The Price of Inequality: How Today's Divided Society Endangers Our Future (13 page)

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So far, we have discussed the role that market forces, politics, and rent seeking play in creating the high level of inequality in our society. Broader societal changes are also important, changes both in norms and in institutions.
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These too are shaped by, and help shape, politics.

The most obvious societal change is the decline of unions, from 20.1 percent of wage- and salary-earning U.S. workers in 1980 to 11.9 percent in 2010.
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This has created an imbalance of economic power and a political vacuum. Without the protection afforded by a union, workers have fared even more poorly than they would have otherwise. Market forces have also limited the effectiveness of the unions that remain. The threat of job loss by the moving of jobs abroad has weakened their power. A bad job without decent pay is better than no job. But just as the passage of the Wagner Act during Franklin Delano Roosevelt’s presidency encouraged unionization, Republicans at both the state and the federal levels, in the name of labor flexibility, have worked to weaken them. President Reagan’s breaking of the air traffic controllers strike in 1981 represented a critical juncture in the breaking of the strength of unions.
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Part of the conventional wisdom in economics of the past three decades is that flexible labor markets contribute to economic strength. I would argue, in contrast, that strong worker protections correct what would otherwise be an imbalance of economic power. Such protection leads to a higher-quality labor force with workers who are more loyal to their firms and more willing to invest in themselves and in their jobs. It also makes for a more cohesive society and better workplaces.
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That the American labor market performed so poorly in the Great Recession and that American workers have done so badly for three decades should cast doubt on the mythical virtues of a flexible labor market. But in the United States unions have been seen as a source of rigidity and thus of labor market inefficiency. This has undermined support for unions both inside and outside of politics.
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Inequality may be at once cause and consequence of a breakdown in social cohesion over the past four decades. The pattern and magnitude of changes in labor compensation as a share of national income are hard to reconcile with any theory that relies
solely
on conventional economic factors. For instance, in manufacturing, for more than three decades, from 1949 to 1980, productivity and real hourly compensation moved together. Suddenly, in 1980, they began to drift apart, with real hourly compensation stagnating for almost fifteen years, before starting to rise, again almost at the pace of productivity, until the early 2000s, when compensation again began essentially stagnating. One of the interpretations of these data is that in effect, during the periods when wages grew so much slower than productivity, corporate managers seized a larger share of the “rents” associated with corporations.
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The extent to which this occurs is affected not just by economics and societal forces (the ability and willingness of CEOs to garner for themselves a larger fraction of the corporate revenues), but also by politics and how they shape the legal framework.

Corporate governance

Politics—and in particular how politics shapes the laws governing corporations—is a major determinant of the fraction of a corporation’s revenues that its top executives take for themselves. U.S. laws provide them considerable discretion. This meant that when social mores changed in ways that made large disparities in compensation more acceptable, executives in the United States could enrich themselves at the expense of workers or shareholders more easily than could executives in other countries.

A significant fraction of U.S. output occurs in corporations whose shares are publicly traded. Corporations have numerous advantages—legal protection afforded by limited liability,
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advantages of scale, often long-established reputations—that allow them to earn excess returns over what they would otherwise have to pay to raise capital. We call these excess returns “corporate rents,” and the question is how these rents are divided among the various “stakeholders” in the corporation (in particular, between workers, shareholders, and management). Before the mid-1970s there was a broad social consensus: executives were well paid, but not fabulously so; the rents got divided largely between loyal workers and management. Shareholders never had much say. America’s corporate law gives wide deference to management. It’s hard for shareholders to challenge what the management does, hard to wage a takeover battle,
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hard even to wage a proxy battle for control. Over the years, managers learned how to entrench and protect their interests. There were numerous ways for them to do this, including investments shrouded in uncertainty that made the value of the firm less certain and a takeover battle that much riskier; poison pills that decreased the value of the firm in the event of a takeover; and golden parachutes that guaranteed managers a lifetime of comfort should the firm be taken over.
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Gradually, beginning in the 1980s and 1990s, management realized that the measures taken to fend off outside attacks, combined with weaker unions, also meant that they could take a larger share of the corporate rents for themselves with impunity. Even some financial leaders recognized that “executive compensation in our deeply flawed system of corporate governance has led to grossly excessive executive compensation.”
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Norms of what was “fair” changed too: the executives thought little of taking a bigger slice of the corporate pie, awarding themselves large amounts
even as they claimed they had to fire workers and reduce wages to keep the firm alive.
In some circles, so engrained did these schizophrenic attitudes to “fairness” become that early in the Great Recession an Obama administration official could say, with a straight face, that it was necessary to honor AIG bonuses, even for the officials who had led the company to need a $150 billion bailout, because of the sanctity of contracts; minutes later he could admonish autoworkers to accept a revision of their contract that would have lowered their compensation enormously.

Different corporate governance laws (even modest ones, like giving shareholders some say in the pay of their CEO)
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might have tamed the unbridled zeal of executives, but the 1 percent didn’t—and still don’t—want such reforms in corporate governance, even if they would make the economy more efficient. And they have used their political muscle to make sure that such reforms don’t occur.

The forces we have just described, including weaker unions and weaker social cohesion working with corporate governance laws that give management enormous discretion to run corporations for their own benefit, have led not only to a declining wage share in national income but also to a change in the way our economy responds to an economic downturn. It used to be that when the economy went into recession, employers, wanting to maintain the loyalty of their workers and concerned about their well-being, would keep as many as they could on their payroll. The result was that labor productivity went down, and the share of wages went up. Profits bore the brunt of the downturn. Wage shares would then fall after the end of a recession. But in this and the previous (2001) recession, the pattern changed; the wage share declined in the recession, as well as in the ensuing years. Firms prided themselves on their ruthlessness—cutting out so many workers that productivity actually increased.
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Discrimination

One other major societal force affects inequality. There is economic discrimination against major groups in American society—against women, against African Americans, against Hispanics. The existence of large differences in income and wealth across these groups is clear. Wages of women, African Americans, and Hispanics are all markedly lower than those of white males.
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Differences in education (or other characteristics) account for a portion of the disparity, but only a portion.
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Some economists have argued that discrimination was impossible in a market economy.
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In a competitive economy, so the theory went, as long as there are some individuals who do not have racial (or gender or ethnic) prejudices, they will hire members of the discriminated-against group because their wages will be lower than those of similarly qualified members of the not discriminated-against group. This process will continue until the wage/income discrimination is eliminated. Prejudice might lead to segregated workplaces, but not to income differentials. That such arguments gained currency in the economics profession says a lot about the state of the discipline. To an economist like me who grew up in the midst of a city and country where discrimination was
obvious
, such arguments provided a challenge: something was wrong with a theory that said discrimination couldn’t exist. Over the past forty years, a number of theories have been developed to help explain the persistence of discrimination.
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Game-theoretic models, for instance, have shown how tacit collusive behavior of a dominant group (whites, men) can be used to suppress the economic interests of another group. Individuals who break with the discriminatory behavior are punished: others will refuse to buy from their store, work for them, supply them inputs; social sanctions, like ostracism, can also be effective. Those who don’t punish transgressors are subjected to the same punishment.
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Related research has shown how other mechanisms (associated with imperfect information) can lead to discriminatory equilibria even in a competitive economy. If it is difficult to assess the true ability of an individual and the quality of his education, then employers may turn to race, ethnicity, or gender—whether justified or not. If employers believe that those who belong to a particular group (women, Hispanics, African Americans) are less productive, then they will pay them lower wages. The result of discrimination is to reduce incentives for members of the group to make the investments that would lead to higher productivity. The beliefs are self-reinforcing. This is sometimes called statistical discrimination—but of a particular form, where the discrimination actually leads to the differences that are believed to exist between groups.
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In the theories of discrimination just described, individuals
consciously
discriminate. Recently, economists have suggested an additional driver of discriminatory behavior: “implicit discrimination,” which is unintentional and outside the awareness of those engaging in discrimation and at variance with what they (explicitly) think or favor for their organization.
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Psychologists have learned to measure implicit attitudes (that is, attitudes of which individuals are not consciously aware). There is preliminary evidence that these attitudes predict discriminatory behavior better than explicit attitudes, especially in the presence of time pressure. That finding sheds new light on studies that have shown systematic racial discrimination.
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This is because many real-world decisions, such as job offers, are often made under time pressure, with ambiguous information—conditions that give greater scope for implicit discrimination.

A striking example, from a study by the sociologist Devah Pager, is of the stigmatizing effect of a criminal record.
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In her field study, matched pairs of twenty-three-year-olds applied for real entry-level jobs in order to test the degree to which a criminal record (a nonviolent drug offense) affects subsequent employment opportunities. All the individuals presented roughly identical credentials, including a high school diploma, so that differences experienced among groups can be attributed to the effects of race or criminal status. After an invited interview, the ratio of callbacks for white nonoffenders to white ex-offenders is 2:1, this same ratio for blacks is nearly 3:1. And a white man
with
a criminal record is slightly more likely to be considered for a job than a black man with no criminal past. Thus, on average, being black reduces employment opportunities substantially, and more so for ex-offenders. These effects can represent important barriers to black men trying to become economically self-sufficient, since roughly one in three black men will spend time in prison in his lifetime.

There are strong interactions between poverty, race, and government policies. If certain minorities are disproportionately poor, and if the government provides poor education and health care to the poor, then members of the minority will suffer disproportionately from poor education and health. Health statistics, for instance, are telling: life expectancy at birth for blacks in 2009 was 74.3 compared with 78.6 for whites.
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The Great Recession has not been good for members of the groups that have been traditionally discriminated against, as we saw in chapter 1. The banks saw them as easy targets, because they had aspirations of upward mobility; owning a home was a sign that they were making it into America’s middle class. Unscrupulous vendors pushed mortgages on households that were beyond their ability to pay, ill-suited for their needs, and carrying high transactions costs. Today large fractions of these populations have lost not only their homes but also their life savings. The data on what has happened to their wealth are truly disturbing: in the aftermath of the crisis, the typical black household had a net worth of only $5,677, a twentieth of that of a typical white household.
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Our economic system rewards profits, no matter how they’re made, and in a money-centric economy it’s not surprising to see moral scruples put to the side. Occasionally, our system holds those who have behaved wrongly accountable, though only after a long and expensive legal battle. Even then, it’s not always clear whether the penalties do more than take back a part of the profits that the banks have made by their unscrupulous behavior. In that case, even among those who are punished, crime pays.
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In December 2011, four to seven years after the subprime lending occurred, Bank of America agreed to a $335 million settlement for its discriminatory practices against African Americans and Hispanics, the largest settlement ever over residential fair lending practices. Wells Fargo and other lenders have been similarly accused of discriminatory practices; Wells, the country’s largest home mortgage lender, paid the Fed $85 million to settle charges that it had brought. In short, discrimination in lending was not limited to isolated instances, but was a pervasive practice.