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Rising Economic Inequality in America: Its Causes and Consequences, Part 1

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Even though the United States has the largest total gross domestic product (GDP) in the world, this does not guarantee the highest level of social wellbeing that is believed to depend primarily on economic equality nor does the GDP address the income distribution issue . Income inequality in the U.S. is rampant and counterproductive. It is an economic problem that has been in the making for over the last three decades, since 1980. Many researchers have observed a parallel between income concentration before the Great Depression of 1929 and income inequality before the 2008 recession (see chart below ). Accordingly, they have blamed excessive inequality as the principal source of 2008 Great Recession and the lackluster recovery afterward. Left untreated, inequality may force the U.S. economy into another tailspin; this is according to many leading economists, some of whom consider it to be not only an economic dilemma but also a political problem. "Inequality is cause and consequence of the failure of the political system and it contributes to the instability of our economic system" says Dr Joseph Stiglitz. In his newly published book, The Price of Inequality.

Dr. Joseph Stiglitz, a Nobel Prize-winning economist, offers an in-depth examination of the causes and the consequences of income/wealth inequality in America in this book. He begins with an allusion to the popular uprisings in a few countries that were similar to the Occupy Movement in the U.S. The occupiers rightfully realized that there was something deeply wrong with the political and the economic system, that capitalism is no longer a fair game, that government is no longer serious about the plight of 99% of the population, that excessive greed is derailing capitalism from its rightful path, and that we are no longer in it together. Further inquiry shows that inequality in the United States, as measured by the income gap between the haves and have-nots , is not subsiding; rather, it is on the rise. According to the author, the top 1% of income earners is steadily getting a larger and larger share of the national income and wealth. "By 2007, the year before the crisis, the top 0.1 percent of America's households had an income that was 220 times larger than the average of the bottom 90 percent" (p. 2). In addition, the top 1% has managed to acquire more than 93% of the additional income generated by the U.S. economy in 2010, leaving only 7% for the rest of us. Before 1980, income distribution was more equal, it has gotten worse since then, thanks to insufficient government policy and the symbiotic ties between the rich and the politicians. The author claims that historical evidence does not show that greater equality is an obstacle to economic growth; instead it may well be a major contributor to it. For example, during many years after World War II, the U.S. economy grew at a much healthier rate while the income distribution was more evenhanded. The key reason for this greater equality was partially the growth-oriented, pro-middle class, government policies that not only stimulated the economy but also improved the access to public education and other vital public services.

Throughout his book, Dr. Stiglitz maintains that market forces do not bring about equality; government and other factors play a role when it comes to income distribution. Unfortunately, during the years prior to the Great Recession, government did not do much to assuage economic inequality because to do so seemed be costly economically and politically. Consequently, not only inequality persisted but also uneven access to the outcome of economic prosperity. Dr. Stiglitz explains in detail how the top 1% of the population continues to cunningly grab a bigger slice of the national output. Accordingly, inequality in the United States has been increasing not only in absolute terms but also in relative terms. Compared to other countries, the United States is "approaching the limit of inequality that marks dysfunctional societies--it is a club that we would distinctly not want to join, including Iran, Jamaica, Uganda, and the Philippines" (p. 22).   A well-known measure of income inequality is the Gini coefficient; the closer this number is to 1, the higher the level of income inequality. This coefficient has been deteriorating for the United States in recent decades and is presently at 0.47, up from 0.4 in the early 1980s.

First and foremost, the author talks about the fatal consequences of excessive income inequality which include: economic and political polarization, meager economic growth, diminution of the middle class, insecurity, declining standard of living, and particularly the growth of poverty rate--currently at more than 15% according to the U.S. Census Bureau. Increasing poverty leads to further inequality because of the inadequate access to good education by the children of the poor and thus their inability to attain gainful employment later in life, creating what the author calls the "poverty trap". Dr. Joseph Stiglitz argues that the American right does not want to even admit the inconvenient truths about inequality. They would like to deny the problematic facts related to income inequality and poverty in the United States. Consequently, they offer retorts such as poverty in America is relative and not real, or the wealthy are job creators and attempts to reverse income distribution through taxation are equivalent to killing the goose that lays the golden eggs. He rightfully reminds us that inequality is more than just an economic problem; it is a social, moral, and political problem so grave now that we have no choice but to confront it. However, we cannot alleviate inequality unless we examine the reasons behind it.

There is a wide range of factors that contribute to income inequality. Historically, income inequality existed even in pre-capitalist societies and was sanctioned by religion, which was protective of the ruling elite. Later, there emerged a popular theory, the marginal productivity theory, which justified income inequality and suggested that "those with higher productivities earned higher incomes that reflected their greater contribution to society" (p. 30). In modern time, however, other factors such as technology and distribution of financial resources also contribute to income inequality. As well, Dr. Stiglitz persistently blames certain government policies as being a leading cause of income inequality in the United States; among these are the "programs that give away the country's resources to the rich and well-connected increase the inequality" (p. 31). He argues that our political system is controlled by big corporations that have the power to shape or change the rules of the game in their favor thus creating a situation in which rent seeking becomes a way of life for the rich. Economists describe rent seeking as an attempt by certain individuals or corporations to gain a larger and larger share of national income without proper contribution to the economy. In other words, becoming wealthy not by creating wealth but by taking it away from others. The rent seeking ability of the rich, which is sanctioned by politicians, is mainly responsible for continuation of inequality according to the author.

Rent seeking is also facilitated by monopoly power. Under the competitive market, there is neither sustained abnormal profit nor an ability to extract the consumer surplus. Thus, economic profit approaches zero in the long run and the return moves toward the normal level according to economic theory. Monopoly, however, can exploit consumers by controlling supply and prices, by circumventing anti-monopoly laws and regulations, and making its business complicated and less transparent. As an example, commercial banks can make loan contracts so complicated that ordinary borrowers have no way to fully find out if they are getting a good deal. One of the most egregious f orms of rent seeking "has been that ability of those in the financial sector to take advantage of the poor and uninformed, as they made enormous amounts of money by preying upon those groups with predatory lending and abusive credit card practices" (p. 37). In modern time, a new kind of phenomenon is strengthening the monopoly power; this is called network externalities. Good examples of this are the computer operating system and the cell phone. The super interconnectedness across the globe has necessitated standardization that further brings economic power to those having control over the standards and the technology. Government has also facilitated rent seeking through protectionist policies such as imposing barriers to market entry, imposing tariffs against imports, by regulatory forbearance, and by granting too many patent rights. Dr. Stiglitz argues that even though such policies are intended to promote innovations, researches and creativity, or serve other useful purposes, they also increase rent seeking.

Likewise, giving country's natural resources to wealthy corporations at a minuscule price reinforces rent seeking so does the asymmetric information problem. For instance, prior to the recent financial crisis, a number of   financial institutions created and sold securities they knew were risky and would fail; however, they withheld this crucial information from investors. He argues that government, knowingly or unknowingly, strengthen rent seeking scheme by handing cash to companies like pharmaceutical companies through the Medicare drug benefit. "A provision in the law that prohibited government from bargaining for prices on drugs was, in effect, a gift of some $50 billion or more per year to pharmaceutical companies" (p. 49). Similarly, when the Federal Reserve lends money to commercial banks at an almost zero percent interest rate, this allows banks to profit handsomely from free money. The same holds true for generous subsidies extended to a number of other industries. "Sadly, government munificence does not end with a few examples we have given, but to describe each and every instances of government approved rent seeking would require another book" (p. 51). The author claims that the United States differs from other countries at a similar stage of economic development when it comes to income and wealth distribution simply because its market forces are shaped by a political process that is protective of the rich. Rich companies are also able to win by changing the rules of the game to suit their purpose. "They use their political influence to get people appointed to the regulatory agencies who are sympathetic to their perspectives" (p. 47).

In addition to government, there are some other forces that contribute to inequality; these include discrimination in various forms, globalization, and advancing technology. Mismanaged globalization benefits only certain corporations and the increased use of technology leads to elimination of low-skilled jobs. As the supply of unskilled workers increases, their wage rates keep falling causing wage disparity and exacerbating inequality. Too, technology has increased the availability of advanced capital tools and higher productivity of labor, especially in the manufacturing sector. Thus, business firms can produce a given amount of output with a smaller number of workers giving rise to higher unemployment and lower overall wage rates. Unemployed workers may not be able find jobs because their inadequate education and lack of progressive skills make them unemployable in modern industries. Again, government could play a positive role in ameliorating the situation. "The most important role of government, however, is setting the basic rules of the game, through laws such as those that encourage or discourage unionization, corporate governance laws that determine the discretion of management, and competition laws that should limit the extent of monopoly rents" (p. 57). Globalization has not helped either since the increased competition in the labor market has stripped workers of their bargaining power. Frictionless mobility of capital resources and labor throughout the world has created circumstances in which the wage rate for ordinary workers continues to deteriorate. Dr. Stiglitz argues that globalization has neither increased the overall output of countries nor facilitated an even distribution of dividends of liberalized international trade. "In effect, globalization hurts those at the bottom not only directly but also indirectly because of the induced cutbacks in social expenditures and progressive taxation" (p. 63). In a nutshell, globalization has led to further inequality and unleveled playing fields.

Meanwhile, despite dwindling wage rates for ordinary workers, top corporate managers have been able to seize a larger share of corporate earnings thanks to the flawed corporate governance system. According to the Economic Policy Institute, the ratio of CEO pay to the average worker wage rate was 231 times greater for about 350 of the largest corporations in the U.S. in 2011. Even after all the post Great Recession backlash and public outcry against high CEO pay, it still remained high--$9.6 million in 2011 according to a report by Associated Press. Between 1990 and 2005, the cumulative surge in average CEO pay was nearly 300%, while corporate profit rose by only 106% and the average wage rate for workers rose by only 4.3% during the same period.

Discrimination is another source of inequality in the United States. Despite the significant strides made in fighting discrimination, it still persists not only overtly but also implicitly in its new form. Especially after the Great Recession, discrimination has intensified against defenseless minorities who are usually easier targets of unfair treatments; the same is true for low-income borrowers. Prior to the Great Recession era, "the banks saw them as easy targets, because they had aspiration of upward mobility; owning a home was a sign that they   were making it into America's middle class" (p. 70). Unfortunately, however, they lost massively after the price bubble burst in the housing market which resulted in the loss of their savings, especially in African American households.

Government not only did not do enough to reverse the course of deteriorating income distribution, it even contributed to it by requiring a lesser amount in taxes from the top income earners as well as lowering the tax rate on capital gains. "The top marginal tax rate was lowered from 70% under Carter to 28% under Reagan: it went up to 39.6% under Clinton and down finally to 35% under George W. Bush" (p. 71). Given that the rich gain a major share of their income through capital gains, 57% currently, a lower tax on capital gains provides them with significant benefits. "Lowering the tax on capital gains from the ordinary rate of 35% to 15% thus gave each of these 400 [highest-income individuals], on average, a gift of $30 million in 2008 and $45 million in 2007 and lowered overall tax revenues by $12 billion in 2008 and $18 billion in 2007" (p. 72). In addition, the "loopholes and special provisions have eviscerated the [income] tax to such a degree that it has gone from providing 30% of federal revenues in mid-1950s to less than 9% today" (p. 73). The existence of such loopholes enables the rich to minimize their tax liabilities especially by hiring skilled tax lawyers.  

Part 2 soon


Reza Varjavand (Ph.D., University of Oklahoma) is associate professor of economics and finance at the Graham School of management, Saint Xavier University, of Chicago. He has been an avid participant in many professional organizations and active in (more...)
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See Second Incomes at http://www.aesopinstitute.or... by Mark Goldes on Thursday, Jan 24, 2013 at 2:20:30 PM
This is the chart I referred to at the beginning o... by Reza varjavand on Friday, Jan 25, 2013 at 7:41:33 AM
This is an excellent review of Dr... by Seymour Patterson on Friday, Jan 25, 2013 at 8:34:20 AM