MS. DIANE REHMThanks for joining us. I'm Diane Rehm. Americans received a string of good news last week: the lowest on employment rates since late 2008, the stock market hitting all time highs, corporate profits on an upward tier. But some analysts advise putting off the celebrations at least until we see how sequestration cuts might affect economic growth.

MS. DIANE REHMJoining me in the studio to talk about the U.S. economy, Hedrick Smith, author of "Who Stole the American Dream," Damian Paletta of The Wall Street Journal, and, joining us from an NPR studio in New York, Edward Conard of the American Enterprise Institute and a former partner at Bain Capital.

MS. DIANE REHMI invite you to be part of the program. Give us your thoughts, your ideas. Call us on 800-433-8850 or send us an email to drshow@wamu.org. Follow us on Facebook or send us a tweet. Good morning, gentlemen. Good to have you with us.

MR. HEDRICK SMITHNice to be with you, Diane.

MR. DAMIAN PALETTAGood morning.

MR. EDWARD CONARDGood morning.

REHMDamian, let me start with you. Remind us about the good news and then why people are saying don't be too optimistic.

PALETTASure. I mean, we've been in this economic wilderness for almost five years now. But finally, you know, the stock markets had an all-time high. The housing market's come back. That was a lot of pain for homeowners all over the country for so long. Jobs numbers are improving, and there was -- we've had several years of really weak jobs growth, and corporate profits are up.

PALETTAAnd so the one thing that that can do when people keep hearing about this is it can really get consumer confidence back. And people go out and redo their kitchen or they buy a new car. They feel better about sending their kids to college, that sort of thing. So, on the one hand, that's been really positive, but there's still a lot of, you know, clouds hanging over the economy. Long-term unemployment is still a huge problem.

PALETTAPeople have been down to work for six months or more have a really hard time getting back into the workforce. They're the ones that tend to draw down their savings the most quickly obviously. The number of people on food stamps had a record in December 2012. That's a huge issue as well. In the sequester, we don't really know what that -- the spending cuts are going to do later this year, but there's a lot of warnings that it could hurt economic growth and could cost jobs as well. So a lot of concern there.

REHMSo, Ed Conard, how do you interpret last week's news out of Wall Street and the Labor Department?

CONARDYes. I think you have to reconcile the bond market with the stock market. If you look at the bond market, what you see is low interest rates out as far as the eye can see. That suggests that the bond market predicts very low growth. For quite some time to come, when you look over the stock market and see the highs, you kind of scratch your head. But I think there is an explanation for that which is that investors see high profits, lot of money sitting on the sideline.

CONARDThey don't see the kind of competition between companies that you would normally find at this point in the cycle where they began to compete for market share. They invest money. They hire employees. They lower the price of their product. And that pushes the profits from investors, from corporations and businesses out into the rest of the economy, consumers and workers. You don't see that happening. And so I think what's happening is that investors are looking at the high profits.

CONARDThey expect the lack of competition for quite sometime to come. They see low interest rates for a long time to come, and they start capitalizing the high prices at very low interest rates, and you see the stock market hit highs. I don't think it's necessarily on an optimistic sign, although that's certainly one interpretation of it.

REHMHedrick Smith, how do you see it?

SMITHWell, I think, Diane, the critical thing for me is that we're two Americas, and I think when you listen to Damian's numbers, you heard that. Corporate profits for the last four years since the bottom of the recession, 2008, have grown an average of 20 percent a year, 20.1 percent a year. At the same time, average family incomes, the incomes of average families have grown 1.4 percent a year. So you're seeing two economies here.

SMITHThe stock market is hitting records. You've got -- but at the same time, we have 22 million people looking for full-time jobs, either they're unemployed or they're working part-time and they want full-time work or they've dropped out. It was one of the big figures in the recent jobs report was 130,000 people dropped out of the job market.

SMITHOne reason why the unemployment rate came down is they left the market 'cause they didn't see jobs. This has been our pattern for about 30 years. We've had ups and downs. But the reason I talked about the stolen dream, who stole the American dream, is that it was a period in American history. When the economy improved, corporate profits went up. We had economic growth, and the rising tide lifted all boats.

REHMAnd that was...

SMITHThat was me talking...

REHM...right after the second world war.

SMITHYeah. But it continued for 30 years. It wasn't just immediately after the second war.

REHMRight.

SMITHOf course, after the second world war, we were strong. Our enemies were destroyed, even our allies were destroyed. It took them 15 years or so to get back into the ballgame. But still, through the '60s and '70s, we had widely shared prosperity. When -- for example, when productivity rose from 1945 to '75, just about double growth, 97 percent, the median family income rose 95 percent. So almost dollar for dollar, they went together.

SMITHBut the last 30 years, productivity has gone up 80 percent, and the average family income, median family income has gone up 10 percent. So the average people are not sharing in the growth. So when you see these nice numbers, you got to find out, you know, who's benefiting? And you've got these two economies, these two Americas.

REHMDamian.

PALETTAOne of the things that's really tricky and hard to put your finger on, we -- is the herd mentality that happens with the stock market. You know, what happened in late 2008 when the stock market really plummeted was you had a lot of not just, you know, big banks and stuff like that but a lot of, you know, regular investors in the 401 (k) saying, get me out of here. You know, I can't afford to lose all this money. This is the savings for our retirement, the savings for our college -- the kid's -- our kid's college. Now, you wonder, folks are going to say, well, maybe we can get back in.

PALETTAYou know, maybe things aren't as bad, and we want to be part of this upswing. And, you know, that brings both promise and peril. You know, obviously, we don't want people to put all this money at risk again. But on the same token, if you have people investing and they're making money, they go out and spend more money, consumer confidence goes back up and then maybe we can help bring some of the people that are trying to get jobs more jobs because there's more demand for their services.

REHMSo, Ed, do you see perhaps short-term outlook, more consumer spending? What do you see?

CONARDWell, I think there are two possible -- I think we, obviously, should expect some improvement from where we are. But I think there are two scenarios. One is that you grow off a permanently lower base coming out of the financial crisis which I think is the more likely scenario. So you can get to full employment at lower wages, and you can grow at a robust rate off a lower base. The question is whether or not we'll rebound back to where we were in 2007, 2006, leading up to the financial crisis.

CONARDI think we've identified real structural problems that have not gone away. It's a little bit like realizing you live in an earthquake zone. You're going to dial back your risk taking to compensate for that. And so I think you'll see a recovery off a lower base and not a rebound back to where we were before which would drive wages back up to where they were before. One minor point I would make is only that I think we are talking a little bit about the difference between the short run versus Hedrick's who is talking about the long run and their different issues at stake there.

REHMHow do you see the differences, Hedrick?

SMITHWell, I, you know, one of the things I'm struck by is the analysis of economists both in this country and elsewhere that inequality, kind of inequality income that we now have in America is bad for the long-term growth picture. The short-term picture -- I'm sorry, I'm not an expert on the short term. All the factors that Damian mentioned I would agree.

SMITHWe've got a better employment picture. We're worry about -- I mean, congressional budget office are saying that the sequester is going to cut 750,000 jobs this year. Some of the stories I read over the weekend were saying, look out in April and May. Things don't look so good. I don't think people know. But what you do have is fundamentals.

SMITHYou have economists like Joe Stiglitz at Columbia University, of people like Philippe Aghion at Harvard University is saying that there are study after study showing that when you have high inequality of income as we have in America today, CitiGroup call it the greatest inequality of income since Spain in the 16th century that you get low growth, that high inequality of income is destructive to growth. It's a drag on growth.

SMITHYou get the best growth when you have greater equalities -- or not equality of income, but closer incomes. The reason being, it's consumer demand that drives the economy. When people paid low wages, you have low consumer demand. The driver of the economy isn't creating the jobs that we want. So we have industries sitting there. I mean, Damian is saying, well, maybe if people are feeling good and the consumer confidence is up, maybe they're going to spend.

SMITHBut you also have businesses -- there was a story at The New York Times just this last week saying that businesses even like Google are taking much longer to hire. They have four million job vacancies but -- and there are 12 million people are unemployed. So you could match the two, you'd think it would work. No, they're taking longer. They're taking a month. They're taking 23 days when they used to take 10 days, 15 days to fill a job. So you've got that uncertainty out there. I'm safer if I don't hire if I'm running a company. So I'll wait.

REHMSo let's talk about the sequester, Damian, and where those cuts are most likely to hit.

PALETTAWell, the biggest concentration of the cuts is in defense spending. And that's not just buying missiles and aircraft. They may -- all sorts of different defense programs all over the country would be affected. And probably the most visible impact is close to 700,000 Pentagon employees could go -- be forced to take unpaid leave...

REHMFurloughs.

PALETTAThat's right, furloughs, probably one day per period. So one day every two weeks. And that's not going to begin till the end of April we expect. So, you know, it's not going to be a dramatic cut and pay, but it's maybe a 5 percent of their paycheck. And if you have -- as we know, there's a lot of military families where both parents are civilians in the military, so they both have their pay cuts -- their paychecks cut.

REHMBut we're not talking about members of the armed forces.

PALETTAThat's right. But we're still talking about 700,000...

REHMCivilian workers.

PALETTAThat's right. That's right.

REHMAnd I wonder how you see that, Ed. How is that going to affect the outlook generally?

CONARDI think you have to step back and look at the big picture. So there are several factors which play off against each other. One is the sequester, which next year's forecast of the cut spending $85 billion. Keep in mind, we're raising mandatory spending, $85 billion, and we're increasing aid for Hurricane Sandy by $60 billion.

CONARDSo spending next year is -- in 2013 is actually going to be higher -- is projected to be higher than it is in 2012, so only Washington does that count as a spending reduction. It's actually a spending increase. Second thing, I think, you have to recognize is that we raised taxes about $180 billion at the end of 2012, $125 billion payroll tax on the middle class, $65 billion on upper incomes. And so, you know, this is half the size of the tax increases.

REHMAll right. Edward Conard, he is with the American Enterprise Institute. Sort break here. Right back.

REHMAnd welcome back. We're talking about current economic conditions with the rise in the stock market, the number of jobless folks, the whole housing market. All these conditions seem to look good. But there are concerns about where the economy is headed. I've got Edward Conard. He's on the phone with us from New York. He's a visiting scholar at the American Enterprise Institute, author of "Unintended Consequences: Why Everything You've Been Told About the Economy is Wrong."

REHMHe's also a former partner at Bain Capital. He is at an NPR studio in New York. Damian Paletta is a reporter for The Wall Street Journal. Hedrick Smith is author of a new book, "Who Stole the American Dream?" He's also former Washington bureau chief for The New York Times. Damian, you were talking about full time as opposed to part-time work.

PALETTAThat's right. I mean, one of the things we've seen a lot of is people that lost their jobs during, you know, 2008, 2009, the downturn. It's not like when we add these jobs every month, these people are going back into same jobs they had before. A lot of people are being forced to take part-time work where they had been salaried with benefits. So there are, you know, the $10 an hour that they're getting now goes a lot -- doesn't go as far because they have to pay for health care and a lot of other benefits.

REHMHedrick.

SMITHI think the other thing is -- I think you were talking earlier about consumer psychology. You got to remember where people are now. Homeowners in America lost $6 trillion while the housing boom was going up. A homeownership and the equity that people have in their homes for middle -class people is the main source of their wealth, $6 trillion. We were pulling $750 billion a year out of home equity, either taking home equity loans, refinancing our homes, borrowing against the mortgage.

SMITHSo you're sitting with people who used to own 70 percent of the value of their homes, now owning 40 percent of the value of their homes. They don't feel economically secure. So when Damian's talking about going out and remodeling the kitchen, he's talking about the top 10 percent. You start to get down into the middle 50 percent, 60 percent. Those folks are feeling very insecure.

SMITHThey now are financing their 401 (k)'s that have been a huge burden shift. Hundreds of billions of dollars a year have gone off the corporate books under the pocketbooks and checkbooks of ordinary Americans. So people are feeling insecure. This is -- yes, they are looking at things getting better. But if you take a look at what happen right after Jan. 1, Wal-Mart is one of the best indicators of where the American economy is.

SMITHHundred million people shop in Wal-Mart every week, OK, right after the payroll tax went up. Now, we're talking about the tax increase on the wealthy. That's where all the attention of the media went. But at the same time, very little attention went to the fact that the payroll tax went back to where it was before...

REHMSure.

SMITH...went up 2 percent. Wal-Mart sales fell sharply in January.

REHMInteresting.

SMITHThat's reflecting a lot.

REHMHere's an email saying, "I think the state of the economy depends on where you are in the economy. People who already were doing well are now doing even better. The rest of us are struggling." Damian.

PALETTAThat's -- I mean, there's no doubt about it. If you had -- if you were able to invest money in the stock market in 2009 when it kind if bottomed out, it's doubled since then. I mean, that's a good return on your investment. But if you got out of the stock market or were never in the stock market in the first place, you haven't seen any of this recovery and it's, you know, it's a real challenge. I mean, we talk to people every day who are having a hard time living paycheck to paycheck. They're not even living paycheck to paycheck, and this doesn't feel like a recovery for them.

REHMAnd, Ed, here's a question for you, "Why is there such a big gap between the so-called winners and losers and how might we regain some stability for those in the lower -- middle and lower classes?"

CONARDWell, there are differences -- different forces at work, I think, in the short run versus the long run. Let's talk about the short run, which is where Damian and I have been talking, although I love to talk about the long run. You normally get a shot to the economy, and you've discovered that there's either more risk than you thought there was or you have less equity than you thought you had. And you end up with a shortage of equity, and people dial back their risk-taking that lowers economic activity. Unemployment rises.

CONARDWith a surplus of labor and a shortage of equity, what you see coming out of recession normally is that wages will fall and return on investment will rise. And that is what we have seen here, although we've seen it in the extreme. I think the question you have to ask is, why is it that businesses and investors aren't taking the risks that push those profits back out into the economy and ultimately increase employment, raise wages and lower prices of goods to consumers who are largely workers and their wages is the other side of the coin?

CONARDYou haven't seen that here. I believe that's in part because we see a lot more risks today than we saw in 2007 when we didn't really understand the banking industry and the risks that where there. And we haven't taken the steps to mitigate that risk. And then the government has tried to paper over that by spending more money with pretty radical monetary policy.

CONARDAnd the effect of those things is to have further dial back in the private sector. They look at those policies. They don't really understand them. They worry that they destroy more value than they create in the long run. And I think it's very problematic for the private sector and the growth and the employment that you hope to get from it.

REHMHedrick.

SMITHDiane, there's been a tremendous shift that's occurred in the business leadership in America over the last 30 years. If you go back and look at what Charlie Wilson, who used to run General Motors -- biggest corporation in America at the time -- Reginald Jones, General Electric, Frank Abrams ran Standard Oil, if you looked at what they had to say, they said, our job -- I'm thinking about what Mr. Conard has just said and the risks and who gets rewarded here.

SMITHTheir belief was that you should share the wealth that the economy worked better. In fact, the company worked better. If you -- if the stakeholders in the corporation -- that is the groups that had a stake in the success of the corporation, the owners, of course, but the managers, the employers, the suppliers, the creditors, the customers, the communities in which they operated.

SMITHIf the stakeholders all share it -- and we had a sharing of wealth, which was much greater at that time -- we've now moved to what's called shareholder capitalism, which is why what Damian said is just true. If you were lucky enough or smart enough to invest in the stock market when it was at the bottom...

REHMOr stay.

SMITH...or just stayed in, then you've come out and you're back to where you were or maybe better off. If you got in at that time, you're really well off. What we had in 2011, believe it or not, the top 1 percent in America actually got more than 100 percent of the gain of the entire nation's economy. And the other 99 percent, everybody else lost money.

SMITHNow, that has to do with not just the way the market operates, that has to do with the way the spoils are divided by the leaders of American corporations. It has to do with the way the laws are written, the tax laws. It has to do with things like the minimum wage. And -- has to with...

REHMHas to do with the way Congress operates.

SMITHDefinitely has to do with public policy.

REHMAnd here's an email from Michael placing blame, and I want to see if you all agree. He says, "My small business cannot afford much more this obstructionism from the Tea Party both nationally and here in Florida. I feel like I've been dragged through the dirt of the last five years just when we start to get a glimmer of hope. Now, we have the economy killing and job killing foolishness of the sequester." Do you agree with that, Damian?

PALETTAWell, the Tea Party's influence is sort of complicated right now, and we're going to kind of see in the next two months how much influence they still have. Obviously, the election, some people view it as kind of a rebuke of their influence. But they still -- the Republicans still control the House of Representatives, and the Tea Party has a big influence there. And so I think both Democrats and Republicans are re-evaluating their strategy with the budget.

PALETTAYou know, we have another debt ceiling issue in July or August. So, you know, the Tea Party folks that we talked to say, listen, we just want to cut spending. We need to get this under control. Our country is going to go bankrupt. And so they're going to just keep pushing that issue, and they're going to have plenty of opportunity to do that 'cause we're going to have to be debating these budgets for the next few weeks.

REHMHedrick, how much is sequestration likely to make matters worse?

SMITHWell, I'm not an expert on that. But the Congressional Budget office says that we're going to lose 750,000 jobs, and it's going to cut about half of percent on growth this year. They've got lots of experts. And there are similar estimates in the private sector from that. You know, what's interesting -- back to the Tea Party -- first of all, it's amazing to hear a small businessman come out and criticize the Tea Party 'cause normally the political alignment is different from that.

SMITHBut what's interesting is Washington is disconnected from the country. If you look back, the election of 2012 was fought about jobs and growth. We have been absolutely consumed with the federal budget. I even thought the election of 2012 occurred a century ago. We're actually talking about the agenda of the election of 2010.

SMITHThis is not to say that we don't need to deal with America's deficit. But the way to deal with it is over the long term. In the short run, we need stimulus. We need push for growth. We could be building infrastructure. We could do a lot of stuff. And we should be cutting over the long term in order to put our long-term fiscal house in better order.

REHMOf course, we haven't even talked about how sequestration is going to affect low-income people, rental subsidies, food subsidies.

PALETTAChild care subsidies, things like that.

CONARDI...

REHMGo ahead, Ed.

CONARDI really think, though -- yeah. I think -- you look at the CBO forecast on sequestration. It talks about a slowdown in growth for a couple of quarters, and then it talks about the permanent damage that the deficit does over the long run. You know -- but what's missed in this conversation is that we have added $5 trillion of debt since the beginning of President Obama's administration. It's forecasted to add another three.

CONARDWith sequestration, that's $8 billion. When interest rates return to normal, we're talking about a $500 billion a year increase in interest payments. That will have a profound effect on long-term growth, and it will have a profound effect on the middle class and the working class and the poor in the country because it requires either enormous tax increases or spending cuts. And so we can always focus on this we need stimulus in the short run, we need stimulus in the short run.

CONARDBut we have to remember that every economist agrees that that does more damage in the long run than it helps in the short run. So if you have a little Keynesian temporary low on risk-taking, a little bit of detriment to the long run in order to avoid unemployment in the short run is probably a beneficial thing. But we are five years into this. We're still trying to paper over a permanent structural problem with government spending and monetary policy.

CONARDAnd we are beginning to do enormous damage to the long run, and you're seeing that show up in the stock market and in companies that are looking forward. They expect no rise in the interest rate because there's no growth, are incredibly reluctant to hire employees and are incredibly reluctant to compete with each other because everybody focuses on the next quarter.

CONARDIf we don't have stimulus, the next quarter might go down. You all sound like corporate managers. What we care about here is the long run and sound financial policies and monetary policies which will maximize growth in the long run and get us off this low base and return us back to where we were prior to 2007.

REHMAll right. Hedrick, you have another view.

SMITHWell, you can't get to long term revenue increase until you can get the growth, and you do need -- I can read economists that contradict what Mr. Conard said every day, saying you do need short-term stimulus in order to get the economy going again, which will generate the jobs, which will generate the consumer promise, which will generate more profits, which will generate more hiring.

SMITHThe economists call that the virtuous circle of growth. We need to get that going again. What -- and that's been missing. And so austerity in the short run is a mistake. I don't think Mr. Conard, listening to him, would advocate that, but...

CONARDThe government will not create a virtuous circle of growth in the private sector.

REHMAll right. OK. Edward Conard, he is a visiting scholar at the American Enterprise Institute. And you're listening to "The Diane Rehm Show." Going to open the phones now, 800-433-8850. First to Richmond, Va. Good morning, Joe. You're on the air.

JOEGood morning, Diane.

REHMHi.

JOEYeah. I got a pretty basic comment when it comes to the Main Street economy. If we want to get the Main Street economy back to somewhat normal levels and sustain it, we have to get Wall Street out of the picture. I mean, if you look throughout history, most of the problems in the economy, when it goes up and down, up and down, it's all because of Wall Street, either directly or indirectly.

JOEI mean, the current housing crisis is a glaring example of it. And also, we need to change shareholder laws in this country where the majority of the shareholders decide what these clowns on Wall Street make.

REHMAll right. Damian.

PALETTAWell, Wall Street's got such an interesting role in the economy right now. I mean, obviously we need these banks to lend money. I mean, they're the biggest source of credit in this country. And so we need them to kind of help the economy get its juice back, but there are still so many issues we hear about once a week or once every couple of days of some kind of goofy thing that a bank did, or some big mistake they did, or they're in the Justice Department's crosshairs for one thing or another.

PALETTAAnd so, you know, they haven't done much to kind of repair their image. So, you know, we can't -- it's hard to say we can just get rid of Wall Street 'cause Wall Street is just part of the economy right now, but at the same time they aren't doing themselves many favors.

REHMAll right.

SMITHYou can get rid of Wall Street, but our problem isn't shortage of capital. Business has been sitting on $2 trillion worth of capital for the last four, five years.

REHMNot irony.

SMITHAnd there was another story I saw on the paper about a month ago, which said that venture capitalists had raised $1 trillion of capital from pension funds and large investors, and they couldn't find places to invest it. Capital shortage is not our problem.

REHMAll right. To...

CONARDNow, this is a misinterpretation, though, because there's two kinds of capital. There's risk-averse short-term capital that ends up in a banking system. It's all sitting idle because we don't have enough equity to underwrite the risk. When you say that venture capital has raised $1 trillion of equity, they've gotten commitments for people to invest. But what you find is that there's been an enormous dial back in risk-taking in the economy, and that's why venture capital can't find places...

SMITHAnd why is there a dial back in risk-taking? Because there's uncertainty about consumer demand, and there's uncertainty about consumer demand because middle-class people are not getting paid enough money to be willing to go out and buy and do some of the things Damian was talking about at the beginning of the program.

REHMAll right.

CONARDI don't disagree with you, but government spending won't solve that problem.

REHMAll right.

CONARDIt's a temporary bandage that does long-term damage.

REHMWe've received a number of emails saying the Department of Defense furlough is going to be one unpaid day every week, not every two weeks.

SMITHTwenty percent...

REHMWhat's your understanding?

PALETTAThat's interesting. I mean, I know that different agencies are going to handle it differently, but maybe...

REHMOK.

PALETTA...that's going to be even more impactful.

REHMAll right. Let's go to Paulette in Cleveland Heights, Ohio.

PAULETTEDiane, thank you for taking my call.

REHMSurely.

PAULETTEIt's such a popular show. I'm amazed I got through.

REHMI'm glad you did.

PAULETTEYes. I would like your guests, if possible, to address two things, and all of this goes hand in hand with what you've been discussing. The emphasis seems to be on job creation, which is a good thing. But when companies such as one of the very large banks -- and I can't remember which one it is -- is going to let 4,000 people go across their network, and every time you hear about a job being let go, it's not 10 people or 20 people.

PAULETTEIt's hundreds and thousands at a time. I don't know how we're going to create so many new jobs to restore those. So I'm wondering, why can't they emphasize job retention along with job creation? And perhaps the private sector can furlough people. I'm old enough to remember layoffs when times were bad.

REHMSure.

PAULETTEThey would let people go for a week or two...

REHMRight.

PAULETTE...and then call them back and save some money.

REHMRight. I think the problem has become greater productivity. And the banks that are letting people go have found other ways to accomplish what they need to accomplish with fewer people.

SMITHEspecially by hiring overseas.

REHMExactly. We've got to take a short break here. When we come back, more of your calls, your comments. Stay with us.

REHMAnd welcome back. Hedrick Smith, you want to go back to our last caller's question regarding job creation and job retention.

SMITHI think job retention is a very interesting question. One of the issues is, where is your manufacturing sector? People are talking, is the manufacturing sector coming back? Can it come back? Should it come back? We've been told, you know, we're now in the service economy era of manufacturing's debt.

SMITHWell, it's interesting to take a look at some other countries, Germany in particular. Nine percent of our workforce in America today -- we've retained 9 percent of our workforce in manufacturing. Germany has retained 21 percent of its workforce.

REHMHow come?

SMITHI'm going to tell you in just a minute. Let me just tell you a couple of more things about Germany that are interesting. German wages for middle-class German workers have risen five times faster than they have in the United States in the last 25 years, since 1985, remarkable. You would think they'd be terrible…

CONARDWait. That's just...

SMITHLet me just finish, Mr. Conard.

CONARDBut that's just can't be true.

REHMHold on, Ed. Let him finish, and then I'll come by you.

SMITHLet me finish. And what's interesting, 25 years -- 1985 to 2010 -- and in the decade from 2000 to 2010, we had a $6 trillion trade deficit in America, and Germany had a $2 trillion trade surplus. Now, what they've done is they found a way to retain jobs, which is what this woman is talking about, particularly high-end, high-pay jobs in the manufacturing sector, and they've managed to export. They've done it with cooperation between management and labor.

SMITHThey've done it with cooperation between the public sector and the private sector. The government helps a great deal with German exports. They've focused on high machine tools, high engineering, very precision products such as the BMW, such as the Mercedes-Benz and so forth, Airbus, whatnot. They've -- noticed they have adopted a different strategy, which is much more like the stakeholder strategy that we had at work in America in the 1950s, '60s and '70s.

REHMAll right. Let's let Ed have a chance.

CONARDYeah. I think this is a real mistake in thinking. If you really look at German statistics, if you go back to 1908, for example -- 1998 -- I have the statistics in front of me -- German's real personal income per capita grew about 5 percent. The U.S. grew 15 percent over that period.

CONARDToday, disposable incomes in the U.S. in 2007 -- dollars -- was about 31. Germany is about 21. If you look at the countries like Germany and Japan, which exported and try to drive their growth off of manufacturing, they have grown significantly slower than the import-based economies have grown. And if you look at the U.S., contrary to popular belief, we pulled 14 million immigrants into our workforce.

CONARDWe didn't outsource on that. We insourced employment. And so everybody turns to Germany. The way Germany succeeded is they had a -- the government worked to lower wages across the board in Germany to try to get Germany more competitive, to get the little bit of growth that they've been able to get out of their manufacturing sector.

CONARDThe manufacturing sector is not a good place for us to stake unemployment on because the productivity gains have been faster there than every -- than any other sector in the economy. Even China is having a difficult time growing their manufacturing employment because their productivity gains are faster than the world is consuming manufactured goods. If you look at the economy since World War II, we have grown a full -- physical inputs have grown threefold.

REHMOK.

CONARDThe slowest growing sectors of the economy are the physical sectors.

REHMI want to take another call, but to let you know that Edward Conard is the author of "Unintended Consequences: Why Everything You've Been Told About the Economy is Wrong." Let's go to Tampa, Fla. and to Dolores. Good morning. You're on the air.

DOLORESGood morning. Thank you for taking my call.

REHMSurely.

DOLORESI have -- just wonder, if we keep talking about what has happened in the United States with small recessions over the last 40 years and so many people who are supporting the top 2 percent never go back any further than that time, they always emphasize how much the government is causing this or is not doing anything to regroup from the recession. I don't -- we hear the truth about what Roosevelt and the federal government did to get us out of our worst financial situation, which was the Great Depression. You don't hear anything about that.

REHMI think you have heard something about that this morning, Dolores. I'm going to turn back to Hedrick Smith.

SMITHWell, I mean, the argument, at least of some economist -- obviously, Mr. Conard doesn't agree with them. But the argument of some economist is, in fact, the stimulus package that we had in 2009 should have been two or three times the size it was, we could have then had some sustainable growth, and we wouldn't be talking about the kind of problem we're talking about today. We do have a structural problem here. The woman is right.

SMITHI mean, if you look at the length of time it took us to get out of recessions up to the 1990s, it was about 18, 20 months. Recession of the early '90s, it was 21 months. Recession of 2001, it was 46 months. We're now into a recession which we're in 48 months, and it's probably going to be 60, 65, 70 months before we get the unemployment to the same level.

REHMDamian.

SMITHSo we had a structural problem here.

PALETTAOne of the concerns you hear from a lot of economists also, though, is that when you get debt levels up to where they are now in this country, your hands are tied. You don't have as much flexibility to go out and pump money into the economy because, at a certain point, the financial markets are going to no longer finance that kind of activity. So, you know, there are some medium-term and especially long-term risks with the debt level that this country is holding right now, and that's the debate that we're having right now.

REHMWhat happens when the fed begins to pull out the banking industry?

PALETTAThat's the big question, I think, that everyone's trying to figure out right now. I mean, there's obviously -- both on a personal level and on a federal level, there's a lot of risks if interest rates start to go up. I mean, obviously, they'll have to go up at a certain point, but it can really snowball the amount of debt payments that the country has to pay on all the money that it's borrowed, but also, it could have an impact on business and homeowners as well.

REHMAll right. Let's go to Louisville, Ky. Good morning, Tina.

TINAHi.

REHMHi.

TINAThanks for taking my call.

REHMSurely.

TINAMy question was -- and it's kind of a comment/question. My husband and I -- my husband has a small business which is very successful, and I have a really good job. And all of our peers make really good money. They're pharmacists, doctors. You know, we do really well. But one thing that I haven't heard commented on when we're talking about stimulating the economy, when we're talking about people spending and stuff.

TINAAll of my friends, all of our little group -- and maybe we're too small to count -- even though we do have money to go spend, even though we are doing quite well, we just don't spend a lot of money. I mean, we don't have a really large house payment. We've decided to stay in a smaller home. We don't have car payments. We don't go out and just go shopping and spending and stuff like that. And I'm wondering, does that have any impact on the economy at all? Or are we just a small portion of the population?

REHMEd Conard.

CONARDYes. It's funny because she's personifying the very school of economics which I come from, which is called rational expectations. She looks forward in the future, and she sees a high degree of uncertainty. And so she is more cautious today immediately. And I think that when you -- advocates of stimulus, they all point to the seven, $800 billion one-time stimulus. But in truth, we have run about $1.2 trillion a year deficits for the last four years. We're going to run an $850 billion deficit this year. That doesn't count the $500 billion of interest that we're not paying because the interest rates are zero.

CONARDSo the school of stimulus spending never agrees that the amount of stimulus that we have pumped into the economy has been enormous, and it just had almost no effect at all because the other school from the Keynesian school of rational expectation says that the private sector looks forward into the future. They see enormous interest expenses coming and enormous tax increases or spending cuts.

CONARDAnd as this woman described, they dial back their economic activity today to compensate for that. And you can get not into the virtuous circle, you know, but the vicious circle, which is she holds back, more money sits idle, the government steps in and tries to borrow that money and do more stimulus spending. As the deficit grows bigger and bigger, she dials back more and more, and you never get any benefit from it. So I think it is very difficult.

REHMHed.

SMITHI say, but rational expectation is something that she can afford to do, and she said she's talking to and living among people who are doing very well. They have jobs, haven't lost their jobs. I can remember in the middle of recession going out to dinner on Saturday night in Bethesda and Chevy Chase and looking around at the restaurants. They're all jammed. People were buying very nice meals, ordering wine, having drinks, and I'm thinking there's no recession.

SMITHThe Pew Charitable Trust did a survey in the middle of the recession, 2010, and they talked to people about what had happened to their lives as a result of the recession. It was a very interesting poll. And what they found out was that some people had seen their stocks come down, the value of their houses come down, and they were curving their spending a bit as this lady described, this woman described.

SMITHOther people were in desperate shape. They were -- these are people who were borrowing from their family, couldn't afford medical care, couldn't make their housing payments. They'd lost jobs. They found out that the dividing line was at about $75,000. They headlined the poll, one recession, two Americas, and that's what this woman is describing. The people who were making $50,000 a year can't afford to do what this woman is doing. They are spending all their money. And they're spending it at Walmart just in order to stay even.

REHMJust to stay...

SMITHSo when you start to look at the behavior of the people who are in the top 10 percent -- and I would bet just listening to this woman, her family is in the top 10 percent of income earners in the country -- their behavior is quite different from the behavior of people who are bottom 90 percent.

REHMDamian, I keep hearing that, and you've said this morning corporations are sitting on these piles of cash. And they keep claiming risk is what's keeping them from hiring. Hasn't risk always been a part of the investor's decision?

PALETTASure, I think. But the number of self-inflicted wounds that this country's had in the last couple of years has been amazing. And the problem is every two or three months, there's another tornado or hurricane cloud on the horizon, and so, you know, you can't -- in some extent, you can't blame them for wondering what Washington is going to do next this monkey-updated economy.

REHMBut nobody can predict what the weather is going to do nor can they predict what the Congress is going to do.

PALETTARight. But when the Congress and the White House are kind of vowing that they're going to be at loggerheads, then you -- we've kind of learned lessons that, you know, maybe they're going to do this all over again.

REHMDo you see a change coming there?

PALETTAI think that everyone kind of exhaled after the election, and I think both sides have kind of rethought their strategy a little bit, and especially the White House can't afford, you know, this is his last four years in office. He doesn't want to have this legacy of fighting with Republicans on the Hill, and the stock market is coming up.

PALETTAMaybe he sees this kind of Clinton-esque kind of revival that he might be able to enjoy. But the problem is that there -- like we've been talking about, there's a lot of folks that aren't enjoying this rebound. There's a lot of problems that are in the near term that need to be addressed, and it's going to have to be debated very soon.

REHMAnd here's an email, which says, "I'm 60 years old. I work 40 hours a week for city government. I make $30,000 a year. Inflation does not allow me to buy products and support our economy. Gas prices, taxes and food are up. We drive worn-out vehicles. New clothes are a thing of the past. We cannot save. We spend it on our electric bill."

SMITHShe is describing the stealing of the American dream. You've got corporate profits at record levels. Corporate profits have a larger share of America's national income than at any time since 1950. And the way it's...

REHMAnd I'd be interested in how Ed responds to that email.

CONARDYeah, look, I do think -- I think there are two different Americas. I think that the America today is very different than the America in the 1950s when capital investment was really the primary driver of growth. Today, it's a very innovation-based, entrepreneurial-based growth, which has been beneficial to the people at the highest end of the wage scale.

REHMAt the top, right.

CONARDSo I don't disagree with that. But I also think that if you look at the U.S. relative to Europe and Japan who are living in the same world, we added 40 million jobs on a base of 100 million employees since 1980. They are less than has as much. We grew 63 percent since 1991. They grew less than half as much. Our medium wages are 25 to 30 percent higher than their medium wages are. Our hours of work per working age adult are 35 to 40 percent more than theirs are.

REHMAll right. And...

CONARDAnd there's been an enormous increase in middle-class income. It's been spread over a large increase in employment relative to Europe and Japan.

SMITHBut...

REHMAnd you're listening to "The Diane Rehm Show." The issue becomes, what difference does it make if the folks in Japan and Germany are doing what they're doing somehow, and it just acknowledged there are two separate Americas right now?

PALETTAWell, so the email you got was from a 60-year-old who's making...

REHMRight.

PALETTA…$30,000...

REHM30,000.

PALETTA...there within five years of Medicare. I mean, the social safety net was designed for someone just like this, right?

REHMOf course.

CONARDAnd -- but those are the issues, and we have 10,000 people turning 65 every day. These people are just moving into these programs and herds, and it's like they almost weren't designed to take in the number of people that they have. And so that's kind of one of the fundamental debates this country is going to (unintelligible).

REHMAll right. To -- finally, to Hudsonville, Mich. Good morning, Dave.

DAVEGood morning, Diane. Thanks. I just have a quick comment. I keep hearing this whole debate that goes on. And businesses don't hire employees because they have extra money. Unless or until there is demand for products and services, businesses won't hire. So if the middle class had money to spend, then businesses would see that demand for their products would go up. But I just -- every time I hear this debate and you don't -- you know, they say, well, it's corporate America sitting on this many trillions of dollars.

DAVEUnless people have dough to spend, businesses are not going to hire. And I have one last thing I'd like Mr. Conard to answer or to respond to. Why is it that every recovery on record in this country has gone along with an increase in public employment except for this one? And I'll take my answer off the air. Thanks.

REHMAll right. Very quickly, Ed, please.

CONARDSo two things there. So the reason is because the government spending is at 24 percent of GDP, and it's running out of capacity to continue expanding. You know, it has historically ran at 21 percent at GDP. In the Clinton administration, for example, it got down to 18 percent of GDP, so there was more space for growth than you have found in this economy.

CONARDBut I also think it's a mistake to think that demand by consumers is really what drives the economy because it's always the chicken and the egg thing. Work is what creates demand. And there are two kinds of investment. There is investment where you build capital to meet growing demand, but there's also, today, which is the primary source of investment, is innovation, which increases productivity, which creates products like Apple and Google and Facebook...

REHMAll right.

CONARD...which create their own demand and grow the economy.

PALETTABut it isn't...

REHMI'd give you the last word.

SMITHBut it isn't just products. I had a conversation this past week with Klaus Kleinfeld, who was the head of Alcoa, used to be the head of Siemens. He describes how, as a German CEO, he worked very hard when products could be built more cheaply in Czechoslovakia or somewhere else in the world to retrain the workers. It wasn't just innovating new products. It was innovating new workers and having the workers take part. That's how you keep the American dream going.

REHMHedrick Smith, his new book is title "Who Stole the American Dream?" Damian Paletta is a reporter for The Wall Street Journal, and Edward Conard is a visiting scholar at the American Enterprise Institute, author of "Unintended Consequences: Why Everything You've Been Told About the Economy is Wrong." He's a former partner at Bain Capital. Thank you all so much.

PALETTAThank you.

CONARDThank you, Diane.

SMITHThank you.

REHMAnd thanks for listening. I'm Diane Rehm.