The Price of Inequality: How Today's Divided Society Endangers Our Future (41 page)

While the advocates of these policies may claim that they are the
best
policies for all, this is not the case. There is no single, best policy. As I have stressed in this book, policies have distributive effects, so there are trade-offs between the interests of bondholders and debtors, young and old, financial sectors and other sectors, and so on. I have also stressed, however, that there are alternative policies that would have led to better overall economic performance—especially so if we judge economic performance by what is happening to the well-being of most citizens. But if these alternatives are to be implemented, the institutional arrangements through which the decisions are made will have to change. We cannot have a monetary system that is run by people whose thinking is captured by the bankers and that is effectively run for the benefit of the those at the top.

C
HAPTER
T
EN

THE WAY FORWARD: ANOTHER WORLD IS POSSIBLE

T
HERE’S NO USE IN PRETENDING. IN SPITE OF THE
enduring belief that Americans enjoy greater social mobility that their European counterparts, America is no longer the land of opportunity.

Nothing illustrates what has happened more vividly than the plight of today’s twenty-year-olds. Instead of starting a new life, fresh with enthusiasm and hope, many of them confront a world of anxiety and fear. Burdened with student loans that they know they will struggle to repay and that would not be reduced even if they were bankrupt, they search for good jobs in a dismal market. If they are lucky enough to get a job, the wages will be a disappointment, often so low that they will have to keep living with their parents.
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While fifty-something parents worry about their children, they also worry about their own future. Will they lose their home? Will they be forced to retire early? Will their savings, greatly diminished by the Great Recession, carry them through? They know that if they face hardship, they may not be able to turn to their children for help. From Washington comes even worse news: cutbacks in Medicare that will make access by some groups to health care unaffordable are widely discussed. Social Security, too, seems to be on the cutting table. As older Americans face their sunset years, the dreams of a comfortable retirement seem a mirage. The dreams of a prosperous, better life for their children may be as antiquated as something out of a 1950s movie.

What’s been happening in America has also been happening in many countries around the world. But it is not inevitable. It is not the inexorable workings of the market economy. There are societies that have managed things far better, even in a world where market forces and the dominant policy paradigm lead to substantial inequality because of differences in ability, effort, and luck. Those societies produce a standard of living higher than that of the United States for most of their citizens, measured not just in terms of income but in terms of health, education, security, and many other aspects that are key to determining the quality of life. And some societies where inequality was far worse than in the United States have looked over the precipice, seen what might lie ahead, and retreated: they have managed to reduce the degree of inequality, to help the poor and to extend education.

Another world is possible. We can achieve a society more in accord with our fundamental values, with more opportunity, a higher total national income, a stronger democracy, and higher living standards for most individuals. It won’t be easy. There are some market forces pulling us the other way. Those market forces are shaped by politics, by the rules and regulations that we as a society adopt, by the way our institutions (like the Federal Reserve, our central bank, and other regulatory agencies) behave. We have created an economy and a society in which great wealth is amassed through rent seeking, sometimes through direct transfers from the public to the wealthy, more often through rules that allow the wealthy to collect “rents” from the rest of society through monopoly power and other forms of exploitation.

This book is not about the politics of envy: the bottom 99 percent by and large are not jealous of the social contributions that some of those among the 1 percent have made, of their well-deserved incomes. This book is instead about the politics of efficiency and fairness. The central argument is that the model that best describes income determination at the top is not one based on individuals’ contributions to society (the “marginal productivity theory” introduced earlier), even though, of course, some at the top have made enormous contributions. Much of the income at the top is instead what we have called rents. These rents have moved dollars from the bottom and middle to the top, and distorted the market to the advantage of some and to the disadvantage of others.

A more efficient economy and fairer society will also come from making markets work like markets—more competitive, less exploitive—and tempering their excesses. The rules of the game matter not just for the efficiency of the economic system but also for distribution. The wrong rules lead to a less efficient economy and a more divided society.

Investing more in our society—in education, technology, and infrastructure—and providing more security to ordinary citizens will lead to a more efficient and dynamic economy, one more consistent with what we claim to be and offering more opportunity to a wider segment of the society. Even the 1 percent (those who are there now) may benefit when the capabilities of so many at the bottom are not squandered. And many more people will have a shot at one day being in the 1 percent.

Finally, making the society more equal is likely to affect the prevailing ideology that influences our microeconomic and macroeconomic policies. We have identified several myths on which this ideology depends. We can break out of the viscious cycle where the political domination of the top leads to beliefs and policies that enhance economic inequality and reinforce their political domination.

For a third of a century American workers have seen their standard of living first stagnate and then erode. To those who, in the depths of the Great Depression, said that market forces would eventually prevail and restore the economy to full employment, Keynes retorted to the effect that, yes, in the long run markets may work, but in the long run we’re all dead. But I’m not sure that even he had in mind a long run as long as the period that American workers have seen their standard of living being ground down.

In this chapter, I will review what has to be done to create this
other world—
the reforms we need in our economics and our politics. Unfortunately, we are headed in the
wrong
way; there is a risk that political and economic changes will make things worse. I end on a note outlining what has to happen if we are to change course—a cautious note of optimism.

As we think about how to strengthen our economy, it is imperative that we not succumb to GDP fetishism. We’ve seen (in chapters 1 and 4) that GDP is not a good measure of economic performance; it doesn’t reflect accurately changes in the standard of living, broadly defined, of most citizens, and it doesn’t tell us whether the growth we experience is sustainable.

T
HE
E
CONOMIC
R
EFORM
A
GENDA

A real economic reform agenda would simultaneously increase economic efficiency, fairness, and opportunity. Most Americans would gain; the only losers might be some of the 1 percent—those whose income, for instance, depends on rent seeking and those who are excessively linked to them. The reforms follow closely from our diagnosis: we have a problem at the top, the middle, and the bottom. Simple solutions won’t suffice. We identified multiple factors contributing to the country’s current high level of inequality and low level of opportunity. While economists often argue about the relative importance of each of the factors, we explained why resolving the question is an almost impossible task. Besides, inequality of opportunity in America has grown to the point where we have to do everything we can. Some of the causes of inequality may be largely beyond our control, others we can affect only gradually, in the long run, but there are still others that we can address immediately. We need a comprehensive attack, some of the key elements of which I lay out below.

C
URBING THE
E
XCESSES AT THE
T
OP

Chapter 2 showed how so much of the wealth at the top is derived, in one way or another, from rent seeking and rules of the game that are tilted to advantage those at the top. The distortions and perversions of our economic system are pervasive, but the following seven reforms would make a big difference.

Reducing rent seeking and leveling the playing field

Curbing the financial sector.
Since so much of the increase in inequality is associated with the excesses of the financial sector, it is a natural place to begin a reform program. Dodd-Frank is a start, but only a start. Here are six further reforms that are urgent:

(a) Curb excessive risk taking and the too-big-to-fail and too-interconnected-to-fail financial institutions; they’re a lethal combination that has led to the repeated bailouts that have marked the last thirty years. Restrictions on leverage and liquidity are key, for the banks somehow believe that they can create resources out of thin air by the magic of leverage. It can’t be done. What they create is risk and volatility.
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(b) Make banks more transparent, especially in their treatment of over-the-counter derivatives, which should be much more tightly restricted and should not be underwritten by government-insured financial institutions. Taxpayers should not be involved in backing up these risky products, no matter whether we think of them as insurance, gambling instruments, or, as Warren Buffett put it, financial weapons of mass destruction.
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(c) Make the banks and credit card companies more competitive and ensure that they
act
competitively. We have the technology to create an efficient electronics payment mechanism for the twenty-first century, but we have a banking system that is determined to maintain a credit and debit card system that not only exploits consumers but imposes large fees on merchants for every transaction.

(d) Make it more difficult for banks to engage in predatory lending and abusive credit card practices, including by putting stricter limits on usury (excessively high interest rates).

(e) Curb the bonuses that encourage excessive risk taking and shortsighted behavior.

(f) Close down the offshore banking centers (and their onshore counterparts) that have been so successful both at circumventing regulations and at promoting tax evasion and avoidance. There is no good reason that so much finance goes on in the Cayman Islands; there is nothing about it or its climate that makes it so conducive to banking. It exists for one reason only: circumvention.

Many of these reforms are interrelated: a more competitive banking system is less likely to engage in abusive practices, less likely to be successful in rent seeking. Curbing the financial sector will be hard, because the banks are so clever at circumvention. Even if banks are limited in size—a hard enough task—they will make contracts with each other (such as derivatives) that will ensure that they are too intertwined to fail.

Stronger and more effectively enforced competition laws.
While every aspect of our legal and regulatory code is important for both efficiency and equity, the laws governing competition, corporate governance, and bankruptcy are especially relevant.

Monopolies and imperfectly competitive markets are a major source of rents. Banking is not the only sector in which competition is weaker than it should be. As we look across the sectors of the economy, it is striking how many are dominated by at most two, three, or four firms. At one time, it was thought that that was OK—that in the dynamic competition associated with technological change, one dominant firm would replace another. There was competition for the market rather than competition in the market. But we now know that this won’t suffice. Dominant firms have tools with which to suppress competition, and often they can even suppress innovation. The higher prices that they charge not only distort the economy but also act like a tax, the revenue from which doesn’t, however, go to public purposes, but rather enriches the coffers of the monopolists.

Improving corporate governance—especially to limit the power of the CEOs to divert so much of corporate resources for their own benefit.
Too much power, too much deference to their supposed wisdom, is given to corporate executives. We have seen how they use that power to divert too much of the corporation’s resources to their own benefit. Laws that give shareholders a say on pay would make a difference. So would accounting rules that let shareholders know clearly how much they’re giving away to their executives.

Comprehensive reform of bankruptcy laws—from the treatment of derivatives to underwater homes and to student loans.
Bankruptcy law offers another example of how the basic rules of the game that determine how markets work have strong distributional consequences, as well as effects on efficiency. As in many other areas, the rules have increasingly favored those at the top.

Every loan is a contract between a willing borrower and a willing lender, but one side is supposed to understand the market far better than the other; there is a massive asymmetry in information and bargaining power. Accordingly, the lender should bear the brunt of the consequences of a mistake, not the borrower.

Making bankruptcy law more debtor-friendly would give banks an incentive to be more careful in lending. We would have fewer credit bubbles and fewer Americans deeply in debt. One of the most egregious examples of bad lending, as we’ve noted, is the student loan programs; and bad lending there has been encouraged by the nondischargeability of the debt.