What This Election is Really All About

The Economics of the 2016 Election Cycle

The current election cycle in the United States is like none other in recent memory. At least in terms of vitriol, it is no contest. But beyond the partisan slams back and forth lies a deeper fundamental reality which really lies at the heart of the contest.

In fact, despite surface appearances, this is not a typical Democrat versus Republican, left-wing versus right-wing, liberal versus conservative, election. It goes far deeper than that.

My own wish is that partisans on both sides would suspend judgement for a moment, follow me through a rather involved analysis of the economics underlying the current political situation, and think through the implications. In advance, the author thanks you for your attention.


Vantage points are everything. We have a good one provided us by the Keynesian economist, Thomas Palley. Palley’s leftist credentials are impeccable, as might be expected from a former Assistant Director of Public Policy for the AFL-CIO. As such, the following exposition can make the claim, at any rate, to being something other than a mere partisan discussion. The hope is that we get beyond the left-right divide as it has manifested itself in the current political landscape, to the underlying realities that transcend that divide as currently manifested.

Back in 2009, Palley wrote a significant article[1] outlining the real underlying causes of the financial meltdown and credit crisis of 2008. In the course of explaining that catastrophic course of events, Palley ends up providing a succinct summation of the condition of the world economy generally, that retains its applicability to this day.

As Palley has it, the standard explanations of market failure do not go nearly far enough, which is a significant admission by a left-leaning economist. For the usual explanation of economic problems provided by economists of this persuasion puts the blame precisely on market failure. This time is different. “Most commentary has … focused on market failure in the housing and credit markets. But what if the house price bubble developed because the economy needed a bubble to ensure continued growth? In that case the real cause of the crisis would be the economy’s underlying macroeconomic structure” (p. 1).

In other words, the housing bubble was not an unfortunate unforeseen occurrence: it was fostered by deliberate, albeit blind, policy. How and why such a situation would actively be pursued, is the burden of Palley’s article.

The roots of the said macroeconomic arrangement actually go back decades. Palley traces them to the onset of the Reagan administration of 1980. “Before 1980, economic policy was designed to achieve full employment, and the economy was characterized by a system in which wages grew with productivity. This configuration created a virtuous circle of growth …. After 1980, with the advent of the new growth model, the commitment to full employment was abandoned as inflationary, with the result that the link between productivity growth and wages was severed. In place of wage growth as the engine of demand growth, the new model substituted borrowing and asset price inflation” (p. 2).

We must register a quibble with the timing of events here. 1980 did not happen in a vacuum. The hyperinflation of the 1970s is what discredited these Keynesian policies and the Reagan policy responses were the fairly obvious policy response. Anyone who lived through that period knows just how helpless everyone felt at the inability to tame the inflation dragon. In that regard, the Reagan response was inevitable and welcomed.

What really precipitated the new macroeconomic arrangement was the abandonment of the previous such arrangement, the post-war Bretton Woods currency and trade setup. This occurred not in 1980, but in 1971, with President Nixon’s abandonment of the dollar-gold link. What this meant was a switch from fixed to floating exchange rates, which together with the advent of OPEC and skyrocketing oil prices, deranged a hitherto relatively stable situation currency and trade situation.

A graph provided in another of Palley’s articles[2] suggests the same correlation:

Productivity and real average hourly wage and compensation of US non-supervisory workers, 1947-2009. Source: EPI analysis of Bureau of Economic Analysis and Bureau of Labor Statistics data.
Productivity and real average hourly wage and compensation of US non-supervisory workers, 1947-2009. Source: EPI analysis of Bureau of Economic Analysis and Bureau of Labor Statistics data.

As can be seen in the accompanying figure, the divergence between productivity and compensation/wages begins in the early 1970s, corresponding with the breakup of Bretton Woods. So, it was the early 1970s and not 1980 that saw the change in fortunes of which we are speaking.

The new arrangement was characterized by a new priority: globalization. The preference for globalization expressed itself in a new attitude toward trade deficits. “Under the earlier economic model, policymakers viewed trade deficits as cause for concern because they represented a leakage of aggregate demand that undermined the virtuous circle of growth. However, under the post-1980 model, trade deficits came to be viewed as semi-virtuous because they helped to control inflation and because they reflected the choices of consumers and business in the marketplace” (p. 5).

This is a crucially important statement. It provides the kernel of what has been happening over the last 40 years. “The virtuous circle of growth” is Palley’s way of formulating what we in our own model (as described in the accompanying course) refer to as the circular flow of the economy. In essence, all economies are local, then regional, then national, and only then international. A “virtuous circle of growth” is what we understand as the domestic economy. But arrangements can be made that discombobulate this order. What we then have is the domestic economy subordinated to supranational interests. In essence, it is a form of colonialism. And that is what Palley is referring to when he speaks of a “leakage of aggregate demand.” The circular flow is disrupted; supply and demand are disconnected from each other in the domestic economy, diverted toward an international economy characterized by trade deficits and surpluses, the ineluctable by-products of these “leakages.”

This arrangement is papered over by appeals to free-market principles. Hence the epithet “neoliberalism.” These trade deficits do indeed help to control inflation, but at a steep price. And they may reflect “the choices of consumers and business in the marketplace,” but without consumers and business realizing that there is a flip side to these cheap imports, and that is the loss of employment and productive capacity.

For what do these trade deficits actually represent? For one thing, the systematic suppression of wages on both sides of the trade equation. “American workers are increasingly competing with lower-paid foreign workers.” This is obvious and well-known. What is less well-known is what is going on with these foreign workers: “That pressure is further increased by the fact that foreign workers are themselves under pressure owing to the so-called Washington Consensus development policy, sponsored by the International Monetary Fund (IMF) and the World Bank, which forces them into the same neoliberal box as American workers.” They are both being disadvantaged; they are being played against each other. For the loss of purchasing power on the part of American workers is not compensated for by increased demand from abroad, for foreign workers likewise are deprived of purchasing power, despite the fact that they are on the receiving end of the job-offshoring program. “Neoliberal policies not only undermine demand in advanced countries, they fail to compensate for this by creating adequate demand in developing countries” (p. 7; emphasis added).

This is the double bind in which workers find themselves, both in developed and developing countries.

In developed countries this arrangement has hit the manufacturing sector particularly hard. The idea has been spread abroad that in the US the decline of the manufacturing sector is the result of inevitable trends, in particular, increased productivity. But this does not explain the loss of jobs: “A smooth long run declining employment share brought about investment and innovation that creates a more efficient manufacturing sector is a fundamentally different proposition from decline caused by adoption of a policy paradigm that dismantles the manufacturing sector by encouraging off-shoring and undermining competitiveness” (p. 4). It is the latter, not the former, that explains the loss of manufacturing jobs. That is to say, the new macroeconomic arrangement with its leakage of production to low-wage countries is the real reason.

Accompanying the loss of manufacturing jobs has been a steady divergence in income share. “Between 1979 and 2006, the income share of the bottom 40 percent of U.S. households decreased significantly, while the income share of the top 20 percent increased dramatically. Moreover, a disproportionate part of that increase went to the 5 percent of families at the very top of income distribution rankings” (p. 6). Palley also points to increased labor market flexibility and the abandonment of full employment as a policy objective as factors behind widening income inequality, but the obvious driver of the process is the pressure on the job market brought on by the offshoring of jobs.

All of this has displaced what Palley terms the “stable virtuous circle growth model based on full employment and wages tied to productivity growth” (p. 9). What has taken its place? The new arrangement “based on rising indebtedness and asset price inflation.” These two, not productive activity, generate the income to fund consumption.

In the new arrangement, production takes place in developing countries, while consumption takes place in developed countries. Production has been divorced from consumption. This is the reality behind the ever-present trade imbalances characterizing the modern global economy.

In the old model, in line with Say’s Law, production funds consumption and consumption, production. This is the circular flow of the domestic economy, Palley’s “virtuous circle growth model.” The new model divorces production from consumption. Production no longer pays for consumption: the producers in developing countries have their wages suppressed, and so cannot provide increased demand, while the consumers in developed countries are not producing and selling enough to pay for their consumption. The shortfall is paid for by taking on debt: in terms of economic jargon, this is known as “financing the trade deficit.”

This in turn leads to asset bubbles. “Since 1980, each U.S. business cycle has seen successively higher debt/income ratios at end of expansions, and the economy has become increasingly dependent on asset price inflation to spur the growth of aggregate demand” (p. 9). Various asset markets have done duty to generate this asset inflation and thus artificial prosperity, yielding the dot.com bubble, stock market bubbles, and housing market bubbles. These bubbles are self-feeding phenomena: increases in asset prices spur borrowing based on those asset prices, which in turn encourages further spending leading to further increases in asset prices. But they also provide income to sustain standards of living that essentially are beyond the means of the underlying wealth-producing capacity of the economy.

Palley speaks in particular of the “the systemic role of house price inflation in driving economic expansions.” He points out that “Over the last 20 years, the economy has tended to expand when house price inflation has exceeded CPI (consumer price index) inflation.” This is true for the Reagan expansion, the Clinton expansion, and the Bush-Cheney expansion, and so is “indicative of the significance of asset price inflation in driving demand under the neo-liberal model” (p. 10), which has truly been a bipartisan affair.

Of course, “The problem with the model is that it is unsustainable.” It requires continued excessive borrowing and continued reductions in savings rates, which can only be sustained by ever-expanding asset inflation, which eventually must come to an end.

This dynamic lay behind the credit crisis of 2008, only this time things were different. Mainly, the degree of indebtedness, the breadth of participation in it – as might be expected from a bubble generated by the broader housing market – far exceeded previous instances and precipitated the enormous blow to the real economy, not to mention the carnage wrought to the financial economy.


Behind this macroeconomic structure lay the disruption of the production-consumption linkage of the domestic economy. It was this that made necessary the generation of artificial prosperity to maintain a standard of living, a level of consumption, without any connection to the level of production.

This macroeconomic structure was supported by trade policy. Palley points to the establishment of the North American Free Trade Agreement (NAFTA), the establishment of the “strong dollar” policy after the East Asian financial crisis of 1997, and permanent normal trade relations (PNTR) with China in 2000, as the “most critical elements” of the global economic arrangement. These were “implemented by the Clinton administration under the guidance of Treasury secretaries [sic] Robert Rubin and Lawrence Summers.” The measures “cemented the model of globalization that had been lobbied for by corporations and their Washington think-tank allies” (pp. 12-13).

The upshot was a global economic arrangement featuring a “triple hemorrhage:” leakage of spending on imports, leakage of jobs overseas, and leakage of investment overseas.

We gained a new economic arrangement in which trade deficits became the rule and the world became the production zone for US corporations, which could turn around and sell this production to compatriot consumers. “At the bidding of corporate interests, the United States joined itself at the hip to the global economy, opening its borders to an inflow of goods and exposing its manufacturing base. This was done without safeguards to address the problems of exchange rate misalignment and systemic trade deficits, or the mercantilist policies of trading partners” (p. 14).

This created a “widening hole” in the economy “undermining domestic production, employment, and investment.”

NAFTA in particular ushered in a new era of exchange-rate policy. “Before, exchange rates mattered for trade and the exchange of goods. Now, they mattered for the location of production” (p. 15). This worked to the advantage, of course, of multinational corporations, enabling them to pursue the policy of producing in low-wage markets and selling the production in developed markets. This in turn led to a strong dollar policy, likewise pushed by multinationals. “This reversed their commercial interest,” as US corporations previously favored a weak dollar, for obvious reasons.

The collapse of the peso in 1994 was a direct result of this new policy. In the new arrangement, the cheap peso was a boon to US corporations producing in Mexico and exporting to the US. “The effects of NAFTA and the peso devaluation were immediately felt in the U.S. manufacturing sector in the form of job loss; diversion of investment; firms using the threat of relocation to repress wages; and an explosion in the goods trade deficit with Mexico …. Whereas prior to the implementation of the NAFTA agreement the United States was running a goods trade surplus with Mexico, immediately afterward the balance turned massively negative and kept growing more negative up to 2007.”

The strong dollar policy was further implemented during the series of financial crises in the late 1990s, starting in East Asia. “In response to these crises, Treasury Secretaries Rubin and Summers adopted the same policy that was used to deal with the 1994 peso crisis, thereby creating a new global system that replicated the pattern of economic integration established with Mexico” (p. 16). The strong dollar increased the purchasing power of the US consumers: “critical because the U.S. consumer was now the lynchpin of the global economy, becoming the buyer of first and last resort.”

One result of this policy was that “manufacturing job growth was negative over the entirety of the Clinton expansion, a first in U.S. business cycle history” (p. 18). Positive business cycle conditions obscured the underlying trends; to add insult to injury, “the Clinton administration dismissed concerns about the long-term dangers of manufacturing job loss. Instead, the official interpretation was that the U.S. economy was experiencing—in the words of senior Clinton economic policy advisers Alan Blinder and Janet Yellen—a ‘fabulous decade’ significantly driven by policy.” Janet Yellen is, of course, the current Chair of the Federal Reserve Board.

The final step in this process was taken when China was granted the status of PNTR and then admitted to the World Trade Organization. “Once again the results were predictable and similar to the pattern established by NAFTA—though the scale was far larger.”

Hence, all the pieces were put in place during the 1980s and 1990s, but they did not come to full fruition until the crisis of 2008. “From that standpoint, the Bush-Cheney administration is not responsible for the financial crisis. Its economic policies … represented a continuation of the policy paradigm already in place. The financial crisis therefore represents the exhaustion of that paradigm rather than being the result of specific policy failures on the part of the Bush-Cheney administration” (p. 21).


Given the above, it is obvious that the credit crisis of 2008 was not the result of the usual suspects, deregulation of financial institutions and banks pushing excessive lending for no other reason but greed. The excessive lending was built into the structure; the entire world economy depended on it, for only through this asset-inflation-induced debt could US consumption, the driving force of economic growth in developing countries, be paid for.

So what is needed is paradigm change. And in this context, Palley, writing in 2009, makes a prophetic statement.

The case for paradigm change has yet to be taken up politically. Those who built the neoliberal system remain in charge of economic policy. Among mainstream economists who have justified the neoliberal system, there has been some change in thinking when it comes to regulation, but there has been no change in thinking regarding the prevailing economic paradigm. This is starkly illustrated in the debate in the United States over globalization, where the evidence of failure is compelling. Yet, any suggestion that the United States should reshape its model of global economic engagement is brushed aside as “protectionism. [sic]”, which avoids the real issue and shuts down debate (p. 25).

“Shuts down debate,” indeed. In the intervening period between 2009 and 2016, the topics of trade deficits, currency arrangements, and multilateral trade deals, have consistently been dismissed as matters of concern, denigrated as unworthy of debate; while proponents of such a re-evaluation have been routinely dismissed as cranks undeserving of serious attention.

As it happens, two candidates for the office of President have put this issue on the table, despite the bile they have received for it: Bernie Sanders and Donald Trump. The concerns of both have been dismissed out of hand by regnant opinion-makers. This should not come as a surprise. After all, “The neoliberal growth model has benefitted the wealthy, while the model of global economic engagement has benefitted large multinational corporations. That gives these powerful political interests, with their money and well-funded captive think tanks, an incentive to block change” (p. 26). Furthermore, “Judging by its top economics personnel, the Obama administration has decided to maintain the system rather than change it,” and subsequent history confirms this. In fact, at the time of writing, President Obama is promoting the latest iteration of this neoliberal arrangement, in the form of the Trans-Pacific Partnership (TPP).

It is not only the Obama administration that continues to push this arrangement. The entire Washington establishment, both Democrat and Republican, is fully behind the continuation of this unsustainable model. Given this intransigence, what is the logical next step? Palley points to it, and subsequent history has only confirmed it: “stagnation is the logical next stage of the existing paradigm” (p. 27). Ever-burgeoning debt that only gets rolled over and never repaid, leads, as the example of Japan teaches, only to economic stagnation, the so-called zombie economy.

Where does Hillary Clinton stand on this issue? Recent statements indicate softening in the direction of Sanders’ position, including announced opposition to TPP. Besides the pronounced skepticism with which such proclamations have been greeted by the left wing of the Democratic Party, there is the little matter of track record. After all, it was during her husband’s administration that all the pieces of the neoliberal program were implemented, and on that, she was with him all the way. Nothing in her subsequent record either as Senator for New York, or as Secretary of State, would indicate otherwise. Quite obviously, her current registered opposition to TPP was driven by Sanders, Trump, and poll numbers.

But beyond this is her place within the framework of what has become the Clinton global network. This network is anchored by a range of institutions: the Clinton Foundation, the Clinton Family Foundation, and the Clinton Global Initiative, among others. The Clinton Foundation was established in 1997 with the purpose to “strengthen the capacity of people throughout the world to meet the challenges of global interdependence.” The Clinton Global Initiative is part of this entity, although between 2009 and 2013 it was hived off, presumably in connection with Clinton’s stint as Secretary of State, to avoid the appearance of conflict.

Articles such as this one from the Washington Post, providing The Inside Story of How the Clintons Built a $2 Billion Global Empire, yield a glimpse into the global reach the Clintons enjoy within the current neoliberal framework. In fact, one might paraphrase Palley’s characterization of the US by saying that indeed the Clintons are joined at the hip with the neoliberal framework. We might go so far as to say that Hillary Clinton is the poster child of this framework, which doubtless is part of reason she enjoys such favorable press despite the fact that she carries so much baggage, of the kind that would have eliminated just about any other candidate.

And so it can be argued that the globalist corporate elite, which props up, and benefits from, the neoliberal arrangement, is promoting the Democrats’ progressive agenda, using it, exploiting it, the better to ensure that this pernicious arrangement remains cemented in place. Hillary Clinton is certainly progressive on social issues. The question is, is she progressive on economics? Let the record speak for itself.

Notes
  1. Thomas I. Palley, “America’s Exhausted Paradigm: Macroeconomic Causes of the Financial Crisis and Great Recession,” IPE Working Papers 02/2009, Berlin School of Economics and Law, Institute for International Political Economy (IPE). Available at https://goo.gl/gRkfD7.
  2. “Making Finance Serve the Real Economy,” in Thomas I. Palley and Gustav A. Horn (eds.), Restoring Shared Prosperity: A Policy Agenda From Leading Keynesian Economists (CreateSpace Independent Publishing Platform, 2013), p. 74. Available at http://goo.gl/1uJZv6.

Author: Ruben Alvarado