The Price of Inequality: How Today's Divided Society Endangers Our Future (29 page)

Innovation and the resistance to regulation

Opponents of regulation always complain that it’s bad for business. Regulations that prevent pollution, of course, are bad for businesses that would have otherwise polluted. Regulations that prevent child labor are bad for businesses that would have exploited children. Regulations that prevent American companies from engaging in bribery or abuses of human rights may be bad for businesses that engage in bribery or human rights abuses. As we’ve seen, private rewards and social returns often differ; and when they do, markets don’t work well. The task of government is to align the two.

If it were true, as some have claimed, that new banking regulations will stifle innovation, we still would have to weigh the benefits of the regulation against the costs. If regulations can prevent another near-collapse of the banking system, the benefits would be enormous, possibly in the trillions of dollars. And well-designed regulations did succeed in ensuring the stability of our financial system for decades,
so regulations can work
. Moreover, this period of tight financial regulation was also one of rapid economic growth, a period in which the fruits of that growth were more widely shared than they are today. By contrast, in the period of “liberalization” the growth of a typical citizen’s income was far lower than in the period of regulation.

There is a simple reason for the failure of liberalization: when social returns and private rewards are misaligned, all economic activity gets distorted, including innovation. The innovation of the financial sector was directed not to improving the well-being of Americans but to improving the well-being of bankers. At least for a time, it succeeded in doing that; but it failed miserably in improving the plight of the ordinary American or even spurring growth in the American economy as a whole.

S
UCCESSES IN THE
B
ATTLE OF
I
DEAS

I have described the war of ideas—including those ideas that are central to the policies that determine societal inequality—and while the wealthy (and corporations) have been enormously successful in shaping perceptions in ways that benefit them, they have lost, or are losing, at least some of the battles. The marketplace of ideas, while far from perfect, is still competitive. This is a reason for hope.

In the following paragraphs I describe three such battles in which the tide has been turning: that over corporate welfare; that over the IMF, its governance, and some of the policies that it used to pursue; and that over the ultimate objectives of public policy.

Class warfare and corporate welfare

When President Clinton entered office, there was both high unemployment and a large deficit, though the unemployment and debt levels pale in comparison with those of today. It was natural for us to look for budget cuts that would increase efficiency without endangering the core agenda of “putting people first” and perhaps, by redirecting spending, even stimulate the economy. Obvious candidates for cutting were large expenditures on what Robert Reich (then secretary of labor) and I called
corporate welfare,
subsidies to American corporations. The Council of Economic Advisers was tasked with drawing up a list of cuts—not as easy as it might seem, because much of the corporate welfare is hidden within the tax code. Even then, toward the top of the list were subsidies to the banks (for instance, via IMF bailouts), to agriculture, and to the coal and other natural resource companies.

I thought that there would be broad consensus within the administration on the principle, but considerable reservation on the politics. I expected the departments that doled out the subsidies to try to defend their turf. What surprised me was the strong reaction from the head of the National Economic Council (later, secretary of Treasury) Bob Rubin: he suggested that we were trying to wage class warfare. It was, of course, nothing of the kind. For a Democratic administration trying to focus its attention on economic recovery and helping people, expensive subsidies that distorted the economy and increased inequality made no sense. Besides, to pretend that there were not large inequalities, large divisions, in our society was putting one’s head in the sand. Warren Buffett put it correctly when he said, “There’s been class warfare going on for the last 20 years and my class has won.”
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But the accusation of class warfare suggested that those who were trying to reduce corporate welfare were being
divisive.

In the Clinton administration, we made only a little progress in cutting out corporate welfare. The big subsidies for agriculture and energy remained. So did the smaller, but highly symbolic, subsidies for corporate jets.

But during the 2008 crisis, corporate welfare reached new heights. In the great bailout of the Great Recession, one corporation alone, AIG, got more than $150 billion—more than was spent on welfare to the poor from 1990 to 2006.
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As deficits have become larger, there has been increasing scrutiny of the budget, and cutbacks of corporate welfare—whether by that name or not—have been on the table. Some cutbacks have already occurred—as we noted earlier, in the beginning of 2012 the $6 billion ethanol subsidy, in place for three decades, ended. But I suspect that the more powerful industries and firms will be able to retain much of what they receive.

There is a role for government in providing a safety net, in “social protection,” but it should be protecting
individuals and families
against the risks that they face, especially those against which they cannot insure; it should not be protecting corporations from facing the consequences of bad business judgments or providing subsidies to enrich their coffers. Markets can’t work if there isn’t some discipline—if companies get only the upside of the risks, with taxpayers bearing the losses.

The IMF: the emperor has no clothes

In
Globalization and Its Discontents
, I described the intense battles between the IMF and some of those in developing countries and emerging markets in a variety of arenas—in developmental policy, in the policies of transition from communism to a market economy, and in the management of the East Asia crisis. I explained how the IMF had imposed contractionary policies on countries facing economic downturns, and I explained how its “structural adjustment” policies—forcing privatization and liberalization—had often led not to growth but instead to hardship, especially among the poor.

At the time I wrote the book, the IMF was viewed as
the
authority on these matters, especially in the West. Many in the developing world were skeptical: they saw that the policies pushed by the IMF often failed. They perceived the IMF as advancing the interests of the global financial sector and corporate interests in the advanced industrial countries. But they typically felt they had no choice except to follow the IMF’s strictures. They needed its money. I set out to show that
the emperor had no clothes
: that the favored IMF policies were not based on the best economic science; to the contrary, many of the doctrines that they had pushed had been thoroughly discredited by research in economics over the preceding quarter century.

I also sought to expose both some of the intellectual inconsistencies and the failures in governance. Over this period, the IMF increasingly had focused on “governance,” yet its own governance left much to be desired. The financial sector had too much influence, the developing countries had too little. The excessive influence of the financial sector helped explain the IMF’s devotion to contractionary policies—its first priority was to get Western creditors repaid, and that meant countries had to cut back their spending, so that more money would be left to repay debts. It also helped explain its advocacy of capital market liberalization, the stripping away of regulations that affected the flows of money (especially short-term hot money) into and out of a country. While there was little evidence that capital market liberalization led to faster growth, there was ample evidence that it led to more instability. But from the perspective of the advanced industrial countries, it was still desirable, because it gave more scope for Western financial firms to come into developing countries—and make more profits there. Evidently, the IMF had been captured by a self-reinforcing combination of ideology and interests.

Not surprisingly, the IMF did not take kindly to these perspectives—and the response was personal and vituperative. The suggestion that under certain circumstances capital controls might be desirable was greeted with suggestions that I was trying to sell snake oil.

Ten years later, the battlefield looks different. There has been a major change in perceptions, to which my book may have contributed, and there is a broad consensus on the need for governance reform—with some already under way, and more scheduled for the future.

The IMF has admitted that capital controls may be desirable under certain circumstances.
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In some of its programs, such as that for Iceland, it has accepted capital controls and has pushed for much less austerity than was its wont. Behind the scenes, in some of the European countries in crisis, it pushed for debt restructurings—making creditors bear more of the costs, taxpayers less.
But there have been powerful forces on the other side, including the European Central Bank. While in Greece the notion that a deep debt restructuring was finally accepted, in Ireland even unsecured bondholders were protected—they got the high return, supposedly for bearing risk, but in the end, they were protected, at great expense to Irish taxpayers.

In pursuit of the wrong goals

America has been hot in pursuit of the wrong goals. We’ve lost our way. We thought that simply by increasing GDP all would benefit, but that has not been the case. Even if the American economy produces more goods and services, if, year after year, most Americans have lower and lower incomes, our economy is
not
performing well.

It is obvious now that the standard way of measuring economic performance, the level of real per capita GDP (the sum of all of the goods and services produced inside the country, divided by the number of people in the country, adjusted for inflation) and the rate at which it is growing, is not a good measure of success. America has been doing fairly well in terms of real per capita GDP, and those numbers lulled it into thinking that all was going well. (Even then, the United States was not the top performer—Luxembourg Norway, Switzerland, Denmark, and “socialist” Sweden
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had a higher GDP per capita in 2010.)
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To take one example of how GDP can give a false impression of a country’s success, GDP per capita mismeasures the value of goods and services produced in several sectors, including health and the public sector—two sectors whose importance today is much greater than when GDP first started to be measured a half century ago. America, for instance, gets worse health outcomes, in terms of longevity or virtually any other measure of health performance, but spends more money. If we were measuring
performance
, the lower efficiency of America’s sector would count against the United States, and France’s health care sector output would be higher. As it is, it’s just the reverse: the inefficiency helps inflate America’s GDP number.

Our standard measure of performance, GDP, doesn’t take into account sustainability—both individuals and countries can live beyond their means, but only for a time. That, of course, was the case for the United States. Not only were most individuals borrowing to sustain their living standards; so was the country as a whole. A housing bubble kept the economy going for much of the first decade of this century—a kind of artificial life-support system that gave rise to unsustainable consumption.

Most importantly for the purposes of this book, our conventional measures of income don’t adequately reflect a broader sense of what’s happening to most citizens. As we saw in chapter 1, GDP per capita could be going up, and yet most citizens in the country could be stagnating or even becoming worse-off, year after year: precisely what has been happening in the United States.

And just as there are large inequalities in income, there are large disparities in almost all of the other dimensions that contribute to our general welfare, and none of these are reflected in GDP as a measure of economic performance. Take, for instance, health, education, or the environment. The environmental justice movement has called attention to the adverse environmental conditions under which many of the poor live—the only housing they can afford is near polluting factories or noisy airports and trains.
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How we measure performance is an aspect of the battle over perceptions and makes a difference, especially in our performance-oriented society. Our systems of measurement affect our perception of how well we are doing—and of the relative performance of different economic systems. If we measure the wrong thing, we will be tempted to do the wrong thing, and to make the wrong inferences about what is a good economic system.

If we measure our success by GDP, that’s what we’ll push for, and we’ll pay insufficient attention to what’s happening to
most
Americans. To take another example: critics of, say, environmental regulations suggest that they are costly, that they reduce growth. But how we see that trade-off depends on how we measure output. If in our measurements of GDP, we take into account the cost of environmental degradation, then better environmental regulation may actually improve GDP
correctly measured.

For years the standard measure of economic performance was GNP, gross national product, roughly equal to the gross income of the citizens of a country. But then, around 1990, there was a switch to GDP, gross domestic product, the value of the goods and services produced within a country. For a country in isolation, not trading with other countries or receiving inward investments, the two numbers are equivalent. But the switch occurred just as the pace of globalization was increasing. This had some profound effects: if the income associated with goods produced in the country went elsewhere, GDP could go up while GNP decreased. And this was not just a theoretical nicety. Papua New Guinea’s (PNG) gold mines were developed by foreign companies, from Australia, Canada, and elsewhere. Most of the value of what was produced accrued to the foreign companies. PNG got a pittance—not enough even to compensate it for the destruction of its environment, or other adverse effects on its economy or the health of its people.
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A focus on GDP encouraged countries to undertake such projects—the measure of their success was improved. But had the old measure, GNP, been the focus, such projects might have been rejected.