentially, debt had to rise exponentially as well. In such a situation, it is not hard to imagine a day when the credit system would simply explode. That's what happened starting in 2006 or 2007.
MR: The financial emergency, or the freeze in lending, is being touted as the most pressing aspect of the crisis. Why are banks unable or unwilling to lend?
RB: The biggest problem is that consumer debt is so high and the public has used up all its collateral. The banks don't feel confident enough to lend to anybody. The banks have lost so much money that they are feeling gun-shy now.
What we are seeing now is called "debt-unraveling" which is the biggest pain in the world. The potential for this scenario is worse than what happened in the Great Depression. During the Great Depression, consumers did not have that much debt.
The situation could be as bad as the Great Depression because, while banks are protected by the government, the 401ks and other investment plans are not protected. People are losing their savings through the fall in stock prices. The end result is the same: their savings are disappearing - the same thing that happened in the Great Depression.
MR: What policies close a wage-production gap?
RB: We should be following policies that close a wage-production gap, but that means you have to go against policies that created it: free trade, regressive taxation, and merger mania. This is not going to be easy and it will require a revolution in thinking.
This will entail breaking up companies, raising taxes on the rich and lowering them for the poor. I'm not sure the country is ready for this yet, but it will be once we fall deeper into the abyss.
MR: What do you think about the current steps the Obama administration is taking to address the economy?
RB: First of all, they are confusing cause with effect. They think the cause is the financial crisis, but actually that is the effect. The cause is the rise in the wage-productivity gap. The gap between supply and natural demand [as opposed to artificial demand created by easy access to debt] is so vast now. That gap cannot be plugged easily, especially if you're not looking in the right place.
Freeing the credit markets won't end the recession, because why would a bank lend money when it's afraid that it won't come back? When the borrowers are not creditworthy and have no collateral, why would a bank want to lend them money?
The Obama administration should focus on trying to help the economy grow. The stimulus package will help in the sense that it will slow down the bleeding, but it won't stop it. If all the policies that led to the growing wage-production gap remain in place, the stimulus package will not end the recession. Balancing trade - reducing the trade deficit to zero - would be a huge step in the right direction.
Look at the economic policies of the 1950's and 1960's - balanced trade, breaking up monopolies - for example, Exxon-Mobil will have to become Mobil and Exxon; raise taxes on the wealthy and cut them on the poor. Those economic policies will close the wage gap. Those were the decades in which growth was very strong, between four and four and a half percent every year. Since Reagan took over, growth has been three percent or less.