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Rising Economic Inequality in America: Its Causes and Consequences, Part 2

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Dr. Stiglitz emphasizes that, when it comes to inequality, there are two major myths concocted by the rich: first, the claim that high income is compensation for individuals' bigger contribution to creating wealth and second, the cost of dealing with inequality is too high because it has disincentive effects on investors and the so-called job creators. 

However, both of these claims are misleading at best. While the beneficiaries of the status quo offer no substantiated justifications for these claims, they may have some validity; no one, however, can get rich in isolation. Individuals as well as companies cannot accumulate sizable earnings unless there is a steady, strong demand for their products, especially by the middle class. Moreover, without the well-developed infrastructures and the research projects that are mostly funded by government out of taxpayers' money, it is next to impossible to get rich. In view of that, societal support is essential to the buildup of money and wealth. 

The other refutable argument in defense of income inequality is that inequality is the necessary driver of individuals' resourcefulness, and increasing taxes on the wealthy will have disincentive effects on investment by the rich thus negatively impacting economic growth. However, Dr. Stiglitz disputes that contention as well. He says more, not less, equality is essential for economic progress. No one, of course, expects complete equality; this is neither feasible nor desirable. However, he insists again that inequality is excessive not only in America but also in some other countries around the world. It can no longer be overlooked.  

It is natural for individuals to pursue their self-interest; this is the foundation of capitalism and it should neither be shamed nor be delegitimized. However, self-interest should not be an excuse for greed and for the questionable tactics some people use to exploit others, such as deceitful banking practices and predatory lending. There is no question that such practices lead to even more inequality, as indicated by a number of researchers and observations showing inequality is greater in countries with large, aggressively speculative, and weakly regulated financial sector. Dr. Stiglitz reiterates throughout his book that dealing with income inequality is not the task of the market alone. Unless government implements policies to counteract the market forces that reinforce inequality, any attempts to assuage inequality will not likely succeed. To him, inequality really matters simply because of its costly consequences such as: the loss of efficiency and output, high unemployment, and the loss of tax revenue for government, which results in the loss of public investment that puts social programs in jeopardy. Inequality will also contribute to economic as well as social instability, which may trigger the collapse of the entire political system.

Undoubtedly, high-income people devote a very small portion of their income to consumption, which is the driving force behind economic activity; the lion's share of their income goes toward speculative endeavors, often abroad. This is not going to help the U.S. mainstream economy. Owing to income inequality, the wage share of national income has declined dramatically in the face of rising inequality--more than a half trillion dollars a year according to the author. Not only has the unbalanced tax system contributed to income inequality in the U.S., but also deregulation has played a pivotal role in economic instability that the United States and many other countries have experienced in recent years. Deregulation is the product of our unbridled democracy. "If our democracy worked better, it might have resisted the political demand for deregulation and might have responded to the weaknesses in aggregate demand in ways that enhance sustainable growth rather than creating a bubble.... The irony is that while inequality gives rise to instability, the instability itself gives rise to more inequality" (p. 91).

One of the key points Dr. Stiglitz consistently emphasizes in The Price of Inequality is that public investment confers many more social benefits than private investment. However, the lack of adequate profit and other considerations may discourage private investment in certain areas vital to social welfare. As such, if these kinds of investments are left totally to the private sector, the economy will suffer from underinvestment. To be sure, in modern economies, government-funded researchers are indispensable in such capital-intensive and highly ephemeral areas like high-tech and biotechnology. The inequality, however, may obstruct such investments because the wealthy are reluctant to lend their support. They "don't need to rely on the government for parks or education or medical care or personal security, they can buy all these things for themselves" (p. 93). Inadequate public investment can lead to the decline of education and inadequate access to quality education by the children of middle-class people; upward mobility, which depends on quality education, is no longer within their reach. Inadequate income can also force middle-class parents to spend more time in the workplace and less time supervising and caring for their children, or assisting them with their education.

Dr. Stiglitz reverts relentlessly to the main theme of his book--the increasing power of the rich to rent seek, which refers to the controlling elite who have considerable power to milk the economy and divert money away from ordinary people and into their own coffers. To sustain their dominating position, big companies have hired lobbyists to influence not only the course of politics, but also the laws and regulations enacted by the Congress. "There are more than 3100 lobbyists working for the healthcare industry (nearly 6 for every congressperson), and 2100 lobbyists working for the energy and natural-resources industries. All told, more than $3.2 billion was spent on lobbying in 2011 alone" (p. 95). Rent seeking creates distortionary consequences for the economy in many ways. One example is higher prices because the high cost of lobbying is passed on to the consumers, especially by pharmaceutical companies that are also shielded by the patent system. Rent seeking by big companies often takes different and sometimes strange forms, such as making business transactions or contracts complicated and less transparent so that consumers cannot fully comprehend the terms and conditions and their obligations. Such tactics work well, particularly for banks, mortgage companies, cable TV, credit-card companies, and cell-phone providers, to name a few.  

Assisted by the knowledgeable lawyers they hire, wealthy corporations can use their financial might to change the outcome of not only the market but also the legal system to prolong inequality. The evidence shows that people living in countries having fewer lawyers are economically better off and the country's economy grows faster. The inverse correlation between the number of lawyers and economic growth has been supported by some research (see for example, http://www.csmonitor.com/1994/0215/15081.html ). Dr. Stiglitz claims that "researchers suggest that the main channel through which a high proportion of lawyers in a society hurts the economy is the diversion of talents away from more innovative activities (like engineering and science" (p. 100). Another aspect of this problem is the use of precious resources on frivolous litigations that serve no purpose other than to enrich the corporations and their lawyers. Costly distortions will be created by such litigations, lobbying, and even foreign policy, he adds. "Foreign-policy is, by definition, about the balancing of national interest and national resources. With [the] top 1% in charge and paying no price for wars, the notion of balance and restraints goes out the window. [Thus], there is no limit to the adventures we can undertake: corporations and contractors stand only to gain" (p. 101).

Dr. Stiglitz rightfully makes the critical argument that, if workers feel they are being treated unfairly, it becomes very difficult to motivate them and convince them to work hard for the betterment of the society. Obviously, an effective motivation system is crucial to the efficient functioning of the economy. He argues, however, that the claim of the supporters of incentive pay for CEOs is simply inaccurate because incentive pay is not always necessary to the performance of high-income earners. For instance, "Doctors work to make sure each surgery is their absolute best, for reasons that have little to do with money" (p. 109). There are cases in which incentive pay could produce counterproductive outcomes. We have seen, for example in the financial sector, how bankers and traders engaged in excessive risk-taking simply because they wanted to make more money. Those who really contribute to the welfare and the advancement of society, like scientists and academicians, do not usually work to attain wealth and are not motivated solely by pecuniary rewards.

The costs of inequality extend beyond monetary limits. In the long term, the political system may be in danger of disintegration because of the possible voter upheaval and the conflict between what they have voted for and what politicians actually do. The 2012 reelection of President Obama to a second term presents a lucid example of voters' reaction to such a situation. However, despite the fact that the majority of voters want to see higher taxes levied on the wealthy, Republicans are still refusing to respect the voters' mandate. Yet again, 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 income-tax rate, the most visible metric, has gone from 7% in 1913 to 92% in the 1950s to 28% with the Tax Reform Act of 1986 to 39.6% in the Clinton years to today's [2012] 35%" (WSJ, August 6, 2012). Given that the rich gain a major share of their income through capital gains, about 50% for the top 0.1% of the nation's earners --about 315,000 individuals -- and 60% for the Forbes 400, according to Forbes, 11/20/2011 issue. Dr. Stiglitz believes that a lower tax on capital gains provides the rich with significant benefits "each of these 400 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 tax to such a degree that it has gone from providing 30% of federal revenues in the mid-1950s to less than 9% today" (p. 73). The existence of such loopholes enables the rich to minimize their tax liabilities by hiring skilled tax lawyers.  

Disenfranchised voters are asking themselves whether there is any purpose in voting if their vote does not matter. Such apprehension is, perhaps, the reason behind waning voter turnout in the U.S., especially for national elections. "What is worrying is that those in the 1%, in attempting to claim for themselves an unjust proportion of the benefits of this system, may be willing to destroy the system itself to hold on to what they have" (p. 117).

Our political system, driven by campaign finance and politicians' indebtedness to rich donors, is getting worse as a greater percentage of wealth continues to go to the already rich, enabling them to spend even more money buying politicians and favoritism. But that's not all. "Another part of this puzzle is explained by the bias in perceptions and beliefs--that the top has persuaded those in the middle to see the world in a distorted way, leading them to perceive policies that advance the interest of those at the top are consonant with their own interests" (p. 137). The majority of American citizens have come to realize that they have not duly benefited from the economic prosperity of recent decades, as indicated by their diminishing real income, as indicated by the chart below. They are beginning to sense a political system that is committed to serving the interests of only the wealthy.


Real Income for working ouseholds by Centr for Budget and Policy Priorities

Social and political conflicts and the destruction of good-will capital may arise as a result of public reaction to widening inequality. According to the author, the mistakes made during the George W. Bush administration to engage the United States in two costly wars, one in Iraq and one in Afghanistan, have hurt us dearly. American moral and ethical values and the power of American ideas have consequently been denigrated throughout the world. These wars have served no purpose other than to fatten the coffers of wealthy corporations and defense contractors. "Now our credibility is gone: we are seen to have a political system in which one party tries to disenfranchise the poor, in which money buys politicians and policies that reinforce [party] the inequalities" (p. 143). Albeit still a flaccid economic superpower, America has abdicated its position as the democratic superpower of the world and, if the current economic trends continue, China will unseat the U.S. as the world economic superpower in few years. We seem to have eradicated a system that other countries once envied and strove to emulate. If America wants to keep its democracy and invigorate its global influence, it should restructure its system in earnest.

The privileged elite not only have manipulated our politicians but also force-fed the public with a variety of falsehoods, such as high CEO compensation is linked to their performance, high income is the compensation for individuals' efficiency, and generous subsidies to big companies are needed to encourage creativity, innovation, and life-enhancing research. Worth noting is that government subsidies are also given to undeserving industries such as electronic-like game developers. One among these is Electronic Arts, a California-based company that developed Dead Space2, a game promoted with the advertising slogan: Your Mom Hates Dead Space2! Obviously, the wealthy have a vested interest in and the means to continue framing our beliefs in such a way that their interests will be safeguarded. Even the American legal system has been predisposed to the clout of the affluent. "Growing inequality, combined with a flawed system of campaign finance, risks turning America's legal system into a travesty of justice. Some may still call it the rule of laws, but in today's America the proud claim of 'justice for all' is being replaced by a more modest claim of 'justice for those who can afford it'" (p. 206).

Even the recent vengeful talks over the national budget are about priorities that would protect the interests of the rich and intensify the inequality in America; these include tax cuts for the wealthy, wasteful expenditures on war in Afghanistan, massive military expenditures, and the Medicare drug benefit that prevents government from negotiating prices with drug companies. If implemented, the proposed austerity measures, mainly backed by the Republicans, will further impoverish the poor because these are focused more on slimming down the public programs and less on the cutting of the deficit. "The one percent has captured and distorted the budget debate--using an understandable concern about overspending to provide cover for a program aimed at downsizing the government, an action that would weaken the economy today, lower growth in the future, and most importantly, for the purpose of this book, increase inequality" (p. 237).

Dr. Stiglitz is not diffident in revealing his dissatisfaction with our monetary policies and the Federal Reserve System, which he believes have not helped the bottom 99% of the population. When the U.S. economy is in recession, the Federal Reserve policy of lowering interest rates has not achieved its intended goal of helping average consumers to borrow money and spend more; that has not happened simply because of high unemployment rate, nearly 8% now, and the lack of optimistic expectations on the part of consumers. In recessionary economic conditions, it is a mistake to think that low interest rates will help ordinary people since such policies only help the commercial banks to make more money. Banks can borrow almost interest-free money from the Federal Reserve to give loans to borrowers, or invest it in other opportunities that make hefty profits for them. The author is also reproachful of the removal of essential regulations, such as the Glass-Steagall Act, that was designed to keep commercial banks and their operations safe and sound. "This deregulation had two related consequences, both of which we noted earlier. The first, it led to the increasing financialization of the economy--with all the associated distortions and consequences. Second, it allowed the banks to exploit the rest of the society--through predatory lending, abusive credit-card fees, and other practices" (p. 246). Given the fact that high-risk financial products such as derivatives played a central role in the financial crisis, the Federal Reserve should have established tougher regulations with respect to commercial banks and their involvement in such risky trades. However, not enough was done to address this issue.  

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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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Inequality can be dramatically reduced by adopting... by Mark Goldes on Sunday, Mar 17, 2013 at 6:03:26 PM
   The lesson that "Amassing w... by George Flower on Monday, Mar 18, 2013 at 1:13:12 AM
This review provides a tour de force account of th... by Seymour Patterson on Monday, Mar 18, 2013 at 7:41:14 AM
Nothing will get done with the current crop of leg... by John Rachel on Monday, Mar 18, 2013 at 10:08:22 PM
Even though Dr. Stiglitz paints a gloomy picture o... by Michael Dewey on Tuesday, Mar 19, 2013 at 2:21:06 AM