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The Crisis of the Middle Class and American Power – Stratfor

This article from George Friedman of Stratfor is a follow up to his recent one on Europe’s current problems, especially unemployment.

The  Crisis of the Middle Class and American Power is republished with permission  of Stratfor.”

Read more:  The Crisis of the Middle Class and American Power | Stratfor

By George Friedman Founder  and Chief Executive Officer, Stratfor,

Last week I wrote about the crisis of unemployment in Europe. I  received a great deal of feedback, with Europeans agreeing that this is the core  problem and Americans arguing that the United States has the same problem,  asserting that U.S. unemployment is twice as high as the government’s  official unemployment rate. My counterargument is that unemployment in the  United States is not a problem in the same sense that it is in  Europe because it does not pose a geopolitical threat. The United States  does not face political disintegration from unemployment, whatever the number  is. Europe might.

At the same time, I would agree that the United  States faces a potentially significant but longer-term geopolitical problem  deriving from economic trends. The threat to the United States is the persistent  decline in the middle class’ standard of living, a problem that is reshaping the  social order that has been in place since World War II and that, if it  continues, poses a threat to American power.

The Crisis of the American Middle Class

The median household income of Americans in 2011 was $49,103. Adjusted for  inflation, the median income is just below what it was in 1989 and is $4,000  less than it was in 2000. Take-home income is a bit less than $40,000 when  Social Security and state and federal taxes are included. That means a monthly  income, per household, of about $3,300. It is urgent to bear in mind that half  of all American households earn less than this. It is also vital to consider not  the difference between 1990 and 2011, but the difference between the 1950s and  1960s and the 21st century. This is where the difference in the meaning of  middle class becomes most apparent.

In the 1950s and 1960s, the median income allowed you to live with a single  earner — normally the husband, with the wife typically working as  homemaker — and roughly three children. It permitted the purchase of modest  tract housing, one late model car and an older one. It allowed a driving  vacation somewhere and, with care, some savings as well. I know this because my  family was lower-middle class, and this is how we lived, and I know many others  in my generation who had the same background. It was not an easy life and many  luxuries were denied us, but it wasn’t a bad life at all.

Someone earning the median income today might just pull this off,  but it wouldn’t be easy. Assuming that he did not have college loans to pay off  but did have two car loans to pay totaling $700 a month, and that he could buy  food, clothing and cover his utilities for $1,200 a month, he would have $1,400  a month for mortgage, real estate taxes and insurance, plus some funds for  fixing the air conditioner and dishwasher. At a 5 percent mortgage rate, that  would allow him to buy a house in the $200,000 range. He would get a refund back  on his taxes from deductions but that would go to pay credit card bills he had  from Christmas presents and emergencies. It could be done, but not  easily and with great difficulty in major metropolitan areas. And if his  employer didn’t cover health insurance, that $4,000-5,000 for three or four  people would severely limit his expenses. And of course, he would have to have  $20,000-40,000 for a down payment and closing costs on his home. There would be  little else left over for a week at the seashore with the kids.

And this is for the median. Those below him — half of all households —  would be shut out of what is considered middle-class life, with the house, the  car and the other associated amenities. Those amenities shift upward on the  scale for people with at least $70,000 in income. The basics might be available  at the median level, given favorable individual circumstance, but below that  life becomes surprisingly meager, even in the range of the middle class and  certainly what used to be called the lower-middle class.

The Expectation of Upward Mobility

I should pause and mention that this was one of the fundamental causes of the 2007-2008 subprime lending  crisis. People below the median took out loans with deferred interest with  the expectation that their incomes would continue the rise that was traditional  since World War II. The caricature of the borrower as irresponsible misses the  point. The expectation of rising real incomes was built into the American  culture, and many assumed based on that that the rise would resume in five  years. When it didn’t they were trapped, but given history, they were not making  an irresponsible assumption.

American  history was always filled with the assumption that upward mobility was  possible. The Midwest and West opened land that could be exploited, and the  massive industrialization in the late 19th and early 20th centuries opened  opportunities. There was a systemic expectation of upward mobility built into  American culture and reality.

The Great Depression was a shock to the system, and it wasn’t solved by the  New Deal, nor even by World War II alone. The next drive for upward mobility  came from post-war programs for veterans, of whom there were more than 10  million. These programs were instrumental in creating post-industrial America,  by creating a class of suburban professionals. There were three programs that  were critical:

  1. The GI Bill, which allowed veterans to go to college after the war, becoming  professionals frequently several notches above their parents.
  2. The part of the GI Bill that provided federally guaranteed mortgages to  veterans, allowing low and no down payment mortgages and low interest rates to  graduates of publicly funded universities.
  3. The federally funded Interstate Highway System, which made access to land  close to but outside of cities easier, enabling both the dispersal of  populations on inexpensive land (which made single-family houses possible) and,  later, the dispersal of business to the suburbs.

There were undoubtedly many other things that contributed to this, but these  three not only reshaped America but also created a new dimension to the upward  mobility that was built into American life from the beginning. Moreover, these  programs were all directed toward veterans, to whom it was acknowledged a debt  was due, or were created for military reasons (the Interstate Highway System was  funded to enable the rapid movement of troops from coast to coast, which during  World War II was found to be impossible). As a result, there was consensus  around the moral propriety of the programs.

The subprime fiasco was rooted in the failure to understand that the  foundations of middle class life were not under temporary pressure but something  more fundamental. Where a single earner could support a middle class family in  the generation after World War II, it now took at least two earners.  That meant that the rise of the double-income family corresponded with the  decline of the middle class. The lower you go on the income scale, the more  likely you are to be a single mother. That shift away from social pressure for  two parent homes was certainly part of the problem.

Re-engineering the Corporation

But there was, I think, the crisis of the modern corporation. Corporations  provided long-term employment to the middle class. It was not unusual to spend  your entire life working for one. Working for a corporation, you received yearly  pay increases, either as a union or non-union worker. The middle class had both  job security and rising income, along with retirement and other benefits. Over  the course of time, the culture of the corporation diverged from the realities,  as corporate productivity lagged behind costs and the corporations became more  and more dysfunctional and ultimately unsupportable. In addition, the  corporations ceased focusing on doing one thing well and instead became  conglomerates, with a management frequently unable to keep up with the  complexity of multiple lines of business.

For these and many other reasons, the corporation became increasingly  inefficient, and in the terms of the 1980s, they had to be re-engineered —  which meant taken apart, pared down, refined and refocused. And the  re-engineering of the corporation, designed to make them agile, meant that there  was a permanent revolution in business. Everything was being reinvented. Huge  amounts of money, managed by people whose specialty was re-engineering  companies, were deployed. The choice was between total failure and radical  change. From the point of view of the individual worker, this frequently meant  the same thing: unemployment. From the view of the economy, it meant the  creation of value whether through breaking up companies, closing some of them or  sending jobs overseas. It was designed to increase the total efficiency, and it  worked for the most part.

This is where the disjuncture occurred. From the point of view of the  investor, they had saved the corporation from total meltdown by redesigning it.  From the point of view of the workers, some retained the jobs that they would  have lost, while others lost the jobs they would have lost anyway. But the  important thing is not the subjective bitterness of those who lost their jobs,  but something more complex.

As the permanent corporate jobs declined, more people were starting over.  Some of them were starting over every few years as the agile corporation grew  more efficient and needed fewer employees. That meant that if they got new jobs  it would not be at the munificent corporate pay rate but at near entry-level  rates in the small companies that were now the growth engine. As these companies  failed, were bought or shifted direction, they would lose their jobs and start  over again. Wages didn’t rise for them and for long periods they might be  unemployed, never to get a job again in their now obsolete fields, and certainly  not working at a company for the next 20 years.

The restructuring of inefficient companies did create substantial value, but  that value did not flow to the now laid-off workers. Some might flow to the  remaining workers, but much of it went to the engineers who restructured the  companies and the investors they represented. Statistics reveal that, since 1947  (when the data was first compiled), corporate profits as a percentage of gross  domestic product are now at their highest level, while wages as a percentage of  GDP are now at their lowest level. It was not a question of making the economy  more efficient — it did do that — it was a question of where the value  accumulated. The upper segment of the wage curve and the investors continued to  make money. The middle class divided into a segment that entered the  upper-middle class, while another faction sank into the lower-middle class.

American society on the whole was never egalitarian. It always accepted that  there would be substantial differences in wages and wealth. Indeed, progress was  in some ways driven by a desire to emulate the wealthy. There was also the  expectation that while others received far more, the entire wealth structure  would rise in tandem. It was also understood that, because of skill or luck,  others would lose.

What we are facing now is a structural shift, in which the middle class’  center, not because of laziness or stupidity, is shifting downward in terms of  standard of living. It is a structural shift that is rooted in social change  (the breakdown of the conventional family) and economic change (the decline of  traditional corporations and the creation of corporate agility that places  individual workers at a massive disadvantage).

The inherent crisis rests in an increasingly efficient economy and a  population that can’t consume what is produced because it can’t afford the  products. This has happened numerous times in history, but the United States,  excepting the Great Depression, was the counterexample.

Obviously, this is a massive political debate, save that political debates  identify problems without clarifying them. In political debates, someone must be  blamed. In reality, these processes are beyond even the government’s ability to  control. On one hand, the traditional corporation was beneficial to the workers  until it collapsed under the burden of its costs. On the other hand, the  efficiencies created threaten to undermine consumption by weakening the  effective demand among half of society.

The Long-Term Threat

The greatest danger is one that will not be faced for decades but that is  lurking out there. The United States was built on the assumption that a rising  tide lifts all ships. That has not been the case for the past generation, and  there is no indication that this socio-economic reality will change any time  soon. That means that a core assumption is at risk. The problem is that social  stability has been built around this assumption — not on the assumption that  everyone is owed a living, but the assumption that on the whole, all benefit  from growing productivity and efficiency.

If we move to a system where half of the country is either stagnant or  losing ground while the other half is surging, the social fabric of the United  States is at risk, and with it the massive global power the United States has  accumulated. Other superpowers such as Britain or Rome did not have  the idea of a perpetually improving condition of the middle class as a core  value. The United States does. If it loses that, it loses one of the pillars of  its geopolitical power.

The left would argue that the solution is for laws to transfer wealth from  the rich to the middle class. That would increase consumption but, depending on  the scope, would threaten the amount of capital available to investment by the  transfer itself and by eliminating incentives to invest. You can’t invest what  you don’t have, and you won’t accept the risk of investment if the payoff is  transferred away from you.

The agility of the American corporation is critical. The right will argue  that allowing the free  market to function will fix the problem. The free market doesn’t  guarantee social outcomes, merely economic ones. In other words, it may give  more efficiency on the whole and grow the economy as a whole, but by itself it  doesn’t guarantee how wealth is distributed. The left cannot be indifferent to  the historical consequences of extreme redistribution of wealth. The right  cannot be indifferent to the political consequences of a middle-class life  undermined, nor can it be indifferent to half the population’s inability to buy  the products and services that businesses sell.

The most significant actions made by governments tend to be unintentional.  The GI Bill was designed to limit unemployment among returning serviceman; it  inadvertently created a professional class of college graduates. The VA loan was  designed to stimulate the construction industry; it created the basis for  suburban home ownership. The Interstate Highway System was meant to move troops  rapidly in the event of war; it created a new pattern of land use that was  suburbia.

It is unclear how the private sector can deal with the problem of pressure on  the middle class. Government programs frequently fail to fulfill even minimal  intentions while squandering scarce resources. The United States has been a  fortunate country, with solutions frequently emerging in unexpected ways.

It would seem to me that unless the United States gets lucky again, its  global dominance is in jeopardy. Considering its history, the United States can  expect to get lucky again, but it usually gets lucky when it is frightened. And  at this point it isn’t frightened but angry, believing that if only its own  solutions were employed, this problem and all others would go away. I am arguing  that the conventional solutions offered by all sides do not yet grasp the  magnitude of the problem — that the foundation of American society is at risk  — and therefore all sides are content to repeat what has been said before.

People who are smarter and luckier than I am will have to craft the solution.  I am simply pointing out the potential consequences of the problem and the  inadequacy of all the ideas I have seen so far.

Read more:  The Crisis of the Middle Class and American Power | Stratfor

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Europe in 2013: A Year of Decision – Stratfor

 

By George Friedman Founder  and Chief Executive Officer Stratfor

The end of the year always prompts questions about what the most important  issue of the next year may be. It’s a simplistic question, since every year sees  many things happen and for each of us a different one might be important. But it  is still worth considering what single issue could cause the world to change  course. In my view, the most important place to watch in 2013 is Europe.

Taken as a single geographic entity, Europe has the largest economy in the  world. Should it choose to do so, it could become a military  rival to the United States. Europe is one of the pillars of the global  system, and what happens to Europe is going to define how the world works. I  would argue that in 2013 we will begin to get clarity on the future of  Europe.

The question is whether the European Union will stabilize itself, stop  its fragmentation and begin preparing for more integration and expansion.  Alternatively, the tensions could intensify within the European Union, the  institutions could further lose legitimacy and its component  states could increase the pace with which they pursue their own policies,  both domestic and foreign.

The Embattled European Project

It has been more than four years since the crisis of 2008 and about two years  since the problems spawned by 2008 generated a sovereign debt crisis and a  banking crisis in Europe. Since that time, the crisis has turned from a  financial to an economic crisis, with Europe moving into recession and  unemployment across the Continent rising above 10 percent. More important, it  has been a period in which the decision-making apparatus created at the founding  of the European Union has been unable to create policy solutions that were both  widely acceptable and able to be implemented. EU countries have faced each other  less as members of a single political entity than as individual  nation-states pursuing their own national interests in what has become  something of a zero-sum game, where the success of one has to come at the  expense of another.

This can be seen in two ways. The first dimension has centered on which  countries should bear the financial burden of stabilizing the eurozone. The  financially healthier countries wanted the weaker countries to bear the burden  through austerity. The weaker countries wanted the stronger countries to bear  the burden through continued lending despite the rising risk that the loans  will not be fully repaid. The result has been constant attempts to  compromise that have never quite worked out. The second dimension has been  class. Should the burden be borne by the middle and lower classes by reducing  government expenditures that benefit them? Or by the elites through increased  taxation and regulation?

When you speak with Europeans who support the idea that Europe is in the  process of solving its problems, the question becomes: What problem are they  solving? Is it the problem of the banks? The problem of unemployment? Or the  problem of countries’ inability to find common solutions? More to the point,  European officials have been working on this problem for years now, and they are  among the best and brightest in the world. Their inability to craft a solution  is not rooted in a lack of good ideas or the need to think about the problem  more. It is rooted in the fact that there is no political agreement on who will  pay the price geographically and socially. The national tensions and the class  tensions have prevented the crafting of a solution that can be both agreed upon  and honored.

If the Europeans do not generate that sort of solution in 2013, it is time to  seriously doubt whether a solution is possible and therefore to think about the  future of Europe without the European Union or with a very weakened one. If,  however, Europe does emerge with a plan that has general support and momentum  behind it, then we might say that Europe is beginning to emerge from its crisis,  and that, in turn, would be the single most important thing that happens in  2013.

At this point, a reasonable person will argue that I am ignoring the United  States, which has different but equally significant economic problems and is  also unable to generate consensus on how to solve them, as we have seen during  the recent “fiscal cliff” affair, which will have many more iterations. But as  valid as the comparison is on the financial level, it is not valid on the  political level. The  United States does not face the dissolution of the republic if it follows  contradictory policies. The United States is more than two centuries old and has  weathered far worse problems, including the Civil War and the Great Depression.  The European Union is only about 20 years old in its current form, and this is  its first significant crisis. The consequences of mismanaging the U.S. financial  system are significant to say the least. But unlike Europe, the consequences are  not an immediate existential threat.

The Other Costs of the Crisis

It is the political dimension that has become the most important, not the  financial. It may well be that the European Union is in the process of dealing  with its banking problems and might avoid other sovereign debt issues, but the  price it has paid is both a recession and, much more serious, unemployment at a  higher rate than in the United States overall, and enormously higher in some  countries.

We can divide the European Union into three categories by measuring it  against the U.S. unemployment rate, which stands at about 7.7 percent. There are  five EU countries significantly below that rate (Austria, Luxembourg,  Germany, Netherlands and Malta). There are seven countries with unemployment  around the U.S. rate (Romania, Czech Republic, Belgium, Denmark, Finland, the  United Kingdom and Sweden). The remaining 15 countries  are above U.S. unemployment levels; 11 have unemployment rates between  10 and 17 percent, including France at 10.7 percent, Italy at 11.1 percent,  Ireland at 14.7 percent and Portugal at 16.3 percent. Two others are  staggeringly higher — Greece at 25.4 percent and Spain at 26.2 percent. These  levels are close to the unemployment rate in the United States at the height of  the Great Depression.

For advanced industrialized countries — some of the most  powerful in Europe, for that matter — these are stunning numbers. It is  important to consider what these numbers mean socially. Bear in mind that the  unemployment rate goes up for younger workers. In Italy, Portugal, Spain  and Greece, more than a third of the workforce under 25 is reportedly  unemployed. It will take a generation to bring the rate down to an  acceptable level in Spain and Greece. Even for countries that remain at about 10  percent for an extended period of time, the length of time will be substantial,  and Europe is still in a recession.

Consider someone unemployed in his 20s, perhaps with a university degree. The  numbers mean that there is an excellent chance that he will never have the  opportunity to pursue his chosen career and quite possibly will never get a job  at the social level he anticipated. In Spain and Greece, the young — and the  old as well — are facing personal catastrophe. In the others, the percentage  facing personal catastrophe is lower, but still very real. Also remember  that unemployment does not affect just one person. It affects the immediate  family, parents and possibly other relatives. The effect is not only financial  but also psychological. It creates a pall, a sense of failure and dread.

It also creates unrooted young people full of energy and anger. Unemployment  is a root of anti-state movements on the left and the right. The extended and  hopelessly unemployed have little to lose and think they have something to gain  by destabilizing the state. It is hard to quantify what level of unemployment  breeds that sort of unrest, but there is no doubt that Spain and Greece are in  that zone and that others might be.

It is interesting that while Greece has already developed a radical right  movement of some size, Spain’s political system, while experiencing stress  between the center and its autonomous regions, remains  relatively stable. I would argue that that stability is based on a belief  that there will be some solution to the unemployment situation. Its full  enormity has not yet sunk in, nor the fact that this kind of unemployment  problem is not fixed quickly. It is deeply structural. The U.S.  unemployment rate during the Great Depression was mitigated to a limited degree  by the New Deal but required the restructuring of World War II to really  address.

This is why 2013 is a critical year for Europe. It has gone far to solve the  banking crisis and put off a sovereign debt crisis. In order to do so, it has  caused a serious weakening of the economy and created massive unemployment in  some countries. The unequal distribution of the cost, both nationally and  socially, is the threat facing the European Union. It isn’t merely a question of  nations pulling in different directions, but of political movements emerging,  particularly from the most economically affected sectors of society, that will  be both nationalist and distrustful of its own elites. What else can happen in  those countries that are undergoing social catastrophes? Even if the  disaster is mitigated to some degree by the shadow economy and  emigration reducing unemployment, the numbers range from the painful to the  miserable in 14 of Europe’s economies.

Europe’s Crossroads

The European Union has been so focused on the financial crisis that it is not  clear to me that the unemployment reality has reached Europe’s officials and  bureaucrats, partly because of a growing split in the worldview of the European  elites and those whose experience of Europe has turned bitter. Partly, it has  been caused by the fact of geography. The countries with low unemployment tend  to be in Northern Europe, which is the heart of the European Union, while those  with catastrophically high unemployment are on the periphery. It is easy to  ignore things far away.

But 2013 is the year in which the definition of the European problem must  move beyond the financial crisis to the social consequences of that crisis.  Progress, if not a solution, must become visible. It is difficult to see how  continued stagnation and unemployment at these levels can last another year  without starting to generate significant political opposition that will create  governments, or force existing governments, to tear at the fabric of Europe.

That fabric is not old enough, worn enough or tough enough to face the  challenges. People are not being asked to die on a battlefield for the European  Union but to live lives of misery and disappointment. In many ways that is  harder than being brave. And since the core promise of the European Union was  prosperity, the failure to deliver that prosperity — and the delivery of  poverty instead, unevenly distributed — is not sustainable. If Europe is in  crisis, the world’s largest economy is in crisis, political as well as  financial. And that matters to the world perhaps more than anything else.

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