Why Has Inequality Gone Up So Much?

December 1st, 2011 at 12:07 am

[This is #2 in my series on inequality, starting here.]

The main reason—the outer layer of the onion, if you will—is the diminished ability of most Americans to claim as much of the economy’s growth as they once did.

I’ll explain what I mean by that in a moment, but it may sound like a different explanation than you’re used to hearing.   Typically, we hear globalization (g), technological change (t), increased returns (ir) to high levels of education or superstar talents.  All of which play a role, but all of which have existed forever.  So something else must have changed.

Some of what’s changed relates to g, t, and ir themselves. US global trade, as measured by the sum of import and export shares of GDP, increased from around 10% in the 1960s to around 30% now, and the increased competition—and large, persistent trade deficits–with low-wage countries has held down wages and jobs in “tradable sectors.”  Technology appears to have become more “labor saving” in recent years, meaning if what you do is at all repetitive, you can be replaced by a machine.  If you write the software that runs said machines, that’s better.  College attainment has significantly slowed in recent years, and that’s been a factor as well.

But these are not the main reasons for the growth in economic inequality.  These are merely time honored forces that have the potential to deliver the benefits of growth toward a narrower sliver of the income scale.  What’s changed—the reason that potential is now realized—is the absence of a countervailing force pushing back the other way.

Unions, of course, come to mind, and there’s good research showing that less unionization is associated with faster growing inequality.  Other labor market institutions matter as well, including the erosion of the minimum wage, sectoral policies (e.g., promoting manufacturing), and the inattention to labor standards such as wage and hour rules, overtime regulations, and workplace safety.  Such policies provide some countervailing force to workers beset by the pressures of globalization, technology, and whatever else is skewing economic returns.

I’ve stressed the importance of low unemployment here as well.  It’s no accident that periods of truly tight labor markets have consistently been ones where inequality’s growth was constrained.  And that makes sense: full employment labor markets give working people the bargaining clout they lack when the supply of workers much exceeds the demand.

An intimately related factor at the core of the inequality problem is the toxic combination of “rational expectations,” efficient markets hypothesis, trickle-down economics, and increased money in politics. The first two argue that anything that looks like a countervailing force—whether it’s full employment policy, a higher minimum wages, or even using policy to burst a financial bubble—distort market outcomes and must be stopped.

The latter two take that dangerously wrong theory and plug it into regressive tax policy, aggressive deregulation, and the dismantling of any countervailing force that might have pushed back on inequality in earlier times.

That’s about where things stand right now.  We’re way far away from full employment—have been for over a decade.  Unions are fighting to stay alive, especially in the public sector, with little help from national policy.  Progressive taxation, another important force in dampening inequality’s growth (see the top figure here), is under constant attack.   And while the Obama administration and a precious few in Congress fight the toxic combination of bad economic theory and its policy implications, they are too often no match for the power and reach of the deep-pocketed opposition, who continue to oppose any countervailing force, from health care and financial reform to countercyclical measures that might lower the jobless rate even just a tad.

As long as policy remains stymied in its ability to provide the majority of the workforce with some measure of force, some bargaining power, to push for their fair share of the growth they themselves are helping to create, inequality will continue grow apace.

Like they say in that movie, may the (countervailing) force be with you.


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12 comments in reply to "Why Has Inequality Gone Up So Much?"

  1. James Edwards says:

    It seems to me we have another big cause for the growth in economic inequality. Perhaps you can address this in the future. Our economic policy in normal times, and significantly since the 70s, is based on increasing and decreasing easy access to money for the very rich or for institutions that are very rich. This is what I mean. Interest rates are very low, indeed almost zero, but not according to my credit card or my mortgage. The FED wants to buy long term, high yield, bonds in exchange for getting more money into the system to stimulate consumer spending, but I have no high yield, long term bonds to sell them in exchange for that badly needed money.

    I think this is based on a serious fallacy of thinking that the wealthy and the financiers are “Job Creators” or Entrepreneurs. They are no such thing. They are rentiers. They are financial parasites who ensure the barrier to entry is just low enough some will try to be entrepreneurial, and most of the money will go to the investors. When they can’t make money that way, they shake down customers and engage in counterfeiting. We have the word inflation to describe too much money chasing to few goods. We have no conceptual equivalence for to much wealth chasing too few opportunities.

    Monetary policy is a policy that gives free chips to the very wealthy to gamble away and if they do badly they are given more free chips.

  2. D. C. Sessions says:

    I continue to suspect that our monetary policy, by defining “full employment” as “an unemployment rate consistent with 2% inflation,” has been a major factor in keeping unemployment high and labor costs (read: wages) low.

    In effect, our national policy for the last thirty years has been to prevent increases in real hourly wages. And we’ve succeeded.

  3. Tyler says:

    The first step toward a better tax code that reduces inequality should be the abolishment of the federal income tax. Why we tax labor is beyond me. We support labor unions, but tax people’s labor! It’s a total contradiction.

    Instead of taxing people for working fifty weeks a year, we should tax the heck out of pollution. Of course, that would require going to war with the oil companies, which is a war we would win.

    Joseph Stiglitz: “It is better to tax bad things (like pollution) than good things (like work).”

    • Absurdity says:

      Effectively taxing consumption could tax the polluters but you wouldn’t be able to tax equally for each competitor. You would have to include a tax for country of origin, a tariff basically, along with the product type to really solve the pollution problem in any effective manner.

  4. JC Dwyer says:

    I’m trying to understand this from a non-economist, advocate-for-the-poor perspective (that’s me). Frankly, it all seems like a huge bummer.

    My simplification of your thesis:

    a) global economic factors (g, t , and ir) are strong determinants of inequality, and these have gotten stronger in recent years

    b) domestic, countervailing forces (labor market rules / wage standards, unionization, progressive taxation) have gotten weaker in recent years

    c) bad economic theory and a domestic political system favoring one end of the income scale have colluded to cause, or at least exacerbate (a) and (b)

    My limited understanding of economics is that strengthening the (b) forces as you prescribe would drive up the wages of poor households to some extent, but also drive many of the low-skill jobs they depend on to other countries (absent some seriously distortive and probably illegal trade protections). As great as a nation of high-paid computer programmers sounds, the families I try to help are just not going to be qualified for those jobs in the near-term. Is this analysis incorrect?

    Although I also favor strengthening (b) forces, I wonder what effect one country’s (b) forces can really have on the world’s (a) forces. The world is big, and it’s hard for me to believe there’s a policy prescription out there that can maintain America’s long-term economic advantage against the billions-strong workforces of other nations. We seem to be importing poverty — not in the way anti-immigration nuts contend, but as a strategy to compete in a world that is much poorer than us. Is there a way for the U.S. to take our economic lumps while maintaining a decent standard of living for all Americans, or will we need to rewrite our social contract?

    • paul says:

      Yes, those contracts clearly must be rewritten. Capitalism has proven repeatedly that men cannot restrain their greed for any greater good. The basic charter of a company needs to be redefined so they can no longer do harm in seeking profit. American companies should have limits on the number of workers they can import at every level, or lose their status as “American.” Campaign finance reform needs to be implemented and huge corporate lobbying groups should be banned, and the money spent on them put into raising hourly wages across the nation. At every turn, the spirit of fairness and the fair sharing of wealth has been dodged, and those who cheat the rest of us will not stop until we change their contracts and make their actions illegal. Since we cannot outspend them, we must change laws. Since they own our legislatures and easily convince huge numbers of people to vote against their own best interests, this may already be impossible.

    • urban legend says:

      Let the unions make their own determination how far they can push. As it stands when there are no unions, management merely makes the decisions — and often it’s in the managers’ own personal interest not only to keep their compensation piece of the pie larger, but also to please Wall Street and cause their options to increase in value.

      It’s funny how “the market rules” people suddenly can’t stomach working people exercising their constitutional right to associate, and their legal right to bargain collectively. It’s supposedly “pro-market” to allow management to use whatever means possible with practically zero legal consequences to defeat unionization even when that’s what their employees want.

  5. DW Howard says:

    What is the “right” amount of inequality/equality?

    • D. C. Sessions says:

      An upper bound is where wealth becomes so concentrated that the wealth->power->wealth cycle of rent-seeking becomes self-sustaining.

  6. Absurdity says:

    There’s also another school of thought that would suggest that during the Cold War there was a reason to pay better wages and benefits to properly propagandize any potential against a true socialist economy. In other words the capitalist had to make capitalism appear to be the better option.

  7. readerOfTeaLeaves says:

    More discussion about bogus, illogical, inaccurate and downright dangerous bad economic thinking, please!

    Just before reading this post, I’d been at Jesse’s Cafe Americain where I landed on this choice little quotation, which is relevant to the point about why nutty ideas like the ‘Efficient Markets Hypothesis’ (EMH) are dangerous in today’s world:

    The big change has been the utter corruption of Wall Street and that nearly 80% of the trading on the New York Stock Exchange now is being done by high-velocity computers. When an investor puts in an order, it’s basically one computer versus another computer operating in nanoseconds. That’s why all of a sudden the volume is up or down 10 to 1 and you get a couple of hundred points added on or taken off the Dow in minutes. To me that’s a corruption of the process. “Ethics” and “Wall Street” are words you never use in the same sentence.

    The trading mechanism is broken down….The high velocity traders literally get the opportunity to “front-run” public orders as the order flow to “the market” is available to them for a fee. It’s outrageous in the sense that they’ve legalized front running for those who pay up for the high-speed data feed. And then there’s the initial public offering (IPO) business.

    With 80% of the NYSE trades now done by high-speed computing, the notion that markets are ‘efficient’ is ludicrous and anyone who still believes that should be seen by a doctor.

    And that doesn’t even bring up the topic of tax havens, which give lie to both ‘efficient markets’ hokum as well as sane accounting rules.

    The EMH needs a stake through its heart; it’s an ideology that gives far too much cover to rentiers, and savages true entrepreneurs.

  8. Nick says:

    Great post. Thanks for sharing, another perspective on high yield bonds.