The Price of Inequality: How Today's Divided Society Endangers Our Future (55 page)

49.
A survey of the evidence for both developed and developing countries is in Andrew E. Clark and Claudia Senik, “Will GDP Growth Increase Happinenss in Developing Countries?,” Paris School of Economics, Working Paper no. 2010-43, March 2011.

50.
John Maynard Keynes,
Economic Possibilities for Our Grandchildren: Essays in Persuasion
(originally published 1930) (New York: Norton, 1963), pp. 358–73. The discussion here draws upon my reflections on that essay: “Toward a General Theory of Consumerism: Reflections on Keynes’
Economic Possibilities for Our Grandchildren
,” in
Revisiting Keynes: Economic Possibilities for Our Grandchildren
, ed. G. Piga and L. Pecchi (Cambridge: MIT Press, 2008), pp. 41–87. See also the other essays in that volume.

51.
Adam Smith,
Lectures on Jurisprudence
, ed
.
Ronald L. Meek, D. D. Raphael, and Peter Stein (New York: Clarendon Press, 1978), (A) vi.54. The citation and analysis are in Daniel Luban, “Adam Smith on Vanity, Domination, and History,”
Modern Intellectual History
,
forthcoming.

52.
For the long-run survival of the planet, there’s something else wrong with America’s answer: excessive consumption of material goods leads to global warming and puts the earth in peril.

53.
Though incentives are at the core of the conservative justification for inequality, they also appeal to “fairness.” See chapter 2 for a critique.

54.
Wealth in the form of collateral plays a kind of catalytic role rather than a role of input that gets used up in the process of producing output. See K. Hoff, “Market Failures and the Distribution of Wealth: A Perspective from the Economics of Information,”
Politics and Society
24, no. 4 (1996): 411–32; and Hoff, “The Second Theorem of the Second Best,”
Journal of Public Economics
25 (1994): 223­­–42.

55.
The exciting story is told in the bestseller by Dava Sobel,
Longitude: The True Story of a Lone Genius Who Solved the Greatest Scientific Problem of His Time
(New York: Walker, 1995)
.

56.
Technically, the problems with incentive pay arise when there are information asymmetries. The employer doesn’t fully know the quality of the products produced by the worker (otherwise, he would specify that). In a trial, the judge and jury worry that the strength of an expert’s opinion might be affected if his compensation depended on the outcome of the trial.

57.
Given this, one might ask, why are those in finance, supposedly experts in economics, so wedded to these distortionary incentive schemes. The answer, as we explained earlier, relates to failures in corporate governance: these schemes allow them to more easily divert more of the corporate revenue to themselves.

58.
See Patrick Bolton, Jose Scheinkman, and Wei Xiong, “Executive Compensation and Short-Termist Behaviour in Speculative Markets,”
Review of Economic Studies
73, no. 3 (2006): 577–610.

59.
Opponents claimed that there was no way that one could accurately value the options, but at the Council of Economic Advisers we devised a way of providing at least a lower bound on the estimate—a far better estimate than the zero value associated with current accounting practices.

60.
See B. Nalebuff and J. E. Stiglitz, “Information, Competition and Markets,”
American Economic Review
73, no. 2 (May 1983): 278–84; B. Nalebuff and J. E. Stiglitz, “Prizes and Incentives: Toward a General Theory of Compensation and Competition,”
Bell Journal
14, no. 1 (Spring 1983): 21–43; and J. E. Stiglitz, “Design of Labor Contracts: Economics of Incentives and Risk-Sharing,” in
Incentives
,
Cooperation and Risk Sharing
, ed. H. Nalbantian (Totowa, NJ: Rowman & Allanheld, 1987), pp. 47–68.

61.
Dasgupta Partha and Paul A. David, “Toward a New Economics of Science,”
Research Policy
2, no. 5 (September 1994): 487–521.

62.
The study was conducted in Haifa, Israel, by two economists, Uri Gneezy and Aldo Rustichini, and published as “A Fine Is a Price,”
Journal of Legal Studies
29, no. 1 (January 2000): 1–17. A variety of experiments confirm the power of intrinsic rewards, in comparison with extrinsic rewards. See, e.g., Gneezy and Rustichini, “Pay Enough or Don’t Pay At All,”
Quarterly Journal of Economics
115, no. 3 (2000): 791–810. One explanation for why “high-performance work systems” (in which workers are given more responsibility) perform better is that they enhance trust and a perception of intrinsic reward. See Eileen Appelbaum, Thomas Bailey, Peter Berg, and Arne Kalleberg,
Manufacturing Advantage: Why High-Performance Work Systems Pay Off
(Ithaca: Cornell University Press, 2000). See also J. E. Stiglitz, “Democratic Development as the Fruits of Labor,” in
The Rebel Within
, ed. Ha-Joon Chang (London: Wimbledon Publishing, 2001), pp. 279–315. (Originally keynote address at the Industrial Relations Research Association, Boston, January 2000.)

63.
A key insight of modern industrial organization is that in imperfectly competitive markets—and most markets are imperfectly competitive—one can get ahead and increase profits not just by performing better but also by ensuring that one’s rival performs more poorly. Profits—and bonuses—can increase, but societal welfare can be decreased. This theory is called “raising rivals costs.” See Steven C. Salop and David T. Scheffman “Raising Rivals’ Costs,”
American Economic Review
73, no. 2 (May 1983): 267–71.

64.
A good empirical review is “Team-Based Rewards: Current Empirical Evidence and Directions for Future Research,”
Research in Organizational Behavior
20 (1998): 141–83. A more recent study has shown how competition among workers undermines workplace productivity. See Jeffrey Carpenter, Peter Hans Matthews, and John Schirm, “Tournaments and Office Politics: Evidence from a Real Effort Experiment,”
American Economic Review
100, no. 1 (2010): 504–17.

65.
Again, well-being at the workplace was something that the Committee for the Measurement of Economic Social Progress emphasized.

66.
See Gerald Marwell and Ruth E. Ames, “Economists Free Ride, Does Anyone Else?,”
Journal of Public Economics
15 (June 1981): 295–310; John R. Carter and Michael D. Irons, “Are Economists Different, and If So, Why?,”
Journal of Economic Perspectives
5, no. 2 (Spring 1991): 171–77; Günther Schulze and Bjorn Frank, “Does Economics Make Citizens Corrupt?,” 
Journal of Economic Behavior and Organization
43, no. 1 (2000): 101–13; Robert H. Frank, Thomas Gilovich, and Dennis T. Regan, “Does Studying Economics Inhibit Cooperation?,”
Journal of Economic Perspectives
7, no. 2 (Spring 1993): 159–71; Reinhard Selten and Axel Ockenfels, “An Experimental Solidarity Game,”
Journal of Economic Behavior and Organization
34, no. 4 (March 1998): 517–39.

67.
Fidan Ana Kurtulus and Doug Kruse show that in this recession, and in past ones, employee-owned firms did better, maintaining higher levels of employment, than did others. See “How Did Employee Ownership Firms Weather the Last Two Recessions? Employee Ownership and Employment Stability in the US: 1999–2008,” PowerPoint presentation given at Mid-Year Fellows Workshop in Honor of Louis O. Kelso, February 24–25, 2011, at Rutgers School of Management and Labor Relations.

68.
See Peter Diamond and Emmanuel Saez, “The Case for a Progressive Tax: From Basic Research to Policy Recommendations,”
Journal of Economic Perspectives
25, no. 4 (2011): 165–90; and Thomas Piketty, Emmanuel Saez, and Stefanie Stantcheva, “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” NBER Working Paper 17616, 2011, available at
http://www.nber.org/papers/w17616
(accessed March 1, 2012). For an accessible discussion of the second paper’s findings, see the same authors’ article “Taxing the 1%: Why the Top Tax Rate Could Be over 80%,”
Vox
, December 8, 2011, available at
http://www.voxeu.org/index.php?q=node
/7402 (accessed March 6, 2012). Some earlier, idealized economic models suggested that it was optimal not to tax interest income (income from capital), but subsequent research showed that this result was not robust: capital taxation is desirable. See, e.g., Thomas Piketty and Emmanuel Saez, “A Theory of Optimal Capital Taxation,” working paper, 2011, Paris School of Economics and University of California at Berkeley, available at
http://elsa.berkeley.edu/~saez/piketty-saez1_1_11optKtax.pdf
(accessed February 27, 2012); and J. E. Stiglitz, “Pareto Efficient Taxation and Expenditure Policies, with Applications to the Taxation of Capital, Public Investment, and Externalities,” presented at conference in honor of Agnar Sandmo, Bergen, Norway, January 1998.

69.
Which allowed those in private equity firms and hedge funds to be taxed on their returns—including what they received from managing other people’s money—at the favorable capital gains tax rate.

70.
Alexander J. Field,
A Great Leap Forward: 1930s Depression and U.S. Economic Growth
(New Haven: Yale University Press, 2011).

71.
This is the thrust of the analysis of “optimal redistributive taxation,” discussed in an earlier footnote.

72.
In a speech (October 26, 2011) entitled “Saving the American Idea: Rejecting Fear, Envy, and the Philosophy of Division” delivered in response to the CBO report detailing America’s growing inequality, as cited in Jonathan Chait, “No Such Thing as Equal Opportunity,”
New York
, November 7, 2011, pp. 14–16.

73.
Ibid.

74.
Ibid.

75.
See Torsten Persson and Guido Tabellini, “Is Inequality Harmful for Growth?,”
American Economic Review
84, no. 3 (June 1994): 600–21.

Chapter Five
A D
EMOCRACY IN
P
ERIL

1.
For a textbook exposition, and a discussion of the implications, for instance, for education expenditures or the progressivity of the tax system, see J. E. Stiglitz,
The Economics of the Public Sector
, 3rd ed.
(New York: W. W. Norton, 2000). For earlier theoretical discussions, see Anthony Downs, “An Economic Theory of Political Action in a Democracy,”
Journal of Political Economy
65, no. 2 (1957): 135–50; Harold Hotelling, “Stability in Competition,”
Economic Journal
39, no. 153 (1929): 41–57; and Kenneth J. Arrow,
Social Choice and Individual Values
, 2nd ed. (New York: Wiley, 1963).

2.
Edward Wyatt, “S.E.C. Is Avoiding Tough Sanctions for Large Banks,”
New York Times,
February 3, 2012, p. A1. The article provides a detailed analysis, citing as an example JPMorganChase, which “has settled six fraud cases in the last 13 years, including one with a $228 million settlement last summer, but it has obtained at least 22 waivers, in part by arguing that it has ‘a strong record of compliance with securities laws.
’
”

3.
This is undoubtedly one of the reasons why, in the United States, voter turnout among African Americans has so frequently lagged behind that of whites, and turnout among the poor has lagged behind that of better-off other groups. America had so long excluded African Americans from enjoying full rights that even when voting restrictions were lifted,the community’s faith in the electoral process remained seriously harmed. See, e.g., Mark Lopez and Paul Taylor, “Dissecting the 2008 Electorate: Most Diverse in U.S. History,” Pew Research Center, April 30, 2009, available at
http://pewresearch.org/assets/pdf/dissecting-2008-electorate.pdf
.

4.
The strength of faith in democratic processes is, however, remarkable. One interpretation for why it took so long for the Occupy Wall Street protests to emerge was that many hoped that the political process would “work” to rein in the financial sector and redress the country’s economic problems. It was only when it was evident that they did not that protests became widespread. The strong voter turnout in 2008 (the highest since 1968) reflects the power of hope. War, too, elicits a strong sense of civic identity, perhaps accounting for the relatively high voter turnout in 2004.

5.
Economic historians have emphasized the role of trust in the development of modern capitalism. See, e.g., D. McCloskey
The Bourgeois Virtues: Ethics for an Age of Commerce
(Chicago: University of Chicago Press, 2006); and J. Mokyr,
The Enlightened Economy
(New Haven: Yale University Press, 2011). They have argued that Britain’s success in the Industrial Revolution depended on its norms against opportunism. As Mokyr puts it, “opportunistic behavior was made so taboo that in only a few cases was it necessary to use the formal institutions to punish deviants. . . . Entrepreneurial success was based less on multi-talented geniuses than on successful cooperation between individuals who had good reason to think they could trust one another” (pp. 384–86). Trust was also one of the reasons that certain close-knit ethnic communities and certain other communities took on a pivotal role in the early development of capitalism. See, e.g., Avner Greif, “Reputation and Coalitions in Medieval Trade: Evidence on the Maghribi Traders,” 
Journal of Economic History
49, no. 4 (1989): 857–82; and Greif, “Contract Enforceability and Economic Institutions in Early Trade: The Maghribi Traders’ Coalition,” 
American Economic Review
83, no. 3 (1993): 525–48. Albert Hirschman, a great economist whose insights reached beyond economics, has made similar observations. See, e.g., his
The Passions and the Interests
(Princeton: Princeton University Press, 1977).

6.
The quotation is from G. W. Kolodko,
From Shock to Therapy: The Political Economy of Postsocialist Transformation
(New York: Oxford University Press, 2000). The absence of trust made it difficult not only to be productive, particularly when chains of production linked many specialized producers, but also to build the kind of rule-of-law institutions that would make the economy productive under a free market. That is, building institutions itself requires trust. See O. Blanchard and M .Kremer, “Disorganization,”
Quarterly Journal of Economics
112, no. 4 (November 1997): 1091–126; K. Hoff and J. E. Stiglitz, “After the Big Bang? Obstacles to the Emergence of the Rule of Law in Post-Communist Societies,”
American Economic Review
94, no. 3
(June 2004): 753–63; and K. Hoff and J. E. Stiglitz, “Exiting a Lawless State,”
Economic Journal
118, no. 531 (August 2008): 1474–97.