Back in 1991, in what now seems like a far more innocent time, Robert Reich published an influential book titled The Work of Nations, which among other things helped land him a cabinet post in the Clinton administration. It was a good book for its time—but time has moved on. And the gap between that relatively sunny take and Reich’s latest, Saving Capitalism, is itself an indicator of the unpleasant ways America has changed.
The Work of Nations was in some ways a groundbreaking work, because it focused squarely on the issue of rising inequality—an issue some economists, myself included, were already taking seriously, but that was not yet central to political discourse. Reich’s book saw inequality largely as a technical problem, with a technocratic, win-win solution. That was then. These days, Reich offers a much darker vision, and what is in effect a call for class war—or if you like, for an uprising of workers against the quiet class war that America’s oligarchy has been waging for decades.
To understand the difference between The Work of Nations and Saving Capitalism, you need to know about two things. One, which is familiar to most of us, is the increasingly ugly turn taken by American politics, which I’ll be discussing later. The other is more of an insider debate, but one with huge implications for policy and politics alike: the rise and fall of the theory of skill-biased technological change, which was once so widely accepted among economists that it was frequently referred to simply as SBTC.
The starting point for SBTC was the observation that, around 1980, wages of college graduates began rising much more rapidly than wages of Americans with only a high school degree or less. Why?
One possibility was the growth of international trade, with rising imports of labor-intensive manufactured goods from low-wage countries. Such imports could, in principle, cause not just rising inequality but an actual decline in the wages of less-educated workers; the standard theory of international trade that supports such a principle is actually a lot less benign in its implications than many noneconomists imagine. But the numbers didn’t seem to work. Around 1990, trade with developing countries was still too small to explain the big movements in relative wages of college and high school graduates that had already happened. Furthermore, trade should have produced a shift in employment toward more skill-intensive industries; it couldn’t explain what we actually saw, which was a rise in the level of skills within industries, extending across pretty much the entire economy.
Many economists therefore turned to a different explanation: it was all about technology, and in particular the information technology revolution. Modern technology, or so it was claimed, reduced the need for routine manual labor while increasing the demand for conceptual work. And while the average education level was rising, it wasn’t rising fast enough to keep up with this technological shift. Hence the rise of the earnings of the college-educated and the relative, and perhaps absolute, decline in earnings for those without the right skills.
This view was never grounded in direct evidence that technology was the driving force behind wage changes; the technology factor was only inferred from its assumed effects. But it was expressed in a number of technical papers brandishing equations and data, and was codified in particular in a widely cited 1992 paper by Lawrence F. Katz of Harvard and Kevin M. Murphy of the University of Chicago.1 Reich’s The Work of Nations was, in part, a popularization of SBTC, using vivid language to connect abstract economic formalism to commonplace observation. In Reich’s vision, technology was eliminating routine work, and even replacing some jobs that historically required face-to-face interaction. But it was opening new opportunities for “symbolic analysts”—people with the talent and, crucially, the training to work with ideas. Reich’s solution to growing inequality was to equip more people with that necessary training, both through an expansion of conventional education and through retraining later in life.
It was an attractive, optimistic vision; you can see why it received such a favorable reception. But while one still encounters people invoking skill-biased technological change as an explanation of rising inequality and lagging wages—it’s especially popular among moderate Republicans in denial about what’s happened to their party and among “third way” types lamenting the rise of Democratic populism—the truth is that SBTC has fared very badly over the past quarter-century, to the point where it no longer deserves to be taken seriously as an account of what ails us.
The story fell apart in stages.2 First, over the course of the 1990s the skill gap stopped growing at the bottom of the scale: real wages of workers near the middle stopped outpacing those near the bottom, and even began to fall a bit behind. Some economists responded by revising the theory, claiming that technology was hollowing out the middle rather than displacing the bottom. But this had the feel of an epicycle added to a troubled theory—and after about 2000 the real wages of college graduates stopped rising as well. Meanwhile, incomes at the very top—the one percent, and even more so a very tiny group within the one percent—continued to soar. And this divergence evidently had little to do with education, since hedge fund managers and high school teachers have similar levels of formal training.
Something else began happening after 2000: labor in general began losing ground relative to capital. After decades of stability, the share of national income going to employee compensation began dropping fairly fast. One could try to explain this, too, with technology—maybe robots were displacing all workers, not just the less educated. But this story ran into multiple problems. For one thing, if we were experiencing a robot-driven technological revolution, why did productivity growth seem to be slowing, not accelerating? For another, if it was getting easier to replace workers with machines, we should have seen a rise in business investment as corporations raced to take advantage of the new opportunities; we didn’t, and in fact corporations have increasingly been parking their profits in banks or using them to buy back stocks.
In short, a technological account of rising inequality is looking ever less plausible, and the notion that increasing workers’ skills can reverse the trend is looking less plausible still. But in that case, what is going on?
Economists struggling to make sense of economic polarization are, increasingly, talking not about technology but about power. This may sound like straying off the reservation—aren’t economists supposed to focus only on the invisible hand of the market?—but there is actually a long tradition of economic concern about “market power,” aka the effect of monopoly. True, such concerns were deemphasized for several generations, but they’re making a comeback—and one way to read Robert Reich’s new book is in part as a popularization of the new view, just as The Work of Nations was in part a popularization of SBTC. There’s more to Reich’s thesis, as I’ll explain shortly. But let’s start with the material that economists will find easiest to agree with.
Market power has a precise definition: it’s what happens whenever individual economic actors are able to affect the prices they receive or pay, as opposed to facing prices determined anonymously by the invisible hand. Monopolists get to set the price of their product; monopsonists—sole purchasers in a market—get to set the price of things they buy. Oligopoly, where there are a few sellers, is more complicated than monopoly, but also involves substantial market power. And here’s the thing: it’s obvious to the naked eye that our economy consists much more of monopolies and oligopolists than it does of the atomistic, price-taking competitors economists often envision.
But how much does that matter? Milton Friedman, in a deeply influential 1953 essay, argued that monopoly mattered only to the extent that actual market behavior differed from the predictions of simple supply-and-demand analysis—and that in fact there was little evidence that monopoly had important effects.3 Friedman’s view largely prevailed within the economics profession, and de facto in the wider political discussion. While monopoly never vanished from the textbooks, and antitrust laws remained part of the policy arsenal, both have faded in influence since the 1950s.
It’s increasingly clear, however, that this was both an intellectual and a policy error. There’s growing evidence that market power does indeed have large implications for economic behavior—and that the failure to pursue antitrust regulation vigorously has been a major reason for the disturbing trends in the economy.
Reich illustrates the role of monopoly with well-chosen examples, starting with the case of broadband. As he notes, most Americans seeking Internet access are more or less at the mercy of their local cable company; the result is that broadband is both slower and far more expensive in the US than in other countries. Another striking example involves agriculture, usually considered the very model of a perfectly competitive sector. As he notes, a single company, Monsanto, now dominates much of the sector as the sole supplier of genetically modified soybeans and corn. A recent article in The American Prospect points out that other examples of such dominance are easy to find, ranging from sunglasses to syringes to cat food.4
There’s also statistical evidence for a rising role of monopoly power. Recent work by Jason Furman, chairman of the Council of Economic Advisers, and Peter Orszag, former head of the Office of Management and Budget, shows a rising number of firms earning “super-normal” returns—that is, they have persistently high profit rates that don’t seem to be diminished by competition.5
Other evidence points indirectly to a strong role of market power. At this point, for example, there is an extensive empirical literature on the effects of changes in the minimum wage. Conventional supply-and-demand analysis says that raising the minimum wage should reduce employment, but as Reich notes, we now have a number of what amount to controlled experiments, in which employment in counties whose states have hiked the minimum wage can be compared with employment in neighboring counties across the state line. And there is no hint in the data of the supposed negative employment effect.
Why not? One leading hypothesis is that firms employing low-wage workers—such as fast-food chains—have significant monopsony power in the labor market; that is, they are the principal purchasers of low-wage labor in a particular job market. And a monopsonist facing a price floor doesn’t necessarily buy less, just as a monopolist facing a price ceiling doesn’t necessarily sell less and may sell more.
Suppose that we hypothesize that rising market power, rather than the ineluctable logic of modern technology, is driving the rise in inequality. How does this help make sense of what we see?
Part of the answer is that it resolves some of the puzzles posed by other accounts. Notably, it explains why high profits aren’t spurring high investment. Consider those monopolies controlling local Internet service: their high profits don’t act as an incentive to invest in faster connections—on the contrary, they have less incentive to improve service than they would if they faced more competition and earned lower profits. Extend this logic to the economy as a whole, and the combination of a rising profit share and weak investment starts to make sense.
Furthermore, focusing on market power helps explain why the big turn toward income inequality seems to coincide with political shifts, in particular the sharp right turn in American politics. For the extent to which corporations are able to exercise market power is, in large part, determined by political decisions. And this ties the issue of market power to that of political power.
Robert Reich has never shied away from big ambitions. The title of The Work of Nations deliberately alluded to Adam Smith; Reich clearly hoped that readers would see his work not simply as a useful guide but as a foundational text. Saving Capitalism is, if anything, even more ambitious despite its compact length. Reich attempts to cast his new discussion of inequality as a fundamental rethinking of market economics. He is not, he insists, calling for policies that will limit and soften the functioning of markets; rather, he says that the very definition of free markets is a political decision, and that we could run things very differently. “Government doesn’t ‘intrude’ on the ‘free market.’ It creates the market.”
To be honest, I have mixed feelings about this sales pitch. In some ways it seems to concede too much, accepting the orthodoxy that free markets are good even while calling for major changes in policy. And I also worry that the attempt to squeeze everything into a grand intellectual scheme may distract from the prosaic but important policy actions that Reich (and I) support.
Whatever one thinks of the packaging, however, Reich makes a very good case that widening inequality largely reflects political decisions that could have gone in very different directions. The rise in market power reflects a turn away from antitrust laws that looks less and less justified by outcomes, and in some cases the rise in market power is the result of the raw exercise of political clout to prevent policies that would limit monopolies—for example, the sustained and successful campaign to prevent public provision of Internet access.
Similarly, when we look at the extraordinary incomes accruing to a few people in the financial sector, we need to realize that there are real questions about whether those incomes are “earned.” As Reich argues, there’s good reason to believe that high profits at some financial firms largely reflect insider trading that we’ve made a political decision not to regulate effectively. And we also need to realize that the growth of finance reflected political decisions that deregulated banking and failed to regulate newer financial activities.
Meanwhile, forms of market power that benefit large numbers of workers as opposed to small numbers of plutocrats have declined, again thanks in large part to political decisions. We tend to think of the drastic decline in unions as an inevitable consequence of technological change and globalization, but one need look no further than Canada to see that this isn’t true. Once upon a time, around a third of workers in both the US and Canada were union members; today, US unionization is down to 11 percent, while it’s still 27 percent north of the border. The difference was politics: US policy turned hostile toward unions in the 1980s, while Canadian policy didn’t follow suit. And the decline in unions seems to have major impacts beyond the direct effect on members’ wages: researchers at the International Monetary Fund have found a close association between falling unionization and a rising share of income going to the top one percent, suggesting that a strong union movement helps limit the forces causing high concentration of income at the top.6
Following his schema, Reich argues that unions aren’t so much a source of market power as an example of “countervailing power” (a term he borrows from John Kenneth Galbraith) that limits the depredations of monopolists and others. If unions are not subject to restrictions, they may do so by collective bargaining not only for wages but for working conditions. In any case, the causes and consequences of union decline, like the causes and consequences of rising monopoly power, are a very good illustration of the role of politics in increasing inequality.
But why has politics gone in this direction? Like a number of other commentators, Reich argues that there’s a feedback loop between political and market power. Rising wealth at the top buys growing political influence, via campaign contributions, lobbying, and the rewards of the revolving door. Political influence in turn is used to rewrite the rules of the game—antitrust laws, deregulation, changes in contract law, union-busting—in a way that reinforces income concentration. The result is a sort of spiral, a vicious circle of oligarchy. That, Reich suggests, is the story of America over the past generation. And I’m afraid that he’s right. So what can turn it around?
Anyone hoping for a reversal of the spiral of inequality has to answer two questions. First, what policies do you think would do the trick? Second, how would you get the political power to make those policies happen? I don’t think it’s unfair to Robert Reich to say that Saving Capitalism offers only a sketch of an answer to either question.
In his proposals for new policies, Reich calls for a sort of broad portfolio, or maybe a market basket, of changes aimed mainly at “predistribution”—changing the allocation of market income—rather than redistribution. (In Reich’s view, this is seen as altering the predistribution that takes place under current rules.) These changes would include fairly standard liberal ideas like raising the minimum wage, reversing the anti-union bias of labor law and its enforcement, and changing contract law to empower workers to take action against employers and debtors to assert their interests against creditors. Reich would also, in a less orthodox move, seek legislative and other changes that might move corporations back toward what they were a half-century ago: organizations that saw themselves as answering not just to stockholders but to a broader set of “stakeholders,” including workers and customers.
Would such measures be enough? Individually, none of them sounds up to the task. But the experience of the New Deal, which was remarkably successful at creating a middle-class nation—and for that matter the success of the de facto anti–New Deal that has prevailed since the 1970s at creating an oligarchy—suggest that there might be synergistic effects from a program containing all these elements. It’s certainly worth trying.
But how is this supposed to happen politically? Reich professes optimism, citing the growing tendency of politicians in both parties to adopt populist rhetoric. For example, Ted Cruz has criticized the “rich and powerful, those who walk the corridors of power.” But Reich concedes that “the sincerity behind these statements might be questioned.” Indeed. Cruz has proposed large tax cuts that would force large cuts in social spending—and those tax cuts would deliver around 60 percent of their gains to the top one percent of the income distribution. He is definitely not putting his money—or, rather, your money—where his mouth is.
Still, Reich argues that the insincerity doesn’t matter, because the very fact that people like Cruz feel the need to say such things indicates a sea change in public opinion. And this change in public opinion, he suggests, will eventually lead to the kind of political change that he, justifiably, seeks. We can only hope he’s right. In the meantime, Saving Capitalism is a very good guide to the state we’re in.
December 17, 2015
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“Changes in Relative Wages, 1963–1987: Supply and Demand Factors,” The Quarterly Journal of Economics, Vol. 107, No. 1 (February 1992). ↩
A good overview of the decline of SBTC is Lawrence Mishel, Heidi Shierholz, and John Schmitt, “Don’t Blame the Robots: Assessing the Job Polarization Explanation of Growing Wage Inequality,” EPI–CEPR working paper, November 2013. ↩
“The Methodology of Positive Economics,” in Essays in Positive Economics (University of Chicago Press, 1953). ↩
David Dayen, “Bring Back Antitrust,” Fall 2015. ↩
Jason Furman and Peter Orszag, “A Firm-Level Perspective on the Role of Rents in the Rise of Inequality,” October 2015, available at www.whitehouse.gov. ↩
Florence Jaumotte and Carolina Osorio Buitron, “Union Power and Inequality,” www.voxeu.org, October 22, 2015. ↩