Aftershock: The Next Economy and America's Future (12 page)

In early 2010, only a little more than a year after the crash, Wall Street awarded pay packages as if the crash had never occurred. JPMorgan Chase more than doubled its profits from 2008, generating record revenues and paying out $27 billion to its already well-heeled executives, traders, and other “vital” employees. Goldman Sachs posted its largest profit in history and distributed $16.2 billion in bonuses. (Goldman could have paid out bigger bonuses but, concerned about its tarnished public image, held back.
According to
The New York Times
, Goldman’s employees accepted the less-than-anticipated payout but soon expected to be rewarded for going along with what one characterized as “a temporary public relations exercise.”) JPMorgan, Goldman, and the other big banks were so eager to lure and keep top deal makers and traders, they even revived the practice of offering multimillion-dollar guaranteed payments regardless of performance. Even though some of the worst abuses of the boom years had been contained, the Street effectively resisted congressional efforts to tie its collective hands. It was still making large global bets with other people’s money and taking in giant fees regardless of how those bets turned out. Few financial trends are as certain as the outsized rewards the denizens of Wall Street will continue to claim as their rightful winnings.

The compensation packages awarded to corporate CEOs and executives likewise continued to soar. Here again, top executive pay was on the same trajectory it had been on before the Great Recession, as if almost nothing had happened in the intervening time. Executive pay was linked to the profitability and stock market performance of their companies. Both were on the rise, reflecting the increasing ease with which payrolls could be cut and the work automated or parceled out overseas, and also the telling fact that many foreign markets were emerging from recession more rapidly than the United States. The race for executive “talent” had also become more global. Big companies continued
to raise executive pay in order to attract the best from around the world, who in turn continued to scour the globe for great deals and new markets. This trend will surely endure. Astonishingly, the twenty-five leading hedge-fund managers did far better than even investment bankers and top corporate executives, raking in an average of $1 billion each, as I’ve noted.

Yet the majority of Americans will continue to battle obsolescence—competing ever more furiously with workers around the world as well as with new generations of software. Unless action is taken to reverse these trends, the share of national income going to the top will continue to grow and the share going to everyone else will continue to decline.

Many of the things people want are valuable in relation to what other people have. Indeed, much of the idea of “value” is related to the social role we’re playing.
As economist Richard Layard has written, “In a poor society a man proves to his wife that he loves her by giving her a rose, but in a rich society he must give her a dozen roses.” You can see this most graphically in computer-based simulated worlds, where many people seem to get almost as much satisfaction from paying real money for “virtual” goods—tiny icons representing designer clothes or fancy cars—as they do from buying the genuine articles in the real world, at a much higher cost. In these simulated worlds, the virtual goods serve a similar social function as the real ones, establishing one’s relative wealth—and worth.

Relativity accounts for what’s seen as a “luxury” and what’s a “necessity.”
As far back as the eighteenth century, Adam Smith defined necessities as “not only the commodities which are indispensably necessary for the support of life, but whatever the custom of the country renders it indecent for creditable people, even of the lowest order, to be without.” In most of eighteenth-century
Europe, a linen shirt was not strictly speaking a necessity, but Smith noted that a common laborer would be ashamed to appear in public without one, “the want of which would be supposed to denote that disgraceful degree of poverty, which, it is presumed, nobody can well fall into without extreme bad conduct.” Leather shoes were a “necessity” in England for both men and women, he wrote, but only for men in Scotland, and for neither in France.

In 1899, the economist-sociologist Thorstein Veblen noted that people take their cues from those above them and seek to match their living standards with the “conspicuous consumption” of the very rich.
More than a half century later, economist James Duesenberry recognized that the demand for many products has more to do with the social standing they give their purchasers than with any intrinsic value. He called it the “demonstration effect,” which signals to others that the possessor of an item is wealthy enough to afford it, and thereby establishes his or her position in a social pecking order.

“Wealth,” said H. L. Mencken, the American satirist of the early twentieth century, “is any income at least $100 more a year than the income of one’s wife’s sister’s husband.” Times have changed and many women are now breadwinners, but a family’s relative position (and not just compared to one’s relatives) still matters. Yet the desire to do better when the incomes of people at the top are rising is not just due to envy or any other character flaw on most people’s parts. It’s connected to an implicit upward shift in the social norm of what constitutes a good life. Even people whose incomes haven’t actually dropped feel deprived relative to how those at the top now live; people whose incomes have dropped feel even poorer.

The evidence is all around us. People who live in states where incomes are more equal register higher levels of satisfaction than do people where the gap is wider. The same holds among nations.
Scandinavians express more contentment with their lot in life than do inhabitants of southern Europe, where inequality is higher. Researchers have found that inequality correlates with health, for much the same reason. Richard Wilkinson of the University of Nottingham, in England, has discovered that once economic growth lifts a country out of extreme poverty, its citizens are likely to live longer and healthier lives—as long as there are not large differences in their incomes. The inhabitants of poorer countries with more equal incomes are sometimes healthier, on average, than are the citizens of richer countries whose incomes are more unequal.

Even people whose incomes rise feel less satisfied than beforehand when they are exposed to others whose incomes are much higher. After the Berlin Wall tumbled, living standards for the former inhabitants of East Germany soared, but their level of contentment declined. The reason: They began comparing themselves to West Germans rather than to others in the Soviet bloc.

Few middle-class people aspire to live in a forty-four-thousand-square-foot mansion like the one Bill Gates built for himself near Seattle. But by building that mansion, Gates set a new norm for other exceedingly wealthy people, some of whom subsequently built mansions just as big. These giant mansions also ratcheted up the aspirations of people below them, who were rich rather than exceedingly wealthy, and who began building larger homes than they had ever lived in before. And so on down the income ladder, until the new norm reached the middle class.

As economist Robert H. Frank has pointed out, something like this chain of comparisons helps explain why the typical new home built in the United States in 2007 (2,500 square feet) was about 50 percent bigger than its counterpart built in 1977 (1,780 square feet), even though median incomes barely rose. A similar
comparative process operated on other purchases. As the exceedingly rich threw million-dollar birthday parties and even more extravagant weddings, a chain of comparison also pushed up the price of middle-class celebrations. The typical American wedding cost $11,213 in 1980; by 2007 it cost $28,082 (both figures adjusted for inflation).

Middle-class paychecks couldn’t keep up with the costs of these homes, weddings, and many other amenities, which is why so many people went so deeply into debt. But by 2008 that debt option disappeared—which may help explain why, for example, the typical new home in 2009 slipped back, to 2,392 square feet. Yet the chain of comparison has not disappeared. To the contrary, the middle class has become more acutely aware of how far it has fallen relative to the top.

The very rich may have become somewhat more guarded about displaying their opulence. During the Great Recession, conspicuous consumption became unseemly. “Shopping is a little vulgar right now,” said an editor at
Allure
magazine. Yet in a world of instant and pervasive communication, the rich cannot easily hide their wealth.
Shortly after Lehman Brothers went bust,
The Daily Beast
reported that Kathleen Fuld, wife of former Lehman Brothers CEO Richard Fuld, selected a plain white bag to conceal her purchase of three $2,225 cashmere scarves at an Hermès boutique in New York. One Web site, created in 2009, allows the curious to type in the name of any CEO or financial tycoon and zoom in on a bird’s-eye view of their personal estates.

As income and wealth have continued to accumulate at the top, the rich have been able to buy more highly desirable things whose supply is necessarily limited.
Prestigious universities have only a limited number of places, which is one way they maintain their prestige. Because those schools are often gateways to the best jobs, competition for admission is intense. As the rich have grown richer while the middle class has lost ground, children from
wealthy families have been at an increasing advantage in this race: They attend high-quality private high schools (or top-ranked public high schools accessible only to families wealthy enough to live in the area they serve, which amounts to the same thing), while the quality of public schools available to most families has declined. Children of the affluent have access to private tutors to help them with difficult subjects, to test preparation services that guide them through SATs and other entrance exams, and to coaches to help assemble their applications—incurring expenses that struggling middle-class families cannot afford. Some children of the wealthy also gain favorable treatment by admissions officials because their parents are major donors to the college (or likely to become so if their child is admitted).

Increasingly, too, the most accomplished doctors and medical specialists, and the best hospitals and health care facilities, have become available only to the very rich. New health reform legislation will extend care to more people and necessarily limit what doctors and hospitals can charge, as does Medicare. For this reason, the law is unlikely to dramatically increase the supply of either. One likely result will be to increase the market price of the most desirable physicians and facilities, making them accessible mainly to those who can afford them.

Whether it’s an education at a prestigious school, excellent medical care, or even gorgeous oceanfront property, anything that’s desirable but in limited supply has become less accessible to the vast middle class as purchasing power has become concentrated at the top. And as the rich have simultaneously withdrawn from institutions dedicated to the common good, like public schools, they both bid up the price of desirable private ones and reduce the quality of what remains public. Increasingly, upscale towns, gated communities, and office parks are financed by fees paid by their wealthy inhabitants. Having seceded from townships or jurisdictions inhabited by the middle class and the
poor, the very wealthy pay fewer local taxes to support services for those of more modest means.

As the income gap continues to widen, deprivations like these are likely to cause many Americans to feel even poorer and, in many cases, more frustrated. In other nations, at other times, wide disparities in income and wealth have led to political instability.
Summarizing the research, economists Roberto Perotti and Alberto Alesina have found that “income inequality increases social discontent and fuels social unrest. The latter, by increasing the probability of coups, revolutions, [and] mass violence.”

This has not been the case in America, at least not so far. Here, opulence has provoked more ambition than hostility. In this respect we are different from older cultures with feudal origins and long histories of class conflict. For most Americans, the rich have not been “them”; instead, they’re people whom we aspire to become. We worry only when private wealth exercises political power. It was here that Theodore Roosevelt and Woodrow Wilson drew the line on the trusts, and Franklin D. Roosevelt damned the “economic royalists.” Private wealth applied to ostentatious consumption is perfectly appropriate; applied to the purchase of political power, it becomes diabolic.

Given the chance, most members of the middle class want to join the ranks of the rich and gain all the perks that come with great wealth. The real frustration, and the final straw, will come if and when they no longer feel they have a chance because the dice are loaded against them.

Americans might be able to accept a high rate of unemployment coupled with lower wages. We are likely to accommodate absolute as well as relative losses in our standard of living for a long stretch of time. We might abide even wider inequality. But when all of these are added to a perception that the economic game is rigged—that no matter how hard we try we cannot get ahead because those with great wealth and power will block our way—the combination may very well be toxic.

Losers of rigged games can become very angry. I remember when in 2009 my employer, the University of California, announced that due to state budget cuts, the salaries of all faculty and staff would have to be reduced. Most of my colleagues grudgingly accepted the outcome; we were all in roughly the same boat, and the state’s budget was in crisis.
But when the
San Francisco Chronicle
reported that a few top administrators at the university had gotten pay raises, all hell broke loose. Suddenly the sacrifices seemed larger and less tolerable. (In fact, the
Chronicle
exaggerated, but the damage was done.)

Something like this has been happening on a national scale. Even before the Great Recession, evidence began accumulating that the game was tilted in the direction of big business and the wealthy. Recall the busting of unions, the slashing of payrolls, and the shredding of employee benefits, without any attempt by government to constrain or reverse these practices; the junk-bond and private-equity deals that flipped companies like cards, burdened them with debt, and forced mass layoffs; the resplendent
pay packages of top corporate and financial executives and traders, even as marginal taxes on the rich were cut and Wall Street was deregulated. In the 1980s, irresponsible gambles by some savings-and-loan banks cost taxpayers $125 billion; one such bank was owned by Charles Keating, who “donated” $300,000 to five U.S. senators, thereby greasing the skids with federal regulators. Insider trading scandals involving junk-bond kings including Ivan Boesky and Michael Milken did their damage. The BCCI money-laundering scandal ruined the reputation of Clark Clifford, advisor to four presidents. Then came the corporate looting scandals: In 2002, CEOs of giant corporations like Enron and WorldCom were found to have padded their nests at the expense of small investors. Other corporations that cooked their books included Adelphia, Global Crossing, Tyco, Sunbeam, and ImClone. Every major U.S. accounting firm either admitted negligence or paid substantial fines without admitting guilt. Nearly every major investment bank played a part in defrauding investors, largely by urging them to buy stocks that the bank’s own analysts privately described as junk.