Capitalism and Democracy Facing Challenges:
The recent economic crisis led to a rise in unelected technocratic governments and central banks assuming power. This raises questions about deep problems within capitalism and democracy, especially considering the growing anxiety and unemployment.

Dual Economy and Unequal Impacts:
A dual economy has emerged, where the elite prosper while those falling behind suffer even more post-crisis. This is due to the short-term and unsustainable policies aimed at spreading gains, which backfired and hurt the very people they were intended to help.

Structural Problems Persist:
Structural problems that caused economic disparities before the crisis remain unaddressed, particularly the lack of employment opportunities for certain segments of the population.

Moving Forward:
Going forward, there is a need for long-term policies that address these structural issues and promote sustainable growth. This requires a focus on creating opportunities for all, rather than short-term fixes that exacerbate inequalities.

The Problem of Inequality and Popular Perception:
The economic crisis led to the perception that the elite benefited from capitalism while the middle class suffered, creating a sense of unfairness and undermining the legitimacy of capitalism.

The Bifurcation of Opportunities:
There is a growing divide between those with access to elite education, good family backgrounds, and high-paying jobs and those without these advantages.

The Need for Intervention:
Restoring opportunity to the middle class requires intervention beyond the current social policies due to technological changes, globalization, and increased competition.

The Challenge of Intervention:
The challenge lies in finding ways to intervene without compromising the essential characteristics of capitalism and democracy.

Question of Feasibility:
It is unclear whether it is possible to restore the middle class while maintaining the current economic and political systems.

Uncertain Future:
The outcome of this situation remains uncertain, and it is unclear what the future of capitalism and democracy will look like if the middle class is not restored.

The Post-War Growth and Its Contributing Factors:
Post-war growth was remarkably strong in industrial countries, with the U.S. growing at 2.77% and Europe at 4.77% annually between 1950 and 1973. This growth was driven by factors such as recovery from the Depression and the war, which had led to both destruction and trade-destroying policies. Additionally, there was a widespread rollout of technologies like electricity, the motor car, and the airplane, which had been invented earlier but saw extensive adoption during this period.

Technological Innovations and Their Impact:
Technological innovations, such as the internet today, have significantly changed our lives. Similarly, innovations during the 40s and 50s, such as electricity, the motor car, and the airplane, had a profound impact on the lives of our grandparents. These technologies had been invented earlier but saw widespread rollout after World War II, contributing to the post-war growth, particularly in Europe.

Changing Labor Markets:
The welfare state, bolstered during the 60s, brought promises of secure old age and health care, pacifying labor and contributing to a period of strong growth. The 1970s oil shock and declining productivity brought an end to this growth.

Diverging Economic Approaches:
The US and the UK pursued deregulation and competition to stimulate growth. Continental Europe focused on economic integration to achieve growth.

The Effects of Deregulation:
Deregulation in the US boosted growth but skewed returns toward the talented and innovative, affecting income distribution. Financial sector example: deregulation led to a surge of talented individuals and higher relative pay, highlighting the impact of competition on income distribution.

New Challenges for the Middle Class:
Deregulation and competition created space for new technologies and global competition. Skilled routine jobs (e.g., insurance workers) and routine unskilled jobs (e.g., textile workers) were replaced by machines and outsourced. The remaining jobs became bifurcated into non-routine skilled jobs (creative jobs) and non-routine unskilled jobs (manual jobs).

Non-Routine Unskilled Jobs:
Non-routine unskilled jobs, such as gardeners and hamburger flippers, still require human input and cannot be easily replaced by technology.

Technological Advancements:
Technological advancements have automated many routine tasks, leading to job loss in these areas.

Global Competition:
Global competition has led to outsourcing of routine jobs to countries with lower labor costs.

The Changing Job Market:
Mark Anderson, the founder of Netscape, highlights the increasing divide between individuals who control computers and those who follow computer instructions. This results in a bifurcation of the economy into high-end and low-end jobs.

The Disappearance of Middle-Income Jobs:
Industrial countries have seen a decline in middle-income jobs due to technological advancements. This bifurcation leads to a concentration of high-end jobs, which require specialized skills, and low-end jobs, which often involve manual labor.

Income Inequality and Job Opportunities:
Income inequality is not a necessary consequence of the job market bifurcation. With enough skilled individuals in high-end jobs, wages for low-end jobs can increase. However, a limited supply of skilled labor can lead to a widening wage gap.

The Race Between Technology and Education:
Claudia Golden and Larry Katz of Harvard observe that education is falling behind in its race against technology. Male high school and college graduation rates have remained stagnant over the past two decades, indicating a skill mismatch between education and job market demands.

The Importance of Skilled Labor:
The limited supply of skilled labor in the United States leads to a shortage of individuals with the necessary skills for high-end jobs. This demand-supply imbalance drives up wages for skilled workers while potentially leaving lower-skilled workers behind.

Jobs and Education:
Raghuram Rajan suggests that there is a mismatch between college education and job opportunities, with more jobs available in science, technology, engineering, and math (STEM) fields than in liberal arts. He emphasizes the need to change not only colleges but also schools and families to better prepare individuals for the job market.

Bifurcation in the United States:
Rajan discusses the growing bifurcation in the United States, with increasing disparities between the upper and lower ends of society. He highlights Charles Murray’s book, Growing Apart, which examines the differences between white upper-class and white lower-class families in terms of income, lifestyle, divorce rates, and life expectancy.

Changing Job Market and Skills:
Rajan presents graphs by David Autor from MIT, showing a shift in job creation from the middle to the lower and upper ends of the skill spectrum. This trend is reflected in wage patterns, with middle wages declining while wages at both extremes are increasing.

Wage Differentials and Education:
Rajan illustrates the widening wage gap between college graduates and high school graduates, with the 90-50 log hourly wage differential increasing significantly. However, the wage difference between farm workers and factory workers is narrowing, suggesting that the middle is being squeezed out.

Points of Light:
Despite the bleak outlook, Rajan points out some positive developments. The new elite, composed of educated individuals, is not as elitist in terms of family wealth as in the past. CEOs are increasingly coming from outside the Ivy League and have stronger educational backgrounds.

Inequality in College Completion:
Rajan notes that the children of the rich are more likely to complete college than the children of the poor, and this gap has been increasing. The effects of the egalitarian education of the 1940s, 1950s, and 1960s are still visible at the top levels of society, but the trend is becoming more skewed.

Rising Inequality and Political Pressure:
* Rising inequality and the political pressure to address it led to short-term policies such as increasing access to credit and consumption.
* Politicians prioritized providing immediate relief to struggling individuals rather than addressing the underlying causes of inequality.
* A focus on short-term solutions, like providing credit, ignored the long-term consequences of these policies.

Credit Boom and Consumption:
* The pressure to provide consumption options led to a credit boom, fueled by private sector and government policies.
* The availability of cheap credit allowed individuals to maintain consumption levels despite stagnant incomes.
* This consumption boom was fueled by various policy measures and private sector initiatives.

Deregulation and Financial Sector:
* Raghuram Rajan argues that deregulation was not inherently bad, as it benefited consumers through lower prices and innovation.
* However, the financial sector went off track and contributed to the crisis.
* Deregulation, when not accompanied by adequate regulation and skill-building initiatives, can lead to negative consequences.

The Need for Skill Building:
* Rajan emphasizes the importance of skill-building and education to maintain strong household incomes and reap the benefits of capitalism.
* Failure to invest in skill-building contributes to the widening income gap and undercuts the ability of individuals to compete in the evolving economy.

Addressing Inequality and Inclusion:
* Rajan poses the challenge of harnessing finance and bringing individuals who are falling behind back into the economy.
* This requires creating opportunities for these individuals to compete and earn decent incomes.

The Euro Area’s Response:
* The discussion then shifts to the euro area’s response to the crisis, leaving this topic to be addressed in a subsequent section.

Similarities and Differences in the Euro Area and the United States:
The Euro Area didn’t deregulate as quickly as the US, opting for integration over deregulation. This integration created competition between national champions but lacked deep labor market reforms. Economies in the Euro Area became insider-outsider economies, where workers either had excellent jobs or struggled to find stable employment.

The Move to the Euro and Its Consequences:
The introduction of a common currency, the euro, aimed to enhance competition and integration. However, it also led to a common interest rate, resulting in debt-fueled spending booms in peripheral European countries. These countries experienced excessive government spending, construction booms, and asset bubbles. The resulting unsustainable debt levels eventually led to the current economic crisis.

Inequality and Lack of Competitiveness:
Countries that liberalized and deregulated, like the US, face high inequality and the aftermath of the housing bust. Countries that integrated but didn’t deregulate as much, like some in the Euro Area, face competitiveness issues. Spending during the boom years was often unproductive, leading to uncomparative economies.

Populist Policies and the Crisis:
Democracy created pressure for continuous growth, leading to unsustainable populist policies. Easy credit and government spending contributed to the crisis, with private financial institutions also playing a role. The crisis was not solely caused by elitist policies but rather a response to broader needs.

Bailouts and Crony Capitalism:
Bailouts were necessary to prevent a great recession from becoming a great depression. However, the bank bailouts could have been done better, with more accountability and less focus on kid gloves. The bailouts were primarily due to cognitive capture, not crony capitalism.

The Democratic Process and Citizens United:
The democratic process has become more vibrant and accessible due to the internet. Citizens United gave power to corporations and unions but has been balanced by competition among large organizations. The dissemination of information has increased, leading to greater sources of public influence.

Growing Divide and Inequality:
Deep problems stem from unresolved issues before the crisis, particularly the growing divide. The majority falling behind in an integrated global economy could lead to protests and a breakdown of the social contract. Capitalism and democracy may come under strain as inequality delegitimizes the capitalist system and strains democratic processes.

Oligarchs and Democracy:
Large concentrations of power outside government can act as checks and balances, but in Putin’s Russia, oligarchs who challenge the government face severe consequences. In contrast, in the United States, individuals like Sheldon Adelson can publicly oppose the government without fear of retaliation, fostering a stronger democracy.

Delegitimation of Capitalism and Democracy:
Persistent inequality can delegitimize both capitalists and democracy, harming both in the long run.

Restoring Opportunity and Hope:
To address inequality, we must focus on education, skills, and innovation. These measures require resources, and the challenge lies in convincing the wealthy to support these changes while avoiding excessive taxation and redistribution that could stifle innovation.

Addressing Short-Term Problems:
We must find ways to bring unemployed individuals, especially youth and those in marginalized communities, into the labor force. We also need to address the challenges faced by workers whose skills have become outdated due to technological changes or industrial shifts. There is a need to engage and support individuals who lack the skills or opportunities to participate in the workforce.

Populist Policies:
Recent economic crises were caused by populist policies rather than elite capture. Populist policies are rooted in democracy and aim to alleviate pain. However, these policies have failed and led to increased impatience and division among the electorate.

Polarization:
Politicians face difficulty in bridging gaps between their constituencies and other politicians due to polarization. Polarization among politicians reflects the polarization of the electorate.

Short-Term Policies:
Short-term policies have worsened the situation by blaming capitalists. This can weaken important checks on arbitrary government power.

Alternative Visions of the Future:
Bleak vision: technology and globalization displace the middle class, leaving a few at the top and many at the bottom. Pleasant vision: improving education, capabilities, and tying them to jobs can lead to a vibrant capitalism and democracy.