The Price of Inequality: How Today's Divided Society Endangers Our Future (16 page)

Overleveraged households and excess real estate have already weighed down the economy for years and are likely to do so for more years, contributing to unemployment and a massive waste of resources. At least the tech bubble left something useful in its wake—fiber optics networks and new technology that would provide sources of strength for the economy. The housing bubble left shoddily built houses, located in the wrong places and inappropriate to the needs of a country where most people’s economic position was in decline. It’s the culmination of a three-decade stretch spent careening from one crisis to another without learning some very obvious lessons along the way.

In a democracy where there are high levels of inequality, politics can be unbalanced, too, and the combination of an unbalanced politics managing an unbalanced economy can be lethal.

Deregulation

There is a second way that unbalanced politics driven by extremes of inequality leads to instability: deregulation. Deregulation has played a central part in the instability that we, and many other countries, have experienced. Giving corporations, and especially the financial sector, free rein was in the
shortsighted
interest of the wealthy; they used their political weight, and their power to shape ideas, to push deregulation, first in airlines and other areas of transportation, then in telecom, and finally, and most dangerously, in finance.
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Regulations are the rules of the game that are designed to make our system work better—to ensure competition, to prevent abuses, to protect those who cannot protect themselves. Without restraints, the kinds of market failures described in the last chapter—where markets fail to produce efficient outcomes—are rampant. In the financial sector, for instance, there will be conflicts of interest and excesses, excess credit, excess leverage, excess risk taking, and bubbles. But those in the business sector see things differently: without the restraints, they see increases in profits. They think not of the broad, and often long-term, social and economic consequences, but of their narrower, short-term self-interest, the profits that they might garner now.
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In the aftermath of the Great Depression, an event preceded by similar excesses, the country enacted strong financial regulations, including the Glass-Steagall Act in 1933. These laws, effectively enforced, served the country well: in the decades following passage, the economy was spared the kind of financial crisis that had repeatedly plagued this country (and others). With the dismantling of these regulations in 1999, the excesses returned with even greater force: bankers quickly put to use advances in technology, finance, and economics. The innovations offered ways to increase leverage that circumvented the regulations that remained and that the regulators didn’t fully understand, new ways of engaging in predatory lending, and new ways to deceive unwary credit card users.

The losses from the underutilization of resources associated with the Great Recession and other economic downturns are enormous. Indeed, the sheer waste of resources brought on by this crisis caused by the private sector—a shortfall of trillions of dollars between what the economy could have produced and what it has produced—is greater than the waste of any democratic government, ever. The financial sector claimed that its innovations had led to a more productive economy—a claim for which there is no evidence—but there is no doubting the instability and inequality for which it is responsible. Even if the financial sector had led to a quarter percent higher growth for three decades—a claim that is beyond that of even the most exaggerated supporters of the sector—it would barely have made up for the losses that its misbehavior precipitated.

We have seen how inequality gives rise to instability, as a result of both the deregulatory policies that are enacted and the policies that are typically adopted in response to the deficiencies in aggregate demand. Neither is a
necessary
consequence of inequality: if our democracy worked better, it might have resisted the political demand for deregulation and might have responded to the weaknesses in aggregate demand in ways that enhanced sustainable growth rather than creating a bubble.
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There are further adverse effects of this instability: it increases risk. Firms are risk averse, which means that they demand compensation for bearing the risk. Without compensation, firms will invest less, and so there will be less growth.
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The irony is that while inequality gives rise to instability, the instability itself gives rise to more inequality, one of the vicious cycles that we identify in this chapter. In chapter 1, we saw how the Great Recession has been particularly hard on those at the bottom, and even those in the middle, and this is typical: ordinary workers face higher unemployment, lower wages, declining house prices, a loss of much of their wealth. Since the rich are better able to bear risk, they reap the reward that society provides for compensating for the greater risk.
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As always, they seem to be the winners from the policies that they advocated and that imposed such high costs on others.

In the wake of the 2008 global financial crisis, there is now an increasing global consensus that inequality leads to instability, and that instability contributes to inequality.
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The International Monetary Fund (IMF), the international agency charged with maintaining global economic stability, which I have strongly criticized for paying insufficient attention to the consequences of its policies for the poor, belatedly acknowledged that it cannot ignore inequality if it is to fulfill its mandate. In a 2011 study, the IMF concluded, “We find that longer growth spells are robustly associated with more equality in the income distribution. . . . Over longer horizons, reduced inequality and sustained growth may thus be two sides of the same coin.”
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In April of that year its former managing director, Dominique Strauss-Kahn, emphasized, “Ultimately, employment and equity are building blocks of economic stability and prosperity, of political stability and peace. This goes to the heart of the IMF’s mandate. It must be placed at the heart of the policy agenda.”
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H
IGH
I
NEQUALITY
M
AKES
FOR A
L
ESS
E
FFICIENT AND
P
RODUCTIVE
E
CONOMY

Beyond the costs of the instability to which it gives rise, there are several other reasons why high inequality—the kind that now characterizes the United States—makes for a less efficient and productive economy. We discuss in turn (a) the reduction in broadly beneficial public investment and support for public education, (b) massive distortions in the economy (especially associated with rent seeking), in law, and in regulations, and (c) effects on workers’ morale and on the problem of “keeping up with the Joneses.”

Lowering public investment

The current economic mantra stresses the role of the private sector as the engine of economic growth. It’s easy to see why: when we think of innovation we think of Apple, Facebook, Google, and a host of other companies that have changed our lives. But behind the scenes lies the public sector: the success of these firms, and indeed the viability of our entire economy, depends heavily on a well-performing public sector. There are creative entrepreneurs all over the world. What makes a difference—whether they are able to bring their ideas to fruition and products to market—is the government.

For one thing, the government sets the basic rules of the game. It enforces the laws. More generally, it provides the soft and hard infrastructure that enables a society, and an economy, to function. If the government doesn’t provide roads, ports, education, or basic research—or see to it that someone else does, or at least provides the conditions under which someone else could—then ordinary business cannot flourish. Economists call such investments “public goods,” a technical term referring to the fact that everyone can enjoy the benefits of, say, basic knowledge.

A modern society requires collective action, the country acting together to make these investments. The broad societal benefits that flow from them cannot be captured by any private investor, which is why leaving it to the market will result in underinvestment.

The United States and the world have benefited greatly from government-sponsored research. In earlier decades research conducted through our state universities and agricultural extension services contributed to enormous increases in agricultural productivity.
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Today, government-sponsored research has promoted the information technology revolution and advances in biotechnology.

For several decades America has suffered from underinvestment in infrastructure, basic research, and education at all levels. Further cutbacks in these areas lie ahead, given the commitment by both parties to bringing down the deficit and the refusal of the House of Representatives to raise taxes. The cuts come despite evidence that the boost these investments give to the economy far exceeds the average return in the private sector, and is certainly higher than the cost of funds to the government.
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Indeed, the boom years of the 1990s were buoyed by innovations made in previous decades that finally took their place in our economy. But the well from which the private sector can draw—for the next generation of transformational investments—is drying up. Applied innovations depend on basic research, and we simply haven’t been doing enough of it.
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Our failure to make these critical public investments should not come as a surprise. It is the end result of a lopsided wealth distribution in society. The more divided a society becomes in terms of wealth, the more reluctant the wealthy are to spend money on common needs. The rich don’t need to rely on government for parks or education or medical care or personal security. They can buy all these things for themselves. In the process, they become more distant from ordinary people.

The wealthy also worry about a strong government—one that could use its power to adjust the imbalances in our society by taking some of their wealth and devoting it to public investments that would contribute to the common good or that would help those at the bottom. While the wealthiest Americans may complain about the kind of government we have in America, in truth many like it just fine: too gridlocked to redistribute, too divided to do anything but lower taxes.

Living up to potential: the end of opportunity

Our underinvestment in the common good, including public education, has contributed to the decline in economic mobility that we noted in chapter 1. This in turn has important consequences for the country’s growth and efficiency. Whenever we diminish equality of opportunity, we are not using one of our most valuable assets—our people—in the most productive way possible.

In earlier chapters we saw how the prospects of a good education for the children of poor and middle-income families were far bleaker than those of the children of the rich. Parental income is becoming increasingly important, as college tuition increases far faster than incomes, especially at public colleges, which educate 70 percent of Americans. But, one might ask, don’t expanded student loan programs fill the gap? The answer, unfortunately, is no; and again, the financial sector is more than a little at fault. Today, the market is characterized by a set of perverse incentives, which, together with the absence of regulations that prevent abuse, mean that the student loan programs, rather than uplifting the poor, can (and too often do) lead to their further immiseration. The financial sector succeeded in making student loans non-dischargeable in bankruptcy, which meant that the lenders had little incentive to see to it that the schools for which the students were borrowing money were actually providing them with an education that would enhance their income. Meanwhile, private for-profit schools with richly compensated executives have defeated attempts to impose high standards that would make schools that exploit the poor and ill informed—by taking their money and not providing them with an education that enables them to get jobs to repay the loans—ineligible for loans.
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It is totally understandable that a young person, seeing how the burden of debt is crushing his parents’ lives, would be reluctant to take on student loans. It is, in fact, remarkable that so many are willing to do so, to the point that the average college graduate now has a debt of over $25,000.
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There may be another factor at play that is decreasing mobility and that, over the long run, will decrease the nation’s productivity. Studies of educational attainment stress the importance of what happens in the home. As those in the middle and at the bottom struggle to make a living—as they have to work more to get by—families have less time to spend together. Parents are less able to supervise their children’s homework. Families have to make compromises, and among them is less investment in their children (though they wouldn’t use those words.)

A distorted economy—rent seeking and financialization—and a less well-regulated economy

A central theme of the preceding chapters was that much of the inequality in our economy was the result of rent seeking. In their simplest form, rents are just redistributions from the rest of us to the rent seekers. That’s the case when oil and mining companies succeed in getting rights to oil and minerals at prices well below what they should be. The main waste of resources is only on lobbying: there are more than 3,100 lobbyists working for the health industry (nearly 6 for every congressperson), and 2,100 lobbyists working for the energy and natural resources industries. All told, more than $3.2 billion was spent on lobbying in 2011 alone.
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The main distortion is to our political system; the main loser, our democracy.

But often rent seeking involves a real waste of resources that lowers the country’s productivity and well-being. It distorts resource allocations and makes the economy weaker. A byproduct of efforts directed toward getting a larger share of the pie is shrinkage of the pie. Monopoly power and preferential tax treatment for special interests have exactly this effect.
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