The Price of Inequality: How Today's Divided Society Endangers Our Future (11 page)

Of course, even when laws that prohibit monopolistic practices are on the books, these have to be enforced. Particularly given the narrative created by the Chicago school of economics, there is a tendency not to interfere with the “free” workings of the market, even when the outcome is anticompetitive. And there are good political reasons not to take too strong a position: after all, it’s antibusiness—and not good for campaign contributions—to be too tough on, say, Microsoft.
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Politics: getting to set the
rules and pick the referee

It’s one thing to win in a “fair” game. It’s quite another to be able to write the rules of the game—and to write them in ways that enhance one’s prospects of winning. And it’s even worse if you can choose your own referees. In many areas today, regulatory agencies are responsible for oversight of a sector (writing and enforcing rules and regulations)—the Federal Communications Commission (FCC) in telecom; the Securities and Exchange Commission (SEC) in securities; and the Federal Reserve in many areas of banking. The problem is that leaders in these sectors use their political influence to get people appointed to the regulatory agencies who are sympathetic to their perspectives.

Economists refer to this as “regulatory capture.”
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Sometimes the capture is associated with pecuniary incentives: those on the regulatory commission come from and return to the sector that they are supposed to regulate. Their incentives and those of the industry are well aligned, even if their incentives are not well aligned with those of the rest of society. If those on the regulatory commission serve the sector well, they get well rewarded in their post-government career.

Sometimes, however, the capture is not just motivated by money. Instead, the mindset of regulators is captured by those whom they regulate. This is called “cognitive capture,” and it is more of a sociological phenomenon. While neither Alan Greenspan nor Tim Geithner actually worked for a big bank before coming to the Federal Reserve, there was a natural affinity, and they may have come to share the same mindset. In the bankers’ mindset—despite the mess that the bankers had made—there was no need to impose stringent conditions on the banks in the bailout.

The bankers have unleashed enormous numbers of lobbyists to persuade any and all who play a role in regulation that they should not be regulated—an estimated 2.5 for every U.S. representative.
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But persuasion is easier if the target of your efforts begins from a sympathetic position. That is why banks and their lobbyists work so strenuously to ensure that the government appoints regulators who have already been “captured” in one way or another. The bankers try to veto anyone who does not share their belief. I saw this firsthand during the Clinton administration, when potential names for the Fed were floated, some even from the banking community. If any of the potential nominees deviated from the party line that markets are self-regulating and that the banks could manage their own risk—there arose a hue and cry so great that the name wouldn’t be put forward or, if it was put forward, that it wouldn’t be approved.
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Government munificence

We’ve seen how monopolies—whether government granted or government “sanctioned,” through inadequate enforcement of competition laws—have built the fortunes of many of the world’s wealthiest people. But there is another way to get rich. You can simply arrange for the government to hand you cash. This can happen in myriad ways. A little-noticed change in legislation, for example, can reap billions of dollars. This was the case when the government extended a much-needed Medicare drug benefit in 2003.
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A provision in the law that prohibited government from bargaining for prices on drugs was, in effect, a gift of some $50 billion or more per year to the pharmaceutical companies.
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More generally, government procurement—paying prices well above costs—is a standard form of government munificence.

Sometimes gifts are hidden in obscure provisions of legislation. A provision of one of the key bills deregulating the financial derivative market—ensuring that no regulator could touch it, no matter how great the peril to which it exposed the economy—also gave derivatives claims “seniority” in the event of bankruptcy. If a bank went under, the claims on the derivatives would be paid off before workers, suppliers, or other creditors saw any money—even if the derivatives had pushed the firm into bankruptcy in the first place.
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(The derivatives market played a central role in the 2008–09 crisis and was responsible for the $150 billion bailout of AIG.)

There are other ways that the banking sector has benefited from government munificence, evident most clearly in the aftermath of the Great Recession. When the Federal Reserve (which can be thought of as one branch of the government) lends unlimited amounts of money to banks at near-zero interest rates, and allows them to lend the money back to the government (or to foreign governments) at much higher interest rates, it is simply giving them a hidden gift worth billions and billions of dollars.

These are not the only ways that governments spur the creation of enormous personal wealth. Many countries, including the United States, control vast amounts of natural resources like oil, gas, and mining concessions. If the government grants you the right to extract these resources for free, it doesn’t take a genius to make a fortune. That is, of course, what the U.S. government did in the nineteenth century, when anyone could stake a claim to natural resources. Today, the government doesn’t typically give away its resources; more often it requires a payment, but a payment that is far less than it should be. This is just a less transparent way of giving away money. If the value of the oil under a particular piece of land is $100 million after paying the extraction costs, and the government requires a payment of only $50 million, the government has, in effect, given away $50 million.

It doesn’t have to be this way, but powerful interests ensure that it is. In the Clinton administration, we tried to make the mining companies pay more for the resources they take out of public lands than the nominal amounts that they do. Not surprisingly, the mining companies—and the congressmen to whom they make generous contributions—opposed these measures, and successfully so. They argued that the policy would impede growth. But the fact of the matter is that, with an auction, companies will bid to get the mining rights so long as the value of the resources is greater than the cost of extraction, and if they win the bid, they will extract the resources. Auctions don’t impede growth; they just make sure that the public gets paid appropriately for what is theirs. Modern auction theory has shown how changing the design of the auction can generate much more revenue for the government. These theories were tested out in the auction of the spectrum used for telecommunications beginning in the 1990s, and they worked remarkably well, generating billions for the government.

Sometimes government munificence, instead of handing over resources for pennies on the dollar, takes the form of rewriting the rules to boost profits. An easy way to do this is to protect firms from foreign competition. Tariffs, taxes paid by companies abroad but not by domestic firms, are in effect a gift to domestic producers. The firms demanding protection from foreign competition always provide a rationale, suggesting that society as a whole is the beneficiary and that any benefits that accrue to the companies themselves are incidental. This is self-serving, of course, and while there are instances in which such pleas contain some truth, the widespread abuse of the argument makes it hard to take seriously. Because tariffs put foreign producers at a disadvantage, they enable domestic firms to raise their prices and increase their profits. In some cases, there may be some incidental benefits such as higher domestic employment and the opportunity for companies to invest in R&D that will increase productivity and competiveness. But just as often, tariffs protect old and tired industries that have lost their competitiveness and are not likely to regain it, or occasionally those that have made bad bets on new technologies and would like to postpone facing competition.

The ethanol subsidy offers an example of this phenomenon. A plan to reduce our dependence on oil by replacing it with the energy of the sun embedded in one of America’s great products, its corn, seemed irresistible. But converting plant energy into a form that can provide energy for cars instead of people is hugely expensive. It is also easier to do with some plants than others. So successful has Brazil’s research on sugar-based ethanol been that in order for America to compete, for years it had to tax Brazilian sugar-based ethanol 54 cents a gallon.
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Forty years after the introduction of the subsidy, it was still in place to support an infant technology that seemingly would not grow up. When oil prices fell after the 2008 recession, many ethanol plants went bankrupt, even with massive subsidies.
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It wasn’t until the end of 2011 that the subsidy and tariff were allowed to expire.

The persistence of such distortionary subsidies stems from a single source: politics. The main—and for a long while, effectively the only—
direct
beneficiary of these subsidies were the corn-ethanol producers, dominated by the megafirm Archer Daniels Midland (ADM). Like so many other executives, those at ADM seemed to be better at managing politics than at innovation. They contributed generously to both parties, so that as much as those in Congress might rail against such corporate largesse, lawmakers were slow to touch the ethanol subsidies.
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As we’ve noted, firms almost always argue that the true beneficiaries of any largesse they receive lie elsewhere. In this case, ethanol advocates argued that the real beneficiaries were America’s corn farmers. But that was, for the most part, not the case, especially in the early days of the subsidy.
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Of course, why American corn farmers, who were already the recipients of massive government handouts, receiving almost half of their income from Washington rather than from the “soil,” should receive still further assistance is hard to understand, and hard to reconcile with principles of a free-market economy. (In fact, the vast preponderance of government money subsidizing agriculture does not go, as many believe, to poor farmers or even family farms.
The design of the program reveals its true objective: to redistribute money from the rest of us to the rich and corporate farms.)
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Sadly, government munificence toward corporations does not end with the few examples we have given, but to describe each and every instance of government approved rent seeking would require another book.
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C
HAPTER
T
HREE

MARKETS AND INEQUALITY

T
HE PRECEDING CHAPTER EMPHASIZED THE ROLE OF
rent seeking in creating America’s high level of inequality. Another approach to explaining inequality emphasizes abstract market forces. In this view, it’s just the bad luck of those in the middle and at the bottom that market forces have played out the way they have—with ordinary workers seeing their wages decline, and skilled bankers seeing their incomes soar. Implicit in this perspective is the notion that one interferes with the wonders of the market at one’s peril: be cautious in any attempt to “correct” the market.

The view I take is somewhat different. I begin with the observation made in chapters 1 and 2: other advanced industrial countries with similar technology and per capita income differ greatly from the United States in inequality of pretax income (before transfers), in inequality of after tax and transfer income, in inequality of wealth, and in economic mobility. These countries also differ greatly from the United States in the
trends
in these four variables over time. If markets were the principal driving force, why do seemingly similar advanced industrial countries differ so much? Our hypothesis is that market forces are real, but that they are shaped by political processes. Markets are shaped by laws, regulations, and institutions. Every law, every regulation, every institutional arrangement has distributive consequences—and the way we have been shaping America’s market economy works to the advantage of those at the top and to the disadvantage of the rest.

There is another factor determining societal inequality, one that we discuss in this chapter. Government, as we have seen, shapes market forces. But so do societal norms and social institutions. Indeed, politics, to a large extent, reflects and amplifies societal norms. In many societies, those at the bottom consist disproportionately of groups that suffer, in one way or another, from discrimination. The extent of such discrimination is a matter of societal norms. We’ll see how changes in social norms—concerning, for instance, what is fair compensation—and in institutions, like unions, have helped shape America’s distribution of income and wealth. But these social norms and institutions, like markets, don’t exist in a vacuum: they too are shaped, in part, by the 1 percent.

T
HE
L
AWS OF
S
UPPLY AND
D
EMAND

Standard economic analysis looks to demand and supply to explain wages and wage differences and to shifts in demand and supply curves to explain changing patterns of wages and income inequality. In standard economic theory, wages of unskilled workers, for example, are determined so as to equate demand and supply. If demand increases more slowly than supply,
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then wages fall. The analysis of changes in inequality then focuses on two questions: (a) What determines shifts in demand and supply curves? and (b) What determines individuals’ endowments, that is, the fraction of the population with high skills or large amounts of wealth?

Immigration, legal and illegal alike, can increase the supply. Increasing the availability of education may reduce the supply of unskilled labor and increase the supply of skilled labor. Changes in technology can lead to reduced demands for labor in some sectors, or reduced demands for some types of labor, and increases in the demand for labor of other types.

In the background of the global financial crisis were major structural changes in the economy. One was a shift in the U.S. job market structures over some twenty years, especially the destruction of millions of jobs in manufacturing,
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the very sector that had helped create a broad middle class in the years after World War II. This was partly a result of technological change, advances in productivity that outpaced increases in demand. Shifting comparative advantages compounded the problem, as the emerging markets, especially China, gained competencies and invested heavily in education, technology, and infrastructure. The U.S. share of global manufacturing shrank in response. Of course, in a dynamic economy jobs are always being destroyed and created. But this time it was different: the new jobs typically were often not as well-paying or as long-lasting as the old. Skills that made workers valuable—and highly paid—in manufacturing were of little value in their new jobs (if they could get new jobs), and, not surprisingly, their wages reflected the changed status, as they went from being a skilled manufacturing worker to being an unskilled worker in some other sector of the economy. American workers were, in a sense, victims of their own success: their increased productivity did them in. As the displaced manufacturing workers fought for jobs elsewhere, wages in other sectors suffered.

The stock market boom and the housing bubble of the early twenty-first century helped to hide the structural dislocation that America was going through. The real estate bubble offered work for some of those who lost their jobs, but it was a temporary palliative. The bubble fueled a consumption boom that allowed Americans to live beyond their means: without this bubble, the weakening of incomes of so many in the middle class would have been readily apparent.

This sectoral shift was one of the key factors in the increase in inequality in the United States. It helps explain why ordinary workers are doing so badly. With their wages so low, it’s not a surprise that those at the top, who get the lion’s share of the profits, are doing so well.

A second structural shift stemmed from changes in technology that increased the demand for skilled workers, and replaced many unskilled workers with machines. This was called skill-biased technological change. It should be obvious that innovations or investments that reduce the need for unskilled labor (for example, investments in robots) weaken the demand for unskilled labor and lead to lower unskilled wages.

Those who attribute the decline of wages at the bottom and in the middle to market forces then see it as the normal working of the balance of these forces. And, unfortunately, if technological change continues as it has, these trends may persist.

Market forces haven’t always played out this way, and there is no theory that says that they necessarily should. Over the past sixty years, supply and demand for skilled and unskilled labor have shifted in ways that at first decreased, and then increased, wage disparities.
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In the aftermath of World War II, large numbers of Americans received a higher education thanks to the GI Bill. (College graduates formed only 6.4 percent of the labor force in 1940, but the percentage had doubled, to 13.8 percent, by 1970.)
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But the growth of the economy and the demand for high-skill jobs kept pace with the increase in supply, so the return to education remained strong. Workers with a college education still received 1.59 times what a high school graduate received, almost unchanged from the ratio in 1940 (1.65). The diminished
relative
supply of unskilled workers meant that even these workers benefited, so wages across the board increased. America enjoyed broadly shared prosperity, and in fact at times incomes at the bottom increased faster than those at the top.

But then U.S. educational attainment stopped improving, especially relative to the rest of the world. The fraction of the U.S. population graduating from college increased much more slowly, which meant the relative supply of skilled workers, which had increased at an average annual rate of almost 4 percent from 1960 to 1980, instead increased at the much smaller rate of 2.25 percent over the next quarter century.
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By 2008 the U.S. high school graduation rate was 76 percent, compared with 85 percent for the EU.
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Among the advanced industrial countries, the United States is only average in college completion; thirteen other countries surpass it.
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And average scores of American high school students, especially in science and mathematics, were at best mediocre.
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In the past quarter century, technological advances, particularly in computerization, enabled machines to replace jobs that could be routinized. This increased the demand for those who mastered the technology and reduced the demand for those who did not, leading to higher relative wages for those who had mastered the skills required by the new technologies.
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Globalization compounded the effects of technology’s advances: jobs that could be routinized were sent abroad, where labor that could handle the work cost a fraction of what it cost in the United States.
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At first, the balance of supply and demand kept wages in the middle rising, but those at the bottom stagnated or even fell. Eventually, the deskilling and outsourcing effects dominated. Over the past fifteen years, wages in the middle have not fared well.
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The result has been what we described in chapter 1 as the “polarization” of America’s labor force. Low-paying jobs that cannot be easily computerized have continued to grow—including “care” and other service sectors jobs—and so have high-skilled jobs at the top.

This skill-biased technological change has obviously played a role in shaping the labor market—increasing the premium on workers with skills, deskilling other jobs, eliminating still others. However, skill-biased technological change has little to do with the enormous increase in wealth at the very top. Its
relative
importance remains a subject of debate, upon which we will comment later in this chapter.

There is one more important market force at play. Earlier in the chapter, we described how increases in productivity in manufacturing—outpacing the increase in demand for manufactured goods—led to higher unemployment in that sector. Normally, when markets work well, the workers displaced easily move to another sector. The economy as a whole benefits from the productivity increase, even if the displaced worker doesn’t. But moving to other sectors may not be so easy. The new jobs may be in another location or require different skills. At the bottom, some workers may be “trapped” in sectors with declining employment, unable to find alternative employment.

A phenomenon akin to what happened in agriculture in the Great Depression may be happening in large swaths of today’s job market. Then increases in agricultural productivity raised the supply of agricultural products, driving down prices and farm incomes relentlessly, year after year, with an occasional exception from a bad harvest. At points, and especially at the beginning of the Depression, the fall was precipitous—a decline of half or more in farmers’ income in three years. When incomes were declining more gradually, workers migrated to new jobs in the cities, and the economy went through an orderly, if difficult, transition. But when prices fell precipitously—and the value of housing and other assets that the farmers owned fell concomitantly—people were suddenly trapped on their farms. They couldn’t afford to move, and their decreased demand for goods made in urban factories caused unemployment in the cities as well.

Today America’s manufacturing workers have been experiencing something similar.
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I recently visited a steel mill near where I was born, in Gary, Indiana, and although it produces the same amount of steel that it did several decades ago, it does so with one-sixth the labor. And once again there is neither the push nor the pull to move people to new sectors: higher costs of education make it difficult for people to obtain the skills they need for jobs that would pay a wage comparable to their old wage; and among the sectors where there might have been growth, low demand from the recession creates few vacancies. The result is stagnant, or even declining, real wages. As recently as 2007, the base wage of an autoworker was around $28 an hour. Now, under a two-tier wage system agreed upon with the United Automobile Workers union, new hires can expect to earn only about $15 an hour.
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Back to the role of government

This broad narrative of what has happened to the market and the contribution of market forces to increasing inequality ignores the role that government plays in shaping the market. Many of the jobs that have not been mechanized, and are not likely to be soon, are public-sector jobs in teaching, public hospitals, and so on. If we had decided to pay our teachers more, we might have attracted and retained better teachers, and that might have improved overall long-term economic performance. It was a public decision to allow public-sector wages to sink below those of comparable private-sector workers.
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The most important role of government, however, is setting the basic rules of the game, through laws such as those that encourage or discourage unionization, corporate governance laws that determine the discretion of management, and competition laws that
should
limit the extent of monopoly rents. As we have already noted, almost every law has
distributive
consequences, with some groups benefiting, typically at the expense of others.
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And these distributive consequences are often the most important effects of the policy or program.
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