The Price of Inequality: How Today's Divided Society Endangers Our Future (49 page)

11.
This predatory behavior took a number of forms. One way was to charge
very
high interest rates, sometimes obfuscated by fees. The abolition of usury laws (which limit the interest rates lenders can charge) provided lenders greater scope for charging exorbitant interest rates; and lenders found ways of circumventing whatever regulations there were. Rent-a-Center claimed to be renting furniture; it was really selling furniture and simultaneously lending money—at extraordinarily high interest rates. Many states tried to circumscribe its activities, but it used its political influence (it had senior ex-politicians, including a former leader of the Republicans in the House of Representatives, on its board) to try to get federal preemption (whereby weaker federal rules preempt the rights of states to regulate). In 2006 Rent-a-Center (with nationwide revenues in excess of $2 billion) was successfully sued by the state of California for deceptive business practices. See
http://oag.ca.gov/news/press_release?id=1391.
Credit cards and payday loans provided other venues for predatory practices. Among many discussions, see, e.g., Robert Faris, “Payday Lending: A Business Model That Encourages Chronic Borrowing,”
Economic Development Quarterly
17, no. 1 (February 2003): 8–32; James H. Carr and Lopa Kolluri,
Predatory Lending: An Overview
(Washington, DC: Fannie Mae Foundation, 2001).

12.
A well-performing financial sector is absolutely essential for a well-performing economy. It allocates capital, manages risk, and runs the payments mechanism. As I explain in
Freefall
(New York: Norton, 2010),
in the run-up to the 2008–09 crisis, it did not perform these functions well. Part of the reason is that it was focused more on circumventing regulations and exploitive activities, like predatory lending. The negative-sum nature is reflected in the immense losses in the real estate sector. The financial sector likes to claim that it has been highly innovative, and that these innovations are at the root of the economy’s overall success. But as Paul Volcker, former chairman of the Federal Reserve, pointed out, there is little evidence of any significant effect of these innovations on economic growth or societal well-being (with the exception of the ATM machine). But even if the financial sector had contributed slightly to the country’s growth in the years before the crisis, the losses associated with the crisis more than offset any of these gains.

13.
A recent study has shown that people of higher status/income have fewer qualms about breaking the rules, are more likely to be driven by self-interest, more likely to cheat, and more likely to behave in other ways that would generally be viewed as unethical. Paul K. Piff, Daniel M. Stancato, Stephane Cote, Rodolfo Menoza-Denton, and Dacher Keltner, “Higher Social Class Predicts Increased Unethical Behavior,”
Proceedings of the National Academy of Sciences
,
February 27, 2012. While what is “unfair” or “unethical” depends on “norms,” and there may be disagreements about what is or is not fair, the experiment focused on situations where there would be broad consensus on what was fair or ethical. Similarly, much of the financial sector behavior that I criticize below violates virtually any sense of “fairness” or “ethics.”

14.
This problem has come to be called the “natural resource curse.” There are other reasons that such countries have not done well: managing natural resources can be difficult (prices fluctuate and exchange rates can become overvalued). For a recent review of some of the problems and how they can be addressed see
Escaping the Resource Curse
, ed. M. Humphreys, J. Sachs, and J. E. Stiglitz (New York: Columbia University Press, 2007). See also, e.g., Michael Ross,
The Oil Curse: How Petroleum Wealth Shapes the Development of Nations
(Princeton: Princeton University Press, 2012); and idem,
Timber Booms and Institutional Breakdown in Southeast Asia
(New York: Cambridge University Press, 2001).

15.
According to World Bank Indicators, available at
http://data.worldbank.org/indicator
, 50 percent of the population was living under the national poverty line in 1998 before Chavez took office in 1999.

16.
He shared the 1964 Nobel Prize in Physics with the Soviet scientistis Nikolay Basov and Aleksandr Prokhorov for “fundamental work in the field of quantum electronics, which has led to the construction of oscilators and amplifiers based on the maser-laser principle.”

17.
They received the 1956 Nobel Prize in Physics “for their researches on semiconductors and their discovery of the transistor effect.”

18.
The World Wide Web Consortium he founded decided that its standards should be based on royalty-free technology, so that they could easily be adopted by anyone. Like Jobs, Bill Gates is often heralded as an innovator, but even though the adoption of his products is nearly universal now, that is due more to his business acumen—and near-monopoly of the market—than to the uniqueness of the technology he sells.

19.
Bakija et al. found (p. 3) that “executives, managers, supervisors, and financial professionals account for about 60 percent of the top 0.1 percent of income earners in recent years, and can account for 70 percent of the increase in the share of national income going to the top 0.1 percent of the income distribution between 1979 and 2005.” The composition of the top 1 percent in 2005 was 31 percent “Executives, managers, supervisors (non-finance)”; 15.7 percent “Medical,” 13.9 percent “Financial professionals, including management,” and 8.4 percent “Lawyers.” The share of finance almost doubled over the period, rising from 7.7 percent in 1979 to 13.9 percent in 2005. (Nonfinance executives and medical fell slightly; lawyers increased marginally.) These statistics are based on an income measure that
excludes
capital gains. This is very important because about half of all capital gains accrue to the top 0.1 percent. For the top 400 income earners, 60 percent of their income is in the form of capital gains. J. Bakija, A. Cole, and B. T. Hein, “Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality: Evidence from U.S. Tax Return Data.” See also comments by C. Rampell, “The Top 1%: Executives, Doctors and Bankers”
New York Times
, October 17, 2011, available at
http://economix.blogs.nytimes.com/2011/10/17/the
-top-1-executives-doctors-and-bankers/; and Laura D’Andrea Tyson, “Tackling Income Inequality,”
New York Times
, November 18, 2011, available at
http://economix.blogs.nytimes.com/2011/11/18/tackling
-income-inequality/.

20.
See Forbes World’s Billionaires list at
http://www.forbes.com/wealth/billionaires
/; ranking is from 2011.

21.
Slim’s Grupo Carso, France Telecom, and Southwestern Bell paid $1.7 billion in December 1990 to acquire “a controlling 20.4 percent stake in Telmex, which includes 51 percent of the votes in the company.” See Keith Bradsher, “Regulatory Pitfall in Telmex Sale,”
New York Times
, December 7, 1990, available at
http://www.nytimes.com/1990/12/27/business/talking-deals-regulatory-pitfall-in-telmex-sale.html?scp=1&sq=telmex%20southwestern%20bell%201990&st=cse
(accessed March 3, 2012).

22.
In the midnineties, Russia borrowed large amounts of money from the private sector, putting up shares in its oil and natural resource companies as collateral. But it was all a ruse to turn over state assets to the oligarchs. This was called “loans for shares.” See Chrystia Freeland,
Sale of the Century: Russia’s Wild Ride from Communism to Capitalism
(New York: Crown Business, 2000). A variety of specious arguments are often put forward for these privatizations. Most recently, Greece has been pushed to privatize, as a condition for getting assistance from Europe and the IMF. For a discussion of privatization and the arguments used for it, see chapters 6 and 8, below, and J. E. Stiglitz,
Globalization and Its Discontents
(New York: Norton, 2002)
.
Not every country and not every privatization has suffered from transferring state assets to private parties at below fair market prices. Many believe that the privatizations in the UK under Margaret Thatcher, with shares publicly floated and with the number of shares any one person or company could buy strictly limited, were conducted deliberately in a manner to avoid such outcomes.

23.
See Forbes America’s Highest Paid Chief Executives 2011, available at
http://www.forbes.com/lists/2011/12/ceo-compensation-11_rank.html
.

24.
This is obviously a controversial claim: the CEOs might argue that in fact they receive but a small fraction of what they contribute to shareholder value. But, as we argue below, the so-called incentive structures are poorly designed, providing little link between that part of the increase in market value that is attributable to the efforts of the CEO and that which is the result of broader market forces—lower costs of inputs or higher stock market prices in general. Some studies have suggested, moreover, that once total compensation is taken into account (including adjustments of bonuses when the stock market doesn’t do well), there is little relationship between firm performance and compensation. For a broader discussion of this issue, see J. E. Stiglitz,
Roaring Nineties
(New York: W. W. Norton, 2003); and especially
Lucian Bebchuk and Jesse Fried,
Pay without Performance: The Unfulfilled Promise of Executive Compensation
(Cambridge:
Harvard University Press, 2004).

25.
Still one more group is real estate moguls, who benefit from special provisions of the tax code and often get rents as a result of local government variances in zoning laws.

26.
These are sometimes called natural monopolies. They include the examples given earlier where network externalities are very large.

27.
The advocates of stronger intellectual property rights, of course, claim otherwise. Interestingly, in the United States many of the most innovative firms, those in Silicon Valley, have been among those opposing certain proposals by those in the drug and entertainment industries to strengthen intellectual property rights. Recent revisions of patent law arguably gave large corporations an advantage over new firms, illustrating the fact, repeated in the next chapter, that there are strong distributive consequences of any legal framework. For a discussion of how our current intellectual property framework may actually inhibit innovation, see J. E. Stiglitz,
Making Globalization Work
(New York: Norton, 2006), and Claude Henry and J. E. Stiglitz, “Intellecutal Property, Dissemination of Innovation, and Sustainable Development,”
Global Policy
1, no. 1 (October 2010): 237–51.

28.
See, e.g., A. Dixit, “The Role of Investment in Entry-Deterrence,”
Economic Journal
90, no. 357 (March 1980): 95–106; and J. Tirole and D. Fudenberg, “The Fat Cat Effect, the Puppy Dog Ploy and the Lean and Hungry Look,”
American Economic Review
74 (1984): 361–68. The practices Microsoft used to rid itself of its rivals (described below) also helped prevent entry of new competitors.

29.
It’s clear that one wants standards; one doesn’t want to be operated on by an unqualified doctor. But, for instance, the supply of qualified doctors could have been increased simply by increasing the number of places in medical school.

30.
In 1890 Congress passed the Sherman Anti-Trust Act, and its enforcement speeded up in the twentieth century. In 1911 the Supreme Court ordered the dissolution of the Standard Oil Company and the American Tobacco Company, which brought down the two powerful industrial trusts. In 1984 the Court broke up AT&T’s monopoly following
United States v. AT&T.
See Charles R. Geisst,
Monopolies in America: Empire Builders and Their Enemies from Jay Gould to Bill Gates
(New York: Oxford University Press, 2000).

31.
The term “Chicago school” is often applied to this group of economists, partially because the high priest of this religion, Milton Friedman (and many of his acolytes), taught at the University of Chicago. But it should be understood that many at that great university are not devotees of this school of thought, and that there are many devotees in other universities around the world. The term has, however, become a commonly used shorthand.

32.
One group even went so far as to argue that markets will behave competitively even if there is only one firm, so long as there is potential competition. This argument played an important role in airline deregulation, where it was contended that even if there was only one airline on a given route, it would be disciplined from charging monopoly prices by the threat of entry. Both theory and experience have shown that this argument is wrong, so long as there are sunk costs (costs that won’t be recovered if a firm enters and subsequently leaves), no matter how small those costs. See Joseph Farrell, “How Effective Is Potential Competition?,” 
Economics Letters
20, no. 1 (1986): 67–70; J. E. Stiglitz, “Technological Change, Sunk Costs, and Competition,”
Brookings Papers on Economic Activity
3 (1987), pp. 883–947; and P. Dasgupta and J. E. Stiglitz, “Potential Competition, Actual Competition, and Economic Welfare,”
European Economic Review
32, nos. 2–3 (March 1988): 569–77.

33.
For discussion and examples of conservative foundations’ contribution to the Chicago school law and economics programs, see Alliance for Justice, 
Justice for Sale: Shortchanging the Public Interest for Private Gain
 (Washington, DC: Alliance for Justice, 1993).

34.
The Department of Justice brought a case against American Airlines in the early years of this century. I thought the evidence that American Airlines had engaged in predatory behavior was especially compelling, but the judge didn’t need to look at the evidence: the Supreme Court had ruled that there was just too strong a presumption
against
the existence of predatory pricing to make prosecution possible.