The Price of Inequality: How Today's Divided Society Endangers Our Future (17 page)

The magnitude of “rent seeking” and the associated distortions in our economy, while hard to quantify precisely, are clearly enormous. Individuals and corporations that excel at rent seeking are amply rewarded. They may garner immense profits for their firms. But this does not mean that their
social
contribution is even positive. In a rent-seeking economy such as ours is becoming, private and social returns are badly misaligned. The bankers who gained large profits for their companies were amply rewarded, but, as I have repeatedly said, those profits were ephemeral and unconnected to sustainable improvements in the
real
economy. That something was wrong should have been evident: the financial sector is supposed to
serve
the rest of the economy, not the other way around. Yet before the crisis, 40 percent of all corporate profits went to the financial sector.
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Credit card companies would extract more money from transaction fees than the store would profit from the sale of its goods. For the movement of a few electrons upon the swipe of a card, something that costs at most a few pennies, the finance company received as much money as the store did for managing a complex operation that made a wide variety of food available at a low price.
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Rent seeking distorts our economy in many ways—not the least of which is the misallocation of the country’s most valuable resource: its talent. It used to be that bright young people were attracted to a variety of professions—some to serving others, as in medicine or teaching or public service; some to expanding the frontiers of knowledge. Some always went into business, but in the years before the crisis an increasingly large fraction of the country’s best minds chose finance. And with so many talented young people in finance, it’s not surprising that there would be innovation in that sector. But many of these “financial innovations” were designed to circumvent regulations, and actually lowered long-run economic performance. These financial innovations do not compare with real innovations like the transistor or the laser that increased our standard of living.

The financial sector is not the only source of rent seeking in our economy. What is striking is the prevalence of limited competition and rent seeking in so many key sectors of the economy. Earlier chapters referred to the hi-tech sector (Microsoft). Two others that have drawn attention are the health care sector and telecommunications. Drug prices are so much higher than the costs of production that it pays drug companies to spend enormous amounts of money to persuade doctors and patients to use them, so much so that they now spend more on marketing than on research.
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And much of the so-called research itself is rent seeking—producing a me-too drug that will divide the high profits of a rival firm’s blockbuster drug. Imagine how competitive our economy might be—and how many jobs might be created—if all that money was invested in
real
research and
real
investments to increase the nation’s productivity.

Whenever rents are generated by monopoly power, a large distortion in the economy occurs. Prices are too high, and that induces a shift from the monopolized product to others. It is remarkable that even though the United States is allegedly a highly competitive economy, certain sectors seem to continue to reap excess profits. Economists marvel at our health care sector and its ability to deliver less for more: health outcomes are worse in the United States than in almost all other advanced industrial countries, and yet the United States spends absolutely more per capita, and more as a percentage of GDP, by a considerable amount. We’ve been spending more than one-sixth of GDP on health care, while France has been spending less than an eighth. Per capita spending in the United States has been two and a half times higher than the average of the advanced industrial countries.
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This inefficiency is so large that after it is taken into account, the gap between income per capita in the United States and in France shrinks by about a third.
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While there are many reasons for this disparity in the efficiency of the health care system, rent seeking, in particular on the part of health insurance companies and drug companies, plays a significant role.

Earlier, we cited the most notorious example: a provision in the 2003 Bush Medicare expansion that led to much higher drug prices in the United States and to a windfall gain (a rent) for the drug companies estimated at $50 billion or more a year. Well, one might say, what is $50 billion among friends? In a $15 trillion economy,
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it amounts to less than a third of 1 percent. But as Everett Dirksen, the senator from Illinois, is reputed to have said: a billion here, a billion there, and pretty soon you’re talking real money.
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In the case of our rent-seeking corporations, it’s more like $50 billion here, $50 billion there, and pretty soon you’re talking very big money.

When competition is very restricted, the real effect of competition is often waste, as the competitors fight over who gets to exploit the consumer. Accordingly, high profits are not the only sign of rent seeking. Indeed, distorted, oligopolistic competition among firms can even lead to dissipation of rents, but not economic efficiency; when profits (above a normal return) are driven to or near zero (or to where the return on capital is normal), it is not necessarily evidence of an efficient economy. We see evidence of rent seeking in the high expenditures to recruit credit card or cell phone customers. Here the object becomes to exploit customers as much and as fast as possible, with fees and charges that are neither understandable nor predictable. Companies work hard to make it difficult to compare the costs of using, say, one credit card versus another because to do so would enhance competition, and competition would erode profits.

American businesses, too, have to pay much more to the credit card companies than do businesses in other countries that have managed to curb some of the anticompetitive practices—and the higher costs faced by businesses get passed on to American consumers, lowering standards of living.

The same holds for cell phones: Americans pay higher cell phone rates, and get poorer service, than people in countries that have succeeded in creating a more truly competitive marketplace.

Sometimes the distortions of the rent seekers are subtle, not well captured in the diminution of GDP. This is because GDP doesn’t adequately capture costs to the environment. It doesn’t assess the sustainability of the growth that is occurring. When GDP arises from taking resources out of the ground, we should make note that the country’s wealth is diminished, unless that wealth is reinvested above ground in human or physical capital. But our metrics don’t do that. Growth that arises from depleting fish stocks or groundwater is ephemeral, but our metrics don’t tell us that. Our price system is flawed, because it doesn’t reflect accurately the scarcity of many of these environmental resources. And since GDP is based on market prices, our GDP metrics are also flawed.

Industries like coal and oil want to keep it that way. They don’t want the scarcity of natural resources or the damage to our environment to be priced, and they don’t want our GDP metrics to be adjusted to reflect sustainability. Not charging them for the costs they impose on the environment is, in effect, a hidden subsidy, little different from the other gifts the industry receives in favorable tax treatment and acquiring resources at below fair market prices.

When I was chair of the Council of Economic Advisers under President Clinton, I tried to have the United States issue a “Green GDP account,” which would reflect the depletion of our resources and the degradation of our environment. But the coal industry knew what it would mean—and it used its enormous influence in Congress to threaten to cut off funding for those engaged in this attempt to define Green GDP, and not just for this project.

When the oil industry pushes for more offshore drilling and simultaneously pushes for laws that free companies from the full consequences of an oil spill, it is, in effect, asking for a public subsidy. And such subsidies do more than provide rents; they also distort resource allocations. GDP, and more broadly, societal welfare, is diminished—as was made so evident by the 2010 BP oil spill in the Gulf of Mexico. Because the oil and coal companies that use their money to influence environmental regulation, we live in a world with more air and water pollution, in an environment that is less attractive and less healthy, than would otherwise be the case. The costs show up as lower standards of living for ordinary Americans, the benefits as higher profits for the oil and coal companies. Again, there is a misalignment between social returns (which may in fact be negative, as a result of the lowering of our standard of living in the wake of environmental deterioration) and private rewards (which are often huge).
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As we explained in the last two chapters, one objective of rent seekers is to shape laws and regulations to their benefit. To do that, you need lawyers. If it can be said that America has a government of the 1 percent, by the 1 percent, and for the 1 percent, it can be said with even more conviction that America has a government of the lawyers, by the lawyers, and for the lawyers. Twenty-six of America’s forty-four presidents have been lawyers, and 36 percent of the legislators in the House have a background in law. Even if they are not narrowly pursuing what is in the financial interests of lawyers, they may be “cognitively captured.”

The legal framework is
supposed
to make our economy more efficient by providing incentives for individuals and firms not to behave badly. But we have designed a legal system that is an arms race: the two protagonists work hard to out-lawyer each other, which is to say outspend each other, since good and clever lawyers are expensive. The outcome is often determined less by the merits of the case or issue than by the depth of the pockets. In the process, there is massive distortion of resources, not just in the litigation but in actions taken to affect the outcome of litigation and to prevent litigation in the first place.

The macroeconomic effect of America’s litigious society was suggested by some studies that showed that countries with fewer lawyers (relative to their population) grew faster.
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Other research suggests that the main channel through which a high proportion of lawyers in a society hurts the economy is the diversion of talent away from more innovative activities (like engineering and science), a finding consistent with our earlier discussion of finance.
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But I should be clear: given the success of the financial sector and corporations more generally in stripping away the regulations that protect ordinary citizens, the legal system is often the only source of protection that poor and middle-class Americans have. But instead of a system with high social cohesion, high levels of social responsibility, and good regulations protecting our environment, workers, and consumers, we maintain a very expensive system of
ex post accountability
, which to too large an extent relies on penalties for those that do injury (say, to the environment)
after the fact
rather than restricting action
before the damage is done.
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Corporations successfully beat back regulations in their battle with the rest of society, but have met their match with the lawyers. Both groups spend heavily on lobbying to ensure that they can continue their rent-extracting activities. In the course of this arms race, a balance appears to have been struck—there are at least some countervailing powers checking the behavior of corporations. While the balance is better than what would emerge if, say, the corporations wrote their own rules—where the victims of their actions would have no recourse—the current system is still enormously costly to our society.

The 1 percent that shapes our politics not only distorts our economy by not doing what it should, in aligning private and social incentives, but also by encouraging it to do what it shouldn’t. The recurrent bank bailouts, which encourage banks to engage in excessive risk taking,
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offer the most obvious example. But many argue that even more costly are the distortions in foreign policy. More persuasive as an explanation of the Iraq War than Bush’s avowed determination to eliminate one dictator was the attraction of Iraqi oil (and perhaps the huge profits that would accrue to Bush devotees, including Vice President Richard Cheney’s Halliburton Corporation).
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While those at the top may disproportionately be among the beneficiaries of war, they bear disproportionately less of the cost. Members of the top 1 percent rarely serve in the military—the reality is that the all-volunteer army does not pay enough to attract their sons and daughters. The wealthiest class feels no pinch from higher taxes when the nation goes to war: borrowed money pays for it,
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and if budgets get tight, middle-class tax benefits and social programs are given the ax, not the preferential tax treatment and manifold loopholes for the rich.

Foreign policy is, by definition, about the balancing of national interests and national resources. With the top 1 percent in charge and paying no price for wars, the notion of balance and restraint goes out the window. There is no limit to the adventures we can undertake; corporations and contractors stand only to gain. At the local level around the world, contractors love roads and buildings, from which they can benefit enormously, especially if they make the right political contributions. For U.S. contractors, the military has provided a bonanza beyond imagination.

Efficiency wage theory and alienation

A central theme of this chapter is that much of the inequality in our society arises because private rewards differ from social returns, and that the high level of inequality that now characterizes the United States, and the
widespread acceptance
of that level of inequality (despite the encouraging signs from the Occupy Wall Street movement), makes it difficult in the United States to adopt good policies. Policy failures include those in macroeconomic stabilization, industry deregulation, and underinvestment in infrastructure, public education, social protection, and research.