Rewriting the Rules of the American Economy: An Agenda for Growth and Shared Prosperity
The fundamental truth about American economic growth today is that while the work is done by many, the real rewards largely go to the few. The numbers are, at this point, woefully familiar: the top one percent of earners take home more than 20 percent of the income, and their share has more than doubled in the last thirty-five years. The gains for people in the top 0.1 percent, meanwhile, have been even greater. Yet over that same period, average wages and household incomes in the US have risen only slightly, and a number of demographic groups (like men with only a high school education) have actually seen their average wages decline.
Income inequality has become such an undeniable problem, in fact, that even Republican politicians have taken to decrying its effects. It’s not surprising that a Democrat like Barack Obama would call dealing with inequality “the defining challenge of our time.” But when Jeb Bush’s first big policy speech of 2015 spoke of the frustration that Americans feel at seeing “only a small portion of the population riding the economy’s up escalator,” it was a sign that inequality had simply become too obvious, and too harmful, to be ignored.
Something similar has happened in economics. Historically, inequality was not something that academic economists, at least in the dominant neoclassical tradition, worried much about. Economics was about production and allocation, and the efficient use of scarce resources. It was about increasing the size of the pie, not figuring out how it should be divided. Indeed, for many economists, discussions of equity were seen as perilous, because there was assumed to be a necessary “tradeoff” between efficiency and equity: tinkering with the way the market divided the pie would end up making the pie smaller. As the University of Chicago economist Robert Lucas put it, in an oft-cited quote: “Of the tendencies that are harmful to sound economics, the most seductive, and…the most poisonous, is to focus on questions of distribution.”
Today, the landscape of economic debate has changed. Inequality was at the heart of the most popular economics book in recent memory, the economist Thomas Piketty’s Capital. The work of Piketty and his colleague Emmanuel Saez has been instrumental in documenting the rise of income inequality, not just in the US but around the world. Major economic institutions, like the IMF and the OECD, have published studies arguing that inequality, far from enhancing economic growth, actually damages it. And it’s now easy to find discussions of the subject in academic journals.
All of which makes this an ideal moment for the Columbia economist Joseph Stiglitz. In the years since the financial crisis, Stiglitz has been among the loudest and most influential public intellectuals decrying the costs of inequality, and making the case for how we can use government policy to deal with it. In his 2012 book, The Price of Inequality, and in a series of articles and Op-Eds for Project Syndicate, Vanity Fair, and The New York Times, which have now been collected in The Great Divide, Stiglitz has made the case that the rise in inequality in the US, far from being the natural outcome of market forces, has been profoundly shaped by “our policies and our politics,” with disastrous effects on society and the economy as a whole. In a recent report for the Roosevelt Institute called Rewriting the Rules, Stiglitz has laid out a detailed list of reforms that he argues will make it possible to create “an economy that works for everyone.”
Stiglitz’s emergence as a prominent critic of the current economic order was no surprise. His original Ph.D. thesis was on inequality. And his entire career in academia has been devoted to showing how markets cannot always be counted on to produce ideal results. In a series of enormously important papers, for which he would eventually win the Nobel Prize, Stiglitz showed how imperfections and asymmetries of information regularly lead markets to results that do not maximize welfare. He also argued that this meant, at least in theory, that well-placed government interventions could help correct these market failures. Stiglitz’s work in this field has continued: he has just written (with Bruce Greenwald) Creating a Learning Society, a dense academic work on how government policy can help drive innovation in the age of the knowledge economy.
Stiglitz served as chairman of the Council of Economic Advisers in the Clinton administration, and then was the chief economist at the World Bank during the Asian financial crisis of the late 1990s. His experience there convinced him of the folly of much of the advice that Western economists had given developing countries, and in books like Globalization and Its Discontents (2002) he offered up a stinging critique of the way the US has tried to manage globalization, a critique that made him a cult hero in much of the developing world. In a similar vein, Stiglitz has been one of the fiercest critics of the way the Eurozone has handled the Greek debt crisis, arguing that the so-called troika’s ideological commitment to austerity and its opposition to serious debt relief have deepened Greece’s economic woes and raised the prospect that that country could face “depression without end.” For Stiglitz, the fight over Greece’s future isn’t just about the right policy. It’s also about “ideology and power.” That perspective has also been crucial to his work on inequality.
The Great Divide presents that work in Stiglitz’s most popular—and most populist—voice. While Piketty’s Capital is written in a cool, dispassionate tone, The Great Divide is clearly intended as a political intervention, and its tone is often impassioned and angry. As a collection of columns, The Great Divide is somewhat fragmented and repetitive, but it has a clear thesis, namely that inequality in the US is not an unfortunate by-product of a well-functioning economy. Instead, the enormous riches at the top of the income ladder are largely the result of the ability of the one percent to manipulate markets and the political process to their own benefit. (Thus, the title of his best-known Vanity Fair piece: “Of the 1 percent, by the 1 percent, for the 1 percent.”) Soaring inequality is a sign that American capitalism itself has gone woefully wrong. Indeed, Stiglitz argues, what we’re stuck with isn’t really capitalism at all, but rather an “ersatz” version of the system.
Inequality obviously has no single definition. As Stiglitz writes:
There are so many different parts to America’s inequality: the extremes of income and wealth at the top, the hollowing out of the middle, the increase of poverty at the bottom. Each has its own causes, and needs its own remedies.
But in The Great Divide, Stiglitz is mostly interested in one dimension of inequality: the gap between the people at the very top and everyone else. And his analysis of that gap concentrates on the question of why incomes at the top have risen so sharply, rather than why the incomes of everyone else have stagnated. While Stiglitz obviously recognizes the importance of the decline in union power, the impact of globalization on American workers, and the shrinking value of the minimum wage, his preoccupation here is primarily with why the rich today are so much richer than they used to be.
To answer that question, you have to start by recognizing that the rise of high-end incomes in the US is still largely about labor income rather than capital income. Piketty’s book is, as the title suggests, largely about capital: about the way the concentration of wealth tends to reproduce itself, leading to greater and greater inequality. And this is an increasing problem in the US, particularly at the highest reaches of the income spectrum. But the main reason people at the top are so much richer these days than they once were (and so much richer than everyone else) is not that they own so much more capital: it’s that they get paid much more for their work than they once did, while everyone else gets paid about the same, or less. Corporate CEOs, for instance, are paid far more today than they were in the 1970s, while assembly line workers aren’t. And while incomes at the top have risen in countries around the world, nowhere have they risen faster than in the US.
One oft-heard justification of this phenomenon is that the rich get paid so much more because they are creating so much more value than they once did. Globalization and technology have increased the size of the markets that successful companies and individuals (like pop singers or athletes) can reach, so that being a superstar is more valuable than ever. And as companies have gotten bigger, the potential value that CEOs can add has increased as well, driving their pay higher.
Stiglitz will have none of this. He sees the boom in the incomes of the one percent as largely the result of what economists call “rent-seeking.” Most of us think of rent as the payment a landlord gets in exchange for the use of his property. But economists use the word in a broader sense: it’s any excess payment a company or an individual receives because something is keeping competitive forces from driving returns down. So the extra profit a monopolist earns because he faces no competition is a rent. The extra profits that big banks earn because they have the implicit backing of the government, which will bail them out if things go wrong, are a rent. And the extra profits that pharmaceutical companies make because their products are protected by patents are rents as well.
Not all rents are terrible for the economy—in some cases they’re necessary evils. We have patents, for instance, because we think that the costs of granting a temporary monopoly are outweighed by the benefits of the increased innovation that patent protection is supposed to encourage. But rents make the economy less efficient, because they move it away from the ideal of perfect competition, and they make consumers worse off. So from the perspective of the economy as a whole, rent-seeking is a waste of time and energy. As Stiglitz puts it, the economy suffers when “more efforts go into ‘rent seeking’—getting a larger slice of the country’s economic pie—than into enlarging the size of the pie.”
Rents are nothing new—if you go back to the 1950s, many big American corporations faced little competition and enjoyed what amounted to oligopolies. But there’s a good case to be made that the sheer amount of rent-seeking in the US economy has expanded over the years. The number of patents is vastly greater than it once was. Copyright terms have gotten longer. Occupational licensing rules (which protect professionals from competition) are far more common. Tepid antitrust enforcement has led to reduced competition in many industries. Most importantly, the financial industry is now a much bigger part of the US economy than it was in the 1970s, and for Stiglitz, finance profits are, in large part, the result of what he calls “predatory rent-seeking activities,” including the exploitation of uninformed borrowers and investors, the gaming of regulatory schemes, and the taking of risks for which financial institutions don’t bear the full cost (because the government will bail them out if things go wrong).
All this rent-seeking, Stiglitz argues, leaves certain industries, like finance and pharmaceuticals, and certain companies within those industries, with an outsized share of the rewards. And within those companies, the rewards tend to be concentrated as well, thanks to what Stiglitz calls “abuses of corporate governance that lead CEOs to take a disproportionate share of corporate profits” (another form of rent-seeking). In Stiglitz’s view of the economy, then, the people at the top are making so much because they’re in effect collecting a huge stack of rents.
This isn’t just bad in some abstract sense, Stiglitz suggests. It also hurts society and the economy. It erodes America’s “sense of identity, in which fair play, equality of opportunity, and a sense of community are so important.” It alienates people from the system. And it makes the rich, who are obviously politically influential, less likely to support government investment in public goods (like education and infrastructure) because those goods have little impact on their lives. (The one percent are, in fact, more likely than the general public to support cutting spending on things like schools and highways.)
More interestingly (and more contentiously), Stiglitz argues that inequality does serious damage to economic growth: the more unequal a country becomes, the slower it’s likely to grow. He argues that inequality hurts demand, because rich people consume less of their incomes. It leads to excessive debt, because people feel the need to borrow to make up for their stagnant incomes and keep up with the Joneses. And it promotes financial instability, as central banks try to make up for stagnant incomes by inflating bubbles, which eventually burst. (Consider, for instance, the toleration, and even promotion, of the housing bubble by Alan Greenspan when he was chairman of the Fed.) So an unequal economy is less robust, productive, and stable than it otherwise would be. More equality, then, can actually lead to more efficiency, not less. As Stiglitz writes, “Looking out for the other guy isn’t just good for the soul—it’s good for business.”
This explanation of both the rise in inequality and its consequences is quite neat, if also bleak. But it’s also, it has to be said, oversimplified. Take the question, for instance, of whether inequality really is bad for economic growth. It certainly seems plausible that it would be, and there are a number of studies that suggest it is. Yet exactly why inequality is bad for growth turns out to be hard to pin down—different studies often point to different culprits. And when you look at cross-country comparisons, it turns out to be difficult to prove that there’s a direct connection between inequality and the particular negative factors that Stiglitz cites. Among developed countries, more unequal ones don’t, as a rule, have lower levels of consumption or higher levels of debt, and financial crises seem to afflict both unequal countries, like the US, and more egalitarian ones, like Sweden.
This doesn’t mean that, as conservative economists once insisted, inequality is good for economic growth. In fact, it’s clear that US-style inequality does not help economies grow faster, and that moving toward more equality will not do any damage. We just can’t yet say for certain that it will give the economy a big boost.
Similarly, Stiglitz’s relentless focus on rent-seeking as an explanation of just why the rich have gotten so much richer makes a messy, complicated problem simpler than it is. To some degree, he acknowledges this: in The Price of Inequality, he writes, “Of course, not all the inequality in our society is the result of rent seeking…. Markets matter, as do social forces….” Yet he doesn’t really say much about either of those in The Great Divide. It’s unquestionably true that rent-seeking is an important part of the rise of the one percent. But it’s really only part of the story.
When we talk about the one percent, we’re talking about two groups of people above all: corporate executives and what are called “financial professionals” (these include people who work for banks and the like, but also money managers, financial advisers, and so on). These are the people that Piketty terms “supermanagers,” and he estimates that together they account for over half of the people in the one percent.
The emblematic figures here are corporate CEOs, whose pay rose 876 percent between 1978 and 2012, and hedge fund managers, some of whom now routinely earn billions of dollars a year. As one famous statistic has it, last year the top twenty-five hedge fund managers together earned more than all the kindergarten teachers in America did.
Stiglitz wants to attribute this extraordinary rise in CEO pay, and the absurd amounts of money that asset managers make, to the lack of good regulation. CEOs, in his account, are exploiting deficiencies in corporate governance—supine boards and powerless shareholders—to exploit shareholders and “appropriate for themselves firm revenues.” Money managers, meanwhile, are exploiting the ignorance of investors, reaping the benefits of what Stiglitz calls “uncompetitive and often undisclosed fees” to ensure that they get paid well even when they underperform.
The idea that high CEO pay is ultimately due to poor corporate governance is a commonplace, and certainly there are many companies where the relationship between the CEO and the board of directors (which in theory is supposed to be supervising him) is too cozy. Yet as an explanation for why CEOs get paid so much more today than they once did, Stiglitz’s argument is unsatisfying. After all, back in the 1960s and 1970s, when CEOs were paid much less, corporate governance was, by any measure, considerably worse than it is today, not better. As one recent study put it:
Corporate boards were predominately made up of insiders…or friends of the CEO from the “old boys’ network.” These directors had a largely advisory role, and would rarely overturn or even mount major challenges to CEO decisions.
Shareholders, meanwhile, had fewer rights and were less active. Since then, we’ve seen a host of reforms that have given shareholders more power and made boards more diverse and independent. If CEO compensation were primarily the result of bad corporate governance, these changes should have had at least some effect. They haven’t. In fact, CEO pay has continued to rise at a brisk rate.
It’s possible, of course, that further reform of corporate governance (like giving shareholders the ability to cast a binding vote on CEO pay packages) will change this dynamic, but it seems unlikely. After all, companies with private owners—who have total control over how much to pay their executives—pay their CEOs absurd salaries, too. And CEOs who come into a company from outside—meaning that they have no sway at all over the board—actually get paid more than inside candidates, not less. Since 2010, shareholders have been able to show their approval or disapproval of CEO pay packages by casting nonbinding “say on pay” votes. Almost all of those packages have been approved by large margins. (This year, for instance, these packages were supported, on average, by 95 percent of the votes cast.)
Similarly, while money managers do reap the benefits of opaque and overpriced fees for their advice and management of portfolios, particularly when dealing with ordinary investors (who sometimes don’t understand what they’re paying for), it’s hard to make the case that this is why they’re so much richer than they used to be. In the first place, opaque as they are, fees are actually easier to understand than they once were, and money managers face considerably more competition than before, particularly from low-cost index funds. And when it comes to hedge fund managers, their fee structure hasn’t changed much over the years, and their clients are typically reasonably sophisticated investors. It seems improbable that hedge fund managers have somehow gotten better at fooling their clients with “uncompetitive and often undisclosed fees.”
So what’s really going on? Something much simpler: asset managers are just managing much more money than they used to, because there’s much more capital in the markets than there once was. As recently as 1990, hedge funds managed a total of $38.9 billion. Today, it’s closer to $3 trillion. Mutual funds in the US had $1.6 trillion in assets in 1992. Today, it’s more than $16 trillion. And that means that an asset manager today can get paid far better than an asset manager was twenty years ago, even without doing a better job.
This doesn’t mean that asset managers or corporate executives “deserve” what they earn. In fact, there’s no convincing evidence that CEOs are any better, in relative terms, than they once were, and plenty of evidence that they are paid more than they need to be, in view of their performance. Similarly, asset managers haven’t gotten better at beating the market. The point, though, is that attributing the rise in their pay to corruption, or bad rules, doesn’t get us that far. More important, probably, has been the rise of ideological assumptions about the indispensability of CEOs, and changes in social norms that made it seem like executives should take whatever they could get. (Stiglitz alludes to these in The Price of Inequality, writing, “Norms of what was ‘fair’ changed, too.”) Discussions of shifts in norms often become what the economist Robert Solow once called a “blaze of amateur sociology.” But that doesn’t mean we can afford to ignore those shifts, either, since the rise of the one percent has been propelled by ideological changes as much as by economic or regulatory ones.
Complicating Stiglitz’s account of the rise of the one percent is not just an intellectual exercise. It actually has important consequences for thinking about how we can best deal with inequality. Strategies for reducing inequality can be generally put into two categories: those that try to improve the pretax distribution of income (this is sometimes called, clunkily, predistribution) and those that use taxes and transfers to change the post-tax distribution of income (this is what we usually think of as redistribution). Increasing the minimum wage is an example of predistribution. Medicaid is redistribution.
Stiglitz’s agenda for policy—which is sketched in The Great Divide, and laid out in comprehensive detail in Rewriting the Rules—relies on both kinds of strategies, but he has high hopes that better rules, designed to curb rent-seeking, will have a meaningful impact on the pretax distribution of income. Among other things, he wants much tighter regulation of the financial sector. He wants to loosen intellectual property restrictions (which will reduce the value of patents), and have the government aggressively enforce antitrust laws. He wants to reform corporate governance so CEOs have less influence over corporate boards and shareholders have more say over CEO pay. He wants to limit tax breaks that encourage the use of stock options. And he wants asset managers to “publicly disclose holdings, returns, and fee structures.” In addition to bringing down the income of the wealthiest Americans, he advocates measures like a higher minimum wage and laws encouraging stronger unions, to raise the income of ordinary Americans (though this is not the main focus of The Great Divide).
These are almost all excellent suggestions. And were they enacted, some—including above all tighter regulation of the financial industry—would have an impact on corporate rents and inequality. But it would be surprising if these rules did all that much to shrink the income of much of the one percent, precisely because improvements in corporate governance and asset managers’ transparency are likely to have a limited effect on CEO salaries and money managers’ compensation.
This is not a counsel of despair, though. In the first place, these rules would be good things for the economy as a whole, making it more efficient and competitive. More important, the second half of Stiglitz’s agenda—redistribution via taxes and transfers—remains a tremendously powerful tool for dealing with inequality. After all, while pretax inequality is a problem in its own right, what’s most destructive is soaring posttax inequality. And it’s posttax inequality that most distinguishes the US from other developed countries. As Stiglitz writes:
Some other countries have as much, or almost as much, before-tax and transfer inequality; but those countries that have allowed market forces to play out in this way then trim back the inequality through taxes and transfer and the provision of public services.
The redistributive policies Stiglitz advocates look pretty much like what you’d expect. On the tax front, he wants to raise taxes on the highest earners and on capital gains, institute a carbon tax and a financial transactions tax, and cut corporate subsidies. But dealing with inequality isn’t just about taxation. It’s also about investing. As he puts it, “If we spent more on education, health, and infrastructure, we would strengthen our economy, now and in the future.” So he wants more investment in schools, infrastructure, and basic research.
If you’re a free-market fundamentalist, this sounds disastrous—a recipe for taking money away from the job creators and giving it to government, which will just waste it on bridges to nowhere. But here is where Stiglitz’s academic work and his political perspective intersect most clearly. The core insight of Stiglitz’s research has been that, left on their own, markets are not perfect, and that smart policy can nudge them in better directions.
Indeed, Creating a Learning Society is dedicated to showing how developing countries can use government policy to become high-growth, knowledge- intensive economies, rather than remaining low-cost producers of commodities. What this means for the future of the US is only suggestive, but Stiglitz argues that it means the government should play a major role in the ongoing “structural transformation” of the economy.
Of course, the political challenge in doing any of this (let alone all of it) is immense, in part because inequality makes it harder to fix inequality. And even for progressives, the very familiarity of the tax-and-transfer agenda may make it seem less appealing. After all, the policies that Stiglitz is calling for are, in their essence, not much different from the policies that shaped the US in the postwar era: high marginal tax rates on the rich and meaningful investment in public infrastructure, education, and technology. Yet there’s a reason people have never stopped pushing for those policies: they worked. And as Stiglitz writes, “Just because you’ve heard it before doesn’t mean we shouldn’t try it again.”