Prof. Reuven Brenner | On November 8, 2013

In an interview over the summer, Mr. Obama correctly emphasized both that “upside mobility was part and parcel of who we were as Americans” and also that such mobility has been “eroding over the last 20, 30 years, well before the financial crisis.”

The question is: What can Washington do to remedy the situation?

In order to narrow down the possible answers, here is a brief recap of events that brought about the vanishing middle classes in the US (and other Western countries as well).

After World War II and well until the 1990s, the United States enjoyed an influx of both highly skilled, ambitious people who were escaping a world largely ruled by dictatorial and unstable regimes and capital.  Hundreds of millions of people, those with skills, drive and intelligence equal to those lucky enough to be born in the West or reach its shores were trapped behind iron and other dictatorial curtains. As long as the U.S. enjoyed monopoly powers on the leveraging of talent and capital, it could impose high taxes, with large segments of the population benefiting from high wages and transfer payments. The global political barriers gave these groups of employees in the U.S. the negotiating powers to extract such extraordinary benefits – and not only in Detroit.

Governments, federal and state, and many other bureaucracies expanded – creating a “middle class” not based on either commerce or backed by particular skills. This happened due to such accidental, historical circumstances of having only a dozen Western-type states with top talent – what I often call “the vital fews” – and capital having nowhere else to go.

The fall of communism and the political stabilization of what we now call “emerging countries” eroded the U.S.’s and the West’s advantages, weakening such artificially created middle classes’ negotiating powers. Talented, entrepreneurial people and capital can and still do move to the United States, but capital and industrious individuals can also now move to other parts of the world, where hundreds of millions of individuals are eager to work harder and catch up for decades of lost time.  Technology has been a fact in the speed of such moves – but the key has been the opening of borders.

What can then be done with the suddenly redundant bureaucracies and compensations that put them and large segments of Western population in “middle classes” until the 1990s, even though their skills are now offered for a fraction of the compensations negotiated during the “immobile times”?

For one, economists, politicians and commentators must shed a pre-1990s mentality that fits a world of limited mobility. Paul Krugman, for example, doesn’t fear a top marginal tax rate of 70%, given his view that such a rate did not cripple effort at similar levels back in the 1960s and ’70s. He concludes that a return to the tax rates of the past is feasible.

But such rates are not presently feasible, because capital can move with far more ease to many more destinations, as can the top talent.  Unless these same economists recommend imposing heavy impediments of such moves – such tax rates are simply not feasible.  The present debate about the 35% corporate tax rate illustrates the point.  Today US companies avoid paying these rates legally, and prominent ones end up paying in the 4 percent range (Apple and Google among them), as do European companies (Ikea, among them).

The question that should be raised is this: Assume that Washington could impose paying the 35% tax.  Assume that more money would be then flowing through the government: Would that increased flow stabilize the middle classes in the US and offer chances of greater upward mobility?  Or would the upward mobility be speeded up by having the Apples, Googles and Ikeas spend the money on talent and capital?  Historically, in open societies, commerce, industry and finance have offered chances for upward mobility – not political parties and governments.

Whereas both the US and the other Western countries must take care of those whose negotiating powers have been drastically weakened and exit as gracefully as possible from commitments made in the past, the speed of recovery of the US and restoring its middle class and upward mobility, depends on pursuing policies that would encourage the shift toward industry and commerce.

Whereas the pre-1990s escapees from Iron Curtain countries were willing to work in the U.S. despite high rates of taxation (the U.S. was still paradise relative to what they left behind), that’s no longer the case. Emerging countries are competing for the “vital few” with both lower tax rates and with a population ready to work for less than their U.S. counterparts.

A version of this article originally appeared on Asia Times Online.

Prof. Reuven Brenner

Reuven Brenner holds the Repap Chair at McGill’s Desautels Faculty of Management, serves on the Board of the McGill Pension Fund and is member of its investment committee.

He worked with Bank of America, Knowledge Universe, EEN, Bell Canada, Repap Enterprises and with investors in Canada, Mexico, the US and Europe. He has been involved in the private equity markets as partner in Match Strategic Partners, has been investing in start-ups across Canada, as part of an “angel group,” and also created his own start-up, “e-mortal.com.” He has also been serving on boards of companies and institutions.

He was expert witness in cases covering anti-trust, bankruptcy and financial matters. In other spheres, Quebec’s government asked him in 1995 to be member of a commission whose mandate was to examine all aspects of Quebec’s possible separation. He was also asked to testify before US Congressional Commissions and Canada’s Senate’s Banking and Finance Committee, and worked with Poland’s central bank during the recent crisis.

His recent books are A World of Chance (2008) and Force of Finance (2002). His regular columns appeared in Forbes, The Wall Street Journal, Asia Times and other financial press around of the world. Forbes’ journalists put two of his earlier books in their all time recommended list, and Forbes Global dedicated a cover story, titled “Leapfrogging,” to his works and endeavors. Brenner also received the Killam Award (1992), the Royal Society elected him as “Fellow”(1999), and he received a Fulbright Fellowship Grant (1976).

Brenner was born in Rumania and immigrated to Israel in 1962. He served in the Israeli army between 1966-69, during the Six-Day War, and again during the 1973 Yom Kippur War. The Fulbright fellowship brought him in 1977 to Chicago, after completing his PhD at the Hebrew University and working at the Bank of Israel, where he received the First Prize from Israeli banks (for work with Saul Bronfeld, designing indexed securities). He lives in Canada since 1980. He is fluent in English, French, Hebrew and Hungarian.