The Midterms and the Economy

Although the final votes are still being counted, the results of the U.S. midterm elections seem clear. The predicted Democratic wipe-out never happened. The Democrats actually held the Senate and lost the House by a very small margin.

It was not supposed to be like this. Inflation has been running hot for quite some time and currently stands at 7.7 percent. Biden’s approval rating is abysmal. People genuinely hate inflation, especially when nominal wages don’t keep up. To compound the problem, inflation has a nasty habit of messing with peoples’ psychology, causing them to lose faith in the system’s ability to deliver what they want - stability, fair outcomes, and a rising tide. In Brad DeLong’s telling, it was the high inflation of the late 1960s and early 1970s that spelled the end of the social democratic era, paving the way for a sharp neoliberal turn.

So what happened? The conventional wisdom points to two factors. First, the salience of abortion following the overturning of Roe v. Wade. Exit polls indeed picked up a lot of angst about this issue. Second, the malevolent presence of Trump hovering over the election. Nearly all of his handpicked election-denying candidates lost. The country clearly wants to move on from his chaos and mendacity.

These two factors were undoubtedly important. But I would argue there is more to it. I’m generally of the belief that the economy is always the most important issue at election time. In the immortal words of James Carville, “it’s the economy stupid.”

It turns out the economy is a lot stronger than people realized.

Just look at jobs. Under Biden’s watch, the economy gained ten million new jobs, completely erasing the deficit from the Covid slump. This happened in a remarkably fast period of time - less than two years. The unemployment rate is at a five-decade low of 3.7 percent. Contrast this with the global financial crisis, when it took eight years to recover the lost jobs. Obama, remember, lost heavily in the 2010 midterms. So this is the first point - inflation might be painful, but it’s much more painful not to have a job.

The second point is that, despite inflation, many people are not that badly off financially. Here, I’m appealing to a recent paper by Thomas Blanchet, Emmanuel Saez, and Gabriel Zucman entitled “Real Time Inequality.” These authors look at high-frequency data to assess what’s happening to inequality over the short run. The most interesting results they present pertain to the Covid recession. Here, they find that all income groups recovered lost income within twenty months - again, remarkably fast. Importantly, real wages saw significant gains at the bottom of the distribution in both 2021 and 2022. Under Biden, the working class (defined as the bottom 50 percent) saw income gains running at twice the average. And they find this growth is coming from wages. Low-wage workers (those in the second quartile) gained a 12 percent increase in real wages since Biden’s inauguration. This is a remarkable departure from the previous forty years of wage stagnation and it led to falling inequality.

If these data are right, then the working-class came out ahead, even factoring in inflation. This must affect our assessment of the American Rescue Plan Act, Biden’s signature fiscal stimulus at the start of his term (comprising $1400 direct checks to qualifying households, a child tax credit, and higher unemployment benefits). Critics like Larry Summers point the finger at this Act, arguing that it stimulated the economy too much and produced inflation. Even though inflation is largely a global phenomenon driven by supply-side factors such as supply chain bottlenecks and the Ukraine war, this stimulus probably had something to do with it.

But it was worth it. Not only was it amazing from the perspective of poverty (the child tax credit alone reduced child poverty by 40 percent) but the American Rescue Plan Act also holds up as Keynesian stimulus. More than anything else, it was this policy that gave us record-setting job creation. It was this policy that led to tight labor markets, bidding up wages at the bottom. Contrast this with the wholly inadequate stimulus passed by the Obama administration to counter the global financial crisis. Then, unemployment stayed too high for too long, and nearly all the income gains went to the top 1 percent.

The bottom line is that the economy is much healthier than it would appear from the headline inflation number. I believe this had an impact on the midterms. Don’t get me wrong: people still hate inflation for psychological reasons. Biden remains deeply unpopular. But at the very least, the state of the economy gave people permission to vote on non-economic factors - abortion and Trump.