Robert Reich’s F Minus In Economics: False Facts, False Theories

Karl Marx (1818-1883)

Karl Marx (1818-1883) (Photo credit: Wikipedia)

Robert Reich

Robert Reich (Photo credit: Wikipedia)

Robert Reich’s F Minus In Economics: False Facts, False Theories

Robert Reich (Photo credit: Wikipedia)

I am appalled by the economic illiteracy encountered in leading newspapers, business magazines, and prominent web sites (thenews section of the Wall Street Journal is no exception). Robert Reich’s Higher Wages Can Save America’s Economy – and Its Democracy ( is only one of many examples. As a teacher of economics for over forty years and a co-author of a best-selling 1980s economics 101 textbook, I would have given Reich’s paper a resounding F, if he had submitted it for my elementary economics class.

Reich’s elevated credentials point to an automatic A+.  As a frequent TV pundit, author of 13 books, Chancellor’s Professor of Public Policy at the University of California at Berkeley no less, and self-identified as “one of the nation’s leading experts on work and the economy,” many readers will automatically believe his economic nonsense. As a former Secretary of Labor, readers would be surprised to learn that Reich does not appear to understand how wages and labor markets work.

Reich’s resume raises one red flag: He is not an economist but a lawyer – a Yale Law School classmate of Hillary Clinton, who studied a smattering of economics for his PPE (politics, philosophy, and economics) degree at Oxford – a Rhodes Scholar no less. I am no formal credentials snob. Non PhD economists, such as Robert Samuelson, write very good economics. Robert Reich is not one of them.

My F grade is also not based on Reich’s politics, which are quite different from my own.  I award it instead for Reich’s incorrect facts and his embarrassing misunderstanding of basic issues about which economists agree.

Reich’s basic complaint in his Higher Wages Can Save America’s Economy – and Its Democracy is that “monied interests” have forgotten the century-old “basic bargain at the heart of America” that employers pay their employees enough to buy what they are selling.  This bargain “created a virtuous cycle of higher living standards, more jobs, and better wages. And a democracy that worked reasonably well.”  Reich worries that, with this basic bargain now forgotten, production will pile up in warehouses, vainly seeking buyers as the economy stagnates and jobs disappear.

Reich’s “forgotten bargain” is actually a hackneyed reprise of Karl Marx. In Das Kapital Marx warned of crises of overproduction and under consumption. Capitalists push down wages by exploiting workers, but they themselves do not consume. There is no one left to buy what the capitalist factories are producing.  I’ll not mark Reich’s paper down for his failure to cite Das Kapital in his sources.

Reich dates the “basic bargain” back to Henry Ford.  Henry Ford announced in 1914 that he would pay workers on his Model T assembly line $5 a day – three times what the typical factory employee earned at the time. Ford, according to Reich, took this step because he understood that the higher wage would turn Ford’s auto workers into customers for his Model T’s.

One side question for Reich: The U.S. became the world’s richest and most powerful economy in the late nineteenth century, decades before Ford’s bargain. Reich may want to explain how that could happen without employers agreeing to pay workers enough like the enlightened Henry Ford.

Ford’s $5 wage to convert his workers into Model T customers is an urban legend that thinking economist dismiss as nonsense. Henry Ford’s employees would have had to buy forty cars each to absorb the half million Model T’s rolling off his assembly line in 1916. Ford could sell his Model T’s only if wages were rising generally throughout the economy, not just in his own factories.

Ford raised the wage to $5 because labor productivity was soaring, not because he wanted to create customers. In 1909, his assembly line produced one Model T at his Highland Park plant every 12 hours. By 1914, it had fallen to one car every 96 minutes, and by 1920 to one Model T a minute. (SeeHenry Ford and the Model T: A Case Study in Productivity). Ford could afford to pay auto workers producing one car a minute much more than those producing a car every twelve hours. He also expanded his market by passing productivity gains on to customers. The Model T’s price fell from $825 in 1908 to $360 in 1916. With generally rising wages and a falling price, Ford became one of the richest men of his era.

Ford Motors was no exception in 1914.  Wages were rising throughout the economy because of massive increases in productivity, not because Ford and other employers wanted to pay workers enough to buy their products. Few principles of economics students would fall for this one, but Reich does. That’s ten points off his grade, right there.

Reich’s essay goes from bad to worse as he explains the causes of the Great Depression. Reich must answer a tricky question: If the 1914 basic bargain explains the “virtuous cycle of higher living standards, more jobs, and better wages,” why should the economy collapse fifteen years later in 1929?

Reich has a ready but false answer:  “In the years leading up to the Great Crash of 1929, employers forgot Henry Ford’s example. The wages of most American workers stagnated even as the economy surged. Gains went mainly into corporate profits and into the pockets of the very rich.” According to Reich, greedy and short-sighted American employers fell into the Marxist trap. They wanted everything for themselves. They reduced the wages of their workers, who could no longer buy what was being produced. Per Reich: The myopic capitalists created the conditions for a classic Marxist crisis of over production, which we today call the Great Depression.

Reich draws conclusions without checking the facts first.  If he had googledHistorical Statistics of the United States 1789-1945 on line, he would have discovered that wages rose sharply from 1915 to the Great Depression. Moreover, Simon Kuznets, in his pioneering statistical studies  at the NBER, found that labor’s share of national income was on the rise and capital’s share falling in the roaring twenties. In short, Reich uses false facts to support his proposition that the Great Depression was caused by corporations taking too much and paying their workers too little. Making up statistics to prove a theory is an automatic F. Sorry, but that’s the way it is.

Turning to the present, Reich warns that we are repeating the errors of the 1920s. Corporations are again taking too much and leaving workers with too little: “Nothing fundamentally has changed. Corporate profits are up largely because payrolls are down. Even Ford Motor Company is now paying its new hires half what it paid new employees a few years ago.” Reich sounds the alarm: The share of corporate profits is at an all time high of 11 percent…Without enough American consumers, their profitable days (of business) are numbered…. In order to create jobs, businesses need customers.”

Reich may be excused for getting his facts wrong on the lead-up to the Great Depression. After all, he is a busy man. But the basic facts of the business cycle are known to all bankers, corporations, business persons, and economists: During economic downturns, corporate profits fall (often dramatically), while compensation of employees rises but more slowly. Simple arithmetic and the statistical facts confirm, indeed, that the corporate profit share is low during recessions and rises during recoveries, as it is now.

Anyone who bothers to check government data from 1964 to the present can see that the employee compensation share of national income rose immediately preceding and during recessions. If anything, the long-term trend in labor’s share of the pie is slightly upward, not downward as Reich implies.

Reich disputes these irrefutable facts. According to him, recessions are caused by corporate profits taking too much, leaving too little for their employees to buy what corporations are producing. If we believe Reich, the economy should have been booming during each of our recessions and in the tank during recoveries. I do not recall Reich writing a column congratulating corporations when their profits fall relative to wages.

Most alarming, Reich, a former labor secretary, displays a glaring ignorance of how markets work, even labor markets. In his world, big corporations convene behind closed doors to decide how much they deign to give to their workers after they have taken their often obscene profits. He does not understand that wages are generally set in markets, not in smoke-filled corporate board rooms.  He displays an even greater lack of appreciation of profits as signals to guide resource allocation and as sources of investment finance. To Reich, profits seem always to be too high, wages too low. I would like to ask him how many workers would be employed if businesses earned no profit, and labor got everything.

Reich uses his F- economics to conclude that “the only way back to a buoyant economy is through a productive system whose gains are more widely shared.”

In Reich’s liberal vision, it is not  Henry Ford, Gordon Moore, Jack Welch, Warren Buffet, Bill Gates, Steve Jobs, and hundreds of thousands of medium and small business owners “who make the basic bargain at the heart of America.” Instead, it should be the federal government with progressive taxes, minimum wage laws, and pro-labor regulatory agencies that gives us a prosperous system that, in President Obama’s words, “spreads the wealth around.”

Reich’s F- paper is only one of hundreds or thousands of its ilk. Economics is not an easy subject, and readers can be made to believe all kinds of claptrap, especially if the writer has impressive credentials. We are bombarded with assertions that stimulus should be permanent, deficits do not matter, unemployment insurance creates jobs, higher minimum wages do not cost jobs, marginal tax rates do not affect taxpayer behavior, one out of six Americans are hungry, and welfare programs that give high-school dropouts more than they can earn are good for the economy.

All I can say in my grade school Latin: Caveat lector.

My new book Women of the Gulag: Portraits of Five Remarkable Lives has just been published. It is a great read, if I say so myself.


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