In my column last month I rejected one of the centerpieces of the new Democratic Congress’ agenda — a hefty raise in the minimum wage — on the grounds that it will price out of the market the very workers (low-skilled and undereducated) it is intended to help. While that specific proposal is deeply flawed, Democrats are entirely correct in their concern about the falling fortunes of the middle class. All right, wise guy, what would you do instead?

First, let’s define the problem, because overheated rhetoric has obscured it. After World War II, for about a generation (from the late 1940s till 1973) the middle class flourished. America was the world’s manufacturer, and manufacturing workers could mass-produce and earn good livings. It was the first time in recorded history that high school dropouts could earn middle class wages. But beginning in the early 1970s, productivity growth slackened, which meant incomes did also. (Your income can’t grow faster than the value of what you produce.) This was not a Reaganite plot; it happened throughout the industrialized world, for reasons still being debated by economists.

Productivity boomed back in the late 1990s and has stayed high. Good news for the middle class? Only in theory. In fact, the stagnant incomes that affected only high school graduates and dropouts in the generation after 1980 have in the past few years spread to college graduates also. About the only group making real economic headway are those in the upper strata: the top 1 to 5 percent of workers.

There are two main reasons. First, at the lower end of the skill spectrum, such as those factory workers mentioned above, many of their jobs are being automated, reducing demand for labor. Second, immigration, which is unquestionably a net positive for the American economy (e.g., most Silicon Valley entrepreneurs are immigrants) is tough on the low-skilled, since many immigrants have only a grade school education, and crowd into an already shrinking labor market niche. As a result, those with a high school education or less have seen their incomes drop by about one-eighth in the past generation after adjusting for inflation.

But now the technologies that automated factory jobs are also permitting distant, offshore workers to compete for mid-skilled and even high-skilled service jobs, putting pressure on the wages of even college graduates. Free trade, including outsourcing, is undoubtedly good for the aggregate American economy (like immigration), but the many winners each win only a little, while the fewer losers lose…everything.

There are two broad classes of “solutions”: (a) Redistribute wealth from the winners to the losers (which regrettably seems to be dominating the Democratic congressional leadership’s thinking); or (b) create more opportunity for the losers, and their kids, to bootstrap themselves back into the middle class. The problem with the first category is that everyone wants to become rich, and penalizing the successful will simply discourage their effort. Everybody will lose. State after state and country after country — at present, the former Soviet Baltic republics — have proven that flatter tax structures lead to stronger economic growth.

The answer lies in the second class of options: creating opportunity. This can include massive spending on public works to rebuild the nation’s aging infrastructure (as California has begun); reestablishing generous financial aid for higher education to counteract the obscene tuition increases of the past five years; and a cash infusion into community colleges, which have proved the best means to retrain blue and pink collar workers. It also can mean making the Earned Income Tax Credit (EITC) more generous, so that the working poor don’t — as they often do now — find it more lucrative to live on the dole.

Each of these have the realistic prospect of producing high rates of long run return for the taxpayers’ short-term investment. Infrastructure, for instance, makes it easier to move our goods, and ourselves, around, enhancing our competitiveness. More college graduates means new inventions and new services that America can offer in export markets.

The catch is the short run. The federal government is running deficits of 2-3 percent of GNP. The just-departed GOP Congress proved to be much better at cutting taxes than at cutting spending commensurately. Ironically, the only balanced budgets in most of our lifetimes were passed under Democratic budget rules and signed by a Democratic president in the late 1990s. And heaven knows that Congress has chosen to completely ignore the looming unfunded liabilities in Social Security and (especially) Medicare.

But unless they are perverted by pork-barrel politics, most of the ideas sketched above can both help the middle class and the overall competitiveness of the economy, and therefore help federal revenues. Recent Republican profligacy notwithstanding, “we can’t afford it” is just not a compelling argument.

The social contract between the (fewer and fewer) beneficiaries of the 21st century economy and the threatened middle class is fraying, due to strong headwinds from technology and immigration. Americans’ strong streak of optimism has kept the middle class patient, so far. It’s time for constructive policies to reward their patience.

Philip J. Romero is a professor of business strategy and economics, and former business dean, at the University of Oregon. He is a contributing editor to BrainstormNW.

BrainstormNW - January 2007