[Senate Hearing 113-536]
[From the U.S. Government Publishing Office]
S. Hrg. 113-536
WHO IS THE ECONOMY WORKING FOR? THE IMPACT OF RISING INEQUALITY ON THE
AMERICAN ECONOMY
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
ECONOMIC POLICY
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
ON
EXPLORING THE STATE AND TRENDS OF INEQUALITY AND WEALTH CONCENTRATION
IN THE UNITED STATES AND ITS IMPACT ON THE MIDDLE CLASS AND THE ECONOMY
OVERALL
__________
SEPTEMBER 17, 2014
__________
Printed for the use of the Committee on Banking, Housing, and Urban Affairs
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon MARK KIRK, Illinois
KAY HAGAN, North Carolina JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota
Charles Yi, Staff Director
Gregg Richard, Republican Staff Director
Dawn Ratliff, Chief Clerk
Troy Cornell, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
______
Subcommittee on Economic Policy
JEFF MERKLEY, Oregon, Chairman
DEAN HELLER, Nevada, Ranking Republican Member
JOHN TESTER, Montana TOM COBURN, Oklahoma
MARK R. WARNER, Virginia DAVID VITTER, Louisiana
KAY HAGAN, North Carolina MIKE JOHANNS, Nebraska
JOE MANCHIN III, West Virginia MIKE CRAPO, Idaho
HEIDI HEITKAMP, North Dakota
Andrew Green, Subcommittee Staff Director
Scott Riplinger, Republican Subcommittee Staff Director
(ii)
C O N T E N T S
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WEDNESDAY, SEPTEMBER 17, 2014
Page
Opening statement of Chairman Merkley............................ 1
WITNESSES
Heather C. McGhee, President, Demos.............................. 3
Prepared statement........................................... 26
Amir Sufi, Ph.D., Chicago Board of Trade Professor of Finance,
University of Chicago Booth School of Business................. 5
Prepared statement........................................... 83
Claudia Viek, CEO, CAMEO--California Association for Micro
Enterprise Opportunity......................................... 7
Prepared statement........................................... 87
Adam S. Hersh, Ph.D., Senior Economist, Center for American
Progress....................................................... 9
Prepared statement........................................... 89
Additional Material Supplied for the Record
Letter from the National Asian American Coalition................ 93
Letter from the Los Angeles Latino Chamber of Commerce........... 95
Letter from Reverend Mark E. Whitlock, II, Senior Minister, COR
AME Church, and Chairman of Corporate Partnerships, 5,000
African Methodist Episcopal Churches........................... 97
Letter from the Albina Opportunities Corporation................. 99
(iii)
WHO IS THE ECONOMY WORKING FOR? THE IMPACT OF RISING INEQUALITY ON THE
AMERICAN ECONOMY
----------
WEDNESDAY, SEPTEMBER 17, 2014
U.S. Senate, Subcommittee on Economic Policy,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Subcommittee met at 2:32 p.m., in room SD-538, Dirksen
Senate Office Building, Hon. Jeff Merkley, Chairman of the
Subcommittee, presiding.
OPENING STATEMENT OF CHAIRMAN JEFF MERKLEY
Senator Merkley. I call this hearing of the Economic Policy
Subcommittee of the Committee on Banking, Housing, and Urban
Affairs to order.
This hearing is titled ``Who Is the Economy Working For?
The Impact of Rising Inequality on the American Economy.'' And
put in simple terms, it is a chance to look at how inequality
is driving the results of the economy, and whether it is
driving further inequality, and how this reverberates back
through our political system in terms of additional drivers of
economic policy decisions.
So I am delighted to have our four folks here today to
testify. I will make some opening comments, and then if any of
my colleagues arrive, we will see if they have opening
comments, and we will jump right into your testimony.
Back home in my State of Oregon, I live in the same
working-class neighborhood that I grew up in since the third
grade. Families are struggling to stay afloat, and there is
growing fear that income inequality is undermining the
foundations of our economy for working families. We are seeing
more and more of the living-wage jobs lost during the Great
Recession, replaced with lower-wage jobs that pay minimum wage
or near minimum wage. Indeed, 60 percent of the jobs lost in
the Great Recession were living-wage jobs, and only 40 percent
of the jobs that we are gaining back fall into the same
category of living-wage or good-paying jobs. More and more
families are chasing part-time jobs, low to no benefits, and
near to minimum wage, which is not a foundation for a family to
thrive.
This trend of increasing inequality is diminishing not only
our economic strength but also our working families' trust in
our political system and the ability of policymakers to make
smart decisions on economic policy in regard to restructuring
the results to enable families to thrive.
Growing inequality has rightfully gained national interest
in recent years. A report from the Congressional Budget Office
found that from 1979 to 2007 income growth was concentrated
among the highest earners, with the average after-tax household
income for the top 1 percent rising 275 percent. And for the
rest of the top 20, it still did well but rose only 65 percent.
But for the bottom 20 percent over that time period, 1979
through 2007, it rose just 18 percent. A very small rise
compared to that 275 percent for the top 1 percent.
A separate report from the Economic Policy Institute
asserts the income losses during the Great Recession were
similarly unequal, with the bottom fifth experiencing an
average income loss of 2.7 percent per year while the top fifth
dropped an average of 0.4 percent per year.
This difference is particularly pronounced when we look at
the cumulative change in real annual wages. Between 1979 and
2012, the cumulative change in wage growth was 34.8 percent.
The wage growth for the bottom 90 percent of the people was
less than half that, at 17 percent. Thus, profound impacts on
the families and across the economy.
Today there is evidence that unequal concentrations of
wealth are affecting our policymaking in ways that could make
it more difficult for our Nation to create a stronger middle
class and reignite the middle-out economic growth. Every day
thousands of lobbyists come onto the Hill and seek to influence
policy debates, usually in favor of the interests of more
affluent citizens. We must make sure that the voices of
millions of Americans with low and middle incomes are not
drowned out by those with far more resources. It is not a leap
to suggest that recent decisions like that of Citizens United
has further concentrated such influence.
It is critical that policymakers work to better understand
these trends and ensure that we are doing everything possible
to support policies that broadly benefit families across
America, policies that work for working Americans, and not
simply working well for the best-off.
We have with us today a panel of experts who will discuss
the trends and economic impacts of inequality in the United
States. Thank you, all of you, for your participation today,
and I am going to go ahead and proceed with the introductions
and then invite your testimony.
Heather McGhee is President of Demos, a public policy
organization working for ``an America where we all have an
equal say in our democracy and an equal chance in our
economy.'' Before taking over as President in March 2014, Ms.
McGhee served as Vice President of policy and outreach at
Demos. She is a frequent contributor on MSNBC, and her
opinions, writing, and research have appeared in numerous
outlets, including the Wall Street Journal, USA Today, National
Public Radio, the Washington Post, and the New York Times. Ms.
McGhee holds a B.A. in American studies from Yale and a J.D.
from the University of California at Berkeley's Boalt School of
Law.
Dr. Amir Sufi is the Chicago Board of Trade Professor of
Finance at the University of Chicago Booth School of Business.
He graduated with honors from the Walsh School of Foreign
Service at Georgetown University with a bachelor's degree in
economics and has earned a Ph.D. in economics from the
Massachusetts Institute of Technology. He is co-author of the
book ``House of Debt,'' which was published just earlier this
year.
Claudia Viek is CEO of California Association for Micro
Enterprise Opportunity, a Statewide network of organizations
that promotes economic opportunity through entrepreneurial
training and micro loans. She has been a pioneer in both the
micro enterprise and business incubation fields for over 25
years, including serving as executive director of the
Renaissance Entrepreneurship Center and founding the Pacific
Network of Business Incubators from Baja to Alaska. She is the
past President of the San Francisco Bay Area chapter of the
National Association of Women Business Owners.
And Dr. Adam Hersh is a Senior Economist at the Center for
American Progress, focused on economic growth and inequality in
the United States, China, and the global economy. He has co-
authored a report, ``The American Middle Class, Income
Inequality, and the Strength of Our Economy: New Evidence in
Economics.'' He publishes and is cited regularly in both
academic and popular venues and appears regularly on media
outlets such as NPR, CNBC, and BBC. He earned a Ph.D. in
economics from the University of Massachusetts, Amherst, and a
B.A. in international political economy at the University of
Puget Sound.
Before we begin, I will just ask if my colleague Senator
Warren has any introductory comments she would like to make.
Senator Warren. No, Senator Merkley. The only thing I want
to say is thank you very much for having this hearing, for
pulling together such an illustrious panel. This is a topic we
need to talk about--we need to do more than talk about; we need
to do some things about. And I just appreciate your terrific
leadership on this, and I want us to get straight to their
testimony and our questions.
Thank you.
Senator Merkley. Great. Before I begin, I would like to
request unanimous consent to insert into the record letters
from the National Asian American Coalition, the Los Angeles
Latino Chamber of Commerce, the AME Corporate Partnerships, and
Albina Opportunities Corporation of Portland, Oregon.
Senator Merkley. Let me also ask that the record remain
open for 1 week for additional statements and questions from
Members.
With that, we will begin with our 5-minute statements. Ms.
McGhee, thank you for coming.
STATEMENT OF HEATHER C. McGHEE, PRESIDENT, DEMOS
Ms. McGhee. Thank you, Chairman Merkley and Senator Warren
and Members of the Subcommittee, for this opportunity to
testify. My name is Heather McGhee, and I am the President of
Demos, a nonprofit public policy organization.
As requested, Demos' testimony lays out the experience of
inequality at the household level. Of course, it is actually a
story of divergent experiences among our fellow Americans, of
rapid wealth accumulation for the already wealthy at a time
when half of Americans could not pay a $400 bill without going
into debt or selling something.
The testimony includes the tight monthly budget of Patricia
Locks, who has worked at the same company for 11 years, and we
compare her experience with that of her company's majority
owners, the six richest Walton family heirs, whose net worth is
higher than the combined assets of at least 41 percent of
American households.
We also describe the state of public higher education,
formerly the great equalizer, where cuts to taxes and spending
have made the new price of entry into the middle class so
expensive that a student from a low-income family would have to
pay 95 percent of her family's income to go to college for a
year, and that is after financial aid.
We also analyze the major structural drivers of inequality
from globalization to financialization, and the good news is
that these megatrends have not made this degree of inequality
inevitable. Policy choices have brought us here, and different
ones can lead us out.
So why have our elected representatives not taken urgent
national action when the lights are dimming on the American
dream?
Today a cashier who earns just $7.25 an hour can only buy
$7.25 an hour worth of food for her family. She can only buy
$7.25 an hour worth of education for her children. But she also
only seems to merit $7.25 worth of esteem in our political
culture, and most dangerously, only $7.25 worth of voice in our
democracy.
And I would like to spend the remainder of my time on the
topic of our democracy, as the data now reveal that economic
inequality and political inequality are mutually reinforcing.
In a more than $8 billion election cycle, less than 1
percent of Americans gave over $200 to a Federal candidate in
2012, and it took just 32 super PAC donors to outspend the
millions of small donors to Governor Romney and President Obama
combined.
So why does that matter? Demos has been working with a
group of leading political scientists who are now able to
quantify the compound effects of the distortions in our
democracy on the very subject matter of this Subcommittee--on
our economic policies.
The conclusion? When the policy preferences of the donor
class diverge from those of the working and middle classes,
Congress votes with the donor class. The policy divergence is
most pronounced on economic issues. Significant differences
between the wealthy and the general public are evident in such
areas as taxes and deficits, trade and globalization,
regulation of business, labor protections, the social safety
net, and the overall role of Government. The general public is
more open than the wealthy to a variety of policy measures
designed to reduce inequality and expand economic opportunity.
Take the minimum wage. Over 70 percent of Americans,
including over 50 percent of Republican voters, want it to be
high enough so that a full-time worker can keep his or her
family out of poverty. But when asked, members of the donor
class, only 40 percent of them agree with that proposition. So
add to the donor class' disapproval that 80 different corporate
interests that lobbied against a wage increase in recent years,
and the will of the majority gets drowned out.
Or take higher education: 78 percent of the general public
believes that the Federal Government ought to do everything in
its power to make sure that everyone who wants to go to college
can do so. But only 28 percent of the wealthy are in favor.
Fortunately, there are solutions to political inequality.
Reforms like the public financing system and the Fair Elections
Now Act would allow more officials more time with their
constituents and less time on call time with wealthy donors.
And the good news is that money and politics reforms are
extremely popular with the American public across the
ideological spectrum. In fact, support for solutions from
public financing to a constitutional amendment do not fall
below 7 out of 10 from libertarians to progressives. Demos,
when analyzing this bipartisan opinion data, actually ended up
calling the report ``Citizens Actually United.''
Finally, I just will want to conclude with this: We cannot
strengthen our democracy and, therefore, our economy without
remembering the urgency of addressing the root word of the word
``democracy,'' which is the ``demos,'' the people of a Nation.
Ours is the world's great experiment in democracy. The
ancestral strangers who have come here with ties from every
community on the globe have been met here with the promise that
out of many, we could become one.
But forging a sense of common purpose amidst that great
diversity is not easy, and it takes leadership. No other Nation
has done it on the scale that we are currently endeavoring to
do it, and certainly no Nation for whom racial hierarchy was
the economic policy for most of our history.
I offer that it is no coincidence that the rules have
changed to make it harder for the average American to get by
over the same decades when the face of the average American has
changed and when social distance has increased between regular
citizens and the nearly all-white wealthy donor class which has
such outsized influence on our policymaking.
At Demos we believe that if there is such a thing as
American exceptionalism, our great diversity is its source. In
the 20th century, America placed a bet on the children of
immigrants and the descendants of slaves, and those public
investments spurred on an economic force that changed the
world.
Today the most diverse generation in American history is
ready for that same commitment, for that commitment to the
human capacity that lies within all of us, and to that very
American idea that we all deserve an equal say and an equal
chance.
Thank you.
Senator Merkley. Thank you very much, Ms. McGhee.
Dr. Sufi.
STATEMENT OF AMIR SUFI, Ph.D., CHICAGO BOARD OF TRADE PROFESSOR
OF FINANCE, UNIVERSITY OF CHICAGO BOOTH SCHOOL OF BUSINESS
Mr. Sufi. Chairman Merkley, Senator Warren, Members of the
Subcommittee, thank you very much for the opportunity to
testify. My name is Amir Sufi. I am the Chicago Board of Trade
Professor of Finance at the University of Chicago Booth School
of Business. My research area is macroeconomics and finance,
and I would like to give you some thoughts on the current U.S.
economic situation.
As Senator Merkley noted, it is not good. There is
something very wrong with the U.S. economy. We all know that
the Great Recession was the most severe economic downturn since
the Great Depression. What is perhaps less well understood is
that the recovery since 2009 has been dismal. From the end of
recession through 2014, real economic growth has averaged 2.1
percent per year, far lower than the 3.5 percent average annual
growth that the U.S. economy generated from 1947 to 2007. The
decline in the unemployment rate over the past 2 years should
not be a cause for celebration. It is driven primarily by
households leaving the labor force. There are currently 4
million fewer Americans aged 25 to 54 working today compared to
2006.
How did we get into this mess? And why is it taking so long
to recover?
My research with Atif Mian at Princeton University suggests
that the culprit is the devastation of wealth suffered by
middle- and lower-income American households during the Great
Recession. The weak recovery is due to the lack of any rebound
in wealth among these households since the end of the
recession.
The numbers are simply startling. Americans below the top
25th percentile of the wealth distribution have lower net worth
in real terms today than they did 15 years ago. For Americans
below the median of the wealth distribution, it is even worse.
For example, those in the lower-middle quartile of the wealth
distribution have seen their net worth plummet from $65,000 in
2007 to $40,000 in 2010, with a further decline to $38,000 in
2013. That puts their wealth in 2013 below their 1989 level.
The Great Recession has wiped out 25 years of wealth
accumulation.
The disproportionate negative impact of the Great Recession
on the net worth of lower-wealth Americans may at first seem
surprising, but it makes perfect sense with an understanding of
how the financial system operates. Richer Americans save a much
higher fraction of their income, ultimately holding most of the
financial assets in the economy: stocks, bonds, money market
funds, and deposits. These savings are lent ultimately by banks
to middle- and lower-income Americans, primarily through
mortgages.
There is nothing sinister about the rich financing the home
purchases of the poor. But it is crucial to note that the
borrowing takes the form of debt contracts which leave the
borrower with the first losses in case house prices fall. The
use of mortgage debt within the financial system gives the
holders of financial assets protection against a fall in house
prices. But it provides this insurance by concentrating the
brunt of the economic downturns on borrowers. The standard
mortgage contract is inflexible. The same amount is owed even
if house prices and the economy collapse. Given that 85 percent
of the financial assets in the U.S. economy are held by the top
20 percent of the wealth distribution, the financial system's
reliance on inflexible debt contracts means it insures the rich
while placing an inordinate amount of risk on middle- and
lower-net-worth households.
As we illustrate in our research, it was the massive
pullback in spending by indebted households that triggered the
Great Recession. The financial system concentrated the collapse
in home values on exactly the households that were prone to
cutting spending most dramatically in response. Further, the
lack of any increase in the net worth of lower- and middle-
income Americans helps explain why the recovery in household
spending has been so weak.
Going forward, there are two important lessons from the
framework we outline in our research.
First, encouraging borrowing by lower- and middle-income
Americans may temporarily boost spending, but it is not a path
to sustainable economic growth. We witnessed this in the
subprime mortgage market during the housing boom, and we are
seeing an aggressive expansion of auto loans currently to lower
credit score individuals. Credit card originations are
following a similar pattern, albeit to a lesser degree. The
problem is that these lower credit score borrowers are not
seeing any improvement in real income growth. Credit growth
without income growth is a recipe for disaster. We desperately
need higher income growth for low- and middle-income Americans,
and policymakers should tackle this problem directly rather
than encouraging the extension of credit. Two suggestions I
would make for product would be the expansion of the earned
income tax credit and public infrastructure projects that can
boost productivity while putting Americans to work.
Second, the financial system in its present form
concentrates risk on lower-wealth households who are least able
to bear it. The current policy and regulatory framework
encourages such a system, even though it has disastrous effects
for the economy. We must encourage the financial system to
share risk with lower- and middle-income Americans instead of
making them bear all the risk themselves.
I am happy to talk more about student debt, which is
another market where I see this lesson having a lot of power.
I am happy to expand on these proposals in my remaining
time, and thank you for the time.
Senator Merkley. Thank you very much.
Ms. Viek.
STATEMENT OF CLAUDIA VIEK, CEO, CAMEO--CALIFORNIA ASSOCIATION
FOR MICRO ENTERPRISE OPPORTUNITY
Ms. Viek. Thank you, Chairman Merkley, and thank you also,
Senator Warren, for attending today, and for this opportunity
to submit testimony, and I am really going to be talking about
the impact on small business and also the opportunities
offered.
So let me start out first, though, with a brief story.
Johneric Concordia is a young man who was laid off as a baggage
handler at United Airlines about 3 years ago. He loved to
barbecue in his neighborhood in Filipinotown in Los Angeles. He
and his uncles would compete to see who made the best sauce. So
when he lost his job, he sought business counseling to realize
his dream to start his own barbecue catering business. He
raised $8,000 off of his Facebook wall friends and family, and
then he bought a truck-mounted barbecue rig. Just about a year
later, he opened his first restaurant called Parks Finest in
Echo Park neighborhood. He has now hired nine of his homies,
his friends, to work for him, and he is ready for a larger loan
from a local nonprofit lender.
Now, Parks Finest is not a one-off. I have many, many
similar stories from my members like the American
Sustainability Business Council, the National Asian American
Coalition, and from the 85 CAMEO members who serve
entrepreneurs with small-dollar loans and coaching. Johneric
and many other people share the desire and ability to
contribute to our economy by being their own boss, and then
they can go on to employ others. They are exactly the kind of
people we should be investing in.
If we are serious about addressing income inequality, then
we need to support entrepreneurship across a spectrum, that
this is a real pathway to closing the wealth gap and generating
new jobs.
There are 26 million small businesses in the United States,
and most of them are self-employed people. Just imagine, if one
in three created one job, we could have full employment.
I want to point out that a minimum of a million new jobs a
year could be created through bank investment in lending and
technical assistance programs to startup business. And my
friend the Reverend Mark Whitlock, who is chair of corporate
relations for the 5,000-member National AME Church, told me
recently that these new jobs would address the 50 percent
unemployment rate among black and Latino youth.
The Congressional Budget Office found that the richest
among us own businesses. So to solve inequality, instead of
handouts and promises of trickle-down job creation, let us help
people create their own businesses and have them close the
income inequality gap themselves.
I am going to refer to something Dr. Sufi is aware of: 88
percent of minority business owners finance their small
businesses from home equity compared to about 25 percent
overall. So the loss of home equity disproportionately affects
minority-owned businesses.
In California, almost 2 million homeowners are still
underwater--also true of Nevada, even though Senator Heller is
not here. I wanted to say that, too. And from this fact we can
assume that minority-owned businesses have not been able to
fully recover from the downturn.
Business ownership is an effective strategy to reduce
income inequality. The median net worth of business owners
overall is 2.5 times that of nonbusiness owners, and the median
net work for African American business owners is 8 times higher
than nonbusiness owners.
The Association for Enterprise Opportunities' recent report
showed that households headed by women who own a micro business
generate up to $13,000 more in annual household income than
similar households without a micro business owner. Now, this
may not sound like a lot of money, but it can be the difference
between sending one's child to college or buying a home. And
the same report showed that the children in families with a
micro business owner do better in terms of education and social
mobility. So self-employment, business ownership, and
entrepreneur, again, across the spectrum are key ways for
lower-income people to become middle-income.
We know from the Aspen Institute studies and I know from my
personal experience of 25 years in this field that when
businesses get training and coaching help, 90 percent are still
in business after 5 years as compared to 50 percent of those
that did not get such help. Also, businesses that received
capital and services from a nonprofit organization have a
median annual revenue growth 30 percent higher than those that
do not get help. And when micro businesses succeed, they create
on average another two jobs.
Currently, our bank regulators are proposing giving extra
Community Reinvestment Act credit to banks that provide small
dollar micro loans in low- and moderate-income communities.
This policy could have a major impact on new self-employment
and job growth in communities that have not recovered from the
recession.
So if there is one thing that you remember from my
testimony today, let it be how small business creation and
entrepreneurship can reduce income inequality, and they can
bring hope to our communities that have so much untapped
entrepreneurial potential. Thank you.
Senator Merkley. Thank you very much for your testimony.
Dr. Hersh.
STATEMENT OF ADAM S. HERSH, Ph.D., SENIOR ECONOMIST, CENTER FOR
AMERICAN PROGRESS
Mr. Hersh. Chairman Merkley, Senator Warren, thank you so
much for inviting me to testify today. My name is Adam Hersh. I
am a Senior Economist at the Center for American Progress. I
was asked to focus more narrowly on the role of trade in this
story of U.S. inequality and economic growth.
International trade and investment are critical parts of
the U.S. economy. They always have been, and they always will
be. But trade raises complicated policy issues because it is
simultaneously a cause of inequality and of the innovation and
investment that leads to our growth.
Trade globalization is one factor among several responsible
for the staggering rise of U.S. income and wealth inequality
since the late 1970s. Declining unionization and the real value
of the minimum wage, decreasing tax progressivity, increased
business short-termism, and focus on financial profits, and
shifting technologies all have played roles. But economists do
not really debate whether trade has distributional impacts; we
debate how big those impacts are. And estimates that range from
about 10 percent to 52 percent of the overall increase in U.S.
wage inequality is attributable to increased trade.
Trade's impact on inequality happens both directly through
job and income losses when businesses shrink, close, or move
overseas, and they happen indirectly through the spillover
effects that can saddle entire regional economies in localized
states of depression. The combined effects weigh not just on
those families and businesses impacted by trade, but they also
pass through to our public budgets with lower tax revenues
collected and increased expenditures on social insurance.
To be clear, there are many positive economic benefits from
trading. Opportunities for bigger markets and specialization
create incentives for innovation that propel overall growth.
Access to a broader variety of stuff at lower prices raises our
living standards. But the trend of runaway inequality over the
past generation already takes into account this effect of lower
consumer prices when we measure incomes, wages, and wealth
adjusted for inflation.
More trade does not automatically equal more people getting
ahead. Two new realities face lawmakers in approaching these
issues of trade and inequality. First, the gravitational center
of the world economy is shifting to the east and to the south,
that is, to developing countries, where wages, regulatory
standards, and norms of rule of law and transparent commercial
exchanges are far from the level that they are in the United
States, Europe, or other advanced economies. Already half of
world growth is coming from the developing world, and that
share is set to rise going forward in the future.
The second new reality is the transnationalization of
businesses through offshoring. Trade used to be mainly an
arm's-length affair, trading between countries. But today fully
half of U.S. imports are transactions between related corporate
entities. A substantial additional share of imports are also
offshore trade through unrelated business parties.
Transnationalization makes it easier for companies to take
advantage of opportunities for labor and regulatory and tax
arbitrage. That creates a race to the bottom for economic
development and undermines the social contracts underlying our
economy and those of our trading partners.
This brave new world requires us to rethink the means by
which the United States encourages economic growth beyond just
trade policy, as well as rethinking what success means, not
being measured just in increases in trade and GDP.
The questions before lawmakers are: How should the United
States engage trading partners in an increasingly open and
competitive world in order to grow our economy? And what should
the United States do to make sure that workers and businesses
in the United States can thrive in this environment?
First, in order to have a strong trading economy, we need a
strong overall economy, and there is increasingly broad
consensus among professional economists that high inequality is
extremely detrimental not only to current economic growth but
to future growth as well. This is the case because when we talk
about the economy, we are talking about what is happening to
people and how people are faring in their lives. An economy
delivering equitable growth creates the financially secure
families who can invest in human capital, the health and
education that creates a productive, innovative, workforce.
Families can provide a stable, strong consumer demand that
entices business investment. And strong families can provide
would-be entrepreneurs with the financial security to take the
risk on starting a new business.
Economies with lower inequality and stronger middle classes
also have more stable financial systems, better investment in
public goods, better quality of governance in public and
private institutions, lower crime, and less political
polarization. Taken as a whole, lower inequality is the central
thread that runs through essentially all the factors economists
identify as being important for growth. In other words, a
vibrant U.S. economy does not trickle down from the super rich
but, rather, it springs forth from the well of a thriving
middle class. And over the past generation, America's middle-
class well seems to be running dry.
Congress should commit to investments that build the
foundations for strong growth with a broad middle class in
order to have a strong overall economy and a strong trading
economy. This means more investments in making broadly
available quality education, modernizing our infrastructure,
investing in scientific research and development, replacing
outdated trade adjustment assistance programs with a more
universal dislocated worker program, and upholding standards
for workplace rights and protections, including by extending
paid sick/family leave and pay equity.
Second, Congress should focus on trade policy as well to
grow the economy from the middle out. To do so, Congress should
press U.S. trade negotiators to establish strong, enforceable
standards for open and fair competition in the global economy.
This would include going beyond the May 10th agreement on labor
and environmental rights to include things like currency
manipulation, ensuring public policy space for
nondiscriminatory regulation, enforcing competitive neutrality
with State-invested commercial enterprises, and more.
These rules alone mean little if we do not have the ability
and resources to enforce the rules to ensure that we are
receiving these gains from trade. Therefore, Congress should
also increase the resources available for U.S. trade enforcers,
doubling the funding to ITEC, the Interagency Trade Enforcement
Center, and creating incentives for trade enforcement
authorities to take more at-bats, bringing more trade cases to
prosecution.
Thank you, and I look forward to your questions.
Senator Merkley. Thank you all very much for your
testimony, and I believe for three of our witnesses, this is
your first testimony in Congress, House or Senate, the first
three, and for you, Dr. Hersh, you have testified on the House
side but not on the Senate side before. So for all of you,
welcome to the Senate, and thank you for bringing your
expertise and your insights.
We will take 5 minutes apiece and go back and forth.
Senator Warren. Thank you very much, Mr. Chairman. I
appreciate it, and I appreciate your letting me go first. I am
going to apologize in advance. I have got another commitment,
and so I can only stay for one round here.
This is a terrific panel, and you all--just great topics
that you have hit on and brought some new parts to the
conversation. But since I am only going to get to do this once
around this discussion, I wanted to raise another issue that
layers into this and ask for your thoughts on it.
There is a new report out. I hope you have seen it. It is
from Harvard Business School professor Michael Porter and Jan
Rivkin, and the report is called ``An Economy Doing Half Its
Job.''
Now, here is what the researchers find, and I just want to
quote it to make sure we get this exactly right. They find that
``corporate profits in America are at an all-time, and the Dow
Jones Industrial Average continues to hit new records.'' But
living standards for the average American have fallen over the
last 15 years.
Porter and Rivkin from the Harvard Business School note
that this ``recent divergence of outcomes, with firms,
(especially larger firms) thriving and workers struggling, is
unusual in the United States'' because ``American companies and
citizens have tended either to thrive together . . . or to
suffer together . . . '' But no more.
Now, there is a pretty simple explanation for this recent
divergence. Corporations no longer share their prosperity with
their workers. They share their prosperity only with their
shareholders. According to research by Professor William
Lazonick of the University of Massachusetts at Lowell, back in
the early 1980s, large corporations dedicated less than half
their earnings to their shareholders. The rest went to
investment in their equipment and in their employees. But from
2003 to 2012, those big companies dedicated 91 percent of their
earnings to their shareholders, either in the form of stock
buybacks or dividend payments.
Now, why have companies shifted their priorities so
dramatically in such a short period of time? Well, because CEOs
are now compensated almost entirely based on the company's
share price. As a result, CEOs love buybacks and dividend
payments because they boost share prices, even if they come at
the expense of long-term investments in the company and in its
workers.
So here is my question: If we cannot count on CEOs and
senior management to reinvest at least some of the corporate
profits in their workers like they used to, what steps should
the Government take to fill that void? And I would like to hear
from all of you. Ms. McGhee, would you like to start?
Ms. McGhee. Thank you, Senator Warren. That is an excellent
question, and it really goes to the heart of what our economy
is for. Demos has been doing some investigation into these
issues of how much increasingly large, low-wage employers that
are extremely profitable are financializing, essentially, and
concentrating the effort, the result of the production of their
workers. My colleague Katherine Roishlin actually wrote a
report on our country's largest private employer, Walmart, who
spent $6.6 billion just last year buying back its own stock in
the market. And she calculated that if that money were instead
invested in the human capital of the workers who make that
wealth, it could give the lowest paid workers, those who make
under $12.25 an hour, which is almost a million Walmart
workers, a raise of over $5 an hour just from what they spend
buying back their own shares. So this has a very, very real
effect on the working lives of workers and families.
So some of the things that Government can do----
Senator Warren. I am sorry. I have to say, and to think
about what it would mean if that million workers made $5 more
an hour in terms of what they could buy elsewhere in the
economy.
Ms. McGhee. Exactly.
Senator Warren. And the overall growth in the economy and
growth in jobs. Growth in demand, growth in jobs.
Ms. McGhee. Exactly.
Senator Warren. Sorry, Ms. McGhee. I did not mean----
Ms. McGhee. No, no. Absolutely, because low-paid workers
are the job creators who are waiting to have more money in
their pockets to spend in our economy.
I will just say a few things that could be done. One,
Congress could stop giving preferential treatment to this kind
of income, to wealth income--stocks and dividends--over work.
It is important to remember that less than half of Americans
own any stock at all, so when we give this preferential
treatment, we have to remember to whom it is going.
The part of the picture of that declining ability for the
people who are actually doing the work to get a bigger slice of
the pie that they spend all day baking is the decline in
unionization, which has also been as a result of policy
choices. So Congress could pass, for example, the Employee Free
Choice Act and make sure that there is more collective
bargaining power in our economy and in our enterprises.
Thinking about all of that money that unfortunately is not
going to the public good in many, many cases, you have to look
at the effective corporate tax rate. The Institute for Policy
Studies shows that 26 of our biggest corporations spent more--
paid their CEOs more than they paid to the Government in taxes.
So we should be closing tax loopholes and havens and ensuring
that corporations, which are at an all-time high in
profitability, are sharing some of that revenue and we can make
a new commitment to the quality of life of all Americans.
Senator Warren. Thank you very much. You may have covered a
lot here.
Dr. Sufi, we are over, but would you like to add something
to that.
Mr. Sufi. Yes, that is a great question. I think another
way of saying the same facts that Professor Porter and his co-
author are saying is that the capital share of income, the
amount of income that is going to the owners of capital, has
gone up dramatically over the last 15 years. And in just
thinking about the reasons for that, one reason I think is that
capital markets have become quite ruthless in the sense that
they want profits and they want them in the short term. And I
think, Senator Warren, you are exactly right that we may
worry--and I think there is research to back this up--that it
excessively leads managers to focus on short-term gains rather
than more longer-term investments such as job training, such as
trying to boost the productivity of their workers, which I
think is the best way ultimately to try to get wages and income
up.
So I think going forward, as I mentioned before, I think
expansion of the earned income tax credit, I think public
infrastructure projects--it is amazing to me the consensus
among people, economists, even economists at the University of
Chicago who I sit down at lunch with, who we would all consider
quite right-leaning, say, look, interest rates are zero,
basically, and there may be very good infrastructure projects
to do, it may help with this labor share problem. And it seems
like that consensus is not here on Capitol Hill, but you
definitely see it among economists. I think those are the
solutions I would point to.
Senator Warren. Thank you.
Ms. Viek, would you like to add to it?
Ms. Viek. I am not the economist in the room, but I would
like to just repeat or sort of say certainly closing the tax
loopholes and reinvesting in human capital, small business
entrepreneurs, it is human capital, and that is what
communities need today.
I think also looking at perhaps--and this does not quite
address what you are saying, but there are funds that could be
used to help deal with this home equity issue, which has a huge
impact, and then also reducing student debt.
Again, if you close tax loopholes and you have more income,
let us invest in young people so that they do not have to
increase their debt to go to a university.
Senator Warren. Thank you, Ms. Viek.
Dr. Hersh?
Mr. Hersh. I would reiterate and agree with most of what
has been said here on the panel so far, and I think that there
is a very simple answer to your question of if the private
sector is not willing to invest, even though the corporate
sector is holding more than $2 trillion in cash reserves, even
though they can borrow billions at essentially zero interest
rates right now and are sitting on this cash rather than doing
something productive with it, if they are not willing to
invest, then the public sector has a role to step up and
invest. There is no shortage of public goods and public
services investments that will increase the productive capacity
of the U.S. economy and create jobs that will lead to rising
incomes and aggregate demand that will then crowd in investment
from businesses. When they see a growing market, the investment
will come to serve that market.
And while we are in this time of high unemployment, high
excess capacity in the productive economy, this is really the
way that we are going to get out of this spot.
Senator Warren. Well, thank you very much. Those are very,
very thoughtful answers, and I very much appreciate it.
You know, my Republican colleagues like to say a rising
tide lifts all boats, and what they are saying is if we create
the environment where corporations and investors thrive, then
working families will thrive, too. We now have two decades of
hard evidence disproving that theory. Corporations may be
turning their backs on their workers, but that does not mean
that the American Government should do the same. We can do
better than this, and you have given us some great ideas to
work with. Thank you.
Thank you, Mr. Chairman.
Senator Merkley. Thank you very much, Senator Warren, and I
am sorry you cannot be here for a little while longer to
participate in this, but I know this is the conversation that
you are engaged in every day, and we appreciate that you are.
Senator Warren. Yes, you are. Thank you.
Senator Merkley. I wanted to just reflect for a moment on
the kind of different visions of how you build a successful
economy for working America.
On the one hand, we have the post-World War II model in
which workers earned more. They bought more products. The
products were made in the United States so U.S. employers hired
more people to make more things to sell to those folks. And you
had kind of an upward cycle that was very powerful over a
couple decades.
And then we have the current situation where we have
essentially less and less equality, more concentration of
wealth, and, therefore, diminishment of purchasing power by the
middle class. And in this situation, if they can buy less,
employers are going to make less. And between automation and
decreased demand, that hurts.
But you have the argument--and Senator Warren was making
reference to this. You have this argument among a great number
of folks, but wait, the best-off are the job creators, so if we
concentrate wealth with the job creators, we will have more
jobs. Is there any validity at all left in this theory after
the results of the last decade?
Mr. Sufi. So I can take a shot at trying to answer that.
One of the things I think the economics profession understands
quite well now is that one of the main macroeconomic problems
with the U.S. economy is evident in very low real interest
rates. So we have seen real interest rates pinned at basically
0 percent on the short end. People say it is all the Fed, but
it is not. It shows you that there is in some sense an
excessive demand for savings, especially in risk-free assets.
And where does that come from? That comes from in large part
inequality, because obviously the people at the very top end of
the income distribution, the more and more of aggregate wealth
they get, the more they are going to put it into savings and
not into buying goods.
So I think we have come to a consensus in large part in the
last 6 years--maybe not a consensus but at least a large swath
of the economics profession does believe that excessive
savings, which I think is a product of inequality, is becoming
an issue, that we need people to actually go out and spend
more. And that is something that I think, you know, inequality
actually inhibits and that we do need more income growth, wage
growth among the middle class to help try to spur demand. And I
think that is something that we all kind of agree with in terms
of one of the main frictions facing the economy over the last 6
or 7 years.
Senator Merkley. Any other quick comments before I move on?
Yes, Dr. Hersh.
Mr. Hersh. I would say that no, there is really no evidence
that the trickle-down theory of economics has worked. In fact,
we have now more than three decades of evidence that it has not
worked. The trickle-down theory said that if we made capital
readily available to people who are going to invest it at a low
cost, they would make those investments, grow the economy, and
create the jobs, and the benefits would trickle down.
Well, we have made the capital available, we have moved the
capital into their hands through tax policies, through policies
within companies about how income will be distributed between
the owners and the workers. We have made those changes, and
what we have seen actually is slowing economic growth and more
people struggling to maintain their financial security in the
American economy.
Senator Merkley. So if we are caught in a set of policies
right now that are accentuating inequality, we must still
recognize that we are here in a democracy where people can vote
for changes, and there are a lot more folks outside the top 20
percent than inside the top 20 percent. So why is it that those
dynamics are not resulting in election-driven policy changes
that revert to strategies that more successfully produce growth
in income for middle-class families? Ms. McGhee.
Ms. McGhee. That is an excellent question. I think there
are a lot of different aspects to it, and I tend to want to go
to the structural. I think it is important that we recognize
that there are two big pieces of our democracy that are not
functioning well right now. One is actually our voting system.
One in four eligible citizens is not even registered to vote.
That means they are invisible citizens to the political
process. They do not get the door knocks. They do not get the
campaign materials. Some of us would like not to get that, but
at least we are then engaged in the political process.
There are a lot of reforms that we can do to cut the red
tape that needlessly catches one in four, 51 million Americans,
who should be able to vote and register and are not currently.
And that red tape actually traps people in a differential way
based on age, race, and income. There is a gap, almost 30
percentage points, in voting between higher- and low-income
households. So it is important to note that the electorate is
skewed older, less diverse, and more wealthy.
And then, of course, my comments before about the makeup of
the donor class. Some of the amazing political scientists who
have been doing this work--Martin Gilens, Larry Bartels,
Benjamin Page--have recently calculated that the affluent, the
donor class has 15 times more policy influence than the average
American.
Senator Merkley. Yes, Ms. Viek?
Ms. Viek. I would like to jump in here. I think there is
actually a little ray of hope, and it was in the New York Times
yesterday, the front page where, in Kansas, there is now kind
of a pushback against Mr. Brownback for all these years of
disinvestment in the State. And I think that it does end up
trickling down eventually where people say, ``My God, I cannot
send my kid to college. My God, I cannot even buy a car.'' I
mean, just sort of basic stuff: ``I cannot pay my electrical
bill.'' And things that we used to take for granted in our
culture are not there.
So I think that this--I mentioned investment in human
capital. Investment in small business is the same as investment
in human capital. I think that we are starting to see some
recognition of that, and I always like to take hope wherever I
can. So, anyway, that is my 2 cents.
Senator Merkley. Well, so what you are describing in
Kansas--and I gather it is a close race there, so the outcome
is not clear. But you might think of it a microcosm of the
Great Depression in which coming out of the failure of that
economy, there were many strategies that people collectively
supported to strengthen the economy working for families. But
in the absence of such a horrendous debacle, how does this turn
around?
Let me ask just one example of this. In my community, my
blue-collar community, many parents are starting to ask the
question about whether or not it is smart for their kids to go
to college, and the reason they are asking this question is
because they see students coming out of college with debts the
size of a home loan and not having jobs that can make the
monthly payments, or at least not enough to create some
separation so that you have some money left over after the
monthly payment. And they feel like, well, do we want our
children to have this millstone around their neck for years or
decades to come?
And when I hear this conversation, I realize this is not
some myth or some unjustifiable fear, because the statistics
show that tons of our students are coming out of college and
having trouble paying their loans or having the money to live
after paying their loans.
And so we see kind of a collapse of the aspirational vision
that was so important when I was young. My father, a mechanic,
was able to say to me, ``Son, if you go through the doors of
that schoolhouse and you work hard, you can do just about
anything here in America.'' And he said, ``Mom and I are saving
a little bit of money so that you will have a chance to go to
college, and we hope you go.''
And I think about how the cost of college has risen
compared to a working wage. That then has not been compensated
for by Pell grants. That drives more debt and more debt, and
that debt is creating a sense that there is not a pathway for
every child to thrive.
So why isn't it in a democracy and with so much of the
workers across this country realizing that the path of
opportunity is being choked off by the high cost of college,
how come there has not been a political pushback to vastly
increase Pell grants, control the galloping inflation in
tuition, and make student loans a lot less expensive?
Mr. Sufi. Well, let me completely agree with you, Senator.
I think one of the issues that we talk a lot about in our
research and in thinking about the way debt works, student debt
is an exact example of how awful the financial system works for
lower- and middle-income Americans. As you mentioned, when
someone entered college in 2005, they took on some debt
thinking, like you were saying, they were going to get a good
job and going to get high wages. Of course, they, like no one
else, foresaw the worst economic downturn in U.S. history since
the Great Depression. And what happened to those debt contracts
when, through no fault of their own--I like to say that in some
sense the only fault it was for the class of 2009 was being
born in 1987, 22 years before this horrible recession. And yet
we impose that risk because the debt does not change. The
principal balance is the same. The interest payments are the
same. That makes no economic sense. There is nobody that would
design a financial system that would place such a huge amount
of risk on students, and they are responding, just as you said.
They now understand the risk that is being imposed upon them,
and a lot of them are saying, look, college might not be worth
it--which, of course, in the long run is the worst possible
outcome.
So one of the policy ideas we have advocated, in addition
to expanding Pell grants and trying to lower the cost of
education, is just even in retrospect looking back and
forgiving student debt for people who graduated in 2008 or 2009
or 2010. I saw some young faces in the crowd. There may be
members of that class right here today. Through no fault of
their own, this group of individuals was hit so hard by this
recession, and in some sense given that the Government is the
main lender, it is a policy that could be implemented
potentially quite easily.
In the long run, I completely agree. Expanding Pell grants,
expanding access to higher education is a huge part of reducing
inequality because ultimately we need to boost productivity of
workers in order for them to get higher wages that are
sustainable. And I think we really need to rethink the way the
financial system works to try to accomplish that.
Ms. McGhee. I would just like to add that I do think that
this issue of the lack of affordability of higher education
should be a signature one for all leaders, because it really
goes to the heart of the American dream, the idea that you can
succeed in a way that your parents did not. And we are seeing a
generation over generation economic decline in this country,
and a very big part of that is the fact that we traded away the
blue-collar working-class jobs that did not require a college
degree, and at the same time started to close the doors to the
college degree that then became the most important thing you
could do to secure a middle-class life, although not
guaranteed.
So Demos has been working on this issue for a long time. We
wanted to actually model out. People say, yes, it is true,
student debt, it is getting to be $25,000 from public schools,
but it is good debt. We wanted to actually test that question,
because, in fact, what we found is that $25,000 in student loan
debt would actually end up costing the average borrower over
the course of their lifetime 4 times that amount in lost
wealth, mostly home equity and retirement savings. And so you
are saying to two similarly situated students, one who could
afford to go to college without having to take on debt and one
who could not, that afterwards, 35 years out, the one that
started out needing to borrow money should have a lower wealth
net worth just because of that fact.
We know that this country can afford to do for this
generation and subsequent generations what it did to create the
greatest middle class the world has ever known: Make college a
public good again. This cost shift that has happened, 26 cents
on the dollar just in the past 20 years in terms of States'
cutting back support for public higher education, it is no way
to run a country in a globalized competitive economy.
Senator Merkley. So let me capture your point there. I
believe you said that the college debt leads to other economic
decisions that decrease lifetime success, and that one of those
is home ownership or equity from home ownership. And that can
occur in a variety of ways: a delay in the time that you
purchase your home, which has a huge effect due to the
compounding of value; certainly the size of house you might be
and the equity you might acquire in it; or lower downpayments
that result in more money going out on the interest side.
And so when you think about the fact that home ownership
has been the major source of savings for middle-class America
and that students with--well, students 25 through 30 graduating
from college with student debt, their home ownership rates have
dropped dramatically, so they are buying later, and these are
the effects you looked at to see a lifetime impact on wealth
and that it is very significant.
Ms. McGhee. Exactly. That is exactly right.
Senator Merkley. Yes. And I think that is a great point,
and I think it was the New York Fed that came out with studies
recently looking at, proportionally, as your college debt goes
up, how your home ownership goes down. Yes?
Mr. Sufi. And could I just interject one other distortion
that student debt has on individuals, which is really quite
problematic? It can reduce the incentive to work because at the
end of the day, if you think most of your wages are going to go
toward interest payments that ultimately you are never going to
be able to retire the debt, that if you have these crushing
debt burdens, many people may decide, look, it is not worth it
for me to even work. So you may actually even have a labor
supply effect which would be very detrimental.
So I agree completely. The evidence coming out of the
Federal Reserve Bank of New York is quite compelling about
student debt burdens having reduced car ownership and home
ownership, and I think there is also this knock-on effect and,
in fact, there is research that shows more debt forgiveness
actually increases labor supply, that people are more willing
to work once they have had their debt forgiven because now they
know they actually get the returns to their work rather than
handing it over to a bank.
Senator Merkley. So one idea we have been pursuing--and
Senator Warren has been in the forefront of this--is enabling
folks to refinance their higher-interest loans to a lower
interest. They would still have the same amount of debt, but
their payments would be smaller. They would be more able to
purchase houses, cars, invest in the economy in other ways--in
essence, stimulating the economy in ways that benefit all of
us.
Yet another idea and one that has been pursued by a group
of students in Oregon called Pay It Forward is essentially a
version of a future income-adjusted repayment structure or
income-adjusted loan payments. And there are multiple versions
of that, but essentially a sense that if your future pay is
lower, you pay a maximum proportion of that income so that you
will not be trapped between wages that are here and monthly
payments on your loan that are at or near--so that you have
some gap to live on, if you will. Any thoughts on those two
approaches?
Mr. Sufi. Well, I am in very strong support of both.
Allowing students to refinance into a lower interest rate to me
is a no-brainer. I mean, I think it is something that we allow
people to do with mortgages, to prepay and refinance into lower
interest rates. I think it would provide a huge boost to the
economy overall, not only because it would probably boost
spending by these former students who are carrying the debt,
but also I do think it might actually affect labor supply
decisions and get people to more actively look for jobs if they
know they are going to actually get the returns to those jobs.
Our proposal is very similar to the income adjustment, and
that is to make student debt contingent on what the
unemployment rate is for recent college graduates. If it goes
up above 10 percent, you would get automatic debt forgiveness,
automatic low interest payments. So very similar to the idea
that you were speaking about from Oregon.
Overall, we want to make debt more flexible. We want
students to have lower interest payments if the economy
collapses, and given that interest rates typically fall during
recessions, allowing students to refinance into lower rates
would be one way of doing it.
Senator Merkley. Anyone else on this?
Mr. Hersh. I have to agree with Dr. Sufi that refinancing
student debt should be a no-brainer. This is the only segment
of our credit market that really has not been able to benefit
from the lower interest rates we have seen coming out of the
Great Recession. But just lowering the interest payments on
really exorbitant principals of debt that students are paying
with the escalating costs of higher education is really not
going to be enough to solve the problem of high debt and low
prospects for incomes for these recent college graduates. So
unless we can go further toward the kind of proposals that Dr.
Sufi is discussing to remediate the principals on these debts
when unemployment is so high, when the income prospects of
newly employed college graduates is not as strong as it needs
to be, this is really what is going to impact these people's
lives and their ability to contribute to the economy.
Ms. Viek. I would just like to jump in. You know I am a big
proponent for entrepreneurship, but an unintended consequence
of the student debt is that, as you were mentioning earlier,
people do not fully participate in the economy. And so what we
see is more and more people in the informal economy, so they
are not even contributing to a tax base that would then help
offset some of these other issues. And so I think we need to
think about that fact, too, that people are sheltering--I
definitely know people are sheltering their income, and that
has consequences for our States.
Senator Merkley. So I want to go back to this issue of the
daunting prospect of the pathway through higher education,
because Ms. McGhee noted the impact on home ownership and how
that decreased as well. But has anyone got a handle on how the
message to our working-class high school students that there
may not be a pathway for you to thrive might affect, if you
will, the way they pursue their high school studies? In other
words, why work hard in high school if there is not a pathway
in which those grades matter to be able to go to college? Are
we seeing kind of reverberations back into high school in terms
of the motivation of our students? And this, of course, would
be very--may be a much harder issue to quantify, but it is kind
of a huge impact on the future success of the next generation.
Ms. McGhee. There is good news there and there is bad news.
First, the good news is that young people today are more
determined to go to college than ever. They know how important
it is to a middle-class life, and the vast majority of young
people who graduate from high school do go on to some sort of
college.
The bad news is that there are at least 100,000 young
people who graduate from college who are well qualified--I am
sorry, graduate from high school who are well qualified to go
to college who do not go, who do not apply to school because
simply of the cost.
More often what happens, though, is that young people do go
on to college. They work 20 hours a week while they are in
school. There is a lot of unmet costs for transportation and
housing and in many cases child care. They end up having to
take classes at community colleges where, because community
college spending has actually been declining because of those
State college investment cuts, they are actually trying to work
very hard to get enough credits to finish, and they drop out of
college. And the number one reason cited for dropping out of
college is financial pressures. And we know that, according to
a recent Economic Policy Institute study, nearly half of low-
wage workers have some college.
So it is not that people are being dispirited. They are
going to college in record numbers. It is that we as the
American people have given up the sense that this is a public
good and that it should be a shared contract. I think it is
important, very important, to deal with the existing over $1
trillion in student loan debt, refinance it, open back up the
doors to bankruptcy for a second chance for people with private
student loans, and I would even say Federal loans. But most
importantly, I think we should start with the assumption that
the greatest middle class the world has ever known was made
with debt-free college, and we should have to justify why this
large, diverse generation should have to go into any debt at
all from working in middle class to be--to get a higher
education.
Senator Merkley. So here we are in a world knowledge
economy where America's ability to thrive is going to depend on
education, and we are making it far more expensive to get that
education.
Ms. Viek, I wanted to turn to your thoughts about micro
enterprise. One of the tools that some States have used--and
there is some national policy around it--are individual
development accounts. And these essentially are matching grant
programs. A low-income family saves money, and they can earn
matching grants to either buy a house, go to school, or to
start a small business. And the reason for those three things
is that those three things are the biggest levers or pathways
for movement from poverty into the middle class. And so that
third area, to start a business, is a tool of micro enterprise,
if you will. I am just wondering if that is a tool that you
have run into and have any particular thoughts about.
Ms. Viek. Yes, thanks for asking, because actually at the
same time that we are meeting is the Corporation for Enterprise
Development Asset and Opportunities Conference I just came
from, and one of the tax policies that is being promoted is
that we should start savings at birth. And it relates to what
you all were saying earlier about the lack of wealth and the
lack of assets. So it is not just labor income; it is actually
the lowering of assets.
So we need to address the issue of inequality when it comes
to assets, and starting savings accounts for every child at
birth is working in a pilot in Oklahoma. And as a result of
those years of showing that it can work, it is now being picked
up by Maine and other States.
So I wanted to bring that to your attention, and I think
that this is something, again, that will contribute to college
costs, buying a home, or starting a small business. And more
and more--it is interesting. The two cohorts that are starting
businesses or becoming self-employed: one are the over-55's,
which you and I fall into----
Senator Merkley. Yes, we do.
Ms. Viek. I am assuming.
Senator Merkley. Thank you for reminding me.
[Laughter.]
Ms. Viek. You are on the young side, though. And the other
is the millennials starting businesses at a faster rate.
So, yes, there is an interesting new report out by CFED
called ``From Upside Down to Right Side Up,'' and it really
does deal with tax policies as they apply to savings accounts.
Senator Merkley. Thank you.
Another piece of the small business puzzle is access to
traditional credit, and we have a story--I have a story that
was sent to me by Albina Opportunities Corporation. It is a
nonprofit small business lender in Portland who lends only to
folks who cannot access traditional bank loans. And this is
from a statement that we have now entered into the record, but
Albina describes a typical client.
In 2010, an African American man who owns a trucking
company for earth-moving purposes approached them to obtain a
line of credit to expend his 10-person business, but a previous
bankruptcy prevented a loan from a conventional lender. The
Albina Opportunities Corporation underwrote a $100,000 loan,
and he used it to hire more drivers, obtain larger contracts,
and by 2013, the company now employs 26, the revenues have
grown sixfold to $4.75 million, and is now a preferred
subcontractor to major general contractors.
Now, the thing I really want to emphasize is Albina is a
nonprofit community development organization that lends only
when someone else will not. And in 6 years of operation, they
have not lost a dollar of principal. And the point that they
are making is our traditional banking does not seem to be
reaching out in the same way that perhaps community banks might
have done in the past, and that there is this gap of access to
traditional credit that is constraining the entrepreneurial
track from poverty into the middle class.
Any thoughts about that piece of the puzzle?
Mr. Sufi. Well, as you were telling your story, I was
recalling one time--I teach MBA students, and I was telling
them the foundational theories of banking involve a bank that
goes in and carefully screens and monitors and tries to figure
out whether this business person is credible, whether they have
a good business plan. And one of them came up to me after class
and said, ``Banks do not do that.'' And I said, ``What do you
mean banks do not do that?'' He said, ``Maybe banks used to do
that 20 years ago, but now banks just basically do trading.
They try to make some profits, and if they run into problems
with a borrower, they quickly try to get rid of the loan.''
So there is some way in which banks are no longer doing the
kind of small business lending that would be profitable for
them, I think, and that could be because banks have become so
big that they are just out of this market. It could be for a
lot of reasons. But I would agree that there probably--it is
telling that there are nonprofit institutions coming in and
able to do such great lending in this segment of the market. We
have a supposedly thriving private sector of banks that should
be doing these loans, but they are not. And I think that tells
you that there is something wrong with the banking system as it
is operating today.
Senator Merkley. Anyone else?
Ms. Viek. Yes. We have roughly 28 community development
financial institutions like Albina Corporation in our
membership, and while I am heartened by the use of technology
and the growth, very fast growth in this segment, because the
banks have basically ceded the under $200,000 loans to the
nonprofit sector. But what we are really seeing, though--and it
needs to be addressed--is the online lenders and some of the
cash advance lenders that are not regulated. Some of them are
transparent. Some of them are doing--like Lenders Club, but you
have to have perfect credit to qualify for that. But it is
addressing the market, and now the financial institutions are
actually investing in Lending Club.
So I think that is a whole other hearing that we should
have on the phenomenon, the emerging phenomenon of online
lenders. I think it would be appropriate for the Banking
Committee to take that on. It is something we are watching very
carefully in California. We are concerned about it. But we also
see some real hope for access to capital amongst those folks
that have not had access.
Senator Merkley. So were you referring specifically to cash
advance, payday loan-style online lending? Or were you speaking
more broadly?
Ms. Viek. The whole spectrum, from the cash advance, some
of which are predatory, to there are some good cash advance
groups. I mean, PayPal, Square, they are very transparent, low
interest rates. But then we have others that end up layering on
top. And then you have ones that have--are really working with
the cream of the crop of the top credit scores.
Senator Merkley. When I was Speaker of the House in Oregon,
we passed a law that limited the payday loan interest rates
down to about 36 percent, which sounds like a lot, but they
were charging well in excess of 500 percent. And I was struck a
year later to visit a food bank and have the first thing that
the director of the food bank said was, ``We had a stream of
families coming to us who had been bankrupted by payday
loans,'' because they started with a 2-week plan, and you end
up--by the time you have rolled over a few times, the equity
grew--at 500 percent, the loan multiplies fivefold in a year,
25 in 2 years, and pretty soon people are in a vortex of debt
they cannot escape from. And she was noting how dramatically
that source of bankruptcy had disappeared and how positive that
was by passing that law in Oregon. Then she noted how the
recession of 2008 had unfortunately knocked far more people off
their economic foundation, and so that the demand on the food
bank still had gone up.
But what we are seeing in Oregon are online payday lenders
who are violating the State law because State law does not
allow them to engage in these types of contracts, but they
engage in them anyway, but they are operating from overseas or
other places that cannot be reached, and they utilize the
account number to simply reach in and pull money out of
people's accounts.
So this is a very huge predatory practice that as a society
you would think that we would be able to get control over, but
we do not have control over it yet.
Ms. Viek. Well, you can see there is this huge market for
these payday or faster forms of money. I mean, how do people--
people have used them for generations for that reason.
I think there are alternatives, and I had mentioned in my
testimony the fact that our regulators, the OCC, are looking at
a small-dollar loan--promoting small-dollar loans in banks and
giving banks extra CRA credit. I do not know how much of an
incentive that will be, and we need to look at that. So I would
just like to note that as something you may want to take a look
at in a few months perhaps as it evolves down the line, because
that could be another alternative, although I am not quite sure
how the banks are going to deliver that because it is not
exactly cost-effective to do it through the branches. It is
going to have to be an online product.
Ms. McGhee. There is also something else that the Senate
and the Banking Committee in particular can do. I commend you
and the State of Oregon for making that reform to essentially
eliminate the high-interest payday loan model. But the Senate
Banking Committee--actually, I am sorry. It was not the Banking
Committee, importantly. It was, I believe, the Armed Services
Committee did pass a similar law for military families. I
believe it was called the Military Readiness Act, I think, in
2006, if I recall correctly.
We could do that for the entire country. We could protect
every single member of the American public from triple-digit
interest rates on short payday loans whose model is repeating
borrowing. And I think really the only reason that we do not do
that and that that kind of reform cannot come through the
Senate at this moment is the money in politics problem. I am
sure you experience this in Oregon, but it happens, I think,
every single day there is a very well organized payday loan
lobby across the country that makes a lot of particularly
State-level legislative campaign donations, and it becomes
very, very difficult to regulate an industry that is financing
so much of the campaigns at the State level.
Senator Merkley. Your point is absolutely right. This is a
very good example of that type of economic clout, that
influence, if you will.
I was very struck in Oregon how the industry's core
argument was that clearly there is a demand for these loans;
therefore, we should simply leave the system as it is and allow
these 500-percent loans.
What we knew from other States, though, and from the
military communities due to the 2006 law, was that ready
equivalence did not disappear. The interest rates just came
down dramatically. So you still had access to short-term
lending, but you had it at a far lower rate.
Now, there should be a lot of doctorate theses exploring
why it is competition did not have the effect of bringing this
down. But it did not. It did not.
And so I can tell you there is absolutely no impulse in
Oregon to restore us to where we were before we capped these
loans. And we did it across the spectrum of consumer loans
because we saw the migration in other States from payday loans
to title loans to general consumer unsecured loans and so
forth. And so it is only the folks who are online violating the
law that are really the problem at this point.
But a major argument that we made was from the military
community, because we had generals and admirals who were coming
to Congress and saying these payday loans are destroying our
military families and that is unacceptable. Why should it be
acceptable for any family or community to be destroyed, not
just our military families and our military communities, but
any community to be destroyed? And, unfortunately, we have not
completed the vision that was so well laid out through that
2006 Act.
Well, obviously there is a lot going on here, how we change
the role of influence from money to shape policies that restore
strategies that strengthen the middle class. What is absolutely
clear is we are desperately off track right now in a rapidly
changing world. And all of you are contributing significantly
to the effort to illuminate strategies and possibilities for
putting this back on track. And so I thank you very much for
your participation and particularly for your ongoing work in
your respective fields, and I look forward to learning
additional insights from your work in the time ahead.
I will invite anyone who would like to submit any other
information for the record to do so. We will be holding it open
for a week, and that goes for my colleagues on the Committee
who might want to submit questions. And if you get questions,
certainly we look forward to your answers.
With that, we are going to conclude this hearing of the
Subcommittee. Thank you.
[Whereupon, at 3:55 p.m., the hearing was adjourned.]
[Prepared statements and additional material supplied for
the record follow:]
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PREPARED STATEMENT OF AMIR SUFI, Ph.D.
Chicago Board of Trade Professor of Finance
University of Chicago Booth School of Business
September 17, 2014
There is something wrong with the U.S. economy. We all know that
the Great Recession was the most severe economic downturn since the
Great Depression of the 1930s. What is perhaps less well understood is
that the recovery since 2009 has been dismal. From the end of recession
through 2014, real economic growth has been 2.1 percent per year, much
lower than the 3.5 percent average annual growth the U.S. economy
generated from 1947 to 2007. The decline in the unemployment rate over
the past 2 years should not be a cause for celebration--it is driven
primarily by households leaving the labor force. Only 76 percent of
Americans aged 25 to 54 currently have jobs, compared to 80 percent in
2006 and 82 percent in 1999. Put differently, there are currently 4
million fewer Americans aged 25-54 working today compared to 2006.\1\
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\1\ This is based on active population of United States aged 25 to
54 of 101 million as of 2013, and a 4 percentage point difference
between the employment to population ratio in 2006 versus 2013.
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How did we get into this mess? And why is it taking so long to
recover? My research with Atif Mian at Princeton University suggests
that the culprit is the devastation of wealth suffered by middle and
lower-income American households during the Great Recession.\2\ The
weak recovery is due in part to the lack of any rebound in wealth among
these households since the end of the recession.
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\2\ This research, published in economics and finance academic
journals, is summarized in my book with Atif Mian: House of Debt: How
They (and You) Caused the Great Recession and How We Can Prevent It
From Happening Again, University of Chicago Press: Chicago, 2014.
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Americans below the top 25th percentile of the wealth distribution
have lower net worth in real terms in 2013 than they did 15 years ago.
For Americans below the median of the wealth distribution, it has been
a disaster. For example, those in the lower-middle quartile of the
wealth distribution have seen their net worth plummet from $65 thousand
in 2007 to $40 thousand in 2010, with a further decline to $38 thousand
in 2013. This puts their wealth in 2013 below the 1989 level--the Great
Recession wiped out 25 years of wealth accumulation. The chart below
shows how bad the Great Recession was for the bottom 75 percent of the
wealth distribution.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The disproportionate negative impact of the Great Recession on the
net worth of lower wealth Americans may at first seem surprising, but
it makes perfect sense with an understanding of how the financial
system operates. Richer Americans save a much higher fraction of their
income, ultimately holding most of the financial assets in the economy:
stocks, bonds, money-market funds, and deposits. These savings are lent
by banks to middle and lower-income Americans, primarily through
mortgages.
There is nothing sinister about the rich financing the home
purchases of the poor. But it is crucial to note that the borrowing
takes the form of debt contracts which leave the borrower with the
first losses in case house prices fall. Here is a simple example to
illustrate. Imagine a homeowner in 2007 who had a $100 thousand home, a
$60 thousand mortgage, and therefore $40 thousand of home equity. When
house prices fell by 40 percent from 2007 to 2010, the house plummeted
in value to $60 thousand. The mortgage in 2010 was still worth $60
thousand, but the $40 thousand of home equity vanished. The homeowner
lost 100 percent of their home equity, even though house prices fell
only 40 percent.
This is the effect of debt. The use of mortgage debt within the
financial system gives the holders of financial assets protection
against a fall in house prices. In the example above, the mortgage did
not decline in value.\3\ But it provides this insurance by
concentrating the brunt of economic downturns on borrowers. The
standard mortgage contract is inflexible--the same amount is owed even
if house prices and the economy collapse. Given that 85 percent of the
financial assets in the U.S. economy are held by the top 20 percent of
the wealth distribution, the financial system's reliance on inflexible
debt contracts means it insures the rich while placing an inordinate
amount of risk on middle and lower net worth households.
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\3\ Of course if the home value declines by even more, it will also
reduce the value of the mortgage, which is what happened during the
Great Recession. But the losses will be more severe on home equity
because by definition the mortgage only falls in value after the equity
is wiped out.
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As we illustrate in our research, it was the massive pullback in
spending by indebted households that triggered the Great Recession. The
financial system concentrated the collapse in home values on exactly
the households that were prone to cutting spending most dramatically in
response. Further, the lack of any increase in the net worth of lower-
and middle-income Americans helps explain why the recovery in household
spending has been so weak.
Going forward, there are two important lessons from the framework
we outline in our research. First, encouraging borrowing by lower- and
middle-income Americans may temporarily boost spending, but it is not a
path to sustainable economic growth. Instead, stronger income growth
for the lower and middle part of the income distribution is necessary
for a balanced growth path. Second, the financial system in its present
form concentrates risk on lower wealth households who are least able to
bear it. The current policy and regulatory framework encourages such a
system, even though it has disastrous effects for the economy. We must
re-think how the financial system allocates risk. I explain these two
lessons in more detail below.
Credit Growth Without Income Growth: A Recipe for Disaster
A tempting solution to our current troubles is to encourage even
more borrowing by lower- and middle-income Americans. This group of
Americans is likely to spend out of additional credit, which would
provide a temporary boost to consumption. But unless borrowing is
predicated on higher-income growth, we risk falling into the same trap
that led to economic catastrophe.
In the past 3 years, there has been an aggressive expansion in
credit to lower credit score borrowers. While credit scores and income
are not the same, they are closely related; lower-income Americans tend
to have lower credit scores. More data are available that track
consumers by credit score, and so the statistics I show below focus on
credit scores.
In contrast to the expansion of subprime mortgage credit during the
2002 to 2006 housing boom, the current expansion has been concentrated
in auto lending and to a lesser degree credit card lending. For
example, from 2009 to the first quarter of 2014, auto loan originations
grew by 300 percent among consumers with a credit score below 620,
which is deep subprime territory.\4\ The growth has been much smaller
among prime consumers with a credit score above 700: less than 50
percent. The chart below shows this pattern. The tremendous growth in
auto loans to subprime borrowers may help explain why auto spending has
been a bright spot for retail spending since the end of the Great
Recession. Credit card lending to low credit score consumers has also
accelerated, but the increase has been more modest and more recent.
From 2011 to 2013, credit card originations grew by 30 percent among
consumers with a credit score below 620, compared to 3 percent for
consumers with a credit score above 700.
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\4\ A credit score below 660 is considered subprime.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Such rapid growth in credit to lower credit score households may
not be a cause for alarm--after all, credit to lower credit score
households all but disappeared during the recession, and we would
therefore expect some growth from 2009 to 2014. But the key question is
whether income growth among lower credit score individuals justifies
the expansion in auto lending. Are lenders willing to lend more because
they believe borrowers have better income prospects?
The answer to this question is worrisome: income growth among lower
credit score and lower-income Americans has been flat or even negative
during this same timeframe. A variety of data sets show this pattern.
Analysis by the Economic Policy Institute based on Current Population
Survey data shows that real income was between 2 and 3 percent lower in
2012 than in 2007 for the bottom 60 percent of the income
distribution.\5\ The grand majority of Americans have not seen real
income growth from 2007 to 2012. The recently released 2013 Survey of
Consumer Finances of the Federal Reserve shows the same result from
2010 to 2013.\6\ During these 3 years, income has fallen for all but
the top 10 percent of the income distribution.
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\5\ Gould, Elise, 2014. ``Why America's Workers Need Faster Wage
Growth--and What We Can Do About It,'' EPI Briefing Paper, August 27th.
\6\ See Bricker, Jesse, Lisa Dettling, Alice Henriques, Joanne Hsu,
Kevin Moore, John Sabelhous, Jeffrey Thomson, and Richard Windle, 2014.
``Changed in U.S. Family Finances from 2010 to 2013: Evidence from the
Survey of Consumer Finances,'' Federal Reserve Bulletin, 100:4,
September.
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The evidence from the 2013 SCF is especially alarming, and worth
discussing in more detail. From 2010 to 2013, real income fell by 4 to
7 percent for households in the bottom 60 percent of the income
distribution. These losses were registered after the Great Recession.
For the 60th to 90th percentile of the income distribution, real income
fell by 2 to 3 percent. Real income grew by 2 percent for the top 10
percent of the population. These statistics contradict the notion of a
recovery since 2010 for the grand majority of American households.
Different data sets tell one consistent story: as in the subprime
mortgage credit boom, credit is once again expanding to households that
have declining real incomes. The magnitude of the credit expansion is
smaller given that auto and credit card debt are smaller markets than
mortgages. But something has to give. Income growth needs to improve,
or lenders will eventually shut off the credit spigot.
Relying on lender willingness to provide credit is not a
sustainable way of generating economic growth. We desperately need
higher-income growth for middle and lower-income Americans. The best
way of generating income growth in the long run is by improving the
productivity of workers. Better education and strong life skill
development at a young age can help achieve higher productivity.
Unfortunately, such a boost in worker productivity takes time.
In the short run, policymakers should investigate whether there are
policies that can boost wage and income growth among lower- and middle-
income Americans without reducing economic efficiency. Some potential
policies include expanding the Earned Income Tax Credit, or identifying
public works projects that can boost aggregate productivity. Such
public investment could potentially pay for itself in the longer run
while boosting earnings in the short run. I do not know for certain
whether such policies would help. But I know for certain that
stagnating income growth for the majority of American households is a
serious economic threat.
Financial Reform: Making the Financial System Work for Americans
Another pressing matter is reform of the financial system, which as
currently constructed does not work for the majority of Americans.
Let's start with a basic indisputable point: the economy is a risky
place. House prices go up and down, as do the returns to business
capital. Human capital is risky--the wages one earns could potentially
collapse if the economy falls into recession.
This risk must be borne by someone, and the financial system should
help Americans share this risk with one another. Those that bear the
most risk should be those who have the capacity to bear losses in case
the economy crashes. In general those with a large amount of wealth
have exactly such capacity. And of course, those that bear the most
risk should be compensated for bearing that risk--earning high returns
when the economy is strong. Investors should look to the financial
system to take risk and earn a return as a result.
But how does the financial system currently operate? Does it
encourage those with wealth to bear risk by compensating them for it?
The answer is no. Instead, the financial system relies almost
exclusively on inflexible debt contracts, which force borrowers to bear
risk instead of investors.
Student debt offers a simple example. When the college class of
2009 entered college in 2005, many of them took on debt to pay tuition.
This was a sensible decision--the income premium to a college degree is
high, and students were willing to borrow in the short-run to get the
benefit of higher wages in the future. But of course, no one in the
college class of 2009 understood in 2005 that the U.S. economy was
about to get whacked with the worst recession since the Great
Depression. The unemployment rate for recent college graduates
skyrocketed from 9 percent to 18 percent from 2007 to 2009. Further,
wages for those that were able to find jobs collapsed. The consequences
for the class of 2009 will likely persist into the future: Research
shows that there are long-run, persistent negative effects of
graduating from college in the midst of a severe recession.\7\
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\7\ Kahn, Lisa, 2010. ``The long-term Labor Market Consequences of
Graduating from College in a Bad Economy.'' Labour Economics, 17:2,
303-316.
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Did the financial system help share the risk borne by the college
class of 2009? No. In fact, the student debt burden and interest
payments remained exactly the same for the students, even though their
employment prospects collapsed. The financial system, with its reliance
on inflexible student debt contracts, forced young Americans to bear
risk that they were poorly equipped to bear. They are young with almost
no assets--why should they bear the costs of an economic downturn?
A more sensible financial system would share the risk by having the
principal and interest payments on student debt automatically adjust
downward when recessions hit. The lenders should share some of the
downside risk, and they should be compensated if the economy ends up
being stronger than expected. A simple adjustment would be a debt
contract with a higher average interest payment if the unemployment
rate facing recent college graduates remained low, but automatic debt
forgiveness if the unemployment rate facing college graduates increased
substantially. In this way lenders would be paid a higher interest
payment if the job market were strong, but would have to accept lower
payments if the job market ends up being very weak.
This example applies more broadly to financial contracts in the
economy. The reliance on inflexible debt contracts forces lower-income
and younger Americans to bear too much economic risk. Debt contracts
require the same payment regardless of what happens in the economy. As
mentioned above, there is risk in the economy. That is unavoidable. But
the current bias of the current financial system is to force the most
vulnerable to bear the risk.
We need policies that would help move the financial system away
from its current reliance on inflexible debt contracts. One such policy
the Government could implement in the short-run would be to lower
student debt owed to the Government for those who graduated in the
midst of the Great Recession. The college class of 2009 should not be
forced to bear the costs of the downturn with no assistance: it is not
their fault they were born in 1987, 22 years before the worst recession
in 80 years. This could be done with outright debt forgiveness, or by
allowing borrowers to refinance into current market interest rates.
Going forward, student debt provided by the Government could be indexed
to the unemployment rate facing college students, so that debt burdens
are automatically reduced if the economy enters another recession.
More broadly, the current bias of policy encourages the financial
system to use inflexible debt contracts, even though they have
potentially disastrous effects for the economy. We tolerate the
issuance of fragile short-term debt by financial institutions that
enjoy some level of Government backing, and we allow them to do so
while holding very little capital. Banks then either choose or are told
by regulators to take very little risk on the asset side of their
balance sheets, which results in borrowers bearing the risk. We force
insurance companies to hold highly rated assets, which can only be
produced by debt contracts to borrowers. We encourage inflexible
mortgage contracts by declaring them as ``conforming'' mortgages that
the Government-sponsored entities can buy and securitize. More equity-
like mortgages where the principal adjusts downward if house prices
fall do not qualify, and the private sector therefore has little
incentive to provide them. Further, we give a mortgage interest
deduction for inflexible debt contracts, which encourages households to
use them.
Removing the strong policy bias toward inflexible debt contracts
will not be easy, and it cannot be done overnight. However, I want to
encourage policymakers to think in a big-picture manner about the
current financial system, what it is supposed to do, and what
Government can do to make it work better for Americans. We have a
tendency to accept the financial system as it is, and make minor
changes to help insulate it from risk. But the risk is not going away--
it must be borne by somebody. A properly functioning financial system
would encourage those with wealth--that is, those with risk-bearing
capacity--to bear risk and earn a return for doing so. It would help
those with little wealth attend college or buy a home without bearing
an inordinate amount of economic risk. It may take time, but moving
toward such a financial system would improve the welfare of all
Americans.
______
PREPARED STATEMENT OF CLAUDIA VIEK
CEO, CAMEO--California Association for Micro Enterprise Opportunity
September 17, 2014
Chairman Jeff Merkley, Ranking Member Dean Heller, and Members of
the Committee, thank you for the opportunity to submit testimony about
an issue of crucial importance to the American business community and
economy.
CAMEO's mission is to grow a healthy, vibrant, thriving environment
for all entrepreneurs and startup businesses in California. We are the
largest Statewide network of nonprofits that provided training,
coaching and loans to 18,000 businesses last year, businesses that
created 32,000 jobs. We are also a member of the American Sustainable
Business Council, which collectively represents over 250,000
businesses, many of which are small businesses that create jobs across
the country.
Let me illustrate with a brief story: Johneric Concordia is a young
man who was laid off as a baggage handler for United Airlines. He loved
to barbeque in his neighborhood in Filipinotown in Los Angeles. He and
his uncles would compete to see who made the best sauce. When he lost
his job, he sought business counseling from the Asian Pacific Islander
Small Business Program to start his own barbeque catering business. He
raised $8,000 for a truck-mounted barbeque rig through Facebook, and a
year later opened Parks Finest restaurant in Echo Park. He has hired
nine of his friends to work for him and is ready for a larger loan from
a local nonprofit lender.
Parks Finest is not a one-off--I have many, many similar stories
from members like the National Asian American Coalition, the Los
Angeles Latino Chamber, and the other 85 CAMEO members who serve
entrepreneurs with small dollar loans and coaching. Johneric and others
have the desire and ability to contribute to our economy by being their
own boss, and go on to employ others--they are exactly the kind of
people we should invest in!
If we are serious about addressing income inequality, then we need
to support entrepreneurship and starting a business as a real pathway
to closing the wealth gap and generating new jobs.
There are 26 million small businesses in the United States, most of
which are self-employed. If just 1 in 3 such businesses created one
job, we could have full employment! ``This would address the 50 percent
unemployment rate among black and Latino youth,'' said Reverend Mark
Whitlock, Corporate Relations Chair for the 5,000 member national AME
Church.
For example, a minimum of a million new jobs a year could be
created through bank investment in lending and technical assistance
programs.
Why business ownership? The Congressional Budget Office found that
the cause of the rise in income inequality between 1979 and 2007
derives mostly from disparities in business income. If we get to the
heart of the problem of inequality, the answer can be simple. Instead
of handouts and promises of trickle-down job creation, help people
create their own businesses and have them close the income inequality
gap themselves.
The wealth gap in the United States is large and growing: the
median net worth of Caucasians was $110,500 compared to $7,683 for
Latinos and $6,314 for African Americans. The wealth gap hinders their
ability to create, maintain and grow their small firms, which impacts
all of us.
Eighty-eight percent of minority business owners finance their
small businesses from home equity, compared to about a quarter overall.
Thus, the loss of home equity disproportionately affects minority-owned
businesses. In California, almost 2 million homeowners are still under
water; also true in Nevada, Senator Heller's State. We can assume that
minority-owned businesses have not been able to recover fully from the
downturn.
Business ownership is an effective strategy to reduce income
inequality: the median net worth of business owners is two and a half
times greater than for all nonbusiness owners, and for African
Americans the difference is eight times higher for business owners
compared to nonbusiness owners.
Households headed by women who own a microbusiness generate up to
$13,000 more in annual household income than similar households without
a microbusiness owner. This may not sound like much, but this amount
can be the difference that sends one's child to college or buys a home.
And, research shows that the children in families with a microbusiness
owner do better in terms of education and social mobility (Source: AEO
Report, ``Bigger than You Think'', 2014).
Self-employment, business ownership and entrepreneurship are key
ways for lower-income people to become middle income. Therefore,
Government should increase support to programs that help start and grow
small and microbusinesses. Instead we have seen a 40 percent drop in
funding over past 3 years and fewer businesses benefiting.
This is the case within the U.S. Small Business Administration
(SBA), U.S. Department of Agriculture (USDA), and Housing of Urban
Development (HUD), all of which fund microbusiness development.
Furthermore, women are starting businesses at three times the rate of
men and African American women at four times the rate, but women
receive $1 of capital for every $23 men receive. We are fortunate that
Maria Contreras-Sweet, SBA's new Administrator, is addressing this
inequity, as is the proposed Women's Equity Bill introduced last month
by Senator Maria Cantwell.
Self-employment is the labor market trend--by 2017, 50 percent of
our workforce will be, or have been, self-employed! Research on the
independent workforce reveals that young millennials and those over 55
are the most likely to choose self-employment.
We know that when businesses get training and coaching help, 80
percent are in business after 5 years, compared to 50 percent of those
that did not get such help. (Source: Aspen Institute, FIELD). Also,
businesses that received capital and services from a nonprofit
organization have 30 percent higher median annual revenue growth than
those that did not. And when microbusinesses succeed, they create on
average another two jobs. (Source: AEO Report, ``Bigger than You
Think'', 2014.)
These statistics are borne out by my personal experience of more
than 25 years running entrepreneurship training and business incubation
programs. Again, small business ownership will help close the income
inequality and wealth gap and bring low-income families into the middle
class. So why don't we invest more in them?
For example, the U.S. Department of Labor (DOL) could recognize
self-employment as a job. DOL does not provide funding or have
performance measures for self-employment. This keeps many young, lower
income, and people of color from starting their own businesses because
local Workforce boards will not allow them to pursue entrepreneurship
training, but will pay for training in expensive institutions that
don't place them in a job. And the SBA only budgets $12 million
nationwide for helping women business owners, most of whom are low or
moderate income.
Currently our bank regulators are proposing giving extra Community
Reinvestment Act credit to banks that provide small dollar microloans
in low- and moderate-income communities. This policy could have a major
impact on new self-employment and job growth in communities that have
not recovered from the Great Recession.
So, I urge you to target our economic policies to very small
businesses in and around low- and moderate-income communities, those
that have not recovered from the downturn, that have not regained
equity in their homes and businesses. In this way we can create more
opportunities everyone, especially for young, unemployed people of
color.
If there is one thing you remember from my testimony, let it be how
small business creation and entrepreneurship can reduce income
inequality and bring hope to our communities with so much untapped
entrepreneurial potential. Thank you for this opportunity to address
the Committee.
______
PREPARED STATEMENT OF ADAM S. HERSH, Ph.D.
Senior Economist, Center for American Progress
September 17, 2014
Thank you Chairman Merkley, Ranking Member Heller, for inviting me
to testify today. My name is Adam Hersh and I'm a Senior Economist at
the Center for American Progress Action Fund.
There is an increasingly broad consensus among professional
economists that high levels of inequality are extremely detrimental not
only to current economic growth, but to future growth as well. This is
the case because when we talk about the economy, we are talking about
what's happening to people and how people are faring in their lives. An
economy with broadly shared income gains creates the financially secure
families who can:
Invest in the human capital--health and education--that
creates a productive, innovative labor force
Provide stable, strong consumer demand that entices
business investment
Provide a fertile environment for entrepreneurship to
develop
Research also indicates that economies with lower inequality and
stronger middle classes have more stable financial systems, higher
investments in public goods, better quality of governance and public
institutions, broader civic participation, lower crime, and less
political polarization.\1\
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\1\ Heather Boushey and Adam Hersh, ``The American Middle Class,
Income Inequality, and the Strength of Our Economy: New Evidence in
Economics,'' (Washington, DC: Center for American Progress, 2012),
available at http://cdn.americanprogress.org/wp-content/uploads/issues/
2012/05/pdf/middleclass_growth.pdf.
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Taken as a whole, inequality is the central thread that runs
through essentially all the factors that economists identify as
important for economic growth. In other words, a vibrant U.S. economy
does not trickle down from the super wealthy, but rather springs forth
from a thriving middle class.
International trade and investment are critical parts of the U.S.
economy--they always have been and always will be--but they create
complicated economic policy issues because trade is simultaneously a
cause of inequality and of the innovation and investment that leads to
growth.
Trade is one among several factors that have contributed to the
rise in U.S. income and wealth inequality since the late 1970s--
declines in unionization and the real minimum wage, decreasing tax
progressivity, increased short-termism and focus on financial profits
over real investments in the business sector, and shifting technologies
have all played roles. But economists don't really debate whether trade
has distributional impacts on incomes and wealth; we debate how big is
the impact of trade, among the multiple causes. And across a variety of
studies, economists estimate that increased trade accounts for between
10 percent to 52 percent of the overall increase in U.S. wage
inequality since the 1980s.\2\
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\2\ Paul Krugman, ``Trade and Wages Reconsidered,'' Brookings
Papers on Economic Activity, available at http://www.brookings.edu//
media/Projects/BPEA/Spring%202008/2008a_
bpea_krugman.pdf.
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Trade also has positive effects on living standards in the United
States by incentivizing innovation and providing access to a broader
variety of goods and services at lower prices. While certainly yielding
substantial gains from cheap imports, we account for this when
measuring inflation--adjusted real wages and family incomes, which,
respectively, have stagnated and declined. Median family income, for
example, today is more than $5,400 below its level in 2000 and back
down to its levels before the 1990s economic boom.\3\
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\3\ Author's analysis of U.S. Census ``Family Income: Table F-7.
Type of Family, All Races by Median and Mean Income: 1947 to 2012,''
available at http://www.census.gov/hhes/www/income/data/historical/
families/.
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Trade's impact on inequality comes both through direct channels--
the dislocation of workers when domestic production shrinks or moves
overseas--as well as from indirect effects that can saddle regions in
localized economic depressions. The losses to local economies render
large swathes of capital stock--factories, office buildings,
infrastructure--unproductive. It is equivalent to having a Hurricane
Katrina or Hurricane Sandy, but that capacity won't be rebuilt.
Economist Andrew B. Bernard and co-authors found that the more
manufacturing plants were exposed to low-wage-country imports, the
slower they grew and the more likely they were to exit the market--
close their doors.\4\ Similarly, economist Avi Ebenstein and co-authors
find that wages grow more slowly in occupations more exposed to import
penetration and to U.S. multinational companies ability to move
production offshore.\5\
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\4\ Bernard, Jensen, Redding, and Schott, ``Firms in International
Trade,'' Journal of Economic Perspectives, Vol. 21, no. 3, pp. 105-130.
\5\ Avi Ebenstein, et al., ``Estimating the Impact of Trade and
Offshoring on American Workers Using the Current Population Surveys,''
Review of Economics and Statistics, available at http://
pluto.huji.ac.il/ebenstein/
Ebenstein_Harrison_McMillan_Phillips_August2012.pdf.
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Recent research from economists at the Federal Reserve Bank of San
Francisco shows that these dislocation and wage impacts are
concentrated in industries most exposed to offshore competition--
primarily manufacturing industries, and rising increasingly up the
advanced technology ladder. Their analysis shows it is precisely here
where the impact on the distribution of wages and capital income within
firms have been felt most strongly.\6\
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\6\ Michael Elsby, Bart Hobjin, and Aysegul Sahin, ``The Decline of
the U.S. Labor Share,'' Brookings Papers on Economic Activity, 2013,
available at http://www.frbsf.org/economic-research/files/wp2013-
27.pdf.
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Other recent research, from MIT economist David Autor and co-
authors show that the economic impacts of trade competition and
dislocation are not limited just to affected factories or companies.\7\
The spillover effects can essentially create regional economic
depressions, with broadly elevated unemployment rates, public safety
net expenditures for things like unemployment, disability, and Medicaid
benefits--even while the total U.S. economy steams ahead.
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\7\ David Autor, David Dorn, and Gordon Hanson, ``The China
Syndrome: Local Labor Market Effects of Import Competition in the
United States,'' American Economic Review, Vol. 103, no. 6, pp. 2121-
68.
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Much has and still is changing in the global competitive
environment facing U.S. workers and businesses--and binding together
their futures with those of people and businesses around the world.
Whereas most of the postwar period saw global trade concentrated among
the United States, Europe, and latecomers like Japan, the gravity of
economic growth and international trade in the world is shifting to the
East, and to the South--that is, to developing countries in Asia, Latin
America, and elsewhere that now account for half of global economic
growth, a share that is likely to continue rising for the foreseeable
future. Not only will U.S. businesses compete increasingly with
businesses based in these countries in United States and world markets,
but U.S. workers at all skill levels will increasingly compete for a
share of the work across a growing range of industries and occupations.
In the past, trade tended to occur at arms-length between
independent firms, but today globally integrated production and
corporate governance systems comprise the core of international trade.
In 2013, fully half of U.S. imported goods were traded by companies
within the same corporate families--what the Census Bureau calls
related-party trade.\8\ This means that a foreign affiliate of a U.S.-
based company transacted with another related affiliate or the parent
company in the United States.
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\8\ Adam Hersh, ``Offshoring Work is Taking a Toll on the U.S.
Economy,'' (Washington, DC: Center for American Progress, 2014),
available at http://www.americanprogress.org/issues/economy/news/2014/
07/30/94864/offshoring-work-is-taking-a-toll-on-the-u-s-economy/.
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This practice of offshoring, moving production to foreign locales
while continuing to sell goods to the U.S. market, is now a deeply
entrenched and a pervasive feature of the U.S. economy impacting
inequality and growth in several ways. The work that would otherwise be
conducted in the United States would go elsewhere, causing direct
disemployment, with expected multiplier effects on output and
employment.
Adjustment to these trade shocks need not be too disruptive if
displaced workers and capital investments can be smoothly segued into
other productive uses, and if the shock to aggregate demand can be
offset by growth elsewhere in the economy. However, because of the
widespread trend toward such global production arrangements, and the
sharp fiscal contraction we've seen in the past 4 years, the quality
and quantity of jobs being created in the United States. Three-fifths
of the jobs lost in the United States since the start of the Great
Recession earned middle class incomes, but three-fifths of the jobs
created since the labor market recovery began in 2010 are in low-wage
industries and occupations. The pace of growth is not adequate to move
us back toward full employment--a critical factor for growing market
wages--or to create jobs that generate opportunities to secure a rising
middle class standard of living.\9\
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\9\ Adam Hersh, ``New Jobs Growth Underscore Stable Recovery
Although Wages Have Yet to Budge,'' (Washington, DC: Center for
American Progress, 2014), available at http://www.americanprogress.org/
issues/economy/news/2014/08/01/95027/new-jobs-data-underscore-stable-
recovery-although-wages-have-yet-to-budge/.
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The questions before lawmakers are:
(1) How should the United States engage trading partners in an
increasingly open and competitive world in order to grow the
economy from the middle out?
(2) What should the United States do to make sure that workers and
businesses in the United States can thrive in this environment?
The United States and its trading partners across the globe need to
find a way to set a high road path to trade in an increasingly open and
competitive world. Our national strength, and indeed our mutual social
and environmental future depend on this. And doing so will require us
to rethink our approach to the means and goals of economic growth well
beyond just trade policy.
Though the global competitive landscape has evolved much faster
than U.S. economic policies and institutions, there are clear steps we
can take to set this high road path toward sustained, broadly inclusive
economic growth.
First, the U.S. trade negotiators must be pressed to establish
strong, enforceable standards for fair and open competition in the
global economy. Capitalizing on U.S. economic potential for trade and
getting better outcomes for people in the United States and in trading
partner countries begins with negotiating better international
agreements. Unfortunately, many rules of the international trading
system that the United States has painstakingly built through the post-
WWII era are still lacking in key respects and need to evolve to keep
pace with a changing world economy.
Currency manipulation for trade advantage is prohibited both by IMF
and WTO Articles of Agreement and should be dealt with in conjunction
with other trade issues in bilateral and multilateral trade
agreements--not through separate dialogs--and I believe that
legislation to treat currency manipulation as a countervailable duty
would strengthen that position.\10\ A week's worth of appreciation of
an undervalued exchange rate would do more to expand U.S. manufacturing
and agriculture exports than years of Trans-Pacific Partnership
negotiations.
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\10\ IMF Articles of Agreement, Article VIII, Section 2(a),
available at http://www.imf.org/External/Pubs/FT/AA/#a8s2; WTO Articles
of Agreement, Article XV available at http://www.wto.org/english/res_e/
booksp_e/gatt_ai_e/art15_e.pdf.
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Setting a high enforceable standard of conduct also applies to the
areas of labor rights and conditions at work, incentivizing responsible
stewardship of environmental assets in our economies, and ensuring an
environment of open competition in international commerce.\11\ The May
10th agreement on labor and environmental standards are a start, but
fall far short of what is needed: policies with real teeth to sanction
real, egregious labor practices and conditions that make all workers
around the world worse off. National labor markets are not segmented
along export and domestic lines, and therefore labor standards should
apply economy-wide. Requiring countries to sign on to a handful of
multilateral environmental agreements is a win, but does little to
address the costs of environmental externalities built into current
consumer-driven global supply chain--both due to lax pollution controls
abroad and the environmental footprint from physically trading goods.
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\11\ Adam Hersh and Jennifer Erickson, ``Progressive Pro-Growth
Principles for Trade and Competitiveness,'' (Washington, DC: Center for
American Progress, 2014), available at http://www.americanprogress.org/
issues/economy/report/2014/03/11/85639/progressive-pro-growth-
principles-for-trade-and-competitiveness/.
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And though trading partners should be free to choose their path to
development, the United States should insist on establishing
international norms of transparency and corporate to ensure competitive
neutrality where developing countries pursue initiatives to build their
global economic niches through State ownership. It is imperative that
we establish through our international trade relations standards for
financial reporting disclosures and independent third-party auditing
that can establish companies compete with out the undue and
impermissible forms of State support and privilege--public bodies
operating in the commercial sphere should conform to the OECD
Guidelines on Corporate Governance of SOEs or face withdrawal of
reciprocal trade preferences.
High standard agreements should also set a high standard for public
health and safety. Intellectual property rights aspects of trade
agreements, particularly where they pertain to life-saving drugs and
medical devices must strike a balance between the social welfare and
private incentives to innovate. Granting ``ever-greening'' patent
protections creates a monopoly rent, not an incentive to innovate. Nor
should high standard agreements impede public health policies from
using their purchasing power to negotiate fiscally responsible
procurement for health care goods and services.
Second, Congress should increase commitments to enforce the hard-
fought rules of trade agreements. Trade agreements aren't worth the
paper they are printed on if agreed upon rules are routinely flaunted.
Making sure rules aren't violated takes resources to monitor,
investigate, and enforce. Our Interagency Trade Enforcement Center, or
ITEC, is basically an under-resourced public defenders office. As a
start, Congress should double funding to ITEC to $50 million per year.
Congress can also instruct the USTR to increase transparency,
accountability, and action of trade enforcement by instituting a more
effective National Trade Barriers Report, a new National Trade
Compliance Data base, and expanded statistical reporting to better
identify where trade violations are occurring and what we're doing
about them.\12\
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\12\ Adam Hersh and Jennifer Erickson, ``Progressive Pro-Growth
Principles for Trade and Competitiveness,'' (Washington, DC: Center for
American Progress, 2014), available at http://www.americanprogress.org/
issues/economy/report/2014/03/11/85639/progressive-pro-growth-
principles-for-trade-and-competitiveness/.
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Third, the most important things the United States can do to
improve America's trade competitiveness is to substantially expand
investments in the sources of U.S. competitiveness in:
broadly available quality education to build a workforce
that can compete and fuel innovation as well as the family
friendly workplace environment that allow parents to build a
career while raising their kids;
modernized infrastructure that can move people, goods, and
ideas around more efficiently, lowering costs and making people
and businesses more productive;
scientific research and development, and supporting the
innovation ecosystems that link together research with
workforce development and commercialization;
replacing outdated trade adjustment assistance programs, or
TAA, with a new universal dislocated worker program that
integrates public and private efforts to help workers knocked
down by the shock of job dislocation--anywhere in the economy,
not just in the tradable sector--by helping them climb the next
rung on their job ladder in finding new work and helping smooth
aggregate demand for the overall economy.
Trade is an essential part of the U.S. economy, and it is essential
that the United States get its trade and economic policies on the right
track so that we can set a high road path for the global economy.
Additional Material Supplied for the Record
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