The Price of Inequality: How Today's Divided Society Endangers Our Future (3 page)

A few words of caution

A few other prefatory remarks: I often use the term “the 1 percent” loosely, to refer to the economic and political power of those at the top. In some cases, what I really have in mind is a much smaller group—the top one-tenth of 1 percent; in other cases, in discussing access to elite education, for instance, there is a somewhat larger group, perhaps the top 5 percent or 10 percent.

It may seem to readers that I talk too much about the bankers and corporate CEOs, too much about the financial crisis of 2008 and its aftermath, especially (as I’ll explain) since the problems of inequality in America are of longer standing. It is not just that they have become the whipping boys of popular opinion. They are emblematic of what has gone wrong. Much of the inequality at the top is associated with finance and corporate CEOs. But it’s more than that: these leaders have helped shape our views about what is good economic policy, and unless and until we understand what is wrong with those views—and how, to too large an extent, they serve
their
interests at the expense of the rest—we won’t be able to reformulate policies to ensure a more equitable, more efficient, more dynamic economy.

Any popular book like this entails more sweeping generalizations than would be appropriate in more academic writing, which would be replete with qualifications and footnotes. For this, I apologize in advance and refer the reader to some of the academic writing cited in the more limited number of footnotes that my publisher has allowed me. So too, I should emphasize that in castigating “bankers” I oversimplify: many, many of the financiers that I know would agree with much that I have said. Some fought against the abusive practices and predatory lending. Some wanted to curb the banks’ excessive risk taking. Some believed that the banks should focus on their core businesses. There are even several banks that did just that. But it should be obvious that most important decision makers did not: both before the crisis and after it, the largest and most influential financial institutions did behave in ways that can rightly be criticized, and someone has to take responsibility. When I castigate the “bankers,” it is
those
who decided, for instance, to engage in fraudulent and unethical behavior, and who created the culture within the institutions that facilitated it.

Intellectual debts

A book such as this rests on the scholarship, theoretical and empirical, of hundreds of researchers. It is not easy to put together the data that describe what is happening to inequality, or to provide an interpretation of why what was has been occurring has happened. Why is it that the rich are getting so much richer, that the middle is being hollowed out, and that the numbers in poverty are increasing?

While footnotes in subsequent chapters will provide some acknowledgments, I would be remiss if I did not mention the painstaking work of Emmanuel Saez and Thomas Piketty, or the work over more than four decades of one of my early coauthors, Sir Anthony B. Atkinson. Because a central part of my thesis is the intertwining of politics and economics, I have to stretch beyond economics, narrowly defined. My colleague at the Roosevelt Institute Thomas Ferguson, in his 1995 book
Golden Rule: The Investment Theory of Party Competition and the Logic of Money-Driven Political Systems
, was among the first to explore with some rigor the fundamental puzzle of why, in democracies based on one person one vote, money seems to matter so much.

The link between politics and inequality has, not surprisingly, become a focus of much recent writing. This book, in some sense, picks up where the excellent book by Jacob S. Hacker and Paul Pierson,
Winner-Take-All Politics: How Washington Made the Rich Richer—And Turned Its Back on the Middle Class
,
15
leaves off. They are political scientists. I am an economist. We all grapple with the question of how the high and growing inequality in the United States can be explained. I ask, How can we reconcile what has happened with standard economic theory? And though we approach the question through the lens of two different disciplines, we come to the same answer: to paraphrase President Clinton, “It’s the politics, stupid!” Money speaks in politics, as it does in the marketplace. That that is so has long been evident, and brought forth a bevy of books, such as Lawrence Lessig’s
Republic, Lost: How Money Corrupts Congress—And a Plan to Stop It
.
16
It has also become increasingly clear that growing inequality is having a major effect on our democracy, as reflected in books such as Larry Bartels’s
Unequal Democracy: The Political Economy of the New Gilded Age
17
and Nolan McCarty, Keith T. Poole, and Howard Rosenthal’s
Polarized America: The Dance of Ideology and Unequal Riches.
18

But how and why money should be so powerful in a democracy where each person has a vote—and most voters, by definition, are not in the 1 percent—has remained a mystery, on which I hope this book will shed a little light.
19
Most importantly, I try to illuminate the nexus between economics and politics. While it has become evident that this growing inequality has been bad for our politics (as evidenced by the pack of books just mentioned), I explain how it is also
very
bad for our economy.

A few personal notes

I return in this book to a subject that drew me into the study of economics a half century ago. I was initially a physics major at Amherst College. I loved the elegance of the mathematical theories that described our world. But my heart lay elsewhere, in the social and economic upheaval of the time, the civil rights movement in the United States, and the fight for development and against colonialism in what was called then the Third World. Part of this yearning was rooted in my experience growing up in the heartland of industrial America, in Gary, Indiana. There I saw at first hand inequality, discrimination, unemployment, and recessions. As a ten-year-old, I wondered why the kindly woman who took care of me much of the day had only a sixth-grade education, in this country that seemed so affluent, and I wondered why she was taking care of me, rather than her own children. In an era when most Americans saw economics as the science of money, I was, in some ways, an unlikely candidate to become an economist. My family was politically engaged, and I was told that money wasn’t important; that money would never buy happiness; that what was important was service to others and the life of the mind. In the tumult of the 1960s, though, as I became exposed to new ideas at Amherst, I saw that economics was much more than the study of money; it was actually a form of inquiry that could address the fundamental causes of inequity, and to which I could effectively devote my proclivity for mathematical theories.

The major subject of my doctoral dissertation at MIT was inequality, its evolution over time, and its consequences for macroeconomic behavior and especially growth. I took some of the standard assumptions (of what is called the neoclassical model) and showed that under those assumptions there should be a convergence to equality among individuals.
20
It was clear that something was wrong with the standard model, just as it was clear to me, having grown up in Gary, that something was wrong with a standard model that said the economy was efficient and there was no unemployment or discrimination. It was the realization that the standard model didn’t describe well the world we lived in that set me off on a quest for alternative models in which market imperfections, and especially imperfections of information and “irrationalities,” would play such an important role.
21
Ironically, as these ideas developed and gained currency within some parts of the economics profession, the opposite notion—that markets worked well, or would, if only the government kept out of the way—took hold within much of the public discourse. This book, like several of those that preceded it, is an attempt to set the record straight.

A
CKNOWLEDGMENTS

I
HAVE BEEN WORKING, AS
I
NOTED, ON THE ORIGINS AND
consequences of inequality since my days as a graduate student, and in the almost fifty years since beginning my studies, I have accumulated enormous intellectual debts, too many to enumerate. Robert Solow, one of my thesis advisers, and with whom I wrote an early paper on distribution and macroeconomic behavior, had written his own thesis on inequality. The influence of Paul Samuelson, another of my thesis advisers, will be apparent in the discussion of globalization in chapter 3. My first published papers on the subject were written with my fellow graduate student George Akerlof, with whom I shared the 2001 Nobel Prize.

At the time I went to Cambridge University, as a Fulbright scholar in 1965–66, the distribution of income was a major focus of debate, and I owe debts to the late Nicholas Kaldor, David Champernowne, and Michael Farrell, and especially to Sir James Meade and Frank Hahn. It was there that I first began my work with Tony Atkinson, who subsequently has become one of the world’s leading authorities on inequality. At the time, it was still thought that there were major trade-offs between inequality and growth, and Jim Mirrlees was just then beginning his work on how one could design optimal redistributive taxes (work for which he would later receive the Nobel Prize).

Another of my teachers at MIT (and then a fellow visitor at Cambridge in 1969–70) was Kenneth Arrow, whose work on information greatly influenced my thinking. Later, his work, paralleling my own, would focus on the impact of discrimination; how information, say about relative abilities, affects inequality; and the role of education in the whole process.

A key issue that I touch upon in this volume is the measurement of inequality. This turns out to raise theoretical issues that are closely akin to the measurement of risk, and my early work, four decades ago, was done jointly with Michael Rothschild. Subsequently, I began work with a former student, Ravi Kanbur, on the measurement of socioeconomic mobility.

The influence of behavioral economics on my thinking should be evident in this work. I was first introduced to these ideas some forty years ago by the late Amos Tversky, a pioneer in this field, and subsequently Richard Thaler and Danny Kahneman have greatly influenced my thinking. (When I founded the
Journal of Economic Perspectives
in the mid-1980s, I asked Richard to do a regular column on the subject.)

I benefited enormously from the discussions with Edward Stiglitz of some of the legal issues treated in chapter 7, and with Robert Perkinson on the issues related to America’s high incarceration rate.

I have always benefited a great deal from discussing ideas as I formulate them with my students, and I want to single out Miguel Morin, a current student, and Anton Korinek, a recent one.

I had the good fortune to be able to serve in the Clinton administration. Concerns about inequality and poverty were central to our discussions. We debated how we could best deal with poverty, for instance, with welfare reform (discussions in which David Ellwood of Harvard played a central role), and what we could do about the extremes of inequality at the top, through tax reform. (As I note later, not everything we did was a move in the right direction.) The influence of the insights of Alan Krueger (now chairman of the Council of Economic Advisers) into labor markets, including the role of the minimum wage, should be apparent. Later in the book I refer to work with Jason Furman, and with Peter Orszag. Alicia Munnell, who served with me on the Council of Economic Advisers, helped me better understand the role of social insurance programs and CRA requirements in reducing poverty. (For the many others who greatly influenced my thinking in this period, please see the acknowledgments in
The Roaring Nineties
[New York: W. W. Norton, 2003].)

I also was fortunate to be able to serve as chief economist of the World Bank, an institution that sees one of its central missions as the reduction of poverty. With poverty and inequality the focus of our attention, every day was a learning experience, every encounter an opportunity to get new insights and to shape and reshape views about the causes and consequences of inequality, to better understand why it differed across countries. While I hesitate to single out anyone, I should mention my two successors as chief economist, Nick Stern (whom I first met in Kenya in 1969) and François Bourguignon.

In chapter 1 and elsewhere, I emphasize that GDP per capita—or even other measures of income—do not provide an adequate measure of well-being. My thinking in this area was greatly influenced by the work of the Commission on the Measurement of Economic Performance and Social Progress, which I chaired, and which was also led by Amartya Sen and Jean-Paul Fitoussi. I should also acknowledge the influence of all the twenty-one other members of the commission.

In chapter 4, I explain the link between instability and growth, my understanding of which was greatly influenced by another commission I chaired, the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System.

I especially want to thank my colleagues at the Roosevelt Institute, including Bo Cutter, Mike Konczal, Arjun Jayadev, and Jeff Madrick. (Others who have worked with the Roosevelt Institute events, including Robert Kuttner and Jamie Galbraith, are also deserving of thanks.) Paul Krugman has been an inspiring voice for all of us who would like to see a more equitable society and a better-functioning economy.

In recent years, the economics profession hasn’t, unfortunately, paid sufficient attention to inequality—just as it didn’t pay sufficient attention to the other problems that could give rise to the kind of instability that the country has experienced. The Institute for New Economic Thinking has been created to try to rectify these and other deficiencies, and I want to acknowledge my indebtedness to INET, and especially to its head, Rob Johnson (also a colleague at the Roosevelt Institute and a member of the UN commission), for extensive discussions of the topics of this book.

As always, I want to acknowledge my indebtedness to Columbia University, for providing an intellectual environment in which ideas can flourish, be challenged, and be refined. I must especially extend my gratitude to José Antonio Ocampo and my longtime colleague and collaborator, Bruce Greenwald.

While these are my broad intellectual debts, I owe an especial set of debts to those who helped in one way or another in this book.

This book grew out of an article in
Vanity Fair
, “Of the 1%, for the 1%, by the 1%.” Cullen Murphy solicited the article and did a marvelous job of editing. Graydon Carter suggested the title. Drake McFeely, president of Norton, and my longtime friend and editor, then asked me to expand the ideas into a book. Brendan Curry, once again, did a superb job in editing the book.

Stuart Proffitt, my editor from Penguin/Allen Lane also again did an impressive job combining “big think” ideas on how to strengthen the arguments and making them clearer with detailed comments on the writing.

Karla Hoff read the book cover to cover, improving both the language and the argument. But even before I began to write the book, discussions with her on the ideas that are central to the book helped shape my own thinking.

A team of research assistants, headed by Laurence Wilse-Samson and including An Li and Ritam Chaurey went well beyond the task of fact-checking. They suggested where the analysis could be extended, argued about where it needed to be more qualified, and seemed as excited about the project as I was. Julia Cunico and Hannah Assadi also provided invaluable comments and support throughout the writing process.

Eamon Kircher-Allen not only managed the whole process of producing the manuscript but served as editor and critic as well. I owe him an enormous debt.

As always, my biggest debt is to Anya, who encouraged me to do the book, repeatedly discussed the ideas behind it, and helped shape and reshape it.

To all of them—and to the enthusiasm for the book that they continually shared with me—I am deeply indebted. None of them should be held responsible for any errors and omissions that remain in the book.