The shift from a manufacturing to a service-based economy is partly
to blame. At its extreme—a firm of one person—the service economy is a
winner-takes-all system. A movie star makes millions, for example,
whereas most actors make a pittance. Overall, wages are likely to be far
more widely dispersed in a service economy than in one based on
manufacturing, so the transition contributes to greater inequality. This
fact does not explain, however, why the average wage has not improved
for decades. Moreover, the shift to the service sector is happening in
most other advanced countries: Why are matters so much worse in the
U.S.?
Again, because services are often provided locally, firms have more
market power: the ability to raise prices above what would prevail in a
competitive market. A small town in rural America may have only one
authorized Toyota repair shop, which virtually every Toyota owner is
forced to patronize. The providers of these local services can raise
prices over costs, increasing their profits and the share of income
going to owners and managers. This, too, increases inequality. But
again, why is U.S. inequality practically unique?
In his celebrated 2013 treatise Capital in the Twenty-First Century,
French economist Thomas Piketty shifts the gaze to capitalists. He
suggests that the few who own much of a country's capital save so much
that, given the stable and high return to capital (relative to the
growth rate of the economy), their share of the national income has been
increasing. His theory has, however, been questioned on many grounds.
For instance, the savings rate of even the rich in the U.S. is so low,
compared with the rich in other countries, that the increase in
inequality should be lower here, not greater.
An alternative theory is far more consonant with the facts. Since the
mid-1970s the rules of the economic game have been rewritten, both
globally and nationally, in ways that advantage the rich and
disadvantage the rest. And they have been rewritten further in this
perverse direction in the U.S. than in other developed countries—even
though the rules in the U.S. were already less favorable to workers.
>From this perspective, increasing inequality is a matter of choice: a
consequence of our policies, laws and regulations.
In the U.S., the market power of large corporations, which was
greater than in most other advanced countries to begin with, has
increased even more than elsewhere. On the other hand, the market power
of workers, which started out less than in most other advanced
countries, has fallen further than elsewhere. This is not only because
of the shift to a service-sector economy—it is because of the rigged
rules of the game, rules set in a political system that is itself rigged
through gerrymandering, voter suppression and the influence of money. A
vicious spiral has formed: economic inequality translates into
political inequality, which leads to rules that favor the wealthy, which
in turn reinforces economic inequality.
Feedback Loop
Political scientists have documented the ways in which money
influences politics in certain political systems, converting higher
economic inequality into greater political inequality. Political
inequality, in its turn, gives rise to more economic inequality as the
rich use their political power to shape the rules of the game in ways
that favor them—for instance, by softening antitrust laws and weakening
unions. Using mathematical models, economists such as myself have shown
that this two-way feedback loop between money and regulations leads to
at least two stable points. If an economy starts out with lower
inequality, the political system generates rules that sustain it,
leading to one equilibrium situation. The American system is the other
equilibrium—and will continue to be unless there is a democratic
political awakening.
An account of how the rules have been shaped must begin with
antitrust laws, first enacted 128 years ago in the U.S. to prevent the
agglomeration of market power. Their enforcement has weakened—at a time
when, if anything, the laws themselves should have been strengthened.
Technological changes have concentrated market power in the hands of a
few global players, in part because of so-called network effects: you
are far more likely to join a particular social network or use a certain
word processor if everyone you know is already using it. Once
established, a firm such as Facebook or Microsoft is hard to dislodge.
Moreover, fixed costs, such as that of developing a piece of software,
have increased as compared with marginal costs—that of duplicating the
software. A new entrant has to bear all these fixed costs up front, and
if it does enter, the rich incumbent can respond by lowering prices
drastically. The cost of making an additional e-book or photo-editing
program is essentially zero.
In short, entry is hard and risky, which gives established firms with
deep war chests enormous power to crush competitors and ultimately
raise prices. Making matters worse, U.S. firms have been innovative not
only in the products they make but in thinking of ways to extend and
amplify their market power. The European Commission has imposed fines of
billions of dollars on Microsoft and Google and ordered them to stop
their anticompetitive practices (such as Google privileging its own
comparison shopping service). In the U.S., we have done too little to
control concentrations of market power, so it is not a surprise that it
has increased in many sectors.
Credit: Jen Christiansen; Sources:
Economic Report of the President. January 2017; World Inequality database
Rigged rules also explain why the impact of globalization may have
been worse in the U.S. A concerted attack on unions has almost halved
the fraction of unionized workers in the nation, to about 11 percent.
(In Scandinavia, it is roughly 70 percent.) Weaker unions provide
workers less protection against the efforts of firms to drive down wages
or worsen working conditions. Moreover, U.S. investment treaties such
as the North Atlantic Free Trade Agreement—treaties that were sold as a
way of preventing foreign countries from discriminating against American
firms—also protect investors against a tightening of environmental and
health regulations abroad. For instance, they enable corporations to sue
nations in private international arbitration panels for passing laws
that protect citizens and the environment but threaten the multinational
company's bottom line. Firms like these provisions, which enhance the
credibility of a company's threat to move abroad if workers do not
temper their demands. In short, these investment agreements weaken U.S.
workers' bargaining power even further.
Liberated Finance
Many other changes to our norms, laws, rules and regulations have
contributed to inequality. Weak corporate governance laws have allowed
chief executives in the U.S. to compensate themselves 361 times more
than the average worker, far more than in other developed countries.
Financial liberalization—the stripping away of regulations designed to
prevent the financial sector from imposing harms, such as the 2008
economic crisis, on the rest of society—has enabled the finance industry
to grow in size and profitability and has increased its opportunities
to exploit everyone else. Banks routinely indulge in practices that are
legal but should not be, such as imposing usurious interest rates on
borrowers or exorbitant fees on merchants for credit and debit cards and
creating securities that are designed to fail. They also frequently do
things that are illegal, including market manipulation and insider
trading. In all of this, the financial sector has moved money away from
ordinary Americans to rich bankers and the banks' shareholders. This
redistribution of wealth is an important contributor to American
inequality.
Other means of so-called rent extraction—the withdrawal of income
from the national pie that is incommensurate with societal
contribution—abound. For example, a legal provision enacted in 2003
prohibited the government from negotiating drug prices for Medicare—a
gift of some $50 billion a year or more to the pharmaceutical industry.
Special favors, such as extractive industries' obtaining public
resources such as oil at below fair-market value or banks' getting funds
from the Federal Reserve at near-zero interest rates (which they relend
at high interest rates), also amount to rent extraction. Further
exacerbating inequality is favorable tax treatment for the rich. In the
U.S., those at the top pay a smaller fraction of their income in taxes
than those who are much poorer—a form of largesse that the Trump
administration has just worsened with the 2017 tax bill.
Some economists have argued that we can lessen inequality only by
giving up on growth and efficiency. But recent research, such as work
done by Jonathan Ostry and others at the International Monetary Fund,
suggests that economies with greater equality perform better, with
higher growth, better average standards of living and greater stability.
Inequality in the extremes observed in the U.S. and in the manner
generated there actually damages the economy. The exploitation of market
power and the variety of other distortions I have described, for
instance, makes markets less efficient, leading to underproduction of
valuable goods such as basic research and overproduction of others, such
as exploitative financial products.
Credit: Jen Christiansen; Sources:
World Inequality Report 2018. World Inequality Lab, 2017; Branko Milanovic
Moreover, because the rich typically spend a smaller fraction of
their income on consumption than the poor, total or “aggregate” demand
in countries with higher inequality is weaker. Societies could make up
for this gap by increasing government spending—on infra-structure,
education and health, for instance, all of which are investments
necessary for long-term growth. But the politics of unequal societies
typically puts the burden on monetary policy: interest rates are lowered
to stimulate spending. Artificially low interest rates, especially if
coupled with inadequate financial market regulation, can give rise to
bubbles, which is what happened with the 2008 housing crisis.
It is no surprise that, on average, people living in unequal
societies have less equality of opportunity: those at the bottom never
get the education that would enable them to live up to their potential.
This fact, in turn, exacerbates inequality while wasting the country's
most valuable resource: Americans themselves.
Restoring Justice
Morale is lower in unequal societies, especially when inequality is
seen as unjust, and the feeling of being used or cheated leads to lower
productivity. When those who run gambling casinos or bankers suffering
from moral turpitude make a zillion times more than the scientists and
inventors who brought us lasers, transistors and an understanding of
DNA, it is clear that something is wrong. Then again, the children of
the rich come to think of themselves as a class apart, entitled to their
good fortune, and accordingly more likely to break the rules necessary
for making society function. All of this contributes to a breakdown of
trust, with its attendant impact on social cohesion and economic
performance.
There is no magic bullet to remedy a problem as deep-rooted as
America's inequality. Its origins are largely political, so it is hard
to imagine meaningful change without a concerted effort to take money
out of politics—through, for instance, campaign finance reform. Blocking
the revolving doors by which regulators and other government officials
come from and return to the same industries they regulate and work with
is also essential.
Credit: Jen Christiansen; Sources
: Raising America’s Pay: Why It’s Our Central Economic Policy Challenge, by Josh Bivens
et al. Economic Policy Institute, June 4, 2014;
The State of Working America, by Lawrence Mishel, Josh Bivens, Elise Gould and Heidi Shierholz. 12th Edition. ILR Press, 2012
Beyond that, we need more progressive taxation and high-quality
federally funded public education, including affordable access to
universities for all, no ruinous loans required. We need modern
competition laws to deal with the problems posed by 21st-century market
power and stronger enforcement of the laws we do have. We need labor
laws that protect workers and their rights to unionize. We need
corporate governance laws that curb exorbitant salaries bestowed on
chief executives, and we need stronger financial regulations that will
prevent banks from engaging in the exploitative practices that have
become their hallmark. We need better enforcement of antidiscrimination
laws: it is unconscionable that women and minorities get paid a mere
fraction of what their white male counterparts receive. We also need
more sensible inheritance laws that will reduce the intergenerational
transmission of advantage and disadvantage.
The basic perquisites of a middle-class life, including a secure old
age, are no longer attainable for most Americans. We need to guarantee
access to health care. We need to strengthen and reform retirement
programs, which have put an increasing burden of risk management on
workers (who are expected to manage their portfolios to guard
simultaneously against the risks of inflation and market collapse) and
opened them up to exploitation by our financial sector (which sells them
products designed to maximize bank fees rather than retirement
security). Our mortgage system was our Achilles' heel, and we have not
really fixed it. With such a large fraction of Americans living in
cities, we have to have urban housing policies that ensure affordable
housing for all.
It is a long agenda—but a doable one. When skeptics say it is nice but not affordable, I reply: We cannot afford to not
do these things. We are already paying a high price for inequality, but
it is just a down payment on what we will have to pay if we do not do
something—and quickly. It is not just our economy that is at stake; we
are risking our democracy.
As more of our citizens come to understand why the fruits of economic
progress have been so unequally shared, there is a real danger that
they will become open to a demagogue blaming the country's problems on
others and making false promises of rectifying “a rigged system.” We are
already experiencing a foretaste of what might happen. It could get
much worse.