诺贝尔经济学奖得主斯蒂格利茨-不平等的代价 287页

ALSOBYJOSEPHE.STIGLITZFreefall:America,FreeMarkets,andtheSinkingoftheWorldEconomyTheThreeTrillionDollarWar:TheTrueCostoftheIraqConflict(withLindaJ.Bilmes)MakingGlobalizationWorkTheRoaringNinetiesGlobalizationandItsDiscontents2 THEPRICEOFINEQUALITYJOSEPHE.STIGLITZW.W.NORTON&COMPANYNEWYORKLONDON3 ToSiobhanandMichaelandEdwardandJulia,Inthehopesthattheywillinheritaworldandacountrythatarelessdivided4 CONTENTSPREFACEACKNOWLEDGMENTSChapterOneAMERICA’S1PERCENTPROBLEMChapterTwoRENTSEEKINGANDTHEMAKINGOFANUNEQUALSOCIETYChapterThreeMARKETSANDINEQUALITYChapterFourWHYITMATTERSChapterFiveADEMOCRACYINPERILChapterSix1984ISUPONUSChapterSevenJUSTICEFORALL?HOWINEQUALITYISERODINGTHERULEOFLAWChapterEightTHEBATTLEOFTHEBUDGETChapterNineAMACROECONOMICPOLICYANDACENTRALBANKBYANDFORTHE1PERCENTChapterTenTHEWAYFORWARD:ANOTHERWORLDISPOSSIBLENOTES5 INDEX6 PREFACETHEREAREMOMENTSINHISTORYWHENPEOPLEALLovertheworldseemtoriseup,tosaythatsomethingiswrong,toaskforchange.Thisiswhathappenedinthetumultuousyears1848and1968.Eachoftheseyearsofupheavalmarkedthebeginningofanewera.Theyear2011mayprovetobeanothersuchmoment.AyouthuprisingthatbeganinTunisia,alittlecountryonthecoastofNorthAfrica,spreadtonearbyEgypt,thentoothercountriesoftheMiddleEast.Insomecases,thesparkofprotestseemedatleasttemporarilydoused.Inothers,though,smallprotestsprecipitatedcataclysmicsocietalchange,takingdownlong-establisheddictatorssuchasEgypt’sHosniMubarakandLibya’sMuammarQaddafi.SoonthepeopleofSpainandGreece,theUnitedKingdom,andtheUnitedStates,andothercountriesaroundtheworld,hadtheirownreasonstobeinthestreets.Throughout2011,IgladlyacceptedinvitationstoEgypt,Spain,andTunisiaandmetwithprotestersinMadrid’sBuenRetiroPark,atZuccottiParkinNewYork,andinCairo,whereIspokewithyoungmenandwomenwhohadbeenatTahrirSquare.Aswetalked,itwascleartomethatwhilespecificgrievancesvariedfromcountrytocountryand,inparticular,thatthepoliticalgrievancesintheMiddleEastwereverydifferentfromthoseintheWest,thereweresomesharedthemes.Therewasacommonunderstandingthatinmanywaystheeconomicandpoliticalsystemhadfailedandthatbothwerefundamentallyunfair.Theprotesterswererightthatsomethingwaswrong.Thegapbetweenwhatoureconomicandpoliticalsystemsaresupposedtodo—whatweweretoldtheydiddo—andwhattheyactuallydobecametoolargetobeignored.Governmentsaroundtheworldwerenotaddressingkeyeconomicproblems,includingthatofpersistentunemployment;andasuniversalvaluesoffairnessbecamesacrificedtothegreedofafew,inspiteofrhetorictothecontrary,thefeelingofunfairnessbecameafeelingofbetrayal.ThattheyoungwouldriseupagainstthedictatorshipsofTunisiaandEgyptwasunderstandable.Theyouthweretiredofaging,scleroticleaderswhoprotectedtheirowninterestsattheexpenseoftherestofsociety.Theyhadnoopportunitiestocallforchangethroughdemocraticprocesses.ButelectoralpoliticshadalsofailedinWesterndemocracies.U.S.presidentBarackObamahadpromised“changeyoucanbelievein,”buthesubsequentlydeliveredeconomicpoliciesthat,tomanyAmericans,seemedlikemoreofthesame.AndyetintheUnitedStatesandelsewhere,thereweresignsofhopeintheseyouthfulprotesters,joinedbytheirparents,grandparents,andteachers.Theywerenotrevolutionariesoranarchists.Theywerenottryingtooverthrowthesystem.Theystillbelievedthattheelectoralprocessmightwork,ifonlygovernmentsrememberedthattheyareaccountabletothepeople.7 Theprotesterstooktothestreetsinordertopushthesystemtochange.ThenamechosenbytheyoungSpanishprotestersintheirmovementthatbeganonMay15was“losindignados,”theindignantoroutraged.Theywereoutragedthatsomanywouldsuffersomuch—exemplifiedbyayouthunemploymentrateinexcessof40percentsincethebeginningofthecrisisin2008—asaresultofthemisdeedsofthoseinthefinancialsector.IntheUnitedStatesthe“OccupyWallStreet”movementechoedthesamerefrain.Theunfairnessofasituationinwhichsomanylosttheirhomesandtheirjobswhilethebankersenjoyedlargebonuseswasgrating.ButtheU.S.protestssoonwentbeyondafocusonWallStreettothebroaderinequitiesinAmericansociety.Theirsloganbecame“the99percent.”TheprotesterswhotookthissloganechoedthetitleofanarticleIwroteforthemagazineVanityFair,“Ofthe11%,forthe1%,bythe1%,”whichdescribedtheenormousincreaseininequalityintheUnitedStatesandapoliticalsystem2thatseemedtogivedisproportionatevoicetothoseatthetop.Threethemesresonatedaroundtheworld:thatmarketsweren’tworkingthewaytheyweresupposedto,fortheywereobviously3neitherefficientnorstable;thatthepoliticalsystemhadn’tcorrectedthemarketfailures;andthattheeconomicandpoliticalsystemsarefundamentallyunfair.WhilethisbookfocusesontheexcessiveinequalitythatmarkstheUnitedStatesandsomeotheradvancedindustrialcountriestoday,itexplainshowthethreethemesareintimatelyinterlinked:theinequalityiscauseandconsequenceofthefailureofthepoliticalsystem,anditcontributestotheinstabilityofoureconomicsystem,whichinturncontributestoincreasedinequality—aviciousdownwardspiralintowhichwehavedescended,andfromwhichwecanemergeonlythroughconcertedpoliciesthatIdescribebelow.Beforecenteringourattentiononinequality,Iwanttosetthescene,bydescribingthebroaderfailuresofoureconomicsystem.ThefailureofmarketsMarketshaveclearlynotbeenworkinginthewaythattheirboostersclaim.Marketsaresupposedtobestable,buttheglobalfinancialcrisisshowedthattheycouldbeveryunstable,withdevastatingconsequences.Thebankershadtakenbetsthat,withoutgovernmentassistance,wouldhavebroughtthemandtheentireeconomydown.Butacloserlookatthesystemshowedthatthiswasnotanaccident;thebankershadincentivestobehavethisway.Thevirtueofthemarketissupposedtobeitsefficiency.Butthemarketobviouslyisnotefficient.Themostbasiclawofeconomics—necessaryiftheeconomyistobeefficient—isthatdemandequalssupply.Butwehaveaworldinwhichtherearehugeunmetneeds—investmentstobringthepooroutofpoverty,topromotedevelopmentinlessdevelopedcountriesinAfricaandothercontinentsaroundtheworld,toretrofittheglobaleconomytofacethechallengesofglobalwarming.Atthesametime,wehavevastunderutilizedresources—workersandmachinesthatareidleorarenotproducinguptotheirpotential.Unemployment—theinabilityofthemarkettogeneratejobsforsomanycitizens—istheworstfailureofthemarket,thegreatestsourceofinefficiency,andamajorcauseofinequality.AsofMarch2012,some24millionAmericanswhowouldhave8 4likedafull-timejobcouldn’tgetone.IntheUnitedStates,wearethrowingmillionsoutoftheirhomes.Wehaveemptyhomesandhomelesspeople.Butevenbeforethecrisis,theAmericaneconomyhadnotbeendeliveringwhathadbeenpromised:althoughtherewasgrowthinGDP,mostcitizenswereseeingtheirstandardsoflivingerode.Aschapter1shows,formostAmericanfamilies,evenbeforetheonsetofrecession,incomesadjustedforinflationwerelowerthantheyhadbeenadecadeearlier.Americahadcreatedamarvelouseconomicmachine,butevidentlyonethatworkedonlyforthoseatthetop.SomuchatstakeThisbookisaboutwhyoureconomicsystemisfailingformostAmericans,whyinequalityisgrowingtotheextentitis,andwhattheconsequencesare.Theunderlyingthesisisthatwearepayingahighpriceforourinequality—aneconomicsystemthatislessstableandlessefficient,withlessgrowth,andademocracythathasbeenputintoperil.Butevenmoreisatstake:asoureconomicsystemisseentofailformostcitizens,andasourpoliticalsystemseemstobecapturedbymoneyedinterests,confidenceinourdemocracyandinourmarketeconomywillerodealongwithourglobalinfluence.Astherealitysinksinthatwearenolongeracountryofopportunityandthatevenourlong-vauntedruleoflawandsystemofjusticehavebeencompromised,evenoursenseofnationalidentitymaybeputintojeopardy.InsomecountriestheOccupyWallStreetmovementhasbecomecloselyalliedwiththeantiglobalizationmovement.Theydohavesomethingsincommon:abeliefnotonlythatsomethingiswrongbutalsothatchangeispossible.Theproblem,however,isnotthatglobalizationisbadorwrongbutthatgovernmentsaremanagingitsopoorly—largelyforthebenefitofspecialinterests.Theinterconnectednessofpeoples,countries,andeconomiesaroundtheglobeisadevelopmentthatcanbeusedaseffectivelytopromoteprosperityastospreadgreedandmisery.Thesameistrueforthemarketeconomy:thepowerofmarketsisenormous,buttheyhavenoinherentmoralcharacter.Wehavetodecidehowtomanagethem.Attheirbest,marketshaveplayedacentralroleinthestunningincreasesinproductivityandstandardsoflivinginthepasttwohundredyears—increasesthatfarexceededthoseoftheprevioustwomillennia.Butgovernmenthasalsoplayedamajorroleintheseadvances,afactthatfree-marketadvocatestypicallyfailtoacknowledge.Ontheotherhand,marketscanalsoconcentratewealth,passenvironmentalcostsontosociety,andabuseworkersandconsumers.Forallthesereasons,itisplainthatmarketsmustbetamedandtemperedtomakesuretheyworktothebenefitofmostcitizens.Andthathastobedonerepeatedly,toensurethattheycontinuetodoso.ThathappenedintheUnitedStatesintheProgressiveEra,whencompetitionlawswerepassedforthefirsttime.IthappenedintheNewDeal,whenSocialSecurity,employment,andminimum-wagelawswerepassed.ThemessageofOccupyWallStreet—andofsomanyotherprotestersaroundtheworld—isthatmarketsonceagainmustbetamedandtempered.Theconsequencesofnotdoingsoareserious:withinameaningfuldemocracy,wherethevoicesofordinarycitizensareheard,wecannotmaintainanopenandglobalizedmarketsystem,atleastnotintheformthatweknow9 it,ifthatsystemyearafteryearmakesthosecitizensworse-off.Oneortheotherwillhavetogive—eitherourpoliticsoroureconomics.InequalityandunfairnessMarkets,bythemselves,evenwhentheyarestable,oftenleadtohighlevelsofinequality,outcomesthatarewidelyviewedasunfair.Recentresearchineconomicsandpsychology(describedinchapter6)hasshowntheimportancethatindividualsattachtofairness.Morethananythingelse,asensethattheeconomicandpoliticalsystemswereunfairiswhatmotivatestheprotestsaroundtheworld.InTunisiaandEgyptandotherpartsoftheMiddleEast,itwasn’tmerelythatjobswerehardtocomebybutthatthosejobsthatwereavailablewenttothosewithconnections.IntheUnitedStatesandEurope,thingsseemedmorefair,butonlysuperficiallyso.Thosewhograduatedfromthebestschoolswiththebestgradeshadabetterchanceatthegoodjobs.Butthesystemwasstackedbecausewealthyparentssenttheirchildrentothebestkindergartens,gradeschools,andhighschools,andthosestudentshadafarbetterchanceofgettingintotheeliteuniversities.AmericansgraspedthattheOccupyWallStreetprotesterswerespeakingtotheirvalues,whichwaswhy,whilethenumbersprotestingmayhavebeenrelativelysmall,two-thirdsofAmericanssaidthattheysupportedtheprotesters.Iftherewasanydoubtofthissupport,theabilityoftheprotesterstogather300,000signaturestokeeptheirprotestsalive,almostovernight,whenMayorMichaelBloombergofNewYorkfirstsuggestedthathewouldshutdownthecampatZuccottiPark,nearWallStreet,showed5otherwise.Andsupportcamenotjustamongthepoorandthedisaffected.WhilethepolicemayhavebeenexcessivelyroughwithprotestersinOakland—andthethirtythousandwhojoinedtheproteststhedayafterthedowntownencampmentwasviolentlydisbandedseemedtothinkso—itwasnoteworthythatsomeofthepolicethemselvesexpressedsupportfortheprotesters.Thefinancialcrisisunleashedanewrealizationthatoureconomicsystemwasnotonlyinefficientandunstablebutalsofundamentallyunfair.Indeed,intheaftermathofthecrisis(andtheresponseoftheBushandtheObamaadministrations),almost6halfthoughtso,accordingtoarecentpoll.Itwasrightlyperceivedtobegrosslyunfairthatmanyinthefinancialsector(which,forshorthand,Iwilloftenrefertoas“thebankers”)walkedoffwithoutsizebonuses,whilethosewhosufferedfromthecrisisbroughtonbythesebankerswentwithoutajob;orthatgovernmentbailedoutthebanks,butwasreluctanttoevenextendunemploymentinsuranceforthosewho,throughnofaultoftheirown,couldnotgetemploymentaftersearchingformonthsand7months;orthatgovernmentfailedtoprovideanythingexcepttokenhelptothemillionswhowerelosingtheirhomes.Whathappenedinthemidstofthecrisismadeclearthatitwasnotcontributiontosocietythatdeterminedrelativepay,butsomethingelse:bankersreceivedlargerewards,thoughtheircontributiontosociety—andeventotheirfirms—hadbeennegative.Thewealthgiventotheelitesandtothebankersseemedtoariseoutoftheirabilityandwillingnesstotakeadvantageofothers.10 OneaspectoffairnessthatisdeeplyingrainedinAmericanvaluesisopportunity.Americahasalwaysthoughtofitselfasalandofequalopportunity.HoratioAlgerstories,ofindividualswhomadeitfromthebottomtothetop,arepartofAmericanfolklore.But,aswe’llexplaininchapter1,increasingly,theAmericandreamthatsawthecountryasalandofopportunitybegantoseemjustthat:adream,amythreinforcedbyanecdotesandstories,butnotsupportedbythedata.ThechancesofanAmericancitizenmakinghiswayfromthebottomtothetoparelessthanthoseofcitizensinotheradvancedindustrialcountries.Thereisacorrespondingmyth—ragstorichesinthreegenerations—suggestingthatthoseatthetophavetoworkhardtostaythere;iftheydon’t,they(ortheirdescendants)quicklymovedown.Butaschapter1willdetail,thistooislargelyamyth,forthechildrenofthoseatthetopwill,morelikelythannot,remainthere.Inaway,inAmericaandthroughouttheworld,theyouthfulprotesterstookwhattheyheardfromtheirparentsandpoliticiansatfacevalue—justasAmerica’syouthdidfiftyyearsagoduringthecivilrightsmovement.Backthentheyscrutinizedthevaluesequality,fairness,andjusticeinthecontextofthenation’streatmentofAfricanAmericans,andtheyfoundthenation’spolicieswanting.Nowtheyscrutinizethesamevaluesintermsofhowoureconomicandjudicialsystemworks,andtheyhavefoundthesystemwantingforpoorandmiddle-classAmericans—notjustforminoritiesbutformostAmericansofallbackgrounds.IfPresidentObamaandourcourtsystemhadfoundthosewhobroughttheeconomytothebrinkofruin“guilty”ofsomemalfeasance,thenperhapsitwouldhavebeenpossibletosaythatthesystemwasfunctioning.Therewasatleastsomesenseofaccountability.Infact,however,thosewhoshouldhavebeensoconvictedwereoftennotcharged,andwhentheywerecharged,theyweretypicallyfoundinnocentoratleastnotconvicted.Afewinthehedgefundindustryhavebeenconvictedsubsequentlyofinsidertrading,butthisisasideshow,almostadistraction.Thehedgefundindustrydidnotcausethecrisis.Itwasthebanks.Anditisthebankerswhohavegone,almosttoaperson,free.Ifnooneisaccountable,ifnoindividualcanbeblamedforwhathashappened,itmeansthattheproblemliesintheeconomicandpoliticalsystem.FromsocialcohesiontoclasswarfareTheslogan“wearethe99percent”mayhavemarkedanimportantturningpointinthedebateaboutinequalityintheUnitedStates.Americanshavealwaysshiedawayfromclassanalysis;America,welikedtobelieve,isamiddle-classcountry,andthatbeliefhelpsbindustogether.Thereshouldbenodivisionsbetweentheupper8andthelowerclasses,betweenthebourgeoisieandtheworkers.Butifbyaclass-basedsocietywemeanoneinwhichtheprospectsofthoseatthebottomtomoveuparelow,Americamayhavebecomeevenmoreclass-basedthanoldEurope,andourdivisionshavenow9becomeevengreaterthanthosethere.Thoseinthe99percentarecontinuingwiththe“we’reallmiddleclass”tradition,withoneslightmodification:theyrecognizethatwe’reactuallynotallmovinguptogether.Thevastmajorityissufferingtogether,11 andtheverytop—the1percent—islivingadifferentlife.The“99percent”marksanattempttoforgeanewcoalition—anewsenseofnationalidentity,basednotonthefictionofauniversalmiddleclassbutontherealityoftheeconomicdivideswithinoureconomyandoursociety.Foryearstherewasadealbetweenthetopandtherestofoursocietythatwentsomethinglikethis:wewillprovideyoujobsandprosperity,andyouwillletuswalkawaywiththebonuses.Youallgetashare,evenifwegetabiggershare.Butnowthattacitagreementbetweentherichandtherest,whichwasalwaysfragile,hascomeapart.Thoseinthe1percentarewalkingoffwiththeriches,butindoingsotheyhaveprovidednothingbutanxietyandinsecuritytothe99percent.ThemajorityofAmericanshavesimplynotbeenbenefitingfromthecountry’sgrowth.Isourmarketsystemerodingfundamentalvalues?Whilethisbookfocusesonequalityandfairness,thereisanotherfundamentalvaluethatoursystemseemstobeundermining—asenseoffairplay.Abasicsenseofvaluesshould,forinstance,haveledtoguiltfeelingsonthepartofthosewhowereengagedinpredatorylending,whoprovidedmortgagestopoorpeoplethatweretickingtimebombs,orwhoweredesigningthe“programs”thatledtoexcessivechargesforoverdraftsinthebillionsofdollars.Whatisremarkableishowfewseemed—andstillseem—tofeelguilty,andhowfewwerethewhistleblowers.Somethinghashappenedtooursenseofvalues,whentheendofmakingmoremoneyjustifiesthemeans,whichintheU.S.subprimecrisismeant10exploitingthepoorestandleast-educatedamongus.Muchofwhathasgoneoncanonlybedescribedbythewords“moraldeprivation.”Somethingwronghappenedtothemoralcompassofsomanyofthepeopleworkinginthefinancialsectorandelsewhere.Whenthenormsofasocietychangeinawaythatsomanyhavelosttheirmoralcompass,itsayssomethingsignificantaboutthesociety.Capitalismseemstohavechangedthepeoplewhowereensnaredbyit.ThebrightestofthebrightwhowenttoworkonWallStreetwerelikemostotherAmericansexceptthattheydidbetterintheirschools.Theyputonholdtheirdreamsofmakingalifesavingdiscovery,ofbuildinganewindustry,ofhelpingthepoorestoutofpoverty,astheyreachedoutforsalariesthatseemedbeyondbelief,ofteninreturnforworkthat(initsnumberofhours)seemedbeyondbelief.Butthen,toooften,somethinghappened:itwasn’tthatthedreamswereputonhold;theywere11forgotten.Itisthusnotsurprisingthatthelistofgrievancesagainstcorporations(andnotjustfinancialinstitutions)islongandoflongstanding.Forinstance,cigarettecompaniesstealthilymadetheirdangerousproductsmoreaddictive,andastheytriedtopersuadeAmericansthattherewasno“scientificevidence”oftheirproducts’dangers,theirfileswerefilledwithevidencetothecontrary.ExxonsimilarlyuseditsmoneytotrytopersuadeAmericansthattheevidenceonglobalwarmingwasweak,thoughtheNationalAcademyofScienceshadjoinedeveryothernationalscientificbodyinsayingthattheevidencewasstrong.Andwhiletheeconomywasstillreelingfromthemisdeedsofthefinancial12 sector,theBPoilspillshowedanotheraspectofcorporaterecklessness:lackofcareindrillinghadendangeredtheenvironmentandthreatenedjobsofthousandsofthosedependingonfishingandtourismintheGulfofMexico.Ifmarketshadactuallydeliveredonthepromisesofimprovingthestandardsoflivingofmostcitizens,thenallofthesinsofcorporations,alltheseemingsocialinjustices,theinsultstoourenvironment,theexploitationofthepoor,mighthavebeenforgiven.Buttotheyoungindignadosandprotestorselsewhereintheworld,capitalismisfailingtoproducewhatwaspromised,butisdeliveringonwhatwasnotpromised—inequality,pollution,unemployment,and,mostimportantofall,thedegradationofvaluestothepointwhereeverythingisacceptableandnooneisaccountable.FailureofpoliticalsystemThepoliticalsystemseemstobefailingasmuchastheeconomicsystem.Giventhehighlevelofyouthunemploymentaroundtheworld—near50percentinSpainand18percentintheUnited12States—itwasperhapsmoresurprisingthatittooksolongfortheprotestmovementstobeginthanthatprotestseventuallybrokeout.Theunemployed,includingyoungpeoplewhohadstudiedhardanddoneeverythingthattheyweresupposedtodo(“playedbytherules,”assomepoliticiansarewonttosay),facedastarkchoice:remainingunemployedoracceptingajobfarbelowthatforwhichtheywerequalified.Inmanycasestherewasnotevenachoice:theresimplywerenojobs,andhadn’tbeenforyears.Oneinterpretationofthelongdelayinthearrivalofmassprotestswasthat,intheaftermathofthecrisis,therewashopeindemocracy,faiththatthepoliticalsystemwouldwork,thatitwouldholdaccountablethosewhohadbroughtonthecrisisandquicklyrepairtheeconomicsystem.Butyearsafterthebreakingofthebubble,itbecameclearthatourpoliticalsystemhadfailed,justasithadfailedtopreventthecrisis,tocheckthegrowinginequality,toprotectthoseatthebottom,topreventthecorporateabuses.Itwasonlythenthatprotestersturnedtothestreets.Americans,Europeans,andpeopleinotherdemocraciesaroundtheworldtakegreatprideintheirdemocraticinstitutions.Buttheprotestershavecalledintoquestionwhetherthereisarealdemocracy.Realdemocracyismorethantherighttovoteonceeverytwoorfouryears.Thechoiceshavetobemeaningful.Thepoliticianshavetolistentothevoicesofthecitizens.Butincreasingly,andespeciallyintheUnitedStates,itseemsthatthepoliticalsystemismoreakinto“onedollaronevote”thanto“onepersononevote.”Ratherthancorrectingthemarket’sfailures,thepoliticalsystemwasreinforcingthem.Politiciansgivespeechesaboutwhatishappeningtoourvaluesandoursociety,butthentheyappointtohighofficetheCEOsandothercorporateofficialswhowereatthehelminthefinancialsectorasthesystemwasfailingsobadly.Weshouldn’thaveexpectedthearchitectsofthesystemthathasnotbeenworkingtorebuildthesystemtomakeitwork,andespeciallyworkformostcitizens—andtheydidn’t.Thefailuresinpoliticsandeconomicsarerelated,andtheyreinforceeachother.Apoliticalsystemthatamplifiesthevoiceofthewealthyprovidesampleopportunityforlawsandregulations13 —andtheadministrationofthem—tobedesignedinwaysthatnotonlyfailtoprotecttheordinarycitizensagainstthewealthybutalsofurtherenrichthewealthyattheexpenseoftherestofsociety.Thisbringsmetooneofthecentralthesesofthisbook:whiletheremaybeunderlyingeconomicforcesatplay,politicshaveshapedthemarket,andshapeditinwaysthatadvantagethetopattheexpenseoftherest.Anyeconomicsystemhastohaverulesandregulations;ithastooperatewithinalegalframework.Therearemanydifferentsuchframeworks,andeachhasconsequencesfordistributionaswellasgrowth,efficiency,andstability.Theeconomicelitehavepushedforaframeworkthatbenefitsthemattheexpenseoftherest,butitisaneconomicsystemthatisneitherefficientnorfair.Iexplainhowourinequalitygetsreflectedineveryimportantdecisionthatwemakeasanation—fromourbudgettoourmonetarypolicy,eventooursystemofjustice—andshowhowthesedecisionsthemselveshelpperpetuate13andexacerbatethisinequality.Givenapoliticalsystemthatissosensitivetomoneyedinterests,growingeconomicinequalityleadstoagrowingimbalanceofpoliticalpower,aviciousnexusbetweenpoliticsandeconomics.Andthetwotogethershape,andareshapedby,societalforces—socialmoresandinstitutions—thathelpreinforcethisgrowinginequality.Whattheprotestersareaskingfor,andwhattheyareaccomplishingTheprotesters,perhapsmorethanmostpoliticians,graspedwhatwasgoingon.Atonelevel,theyareaskingforsolittle:forachancetousetheirskills,fortherighttodecentworkatdecentpay,forafairereconomyandsociety,onethattreatsthemwithdignity.InEuropeandtheUnitesStates,theirrequestsarenotrevolutionary,butevolutionary.Atanotherlevel,though,theyareaskingforagreatdeal:forademocracywherepeople,notdollars,matter;andforamarketeconomythatdeliversonwhatitissupposedtodo.Thetwodemandsarerelated:unfetteredmarketsdonotworkwell,aswehaveseen.Formarketstoworkthewaymarketsaresupposedto,therehastobeappropriategovernmentregulation.Butforthattooccur,wehavetohaveademocracythatreflectsthegeneralinterests—notthespecialinterestsorjustthoseatthetop.Theprotestershavebeencriticizedfornothavinganagenda,butsuchcriticismmissesthepointofprotestmovements.Theyareanexpressionoffrustrationwiththepoliticalsystemandeven,inthosecountrieswherethereareelections,withtheelectoralprocess.Theysoundanalarm.Insomewaystheprotestershavealreadyaccomplishedagreatdeal:thinktanks,governmentagencies,andthemediahaveconfirmedtheirallegations,thefailuresnotjustofthemarketsystembutofthehighandunjustifiablelevelofinequality.Theexpression“wearethe99percent”hasenteredintopopularconsciousness.Noonecanbesurewherethemovementswilllead.Butofthiswecanbesure:theseyoungprotestershavealreadyalteredpublicdiscourseandtheconsciousnessofordinarycitizensandpoliticiansalike.14 CONCLUDINGCOMMENTSIntheweeksfollowingtheprotestmovementsinTunisiaandEgypt,Iwrote(inanearlydraftofmyVanityFairarticle),Aswegazeoutatthepopularfervorinthestreets,onequestiontoaskourselvesisthis:whenwillitcometoAmerica?Inimportantways,ourowncountryhasbecomelikeoneofthesedistant,troubledplaces.Inparticular,thereisthestrangleholdexercisedonalmosteverythingbythattinysliverofpeopleatthetop—thewealthiest1percentofthepopulation.Itwastobebutafewmonthsbeforethoseprotestsreachedtheshoresofthiscountry.ThisbookattemptstofathomthedepthsofoneaspectofwhathashappenedintheUnitedStates—howwebecameasocietythatwassounequal,withopportunitysodiminished,andwhatthoseconsequencesarelikelytobe.ThepictureIpainttodayisbleak:weareonlyjustbeginningtograsphowfarourcountryhasdeviatedfromouraspirations.Butthereisalsoamessageofhope.Therearealternativeframeworksthatwillworkbetterfortheeconomyasawholeand,mostimportantly,forthevastmajorityofcitizens.Partofthisalternativeframeworkentailsabetterbalancebetweenmarketsandthestate—aperspectivethatissupported,asIshallexplain,14bothbymoderneconomictheoryandbyhistoricalevidence.Inthesealternativeframeworks,oneoftherolesthatthegovernmentundertakesistoredistributeincome,especiallyiftheoutcomesofmarketprocessesaretoodisparate.Criticsofredistributionsometimessuggestthatthecostofredistributionistoohigh.Thedisincentives,theyclaim,aretoogreat,andthegainstothepoorandthoseinthemiddlearemorethanoffsetbythelossestothetop.Itisoftenarguedontherightthatwecouldhavemoreequality,butonlyatthesteeppriceofslowergrowthandlowerGDP.Thereality(asIwillshow)isjusttheopposite:wehaveasystemthathasbeenworkingovertimetomovemoneyfromthebottomandmiddletothetop,butthesystemissoinefficientthatthegainstothetoparefarlessthanthelossestothemiddleandbottom.Weare,infact,payingahighpriceforourgrowingandoutsizeinequality:notonlyslowergrowthandlowerGDPbutevenmoreinstability.Andthisisnottosayanythingabouttheotherpriceswearepaying:aweakeneddemocracy,adiminishedsenseoffairnessandjustice,andeven,asIhavesuggested,aquestioningofoursenseofidentity.AfewwordsofcautionAfewotherprefatoryremarks:Ioftenusetheterm“the1percent”loosely,torefertotheeconomicandpoliticalpowerofthoseatthetop.Insomecases,whatIreallyhaveinmindisamuchsmallergroup—thetopone-tenthof1percent;inothercases,indiscussingaccesstoeliteeducation,forinstance,thereisasomewhatlargergroup,perhapsthetop5percentor10percent.15 ItmayseemtoreadersthatItalktoomuchaboutthebankersandcorporateCEOs,toomuchaboutthefinancialcrisisof2008anditsaftermath,especially(asI’llexplain)sincetheproblemsofinequalityinAmericaareoflongerstanding.Itisnotjustthattheyhavebecomethewhippingboysofpopularopinion.Theyareemblematicofwhathasgonewrong.MuchoftheinequalityatthetopisassociatedwithfinanceandcorporateCEOs.Butit’smorethanthat:theseleadershavehelpedshapeourviewsaboutwhatisgoodeconomicpolicy,andunlessanduntilweunderstandwhatiswrongwiththoseviews—andhow,totoolargeanextent,theyservetheirinterestsattheexpenseoftherest—wewon’tbeabletoreformulatepoliciestoensureamoreequitable,moreefficient,moredynamiceconomy.Anypopularbooklikethisentailsmoresweepinggeneralizationsthanwouldbeappropriateinmoreacademicwriting,whichwouldberepletewithqualificationsandfootnotes.Forthis,Iapologizeinadvanceandreferthereadertosomeoftheacademicwritingcitedinthemorelimitednumberoffootnotesthatmypublisherhasallowedme.Sotoo,Ishouldemphasizethatincastigating“bankers”Ioversimplify:many,manyofthefinanciersthatIknowwouldagreewithmuchthatIhavesaid.Somefoughtagainsttheabusivepracticesandpredatorylending.Somewantedtocurbthebanks’excessiverisktaking.Somebelievedthatthebanksshouldfocusontheircorebusinesses.Thereareevenseveralbanksthatdidjustthat.Butitshouldbeobviousthatmostimportantdecisionmakersdidnot:bothbeforethecrisisandafterit,thelargestandmostinfluentialfinancialinstitutionsdidbehaveinwaysthatcanrightlybecriticized,andsomeonehastotakeresponsibility.WhenIcastigatethe“bankers,”itisthosewhodecided,forinstance,toengageinfraudulentandunethicalbehavior,andwhocreatedtheculturewithintheinstitutionsthatfacilitatedit.IntellectualdebtsAbooksuchasthisrestsonthescholarship,theoreticalandempirical,ofhundredsofresearchers.Itisnoteasytoputtogetherthedatathatdescribewhatishappeningtoinequality,ortoprovideaninterpretationofwhywhatwashasbeenoccurringhashappened.Whyisitthatthericharegettingsomuchricher,thatthemiddleisbeinghollowedout,andthatthenumbersinpovertyareincreasing?Whilefootnotesinsubsequentchapterswillprovidesomeacknowledgments,IwouldberemissifIdidnotmentionthepainstakingworkofEmmanuelSaezandThomasPiketty,ortheworkovermorethanfourdecadesofoneofmyearlycoauthors,SirAnthonyB.Atkinson.Becauseacentralpartofmythesisistheintertwiningofpoliticsandeconomics,Ihavetostretchbeyondeconomics,narrowlydefined.MycolleagueattheRooseveltInstituteThomasFerguson,inhis1995bookGoldenRule:TheInvestmentTheoryofPartyCompetitionandtheLogicofMoney-DrivenPoliticalSystems,wasamongthefirsttoexplorewithsomerigorthefundamentalpuzzleofwhy,indemocraciesbasedononepersononevote,moneyseemstomattersomuch.Thelinkbetweenpoliticsandinequalityhas,notsurprisingly,becomeafocusofmuchrecentwriting.Thisbook,insomesense,picksupwheretheexcellentbookbyJacobS.HackerandPaulPierson,Winner-Take-AllPolitics:HowWashingtonMadetheRich16 15Richer—AndTurnedItsBackontheMiddleClass,leavesoff.Theyarepoliticalscientists.Iamaneconomist.WeallgrapplewiththequestionofhowthehighandgrowinginequalityintheUnitedStatescanbeexplained.Iask,Howcanwereconcilewhathashappenedwithstandardeconomictheory?Andthoughweapproachthequestionthroughthelensoftwodifferentdisciplines,wecometothesameanswer:toparaphrasePresidentClinton,“It’sthepolitics,stupid!”Moneyspeaksinpolitics,asitdoesinthemarketplace.Thatthatissohaslongbeenevident,andbroughtforthabevyofbooks,suchasLawrenceLessig’sRepublic,Lost:HowMoneyCorruptsCongress—AndaPlantoStop16It.Ithasalsobecomeincreasinglyclearthatgrowinginequalityishavingamajoreffectonourdemocracy,asreflectedinbookssuchasLarryBartels’sUnequalDemocracy:ThePolitical17EconomyoftheNewGildedAgeandNolanMcCarty,KeithT.Poole,andHowardRosenthal’sPolarizedAmerica:TheDanceofIdeology18andUnequalRiches.Buthowandwhymoneyshouldbesopowerfulinademocracywhereeachpersonhasavote—andmostvoters,bydefinition,arenotinthe1percent—hasremainedamystery,onwhichIhopethis19bookwillshedalittlelight.Mostimportantly,Itrytoilluminatethenexusbetweeneconomicsandpolitics.Whileithasbecomeevidentthatthisgrowinginequalityhasbeenbadforourpolitics(asevidencedbythepackofbooksjustmentioned),Iexplainhowitisalsoverybadforoureconomy.AfewpersonalnotesIreturninthisbooktoasubjectthatdrewmeintothestudyofeconomicsahalfcenturyago.IwasinitiallyaphysicsmajoratAmherstCollege.Ilovedtheeleganceofthemathematicaltheoriesthatdescribedourworld.Butmyheartlayelsewhere,inthesocialandeconomicupheavalofthetime,thecivilrightsmovementintheUnitedStates,andthefightfordevelopmentandagainstcolonialisminwhatwascalledthentheThirdWorld.PartofthisyearningwasrootedinmyexperiencegrowingupintheheartlandofindustrialAmerica,inGary,Indiana.ThereIsawatfirsthandinequality,discrimination,unemployment,andrecessions.Asaten-year-old,Iwonderedwhythekindlywomanwhotookcareofmemuchofthedayhadonlyasixth-gradeeducation,inthiscountrythatseemedsoaffluent,andIwonderedwhyshewastakingcareofme,ratherthanherownchildren.InanerawhenmostAmericanssaweconomicsasthescienceofmoney,Iwas,insomeways,anunlikelycandidatetobecomeaneconomist.Myfamilywaspoliticallyengaged,andIwastoldthatmoneywasn’timportant;thatmoneywouldneverbuyhappiness;thatwhatwasimportantwasservicetoothersandthelifeofthemind.Inthetumultofthe1960s,though,asIbecameexposedtonewideasatAmherst,Isawthateconomicswasmuchmorethanthestudyofmoney;itwasactuallyaformofinquirythatcouldaddressthefundamentalcausesofinequity,andtowhichIcouldeffectivelydevotemyproclivityformathematicaltheories.ThemajorsubjectofmydoctoraldissertationatMITwasinequality,itsevolutionovertime,anditsconsequencesformacroeconomicbehaviorandespeciallygrowth.Itooksomeofthestandardassumptions(ofwhatiscalledtheneoclassicalmodel)andshowedthatunderthoseassumptionsthereshouldbea17 20convergencetoequalityamongindividuals.Itwasclearthatsomethingwaswrongwiththestandardmodel,justasitwascleartome,havinggrownupinGary,thatsomethingwaswrongwithastandardmodelthatsaidtheeconomywasefficientandtherewasnounemploymentordiscrimination.Itwastherealizationthatthestandardmodeldidn’tdescribewelltheworldwelivedinthatsetmeoffonaquestforalternativemodelsinwhichmarketimperfections,andespeciallyimperfectionsofinformationand21“irrationalities,”wouldplaysuchanimportantrole.Ironically,astheseideasdevelopedandgainedcurrencywithinsomepartsoftheeconomicsprofession,theoppositenotion—thatmarketsworkedwell,orwould,ifonlythegovernmentkeptoutoftheway—tookholdwithinmuchofthepublicdiscourse.Thisbook,likeseveralofthosethatprecededit,isanattempttosettherecordstraight.18 ACKNOWLEDGMENTSIHAVEBEENWORKING,ASINOTED,ONTHEORIGINSANDconsequencesofinequalitysincemydaysasagraduatestudent,andinthealmostfiftyyearssincebeginningmystudies,Ihaveaccumulatedenormousintellectualdebts,toomanytoenumerate.RobertSolow,oneofmythesisadvisers,andwithwhomIwroteanearlypaperondistributionandmacroeconomicbehavior,hadwrittenhisownthesisoninequality.TheinfluenceofPaulSamuelson,anotherofmythesisadvisers,willbeapparentinthediscussionofglobalizationinchapter3.MyfirstpublishedpapersonthesubjectwerewrittenwithmyfellowgraduatestudentGeorgeAkerlof,withwhomIsharedthe2001NobelPrize.AtthetimeIwenttoCambridgeUniversity,asaFulbrightscholarin1965–66,thedistributionofincomewasamajorfocusofdebate,andIowedebtstothelateNicholasKaldor,DavidChampernowne,andMichaelFarrell,andespeciallytoSirJamesMeadeandFrankHahn.ItwastherethatIfirstbeganmyworkwithTonyAtkinson,whosubsequentlyhasbecomeoneoftheworld’sleadingauthoritiesoninequality.Atthetime,itwasstillthoughtthatthereweremajortrade-offsbetweeninequalityandgrowth,andJimMirrleeswasjustthenbeginninghisworkonhowonecoulddesignoptimalredistributivetaxes(workforwhichhewouldlaterreceivetheNobelPrize).AnotherofmyteachersatMIT(andthenafellowvisitoratCambridgein1969–70)wasKennethArrow,whoseworkoninformationgreatlyinfluencedmythinking.Later,hiswork,parallelingmyown,wouldfocusontheimpactofdiscrimination;howinformation,sayaboutrelativeabilities,affectsinequality;andtheroleofeducationinthewholeprocess.AkeyissuethatItouchuponinthisvolumeisthemeasurementofinequality.Thisturnsouttoraisetheoreticalissuesthatarecloselyakintothemeasurementofrisk,andmyearlywork,fourdecadesago,wasdonejointlywithMichaelRothschild.Subsequently,Ibeganworkwithaformerstudent,RaviKanbur,onthemeasurementofsocioeconomicmobility.Theinfluenceofbehavioraleconomicsonmythinkingshouldbeevidentinthiswork.IwasfirstintroducedtotheseideassomefortyyearsagobythelateAmosTversky,apioneerinthisfield,andsubsequentlyRichardThalerandDannyKahnemanhavegreatlyinfluencedmythinking.(WhenIfoundedtheJournalofEconomicPerspectivesinthemid-1980s,IaskedRichardtodoaregularcolumnonthesubject.)IbenefitedenormouslyfromthediscussionswithEdwardStiglitzofsomeofthelegalissuestreatedinchapter7,andwithRobertPerkinsonontheissuesrelatedtoAmerica’shighincarcerationrate.IhavealwaysbenefitedagreatdealfromdiscussingideasasIformulatethemwithmystudents,andIwanttosingleoutMiguel19 Morin,acurrentstudent,andAntonKorinek,arecentone.IhadthegoodfortunetobeabletoserveintheClintonadministration.Concernsaboutinequalityandpovertywerecentraltoourdiscussions.Wedebatedhowwecouldbestdealwithpoverty,forinstance,withwelfarereform(discussionsinwhichDavidEllwoodofHarvardplayedacentralrole),andwhatwecoulddoabouttheextremesofinequalityatthetop,throughtaxreform.(AsInotelater,noteverythingwedidwasamoveintherightdirection.)TheinfluenceoftheinsightsofAlanKrueger(nowchairmanoftheCouncilofEconomicAdvisers)intolabormarkets,includingtheroleoftheminimumwage,shouldbeapparent.LaterinthebookIrefertoworkwithJasonFurman,andwithPeterOrszag.AliciaMunnell,whoservedwithmeontheCouncilofEconomicAdvisers,helpedmebetterunderstandtheroleofsocialinsuranceprogramsandCRArequirementsinreducingpoverty.(Forthemanyotherswhogreatlyinfluencedmythinkinginthisperiod,pleaseseetheacknowledgmentsinTheRoaringNineties[NewYork:W.W.Norton,2003].)IalsowasfortunatetobeabletoserveaschiefeconomistoftheWorldBank,aninstitutionthatseesoneofitscentralmissionsasthereductionofpoverty.Withpovertyandinequalitythefocusofourattention,everydaywasalearningexperience,everyencounteranopportunitytogetnewinsightsandtoshapeandreshapeviewsaboutthecausesandconsequencesofinequality,tobetterunderstandwhyitdifferedacrosscountries.WhileIhesitatetosingleoutanyone,Ishouldmentionmytwosuccessorsaschiefeconomist,NickStern(whomIfirstmetinKenyain1969)andFrançoisBourguignon.Inchapter1andelsewhere,IemphasizethatGDPpercapita—orevenothermeasuresofincome—donotprovideanadequatemeasureofwell-being.MythinkinginthisareawasgreatlyinfluencedbytheworkoftheCommissionontheMeasurementofEconomicPerformanceandSocialProgress,whichIchaired,andwhichwasalsoledbyAmartyaSenandJean-PaulFitoussi.Ishouldalsoacknowledgetheinfluenceofallthetwenty-oneothermembersofthecommission.Inchapter4,Iexplainthelinkbetweeninstabilityandgrowth,myunderstandingofwhichwasgreatlyinfluencedbyanothercommissionIchaired,theCommissionofExpertsofthePresidentoftheUnitedNationsGeneralAssemblyonReformsoftheInternationalMonetaryandFinancialSystem.IespeciallywanttothankmycolleaguesattheRooseveltInstitute,includingBoCutter,MikeKonczal,ArjunJayadev,andJeffMadrick.(OtherswhohaveworkedwiththeRooseveltInstituteevents,includingRobertKuttnerandJamieGalbraith,arealsodeservingofthanks.)PaulKrugmanhasbeenaninspiringvoiceforallofuswhowouldliketoseeamoreequitablesocietyandabetter-functioningeconomy.Inrecentyears,theeconomicsprofessionhasn’t,unfortunately,paidsufficientattentiontoinequality—justasitdidn’tpaysufficientattentiontotheotherproblemsthatcouldgiverisetothekindofinstabilitythatthecountryhasexperienced.TheInstituteforNewEconomicThinkinghasbeencreatedtotrytorectifytheseandotherdeficiencies,andIwanttoacknowledgemyindebtednesstoINET,andespeciallytoitshead,RobJohnson(alsoacolleagueattheRooseveltInstituteandamemberoftheUNcommission),forextensivediscussionsofthetopicsofthisbook.Asalways,IwanttoacknowledgemyindebtednesstoColumbia20 University,forprovidinganintellectualenvironmentinwhichideascanflourish,bechallenged,andberefined.ImustespeciallyextendmygratitudetoJoséAntonioOcampoandmylongtimecolleagueandcollaborator,BruceGreenwald.Whilethesearemybroadintellectualdebts,Ioweanespecialsetofdebtstothosewhohelpedinonewayoranotherinthisbook.ThisbookgrewoutofanarticleinVanityFair,“Ofthe1%,forthe1%,bythe1%.”CullenMurphysolicitedthearticleanddidamarvelousjobofediting.GraydonCartersuggestedthetitle.DrakeMcFeely,presidentofNorton,andmylongtimefriendandeditor,thenaskedmetoexpandtheideasintoabook.BrendanCurry,onceagain,didasuperbjobineditingthebook.StuartProffitt,myeditorfromPenguin/AllenLanealsoagaindidanimpressivejobcombining“bigthink”ideasonhowtostrengthentheargumentsandmakingthemclearerwithdetailedcommentsonthewriting.KarlaHoffreadthebookcovertocover,improvingboththelanguageandtheargument.ButevenbeforeIbegantowritethebook,discussionswithherontheideasthatarecentraltothebookhelpedshapemyownthinking.Ateamofresearchassistants,headedbyLaurenceWilse-SamsonandincludingAnLiandRitamChaureywentwellbeyondthetaskoffact-checking.Theysuggestedwheretheanalysiscouldbeextended,arguedaboutwhereitneededtobemorequalified,andseemedasexcitedabouttheprojectasIwas.JuliaCunicoandHannahAssadialsoprovidedinvaluablecommentsandsupportthroughoutthewritingprocess.EamonKircher-Allennotonlymanagedthewholeprocessofproducingthemanuscriptbutservedaseditorandcriticaswell.Iowehimanenormousdebt.Asalways,mybiggestdebtistoAnya,whoencouragedmetodothebook,repeatedlydiscussedtheideasbehindit,andhelpedshapeandreshapeit.Toallofthem—andtotheenthusiasmforthebookthattheycontinuallysharedwithme—Iamdeeplyindebted.Noneofthemshouldbeheldresponsibleforanyerrorsandomissionsthatremaininthebook.21 CHAPTERONEAMERICA’S1PERCENTPROBLEMTHE2007–08FINANCIALCRISISANDTHEGREATRECESSIONthatfollowedcastvastnumbersofAmericansadriftamidtheflotsamandjetsamofanincreasinglydysfunctionalformofcapitalism.Ahalfdecadelater,oneoutofsixAmericanswhowouldlikeafull-timejobstillcouldn’tfindone;someeightmillionfamilieshadbeentoldtoleavetheirhomes,andmillionsmoreanticipate1seeingforeclosurenoticesinthenot-too-distantfuture;stillmoresawtheirlifetimesavingsseeminglyevaporate.Evenifsomeofthegreenshootsthattheoptimistskeptseeingwere,infact,theharbingerofarealrecovery,itwouldbeyears—2018attheearliest—beforetheeconomyreturnedtofullemployment.By2012many,however,hadalreadygivenuphope:thesavingsofthosewhohadlosttheirjobsin2008or2009hadbeenspent.Unemploymentcheckshadrunout.Middle-agedpeople,onceconfidentofaswiftreturntotheworkforce,cametorealizetheywereinfactforciblyretired.Youngpeople,freshoutofcollegewithtensofthousandsofdollarsindebt,couldn’tfindanyworkatall.Peoplewhohadmovedinwithfriendsandrelativesatthestartofthecrisishadbecomehomeless.Housesboughtduringthepropertyboomwerestillonthemarketorsoldataloss;manymorestoodempty.Thegrimunderpinningsofthefinancialboomoftheprecedingdecadelayexposedatlast.OneofthedarkestsidestothemarketeconomythatcametolightwasthelargeandgrowinginequalitythathaslefttheAmericansocialfabric,andthecountry’seconomicsustainability,frayingattheedges:therichweregettingricher,whiletherestwerefacinghardshipsthatseemedinconsonantwiththeAmericandream.ThefactthattherewererichandpoorinAmericawaswellknown;andeventhoughthisinequalitywasnotcausedsolelybythesubprimecrisisandthedownturnthatfollowed—ithadbeenbuildingupoverthepastthreedecades—thecrisismademattersworse,tothepointwhereitcouldnolongerbeignored.Themiddleclasswasbeingbadlysqueezedinwayswe’llseelaterinthischapter;thesufferingofthebottomwaspalpable,asweaknessesinAmerica’ssafetynetgrewobviousandaspublicsupportprograms,inadequateatbest,werecutbackfurther;butthroughoutallthis,thetop1percentmanagedtohangontoahugepieceofthenationalincome—afifth2—althoughsomeoftheirinvestmentstookahit.Therewasgreaterinequalitywhereveroneslicedtheincomedistribution;evenwithinthetop1percent,thetop0.1percentofincomeearnerswasgettingalargershareofthemoney.By2007,theyearbeforethecrisis,thetop0.1percentofAmerica’shouseholdshadanincomethatwas220timeslargerthan22 3theaverageofthebottom90percent.Wealthwasevenmoreunequallydistributedthanincome,withthewealthiest1percent4owningmorethanathirdofthenation’swealth.Incomeinequalitydataofferonlyasnapshotofaneconomyatasinglemomentintime.Butthisispreciselywhythedataonwealthinequalityaresotroubling—wealthinequalitygoesbeyondthevariationsseeninyear-to-yearincome.Moreover,wealthgivesabetterpictureofdifferencesinaccesstoresources.Americahasbeengrowingapart,atanincreasinglyrapidrate.Inthefirstpost-recessionyearsofthenewmillennium(2002to2007),thetop1percentseizedmorethan65percentofthegain5intotalnationalincome.Whilethetop1percentwasdoing6fantastically,mostAmericanswereactuallygrowingworse-off.Iftherichweregrowingricherandifthoseinthemiddleandatthebottomwerealsodoingbetter,thatwouldbeonething,especiallyiftheeffortsofthoseatthetopwerecentraltothesuccessesoftherest.Wecouldcelebratethesuccessesofthoseatthetopandbethankfulfortheircontributions.Butthat’snotwhat’sbeenhappening.MembersofAmerica’smiddleclasshavefeltthattheywerelongsuffering,andtheywereright.Forthreedecadesbeforethe7crisis,theirincomeshadbarelybudged.Indeed,theincomeofatypicalfull-timemaleworkerhasstagnatedforwelloverathird8ofacentury.Thecrisismadetheseinequalitiesworseininnumerableways,beyondthehigherunemployment,losthomes,stagnatingwages.Thewealthyhadmoretoloseinstockmarketvalues,butthose9recoveredreasonablywellandrelativelyfast.Infact,thegainsofthe“recovery”sincetherecessionhaveaccruedoverwhelminglytothewealthiestAmericans:thetop1percentofAmericansgained93percentoftheadditionalincomecreatedin10thecountryin2010,ascomparedwith2009.Thepoorandmiddlehadmostoftheirwealthinhousing.Asaveragehousepricesfellmorethanathirdbetweenthesecondquarterof2006andtheend11of2011,alargeproportionofAmericans—thosewithlargemortgages—sawtheirwealthessentiallywipedout.Atthetop,CEOswereremarkablysuccessfulinmaintainingtheirhighpay;afteraslightdipin2008,theratioofCEOannualcompensationtothatofthetypicalworkerby2010wasbacktowhatithadbeen12beforethecrisis,to243to1.Countriesaroundtheworldprovidefrighteningexamplesofwhathappenstosocietieswhentheyreachthelevelofinequalitytowardwhichwearemoving.Itisnotaprettypicture:countrieswheretherichliveingatedcommunities,waiteduponbyhordesoflow-incomeworkers;unstablepoliticalsystemswherepopulistspromisethemassesabetterlife,onlytodisappoint.Perhapsmostimportantly,thereisanabsenceofhope.Inthesecountries,thepoorknowthattheirprospectsofemergingfrompoverty,letalongmakingittothetop,areminuscule.Thisisnotsomethingweshouldbestrivingfor.Inthischapter,IlayoutthescopeofinequalityintheUnitedStatesandhowitaffectsthelivesofmillionsindifferentways.Idescribenotonlyhowwearebecomingamoredividedsocietybutalsohowwearenolongerthelandofopportunitythatweoncewere.Idiscussthelowchancesthatapersonbornatthebottomcanrisetothetop,oreventhemiddle.23 ThelevelofinequalityandtheabsenceofopportunitythatweseeintheUnitedStatestodayisnotinevitable,norisitsrecentrisesimplytheproductofinexorablemarketforces.Laterchapterswilldescribethecausesofthisinequality,thecoststooursociety,ourdemocracy,andoureconomyofthishighandgrowinginequality,andwhatcanbedonetoreduceit.THERISINGTIDETHATDIDN’TLIFTALLBOATSAlthoughtheUnitedStateshasalwaysbeenacapitalistcountry,ourinequality—oratleastitscurrenthighlevel—isnew.Somethirtyyearsago,thetop1percentofincomeearnersreceived13only12percentofthenation’sincome.Thatlevelofinequalityshoulditselfhavebeenunacceptable;butsincethen14thedisparityhasgrowndramatically,sothatby2007theaverageafter-taxincomeofthetop1percenthadreached$1.3million,butthatofthebottom20percentamountedtoonly15$17,800.Thetop1percentgetinoneweek40percentmorethanthebottomfifthreceiveinayear;thetop0.1percentreceivedinadayandahalfaboutwhatthebottom90percentreceivedinayear;andtherichest20percentofincomeearnersearnintotal16aftertaxmorethanthebottom80percentcombined.ForthirtyyearsafterWorldWarII,Americagrewtogether—withgrowthinincomeineverysegment,butwiththoseatthebottomgrowingfasterthanthoseatthetop.Thecountry’sfightforsurvivalbroughtanewsenseofunity,andthatledtopolicies,liketheGIBill,thathelpedbringthecountryevenclosertogether.Butforthepastthirtyyears,we’vebecomeincreasinglyanationdivided;notonlyhasthetopbeengrowingthefastest,butthebottomhasactuallybeendeclining.(Ithasn’tbeenarelentlesspattern—inthe1990s,forawhile,thoseatthebottomandinthemiddledidbetter.Butthen,aswe’veseen,beginningaround2000,inequalitygrewatanevenmorerapidpace.)ThelasttimeinequalityapproachedthealarminglevelweseetodaywasintheyearsbeforetheGreatDepression.Theeconomicinstabilitywesawthenandtheinstabilitywehaveseenmorerecentlyarecloselyrelatedtothisgrowinginequality,asI’llexplaininchapter4.Howweexplainthesepatterns,theebbandflowofinequality,isthesubjectofchapters2and3.Fornow,wesimplynotethatthemarkedreductionininequalityintheperiodbetween1950and1970,wasduepartlytodevelopmentsinthemarketsbutevenmoretogovernmentpolicies,suchastheincreasedaccesstohighereducationprovidedbytheGIBillandthehighlyprogressivetaxsystemenactedduringWorldWarII.Intheyearsafterthe“Reaganrevolution,”bycontrast,thedivideinmarketincomesincreasedand,ironically,atthesametimegovernmentinitiativesdesignedtotempertheinequitiesofthemarketplaceweredismantled,taxesatthetopwereloweredandsocialprogramswerecutback.Marketforces—thelawsofsupplyanddemand—ofcourseinevitablyplaysomeroleindeterminingtheextentofeconomicinequality.Butthoseforcesareatplayinotheradvancedindustrialcountriesaswell.Evenbeforetheburstininequality24 thatmarkedthefirstdecadeofthiscentury,theUnitedStatesalreadyhadmoreinequalityandlessincomemobilitythanpracticallyeverycountryinEurope,aswellasAustraliaandCanada.Thetrendsininequalitycanbereversed.Afewothercountrieshavemanagedtodoso.Brazilhashadoneofthehighestlevelsofinequalityintheworld—butinthe1990s,itrealizedtheperils,intermsbothofsocialandpoliticaldivisivenessandoflong-termeconomicgrowth.Theresultwasapoliticalconsensusacrosssocietythatsomethinghadtobedone.UnderPresidentEnriqueCardoso,thereweremassiveincreasesineducationexpenditures,includingforthepoor.UnderPresidentLuizInácioLuladaSilva,17thereweresocialexpenditurestoreducehungerandpoverty.18Inequalitywasreduced,growthincreased,andsocietybecamemorestable.BrazilstillhasmoreinequalitythantheUnitedStates,butwhileBrazilhasbeenstriving,rathersuccessfully,toimprovetheplightofthepoorandreducegapsinincomebetweenrichandpoor,Americahasallowedinequalitytogrowandpovertytoincrease.Worsestill,aswewillshow,governmentpolicieshavebeencentraltothecreationofinequalityintheUnitedStates.Ifwearetoreversethesetrendsininequality,wewillhavetoreversesomeofthepoliciesthathavehelpedmakeAmericathemosteconomicallydivideddevelopedcountryand,beyondthat,totakefurtheractionstolessentheinequalitiesthatariseontheirownfrommarketforces.Somedefendersofthecurrentlevelofinequalityclaimthatalthoughit’snotinevitable,doinganythingaboutitwouldbejusttoocostly.Theybelievethatforcapitalismtoworkitswonders,highinequalityisaninevitable,evennecessaryfeatureoftheeconomy.Afterall,thosewhoworkhardshouldberewarded,andhavetobe,iftheyaretomaketheeffortsandtheinvestmentsfromwhichallbenefit.Someinequalityisindeedinevitable.Someindividualswillworkharderandlongerthanothers,andanywell-functioningeconomicsystemhastorewardthemfortheseefforts.ButthisbookshowsthatboththemagnitudeofAmerica’sinequalitytodayandthewayitisgeneratedactuallyunderminegrowthandimpairefficiency.PartofthereasonforthisisthatmuchofAmerica’sinequalityistheresultofmarketdistortions,withincentivesdirectednotatcreatingnewwealthbutattakingitfromothers.Itisthusnotsurprisingthatourgrowthhasbeenstrongerinperiodsinwhichinequalityhasbeenlowerandinwhichwehavebeengrowing19together.ThiswastruenotonlyinthedecadesafterWorldWar20IIbut,eveninmorerecenttimes,inthe1990s.Trickle-downeconomicsInequality’sapologists—andtheyaremany—arguetothecontrarythatgivingmoremoneytothetopwillbenefiteveryone,partlybecauseitwouldleadtomoregrowth.Thisisanideacalledtrickle-downeconomics.Ithasalongpedigree—andhaslongbeendiscredited.Aswe’veseen,higherinequalityhasnotledtomoregrowth,andmostAmericanshaveactuallyseentheirincomessinkorstagnate.WhatAmericahasbeenexperiencinginrecentyearsistheoppositeoftrickle-downeconomics:therichesaccruingtothe21tophavecomeattheexpenseofthosedownbelow.25 Onecanthinkofwhat’sbeenhappeningintermsofslicesofapie.Ifthepiewereequallydivided,everyonewouldgetasliceofthesamesize,sothetop1percentwouldget1percentofthepie.Infact,theygetaverybigslice,aboutafifthoftheentirepie.Butthatmeanseveryoneelsegetsasmallerslice.Now,thosewhobelieveintrickle-downeconomicscallthisthepoliticsofenvy.Oneshouldlooknotattherelativesizeoftheslicesbutattheabsolutesize.Givingmoretotherichleadstoalargerpie,sothoughthepoorandmiddlegetasmallershareofthepie,thepieceofpietheygetisenlarged.Iwishthatwereso,butit’snot.Infact,it’stheopposite:aswenoted,intheperiodofincreasinginequality,growthhasbeenslower—andthesizeoftheslicegiventomostAmericanshasbeen22diminishing.Youngmen(agedtwenty-fivetothirty-four)whoarelesseducatedhaveanevenhardertime;thosewhohaveonlygraduatedfromhighschoolhaveseentheirrealincomesdeclinebymorethan23aquarterinthelasttwenty-fiveyears.Butevenhouseholdsofindividualswithabachelor’sdegreeorhigherhavenotdonewell—theirmedianincome(adjustedforinflation)fellbyatenth24from2000to2010.(Medianincomeistheincomesuchthathalfhaveanincomegreaterthanthatnumber,halfless.)We’llshowlaterthatwhereastrickle-downeconomicsdoesn’twork,trickle-upeconomicsmay:all—eventhoseatthetop—couldbenefitbygivingmoretothoseatthebottomandthemiddle.AsnapshotofAmerica’sinequalityThesimplestoryofAmericaisthis:thericharegettingricher,25therichestofthericharegettingstillricher,thepoorarebecomingpoorerandmorenumerous,andthemiddleclassisbeinghollowedout.Theincomesofthemiddleclassarestagnatingorfalling,andthedifferencebetweenthemandthetrulyrichisincreasing.Disparitiesinhouseholdincomearerelatedtodisparitiesinwagesandinwealthandincomefromcapital—andinequalityin26bothisincreasing.Justasoverallinequalityhasbeengrowing,sohaveinequalitiesinwagesandsalaries.Forinstance,overthelastthreedecadesthosewithlowwages(inthebottom90percent)haveseenagrowthofonlyaround15percentintheirwages,whilethoseinthetop1percenthaveseenanincreaseofalmost15027percentandthetop0.1percentofmorethan300percent.Meanwhile,changesinthewealthpictureareevenmoredramatic.Forthequartercenturybeforethecrisis,whileeveryonewasgettingwealthier,therichweregettingwealthieratamorerapidpace.Aswenoted,however,muchofthewealthofthebottomandthemiddle,restingonthevalueoftheirhomes,wasphantomwealth—basedonbubblehousingprices—andwhileeveryonelostoutinthemidstofthecrisis,thoseatthetopquicklyrecovered,butthebottomandmiddledidnot.EvenafterthewealthylostsomeoftheirwealthasstockpricesdeclinedintheGreatRecession,thewealthiest1percentofhouseholdshad225timesthewealthofthetypicalAmerican,almostdoubletheratio28in1962or1983.Giventheinequalityinwealth,it’snotsurprisingthatthoseatthetopgetthelion’sshareoftheincomefromcapital—26 beforethecrisis,in2007,some57percentwenttothetop129percent.Norisitsurprisingthatthoseinthetop1percenthavereceivedanevenlargershareoftheincreaseincapitalincomeintheperiodafter1979—someseven-eighths—whilethoseinthebottom95percenthavegottenlessthan3percentofthe30increment.Thesebroad-spectrumnumbers,whilealarming,canfailtocapturethecurrentdisparitieswithsufficientforce.ForanevenmorestrikingillustrationofthestateofinequalityinAmerica,considertheWaltonfamily:thesixheirstotheWal-Martempirecommandwealthof$69.7billion,whichisequivalenttothewealthoftheentirebottom30percentofU.S.society.Thenumbersmaynotbeassurprisingastheyseem,simplybecausethoseatthe31bottomhavesolittlewealth.PolarizationAmericahasalwaysthoughtofitselfasamiddle-classcountry.Noonewantstothinkofhimselfasprivileged,andnoonewantstothinkofhisfamilyasamongthepoor.Butinrecentyears,America’smiddleclasshasbecomeeviscerated,asthe“good”middle-classjobs—requiringamoderatelevelofskills,likeautoworkers’jobs—seemedtobedisappearingrelativetothoseatthebottom,requiringfewskills,andthoseatthetop,requiringgreaterskilllevels.Economistsrefertothisasthe32“polarization”ofthelaborforce.We’lldiscusssomeofthetheoriesexplainingwhythisishappening,andwhatcanbedoneaboutit,inchapter3.Thecollapseofthegoodjobshashappenedduringthelastquartercentury,and,notsurprisingly,wagesforsuchjobshavegonedownandthedisparitybetweenwagesatthetopandthosein33themiddlehasincreased.Thepolarizationofthelaborforcehasmeantthatwhilemoreofthemoneyisgoingtothetop,more34ofthepeoplearegoingtowardthebottom.THEGREATRECESSIONMAKESHARDLIVESEVENHARDERAmerica’seconomicdividehasgrownsolargethatit’shardforthoseinthe1percenttoimaginewhatlifeatthebottom—andincreasinglyinthemiddle—islike.Considerforamomentahouseholdwithasingleearnerandtwochildren.Assumethattheearnerisingoodhealthandmanagestoworkafull40hoursa35week(theaverageworkweekofAmericanworkersisonly34hours)atawagesomewhatabovetheminimum:say,around$8.50perhour,sothatafterpayinghisSocialSecuritytax,hegets$8perhour,andthusreceives$16,640forhis2,080hours.Assumehepaysnoincometax,buthisemployerchargeshim$200amonthforhealthinsuranceforhisentirefamilyandpicksuptherestofthe$550permonthcostofinsurance.Thisbringshistake-homepayto$14,240ayear.Ifheislucky,hemightbeabletofindatwo-bedroomapartment(withutilitiesincluded)for$700amonth.Thisleaveshimwith$5,840tocoverallotherfamilyexpensesfortheyear.LikemostAmericans,hemayconsideracarabasicnecessity;insurance,gas,maintenance,anddepreciationonthe27 vehiclecouldeasilytakeupsome$3,000.Thefamily’sremainingfundsare$2,840—under$3adayperperson—tocoverbasicexpenseslikefoodandclothing,nottomentionthingsthatmakelifeworthliving,likeentertainment.Ifsomethinggoeswrong,thereissimplynobuffer.AsAmericawentintotheGreatRecession,somethingdidgowrong,forourhypotheticalfamilyandmillionsofrealAmericansnationwide.Jobswerelost,thevalueoftheirhomes—theirmajorasset—plummeted,and,asgovernmentrevenuesfell,safetynetswerecutbackjustwhentheywereneededmost.Evenbeforethecrisis,America’spoorlivedontheprecipice;butwiththeGreatRecession,thatbecameincreasinglytrueevenofthemiddleclass.Thehumanstoriesofthiscrisisarerepletewithtragedies:onemissedmortgagepaymentescalatesintoalosthouse;homelessnessescalatesintolostjobsandtheeventual36destructionoffamilies.Forthesefamilies,oneshockmaybemanageable;thesecondisnot.AssomefiftymillionAmericanslackhealthinsurance,anillnesscanpushtheentirefamilyclose37toedge;asecondillness,thelossofajob,oranautoaccidentcanthenpushthemover.Indeed,recentresearchhasshownthatbyfarthelargestfractionofpersonalbankruptcies38involvetheillnessofafamilymember.Toseehowevenlittlechangesinprogramsofsocialprotectioncanhavebigeffectsonpoorfamilies,let’sreturntoourfamily,whichhad$2,840amonthtospend.Astherecessioncontinued,manystatescutbackonassistanceforchildcare.InWashingtonState,forinstance,theaveragemonthlycostof39childcarefortwochildrenis$1,433.Ifthereisnopublicassistanceforchildcare,thiswouldimmediatelyeatuphalfofwhatourfamilyhadleftover,leavinglessthan$1.30adayperpersonforeverythingelse.AlabormarketwithoutasafetynetButthehardshipfacedbythosewholosttheirjobsandcouldn’tfindanotherwasevengreater.Full-timeemploymentdeclinedby408.7millionfromNovember2007toNovember2011,aperiodduringwhichnormallyalmost7millionnewpersonswouldhaveenteredthelaborforce—anincreaseinthetruejobsdeficitofmorethan15million.Millionsofthosewhocouldn’tfindajobaftersearchingandsearchinggaveupanddroppedoutofthelaborforce;youngpeopledecidedtostayinschool,asemploymentprospectsevenforcollegegraduatesseemedbleak.The“missing”workersmeantthattheofficialunemploymentstatistics(which,byearly2012suggestedthattheunemploymentratewas“only”8.3percent)presentedanoverlyrosypictureofthestateofthelabormarket.Ourunemploymentinsurancesystem,oneoftheleastgenerousintheadvancedindustrialworld,simplywasn’tuptothetaskof41providingadequatesupportforthoselosingtheirjobs.Normally,insuranceextendsforonlysixmonths.Beforethecrisis,adynamiclabormarketatfullemploymentmeantthatmostofthosewhowantedajobcouldfindonewithinashorttime,evenifthejobwasn’tuptotheirexpectationsorskills.ButintheGreatRecessionthatwasnolongertrue.Almosthalfofthejoblesswerelong-termunemployed.Thetermofeligibilityforunemploymentinsurancewasextended28 42(typicallyafteraveryhardcongressionaldebate),but,evenso,millionsarefindingthattheyarestillunemployedwhenthe43benefitsexpire.Astherecessionandtheweakjobmarketcontinuedinto2010,anewsegmentofoursocietyemerged,the“99ers”—thosewhohadbeenunemployedformorethan99weeks—andeveninthebeststates,evenwithfederalassistance,theywereleftoutinthecold.Theylookedforwork,buttherejustweren’tenoughjobstobehad.Therewerefourjobseekersfor44everyjob.Andgivenhowmuchpoliticalcapitalhadtobespenttoextendunemploymentinsuranceto52,72,or99weeks,few45politiciansevenproposedtodoanythingaboutthe99ers.ApollbytheNewYorkTimeslatein2011revealedtheextent46oftheinadequaciesinourunemploymentinsurancesystem.Only38percentoftheunemployedwerethenreceivingunemploymentbenefits,andsome44percenthadneverreceivedany.Ofthosereceivingassistance,70percentthoughtthatitwasveryorsomewhatlikelythatthebenefitswouldrunoutbeforetheygotajob.Forthree-quartersofthoseonassistance,thebenefitsfellfarshortoftheirpreviousincome.Notsurprisingly,morethanhalfoftheunemployedhadexperiencedemotionalorhealthproblemsasaresultofbeingjoblessbutcouldnotgettreatment,sincemorethanhalfoftheunemployedhadnohealthinsurancecoverage.Manyoftheunemployedwhoweremiddle-agedsawnoprospectofeverfindinganotherjob.Forthoseoverforty-five,theaverage47durationofunemploymentisalreadyapproachingoneyear.Theonlypositivenoteinthesurveywastheoptimisticresponsethat,overall,70percentthoughtitwasveryorsomewhatlikelythattheywouldgetajobinthenexttwelvemonths.Americanoptimism,itseemed,stillsurvived.Beforetherecession,theUnitedStatesappearedinsomewaystobeperformingbetterthanothercountries.Whilewages,say,inthemiddlemightnotbegrowing,atleasteveryonewhowantedajobcouldgetone.Thiswasthelong-vauntedadvantageof“flexiblelabormarkets.”Butthecrisisshowedthateventhisadvantageseemedtobedisappearing,asAmerica’slabormarketsincreasinglyresembledthoseofEurope,withnotmerelyhighbutlong-lastingunemployment.Theyoungarefrustrated—butIsuspectthatuponlearningwhatthecurrenttrendportends,theywouldbeevenmoreso:thosewhoremainunemployedforanextendedperiodoftimehavelowerlifetimeemploymentprospectsthanthosewithsimilarqualificationswhohavebeenluckierinthejobmarket.Evenwhentheygetajob,itwillbeatalowerwagethanthatofpersonswithsimilarqualifications.Indeed,thebadluckofenteringthelaborforceinayearofhighunemploymentshowsup48inthelifelongearningsoftheseindividuals.EconomicinsecurityItiseasytounderstandthegrowinginsecuritythatsomanyAmericansfeel.Eventheemployedknowthattheirjobsareatrisk,andthatwiththehighlevelofunemploymentandthelowlevelofsocialprotection,theirlivescouldsuddenlytakeaturnfortheworse.Thelossofajobmeantthelossofhealthinsuranceandperhapseventhelossoftheirhome.Thosewithseeminglysecurejobsfacedaninsecureretirement,29 becauseinrecentyears,theUnitedStateshaschangedhowitmanagespensions.Mostretirementbenefitsusedtobeprovidedthroughdefined-benefitretirementschemes—whereindividualscouldbesureofwhattheywouldgetwhentheyretired,withcorporationsbearingtheriskofstockmarketfluctuations.Butnowmostworkershavedefined-contributionschemes,wheretheindividualisleftwiththeresponsibilityofmanaginghisretirementaccounts—andbearingtheriskofstockmarketfluctuationsandinflation.There’stheobviousdanger:iftheindividualhadlistenedtofinancialanalystsandputhermoneyintothestockmarkets,shetookabeatingin2008.TheGreatRecessionthusrepresentedatriplewhammyformanyAmericans:theirjobs,theirretirementincomes,andtheirhomeswereallatrisk.Thehousingbubblehadprovidedatemporaryreprievefromtheconsequencesthatwouldhavefollowedfromfallingincomes.Theycould,anddid,spendbeyondtheirincomeastheystruggledtomaintaintheirstandardofliving.Indeed,inthemid-2000s,beforetheonsetoftheGreatRecession,peopleinthebottom80percentwerespendingaround110percentoftheir49incomes.Nowthatthebubblehasbroken,notonlywilltheseAmericanshavetolivewithintheirincome;manywillhavetolivebelowtheirincometopaybackamountainofdebt.Morethanafifthofthosewithmortgagesareunderwater,owingmoreontheir50housethanit’sworth.Thehouse,insteadofbeingthepiggybanktopayforretirementorachild’scollegeeducation,hasbecomeaburden.Andmanypersonsareatriskoflosingtheirhomes—andmanyhavedonesoalready.Themillionsoffamiliesthatwenotedlosttheirhomessincethecrashingofthehousingbubblelostnotonlytheroofovertheirheadsbutalsomuchof51theirlifesavings.Betweenthelossonretirementaccountsandthe$6.5trillion52lossinhousingvaluations,ordinaryAmericanshavebeenhardhitbythecrisis,andpoorerAmericans,whowerejustbeginningtoglimpsetheAmericandream—orsotheythought,astheyboughtahomeandsawthevalueoftheirhousesriseinthebubble—havedoneparticularlybadly.Between2005and2009,thetypicalAfricanAmericanhouseholdhaslost53percentofitswealth—puttingitsassetsatamere5percentoftheaveragewhiteAmerican’s,andtheaverageHispanichouseholdhaslost66percentofitswealth.AndeventhenetworthofthetypicalwhiteAmericanhouseholdwasdownsubstantially,to$113,149in2009,a5316percentlossofwealthfrom2005.AstandardoflivingindeclineTheincomemeasuresonwhichwehavefocusedsofar,dismalastheyare,donotfullycapturethedeclineinthestandardoflivingofmostAmericans.Mostfacenotonlyeconomicinsecuritybutalsohealthinsecurityand,insomecases,evenphysicalinsecurity.PresidentObama’shealthcareprogramwasdesignedtoextendcoverage,buttheGreatRecessionandthebudgetstringencythatfollowedhaveledtoamoveintheoppositedirection.Medicaidprograms,onwhichthepoordepend,havebeenscaledback.Lackofhealthinsuranceisonefactorcontributingtopoorerhealth,especiallyamongthepoor.LifeexpectancyintheUnitedStatesis78years,lowerthanJapan’s83years,orAustralia’s30 orIsrael’s82years.AccordingtotheWorldBank,in2009the54UnitedStatesrankedfortiethoverall,justbelowCuba.InfantandmaternalmortalityintheUnitedStatesislittlebetterthaninsomedevelopingcountries;forinfantmortality,itisworse55thanCuba,Belarus,andMalaysia,tonameafew.AndthesepoorhealthindicatorsarelargelyareflectionofthedismalstatisticsforAmerica’spoor.Forinstance,America’spoorhavealifeexpectancythatisalmost10percentlowerthanthatof56thoseatthetop.Wenotedearlierthattheincomeofatypicalfull-timemaleworkerhasstagnatedforathirdofacentury,andthatofthosewhohavenotgonetocollegehasdeclined.Tokeepincomesfromdecliningevenmorethantheyhave,workhoursperfamilyhaveincreased,mostlybecausemorewomenarejoiningtheworkforcealongsidetheirhusbands.Ourincomestatisticsdonottakeintoaccounteitherthelossofleisureorwhatthisdoestothequalityoffamilylife.Thedeclineinlivingstandardsisalsomanifestedinchangingsocialpatternsaswellashardeconomicfacts.Anincreasingfractionofyoungadultsarelivingwiththeirparents:some19percentofmenbetweentwenty-fiveandthirty-four,upfrom14percentasrecentlyas2005.Forwomeninthisagegroup,the57increasewasfrom8percentto10percent.Sometimescalledthe“boomeranggeneration,”theseyoungpeopleareforcedtostayathome,orreturnhomeaftergraduation,becausetheycannotaffordtoliveindependently.Evencustomslikemarriagearebeingaffected,atleastforthemoment,bythelackofincomeandsecurity.Injustoneyear(2010),thenumberofcoupleswhowere58livingtogetherwithoutbeingmarriedjumpedby13percent.Theconsequencesofpervasiveandpersistentpovertyandlong-termunderinvestmentinpubliceducationandothersocialexpendituresarealsomanifestinotherindicatorsthatoursocietyisnotfunctioningasitshould:ahighlevelofcrime,59andalargefractionofthepopulationinprison.Whileviolent-crimestatisticsarebetterthantheywereattheirnadir(in601991),theyremainhigh,farworsethaninotheradvancedindustrialcountries,andtheyimposelargeeconomicandsocialcostsonoursociety.Residentsofmanypoor(andnotsopoor)neighborhoodsstillfeeltheriskofphysicalassault.It’sexpensivetokeep2.3millionpeopleinprison.TheU.S.incarcerationrateof730per100,000people(oralmost1in100adults),istheworld’shighestandsomeninetotentimesthat61ofmanyEuropeancountries.SomeU.S.statesspendasmuchon62theirprisonsastheydoontheiruniversities.Suchexpendituresarenotthehallmarksofawell-performingeconomyandsociety.Moneythatisspenton“security”—protectinglivesandproperty—doesn’taddtowell-being;itsimplypreventsthingsfromgettingworse.Yetweconsidertheseoutlayspartofthecountry’sgrossdomesticproduct(GDP)asmuchasanyotherexpenditure.IfAmerica’sgrowinginequalityleadstomorespendingtopreventcrime,itwillshowupasanincreaseinGDP,butnooneshouldconfusethatwithanincrease63inwell-being.Incarcerationevendistortsourunemploymentstatistics.Individualsinprisonaredisproportionatelypoorlyeducatedandcomefromgroupsthatotherwisefacehighunemployment.Itis31 highlylikelythat,iftheyweren’tincarcerated,theywouldjointhealreadyswollenranksoftheunemployed.Viewedinthislight,America’strueunemploymentratewouldbeworse,anditwouldcomparelessfavorablywiththatofEurope;iftheentireprisonpopulationofnearly2.3millionwascounted,theunemployment64ratewouldbewellabove9percent.PovertyTheGreatRecessionmadelifeforAmerica’sdiminishingmiddleclassharder.Butitwasespeciallyhardforthoseatthebottom,asillustratedbythedatapresentedearlierinthischapterforthefamilytryingtosurviveonawageslightlyabovetheminimumwage.AnincreasinglylargenumberofAmericanscanbarelymeetthenecessitiesoflife.Theseindividualsaresaidtobeinpoverty.65Thefractionofthoseinpovertywas15.1percentin2010,upfrom12.5percentin2007.Andourdiscussionaboveshouldhavemadeclearhowlowthestandardoflivingisofthoseatthatthreshold.Attheverybottom,by2011thenumberofAmericanfamiliesinextremepoverty—livingontwodollarsadayperpersonorless,themeasureofpovertyusedbytheWorldBankfor66developingcountries—haddoubledsince1996,to1.5million.The“povertygap,”whichisthepercentagebywhichthemeanincomeofacountry’spoorfallsbelowtheofficialpovertyline,isanothertellingstatistic.At37percent,theUnitedStatesisoneoftheworst-rankingcountriesintheOrganizationforEconomicCooperationandDevelopment(OECD),the“club”ofthemoredevelopedcountries,inthesameleagueasSpain(4067percent),Mexico(38.5percent),andKorea(36.6percent).TheextentofpovertyisillustratedbythefractionofAmericansdependingongovernmenttomeettheirbasicfoodneeds(oneinseven);andeventhen,largenumbersofAmericansgotobedatleastonceamonthhungry,notbecausetheyareonadiet68butbecausetheycan’taffordfood.Themeasurementofpoverty—likethemeasurementofincome—isdifficultandfarfromuncontroversial.Until2011,standardpovertymeasuresfocusedonincomebeforetheeffectsofgovernmentprogramsaretakenintoaccount,andthosearethenumbersthataregivenabove.Thisiswhatlifewouldbelikeintheabsenceofgovernmentsafetynets.Notsurprisingly,governmentprogramsdomatter.Andtheymatterespeciallyineconomicdownturns.Manyoftheprograms,likeunemploymentinsurance,provideonlyshort-termassistance.Theyaredirectedatthosefacingtemporaryhardship.Withthereformofthewelfaresystemin1996(PersonalResponsibilityandWorkOpportunityReconciliationAct),welfarepayments,too,becametimelimited(federalfundsaregenerallylimitedtoatmostfiveyears).Lookingattheseprograms,andsimultaneouslyexaminingmorecarefullythedifferentneedsofvariousgroupsinsociety—thoseintheruralsectorfacelowerhousingcosts;theelderlyfacehighermedicalcosts—yieldsamorenuancedpictureofpoverty,oneinwhichtherearefewerruralpoor,moreurbanpoor,fewerpoorchildren,andmorepoorelderlythanintheoldermeasures,whichdidn’ttakeintoaccountthedifferentcircumstancesofdifferentgroupsofthepoor.Underthisnewmeasure(aswellasbytheold),thenumbersinpovertyhavebeenincreasingrapidly,32 bysome6percentjustfrom2009to2010alone,andthenumbersinpovertyunderthenewmeasureareevenhigherthanundertheold,69sothatalmostoneoutofsixAmericansisnowinpoverty.Itmaybetruethat“thepooralwaysyehavewithyou,”butthatdoesn’tmeanthattherehavetobesomanypoor,orthattheyshouldsuffersomuch.Wehavethewealthandresourcestoeliminatepoverty:SocialSecurityandMedicarehavealmost70eliminatedpovertyamongtheelderly.Andothercountries,notasrichastheUnitedStates,havedoneabetterjobofreducingpovertyandinequality.Itisparticularlydisturbingthattodayalmostaquarterof71allchildrenliveinpoverty.Notdoinganythingabouttheirplightisapoliticalchoicethatwillhavelong-lastingconsequencesforourcountry.OPPORTUNITYBeliefinAmerica’sessentialfairness,thatweliveinalandofequalopportunity,helpsbindustogether.That,atleast,istheAmericanmyth,powerfulandenduring.Increasingly,itisjustthat—amyth.Ofcourse,thereareexceptions,butforeconomistsandsociologistswhatmattersarenotthefewsuccessstoriesbutwhathappenstomostofthoseatthebottomandinthemiddle.Whataretheirchancesofmakingit,say,tothetop?Whatisthelikelihoodthattheirchildrenwillbenobetter-offthanthey?IfAmericawerereallyalandofopportunity,thelifechancesofsuccess—of,say,windingupinthetop10percent—ofsomeoneborntoapoororless-educatedfamilywouldbethesameasthoseofsomeoneborntoarich,well-educated,andwell-connectedfamily.Butthat’ssimplynotthecase,andthereissome72evidencethatit’sgettinglessso.Indeed,accordingtotheEconomicMobilityProject,“thereisastrongerlinkbetweenparentaleducationandchildren’seconomic,educational,andsocio-emotionaloutcomes”intheUnitedStatesthaninanyothercountryinvestigated,includingthoseof“oldEurope”(theUK,France,Germany,andItaly),otherEnglishspeakingcountries(CanadaandAustralia),andtheNordiccountriesSweden,Finland,73andDenmark,wheretheresultsweremoreexpected.Avarietyof74otherstudieshavecorroboratedthesefindings.Thisdeclineinopportunityhasgonehandinhandwithourgrowinginequality.Infact,thatpatternhasbeenobservedacrosscountries—countrieswithmoreinequalitysystematicallyhaveless75equalityofopportunity.Inequalitypersists.Butwhat’sparticularlydisturbingaboutthisrelationshipiswhatitbodesforthecountry’sfuture:thegrowinginequalityoverrecentyearssuggeststhatthelevelofopportunityinthefuturewillbediminishedandthelevelofinequalitywillbeincreased—unlesswedosomething.ItmeansthattheAmericaof2053willbeamuchmoredividedsocietythaneventheAmericaof2013.Allthesocial,political,andeconomicproblemsarisingoutofinequalitythatwediscussinsubsequentchapterswillbethatmuchworse.ItisatthebottomandthetopwheretheUnitedStatesperformsespeciallybadly:thoseatthebottomhaveagoodchanceofstayingthere,andasdothoseatthetop,andmuchmoresothaninothercountries.Withfullequalityofopportunity,2033 percentofthoseinthebottomfifthwouldseetheirchildreninthebottomfifth.Denmarkalmostachievesthat—25percentarestuckthere.Britain,supposedlynotoriousforitsclassdivisions,doesonlyalittleworse(30percent).Thatmeanstheyhavea70percentchanceofmovingup.ThechancesofmovingupinAmerica,though,aremarkedlysmaller(only58percentofchildren76borntothebottomgroupmakeitout),andwhentheydomoveup,theytendtomoveuponlyalittle.Almosttwo-thirdsofthoseinthebottom20percenthavechildrenwhoareinthebottom40percent—50percentmorethanwouldbethecasewithfullequality77ofopportunity.Sotoo,withfullequalityofopportunity,20percentofthebottomwouldmakeitallthewaytothetopfifth.Nocountrycomesclosetoachievingthatgoal,butagainbothDenmark(with14percent)andtheUK(with12percent)domuchbetterthantheUnitedStates,withamere8percent.Bythesametoken,onceonemakesittothetopintheUnitedStates,oneis78morelikelytoremainthere.Therearemanyotherwaysofsummarizingthedisadvantageouspositionofthepoor.ThejournalistJonathanChaithasdrawnattentiontotwoofthemosttellingstatisticsfromtheEconomicMobilityProjectandresearchfromtheEconomicPolicy79Institute.•Poorkidswhosucceedacademicallyarelesslikelytograduatefromcollegethanricherkidswhodoworsein80school.•Eveniftheygraduatefromcollege,thechildrenofthepoor81arestillworse-offthanlow-achievingchildrenoftherich.Noneofthiscomesasasurprise:educationisoneofthekeystosuccess;atthetop,thecountrygivesitseliteaneducationthatiscomparabletothebestintheworld.ButtheaverageAmericangetsjustanaverageeducation—andinmathematics,keytosuccessinmanyareasofmodernlife,it’ssubpar.ThisisincontrasttoChina(ShanghaiandHongKong),Korea,Finland,Singapore,Canada,NewZealand,Japan,Australia,Netherlands,andBelgium,whichperformsignificantlyaboveaverageonalltests(readingand82mathematics).AstarkreflectionoftheinequalityofeducationalopportunityinoursocietyisthecompositionofstudentsinAmerica’shighlyselectivecolleges.Onlyaround9percentcomefromthebottomhalfofthepopulation,while74percentcomefromthetop83quarter.Sofar,wehaveconstructedapictureofaneconomyandasocietythatisincreasinglydivided.Itshowsupnotonlyinincomedatabutalsoinhealth,education,crime—indeed,ineverymetricofperformance.Whileinequalitiesinparentalincomeandeducationtranslatedirectlyintoinequalitiesofeducationalopportunity,inequalitiesofopportunitybeginevenbeforeschool—intheconditionsthatpoorpeoplefaceimmediatelybeforeandafterbirth,differencesinnutritionandtheexposureto84environmentalpollutantsthatcanhavelifelongeffects.Sodifficultisitforthosebornintopovertytoescapethat85economistsrefertothesituationasa“povertytrap.”Evenasthedatashowotherwise,Americansstillbelieveinthemythofopportunity.ApublicopinionpollbythePewFoundation34 foundthat“nearly7in10Americanshadalreadyachieved,orexpectedtoachieve,theAmericanDreamatsomepointintheir86lives.”Evenasamyth,thebeliefthateveryonehadafairchancehaditsuses:itmotivatedpeopletoworkhard.Itseemedwewereallinthesameboat;evenifsomewere,forthemoment,travelingfirst-classwhileothersstayedinsteerage.Onthenextcruisepositionsmightbereversed.ThebeliefenabledtheUnitedStatestoavoidsomeoftheclassdivisionsandtensionsthatmarkedsomeEuropeancountries.Bythesametoken,astherealitysinksin,asmostAmericansfinallygraspthattheeconomicgameisstackedagainstthem,allofthisisatrisk.Alienationhasbeguntoreplacemotivation.Insteadofsocialcohesionwehaveanewdivisiveness.ACLOSERLOOKATTHETOP:GRABBINGABIGGERSLICEOFTHEPIEAswe’venoted,thegrowinginequalityinoursocietyisvisibleatthetop,themiddle,andthebottom.We’vealreadyobservedwhat’shappeningatthebottomandinthemiddle.Herewetakeacloserlookatthetop.Ifstrugglingpoorfamiliesgetoursympathytoday,thoseatthetopincreasinglydrawourire.Atonetime,whentherewasabroadsocialconsensusthatthoseatthetopearnedwhattheygot,theyreceivedouradmiration.Intherecentcrisis,however,bankexecutivesreceivedoutsizebonusesforoutsizelosses,andfirmsfiredworkers,claimingtheycouldn’taffordthem,onlytousethesavingstoincreaseexecutivebonusesstillmore.Theresultwasthatadmirationattheirclevernessturnedtoangerattheirinsensitivities.Numbersoncompensationofcorporateexecutives—includingthosewhobroughtonthecrisis—tellthestory.WedescribedearlierthehugegapbetweenCEOpayandthatofthetypicalworker—morethan200timesgreater—anumbermarkedlyhigherthaninothercountries(inJapan,forinstance,thecorresponding87ratiois16to1)andevenmarkedlyhigherthanitwasinthe88UnitedStatesaquartercenturyago.TheoldU.S.ratioof30to1nowseemsquaintbycomparison.ItstrainscredulitytothinkthatovertheinterveningyearsCEOsasagrouphaveincreasedtheirproductivitysomuch,relativetotheaverageworker,thatamultipleofmorethan200couldbejustified.Indeed,theavailabledataonthesuccessofU.S.companiesprovidenosupport89forsuchaview.What’sworse,wehaveprovidedabadexample,asexecutivesinothercountriesaroundtheworldemulatetheirAmericancounterparts.TheUK’sHighPayCommissionreportedthattheexecutivepayatitslargecompaniesisheadingtowardVictorianlevelsofinequality,vis-à-vistherestofsociety(thoughcurrentlythedisparityisonlyasegregiousasitwasin90the1920s).Asthereportputsit,“Fairpaywithincompaniesmatters;itaffectsproductivity,employeeengagementandtrustinourbusinesses.Moreoverpayinpubliclylistedcompaniessetsaprecedent,andwhenitispatentlynotlinkedtoperformance,orrewardsfailure,itsendsoutthewrongmessageandisaclear91symptomofmarketfailure.”35 INTERNATIONALCOMPARISONSAswelookoutattheworld,theUnitedStatesnotonlyhasthehighestlevelofinequalityamongtheadvancedindustrialcountries,butthelevelofitsinequalityisincreasinginabsolutetermsrelativetothatinothercountries.TheUnitedStateswasthemostunequaloftheadvancedindustrialcountries92inthemid-1980s,andithasmaintainedthatposition.Infact,thegapbetweenitandmanyothercountrieshasincreased:fromthemid-1980sFrance,Hungary,andBelgiumhaveseennosignificantincreaseininequality,whileTurkeyandGreecehaveactuallyseenadecreaseininequality.Wearenowapproachingthelevelofinequalitythatmarksdysfunctionalsocieties—itisaclubthatwewoulddistinctlynotwanttojoin,includingIran,93Jamaica,Uganda,andthePhilippines.Becausewehavesomuchinequality,andbecauseitisontherise,what’shappeningtoincome(orGDP)percapitadoesn’ttellusmuchaboutwhatthetypicalAmericanisexperiencing.IfBillGatesandWarrenBuffett’sincomesgoup,theaverageincomeforAmericagoesup.Moremeaningfuliswhat’shappeningtothemedianincome,theincomeofthefamilyinthemiddle,which,aswesaw,hasbeenstagnating,orevenfalling,inrecentyears.TheUNDP(theUNDevelopmentProgram)hasdevelopedastandardmeasureof“humandevelopment,”whichaggregatesmeasuresofincome,health,andeducation.Itthenadjuststhosenumberstoreflectinequality.Beforeadjustmentforinequality,theUnitedSstateslookedreasonablygoodin2011—fourth,behindNorway,Australia,andNetherlands.Butonceaccountistakenofinequality,theUnitedStatesisrankedtwenty-third,behindalloftheEuropeancountries.Thedifferencebetweentherankingswithandwithoutinequalitywasthelargestofanyoftheadvanced94industrialcountries.AlloftheScandinaviancountriesrankmuchhigherthantheUnitedStates,andeachprovidesnotonlyuniversaleducationbutalsohealthcaretoitscitizens.ThestandardmantraintheUnitedStatesclaimsthatthetaxesrequiredtofinancethesebenefitsstiflegrowth.Farfromit.Overtheperiod2000to2010,high-taxingSweden,forexample,grewfarfasterthantheUnitedStates—thecountry’saveragegrowthrateshaveexceededthoseoftheUnitedStates—2.3195percentayearversus1.85percent.Asaformerfinanceministerofoneofthesecountriestoldme,“Wehavegrownsofastanddonesowellbecausewehadhightaxes.”Ofcourse,whathemeantwasnotthatthetaxesthemselvesledtohighergrowthbutthatthetaxesfinancedpublicexpenditures—investmentsineducation,technology,andinfrastructure—andthepublicexpenditureswerewhathadsustainedthehighgrowth—morethanoffsettinganyadverseeffectsfromthehighertaxation.GinicoefficientOnestandardmeasureofinequalityistheGinicoefficient.Ifincomeweresharedinproportiontothepopulation—thebottom10percentgettingroughly10percentoftheincome,thebottom20percentgetting20percent,andsoforth—thentheGinicoefficientwouldbezero.Therewouldbenoinequality.Ontheotherhand,ifalltheincomewenttothetopperson,theGini36 coefficientwouldbeone,insomesense“perfect”inequality.More-equalsocietieshaveGinicoefficientsof.3orbelow.These96includeSweden,Norway,andGermany.ThemostunequalsocietieshaveGinicoefficientsof.5orabove.TheseincludesomecountriesinAfrica(notablySouthAfricawithitshistoryofgrotesqueracialinequality)andLatinAmerica—longrecognizedfortheirdivided(andoftendysfunctional)societiesand97polities.Americahasn’tmadeityetintothis“elite”company,butit’swellontheway.In1980ourGinicoefficient98wasjusttouching.4;todayit’s.47.AccordingtoUNdata,we99areslightlymoreunequalthanIranandTurkey,andmuchless100equalthananycountryintheEuropeanUnion.Weendthisinternationalcomparisonbycomingbacktoathemeweraisedearlier:measuresofincomeinequalitydon’tfullycapturecriticalaspectsofinequality.America’sinequalitymay,infact,befarworsethanthosenumberssuggest.Inotheradvancedindustrialcountries,familiesdon’thavetoworryabouthowtheywillpaythedoctor’sbill,orwhethertheycanaffordtopayfortheirparent’shealthcare.Accesstodecenthealthcareistakenasabasichumanright.Inothercountries,thelossofajobisserious,butatleastthereisabettersafetynet.Innoothercountryaresomanypersonsworriedaboutthelossoftheirhome.ForAmericansatthebottomandinthemiddle,economicinsecurityhasbecomeafactoflife.Itisreal,itisimportant,butit’snotcapturedinthesemetrics.Ifitwere,theinternationalcomparisonswouldcastwhat’sbeenhappeninginAmericainanevenworselight.ConcludingCommentsIntheyearsbeforethecrisis,manyEuropeanslookedtoAmericaasamodelandaskedhowtheycouldreformtheireconomytomakeitperformaswellasthatoftheUnitedStates.Europehasitsproblems,too,causedmainlybycountries’joiningtogethertoformacurrencyunionwithoutmakingthenecessarypoliticalandinstitutionalarrangementstomakeitwork,andtheywillpayahighpriceforthatfailure.Butsettingthataside,they(andpeopleincountriesaroundtheworld)nowknowthatGDPpercapitadoesnotprovideagoodpictureofwhatishappeningtomostcitizensinsociety—andinafundamentalsense,then,ofhowwelltheeconomyisdoing.TheyweremisledbytheGDPpercapitadatatothinkingtheUnitedStateswasperformingwell.Todaythatisnolongerthecase.Ofcourse,economistswholookedbeneaththesurfaceknewbackin2008thatAmerica’sdebt-drivengrowthwasnotsustainable;andevenwhenallappearedtobegoingwell,theincomeofmostAmericanswasdeclining,evenastheoutsizegainsofthoseatthetopweredistortingtheoverallpicture.Thesuccessofaneconomycanbeassessedonlybylookingatwhatishappeningtothelivingstandards—broadlydefined—ofmostcitizensoverasustainedperiodoftime.Inthoseterms,America’seconomyhasnotbeenperformingwell,andithasn’tbeenforatleastathirdofacentury.Althoughithasmanagedto101increaseGDPpercapita,from1980to2010bythree-fourths,mostfull-timemaleworkershave,aswe’venoted,seentheirincomesgodown.Fortheseworkers,theAmericaneconomyisfailingtobringtheincreasesinlivingstandardsthattheyhad37 cometoexpect.ItisnotthattheAmericaneconomicenginehaslostitsabilitytoproduce.ItisthatthewaytheAmericaneconomicenginehasbeenrunhasgiventhebenefitsofthatgrowthtoanincreasinglysmallsliveratthetop—andeventakenawaysomeofwhathadpreviouslygonetothebottom.ThischapterhasilluminatedcertainstarkanduncomfortablefactsabouttheU.S.economy:(a)RecentU.S.incomegrowthprimarilyoccursatthetop1percentoftheincomedistribution.(b)Asaresultthereisgrowinginequality.(c)Andthoseatthebottomandinthemiddleareactuallyworse-offtodaythantheywereatthebeginningofthecentury.(d)Inequalitiesinwealthareevengreaterthaninequalitiesinincome.(e)Inequalitiesareapparentnotjustinincomebutinavarietyofothervariablesthatreflectstandardsofliving,suchasinsecurityandhealth.(f)Lifeisparticularlyharshatthebottom—andtherecessionmadeitmuchworse.(g)Therehasbeenahollowingoutofthemiddleclass.(h)Thereislittleincomemobility—thenotionofAmericaasalandofopportunityisamyth.(i)AndAmericahasmoreinequalitythananyotheradvancedindustrializedcountry,itdoeslesstocorrecttheseinequities,andinequalityisgrowingmorethaninmanyothercountries.TheAmericanRightfindsthefactsdescribedinthischapterinconvenient.Theanalysisrunscountertosomecherishedmythsthatitwouldliketopropagate:thatAmericaisalandofopportunity,thatmostpeoplehavebeenbenefitingfromthemarketeconomy,especiallyintheerasinceReaganderegulatedtheeconomyanddownsizedgovernment.MembersoftheRightwouldliketodenythefacts,buttheaccumulationofdatamakesithardtodoso.Theyespeciallycan’tdenythatthoseatthebottomandinthemiddlearedoingpoorlyandthatthoseatthetoparegrabbinganincreasingfractionofthenation’sincome—somuchofalargersharethatwhat’sleftoverfortherestisdiminished;andthatthechancesthatthoseatthebottomorinthemiddlewillmakeittothetoparefarlowerthanthechancesthatthoseatthetopwillremainthere.NorcantheRightreallydenythefactthatgovernmentcanhelpamelioratepoverty—ithasdonesoespeciallyeffectivelyamongtheelderly.Andthatmeansthatcutbacksingovernmentprograms,includingSocialSecurity,unlesstheyareverycarefullydesigned,arelikelytoincreasepoverty.Inresponse,theRightoffersfourretorts.Thefirstisthatinanyyearsomeonewillbedownandoutandsomeoneelsewillenjoyabonanza.Whatreallymattersislifetimeinequality.Thosewiththelowestincomeswill,byandlarge,havehigherincomesinlateryears,solifetimeinequalityislessthanthesedatasuggest.Economistshavetakenahardlookatdifferencesinlifetimeincome—and,unfortunately,thewishoftheRightdoesn’tconformtotoday’sreality:lifetimeinequalityisverylarge,almostasgreatasincomeateachmomentoftime,andhas102increasedenormouslyinrecentyears.TheRightalsosometimesclaimsthatpovertyinAmericaisnot38 realpoverty.Afterall,mostofthoseinpovertyhaveamenitiesthatarenotavailabletothepoorinothercountries.TheyshouldbegratefulforlivinginAmerica.TheyhaveTVs,indoorplumbing,heating(mostofthetime),andaccesstofreeschools.Butasa103NationalAcademyofSciencespanelfound,onecannotignorerelativedeprivation.BasicstandardsofsanitationinAmerica’scitiesleadnaturallytoindoorplumbing.CheapChineseTVsmeanthateventhepoorcanaffordthem—andindeed,eveninpoorIndianandChinesevillages,thereisingeneralaccesstoTV.Intoday’sworld,thisisnotamarkofaffluence.ButthefactthatpeoplemaybeenjoyingasmallTVdoesn’treallymeanthattheyaren’tfacingstarkpoverty—nordoesitmeanthattheyare104participatingintheAmericandream.Thethirdresponseistoquibbleaboutthestatistics.Somemightclaimthatinflationmaybeoverestimated,sogrowthinincomesmaybeunderestimated.But,ifanything,Isuspectthatthenumbersunder-estimatethetravailsfacingthetypicalAmericanfamily.Asfamilymembersworklongerhourstomaintaintheirstandardofliving—“forthefamily”—familylifeoftensuffers.Earlierinthischapter,wedescribedtheincreasinglevelofinsecuritythatthepoorandthemiddleclassinAmericaface—andthis,too,isnotreflectedintheincomestatistics.Plausibly,trueinequalitymaybefarlargerthanthemeasuresofinequalityofincomewouldsuggest.Indeed,aswenotedearlier,whentheCensusBureaurecentlytookamorecarefullookatthepovertystatistics,itfoundthatthepovertyratefor2010went105upfrom15.2percentto16percent.ThefinalretortbytheRightmakesreferencetoaneconomicandmoraljustificationofinequality,accompaniedbyaclaimthatattemptingtodoanythingaboutitwillsimply“killthegoldengoose,”andsoweakenAmerica’seconomythateventhepoorwill106suffer.AsMittRomneyputit,inequalityisthekindofthing107thatshouldbediscussedquietlyandprivately.Thepoor,inthislandofopportunity,haveonlythemselvestoblame.Inlaterchapterswe’lladdressthesearguments.We’llshowthat,forthemostpart,notonlyshouldwenotblamethepoorfortheirplightbutalsothattheclaimofthoseatthetop,thattheyearnedtheirmoney“ontheirown,”doesn’thavemuchmerit.We’llseethatthe1percentarebyandlargenotthosewhoearnedtheirincomesbygreatsocialcontributions—thegreatthinkerswhohavetransformedourunderstandingoftheworldorthegreatinnovatorswhohavetransformedoureconomy.We’llalsoexplainwhycreatingamoreequalsocietycancreateamoredynamiceconomy.ThetraumaoftheGreatRecession—withlargenumbersofpeoplelosingtheirjobsandhomes—hastriggeredachainreaction,affectingnotjustthelivesoftheindividualsconcernedbutalsosocietyasawhole.Wenowseethat,formostAmericans,theeconomywasn’treallyperformingasitshouldevenbeforetherecession.WecannolongerignoreAmerica’sgrowinginequalityanditsgraveeconomic,political,andsocialconsequences.Butifwearetounderstandwhattodoaboutit,wehavetounderstandtheeconomic,political,andsocialforcesthatgiverisetoit.39 CHAPTERTWORENTSEEKINGANDTHEMAKINGOFANUNEQUALSOCIETYAMERICANINEQUALITYDIDN’TJUSTHAPPEN.ITWAScreated.Marketforcesplayedarole,butitwasnotmarketforcesalone.Inasense,thatshouldbeobvious:economiclawsareuniversal,butourgrowinginequality—especiallytheamountsseizedbytheupper1percent—isadistinctlyAmerican“achievement.”Thatoutsizeinequalityisnotpredestinedoffersreasonforhope,butinrealityitislikelytogetworse.Theforcesthathavebeenatplayincreatingtheseoutcomesareself-reinforcing.Byunderstandingtheoriginsofinequality,wecanbettergraspthecostsandbenefitsofreducingit.Thesimplethesisofthischapteristhateventhoughmarketforceshelpshapethedegreeofinequality,governmentpoliciesshapethosemarketforces.Muchoftheinequalitythatexiststodayisaresultofgovernmentpolicy,bothwhatthegovernmentdoesandwhatitdoesnotdo.Governmenthasthepowertomovemoneyfromthetoptothebottomandthemiddle,orviceversa.WenotedinthelastchapterthatAmerica’scurrentlevelofinequalityisunusual.ComparedwithothercountriesandcomparedwithwhatitwasinthepastevenintheUnitedStates,it’sunusuallylarge,andithasbeenincreasingunusuallyfast.Itusedtobesaidthatwatchingforchangesininequalitywaslikewatchinggrassgrow:it’shardtoseethechangesinanyshortspanoftime.Butthat’snottruenow.Evenwhat’sbeenhappeninginthisrecessionisunusual.Typically,whentheeconomyweakens,wagesandemploymentadjustslowly,soassalesfall,profitsfallmorethanproportionately.Butinthisrecessiontheshareofwageshasactuallyfallen,and1manyfirmsaremakinggoodprofits.Addressinginequalityisofnecessitymultifaceted—wehavetoreinintheexcessesatthetop,strengthenthemiddle,andhelpthoseatthebottom.Eachgoalrequiresaprogramofitsown.Buttoconstructsuchprograms,wehavetohaveabetterunderstandingofwhathasgivenrisetoeachfacetofthisunusualinequality.Distinctastheinequalitywefacetodayis,inequalityitselfisnotsomethingnew.TheconcentrationofeconomicandpoliticalpowerwasinmanywaysmoreextremeintheprecapitalistsocietiesoftheWest.Atthattime,religionbothexplainedandjustifiedtheinequality:thoseatthetopofsocietyweretherebecauseofdivineright.Toquestionthatwastoquestionthesocialorder,oreventoquestionGod’swill.However,formoderneconomistsandpoliticalscientists,asalsofortheancientGreeks,thisinequalitywasnotamatterofa40 preordainedsocialorder.Power—oftenmilitarypower—wasattheoriginoftheseinequities.Militarismwasabouteconomics:theconquerorshadtherighttoextractasmuchastheycouldfromtheconquered.Inantiquity,naturalphilosophyingeneralsawnowrongintreatingotherhumansasmeansfortheendsofothers.AstheancientGreekhistorianThucydidesfamouslysaid,“right,astheworldgoes,isonlyinquestionbetweenequalsinpower,while2thestrongdowhattheycanandtheweaksufferwhattheymust.”Thosewithpowerusedthatpowertostrengthentheireconomic3andpoliticalpositions,orattheveryleasttomaintainthem.Theyalsoattemptedtoshapethinking,tomakeacceptabledifferencesinincomethatwouldotherwisebeodious.Asthenotionofdivinerightbecamerejectedintheearlynation-states,thosewithpowersoughtotherbasesfordefendingtheirpositions.WiththeRenaissanceandtheEnlightenment,whichemphasizedthedignityoftheindividual,andwiththeIndustrialRevolution,whichledtotheemergenceofavasturbanunderclass,itbecameimperativetofindnewjustificationsforinequality,especiallyascriticsofthesystem,likeMarx,talkedabout4exploitation.Thetheorythatcametodominate,beginninginthesecondhalfofthenineteenthcentury—andstilldoes—wascalled“marginalproductivitytheory”;thosewithhigherproductivitiesearnedhigherincomesthatreflectedtheirgreatercontributiontosociety.Competitivemarkets,workingthroughthelawsofsupplyanddemand,determinethevalueofeachindividual’scontributions.Ifsomeonehasascarceandvaluableskill,themarketwillrewardhimamply,becauseofhisgreatercontributiontooutput.Ifhehasnoskills,hisincomewillbelow.Technology,ofcourse,determinestheproductivityofdifferentskills:inaprimitiveagricultureeconomy,physicalstrengthandenduranceiswhatmattered;inamodernhi-techeconomy,brainpowerisofmorerelevance.Technologyandscarcity,workingthroughtheordinarylawsofsupplyanddemand,playaroleinshapingtoday’sinequality,butsomethingelseisatwork,andthatsomethingelseisgovernment.Amajorthemeofthisbookisthatinequalityistheresultofpoliticalforcesasmuchasofeconomicones.Inamoderneconomygovernmentsetsandenforcestherulesofthegame—whatisfaircompetition,andwhatactionsaredeemedanticompetitiveandillegal,whogetswhatintheeventofbankruptcy,whenadebtorcan’tpayallthatheowes,whatarefraudulentpracticesandforbidden.Governmentalsogivesawayresources(bothopenlyandlesstransparently)and,throughtaxesandsocialexpenditures,modifiesthedistributionofincomethatemergesfromthemarket,shapedasitisbytechnologyandpolitics.Finally,governmentaltersthedynamicsofwealthby,forinstance,taxinginheritancesandprovidingfreepubliceducation.Inequalityisdeterminednotjustbyhowmuchthemarketpaysaskilledworkerrelativetoanunskilledworker,butalsobythelevelofskillsthatanindividualhasacquired.Intheabsenceofgovernmentsupport,manychildrenofthepoorwouldnotbeabletoaffordbasichealthcareandnutrition,letalonetheeducationrequiredtoacquiretheskillsnecessaryforenhancedproductivityandhighwages.Governmentcanaffecttheextenttowhichanindividual’seducationandinheritedwealthdependsonthatofhisparents.Moreformally,economistssaythatinequalitydependsonthedistributionof“endowments,”offinancialandhuman41 capital.ThewaytheAmericangovernmentperformsthesefunctionsdeterminestheextentofinequalityinoursociety.Ineachofthesearenastherearesubtledecisionsthatbenefitsomegroupattheexpenseofothers.Theeffectofeachdecisionmaybesmall,butthecumulativeeffectoflargenumbersofdecisions,madetobenefitthoseatthetop,canbeverysignificanat.Competitiveforcesshouldlimitoutsizeprofits,butifgovernmentsdonotensurethatmarketsarecompetitive,therecanbelargemonopolyprofits.Competitiveforcesshouldalsolimitdisproportionateexecutivecompensation,butinmoderncorporations,theCEOhasenormouspower—includingthepowertosethisowncompensation,subject,ofcourse,tohisboard—butinmanycorporations,heevenhasconsiderablepowertoappointtheboard,andwithastackedboard,thereislittlecheck.Shareholdershaveminimalsay.Somecountrieshavebetter“corporategovernancelaws,”thelawsthatcircumscribethepoweroftheCEO,forinstance,byinsistingthattherebeindependentmembersintheboardorthatshareholdershaveasayinpay.Ifthecountrydoesnothavegoodcorporategovernancelawsthatareeffectivelyenforced,CEOscanpaythemselvesoutsizebonuses.Progressivetaxandexpenditurepolicies(whichtaxtherichmorethanthepoorandprovidesystemsofgoodsocialprotection)canlimittheextentofinequality.Bycontrast,programsthatgiveawayacountry’sresourcestotherichandwellconnectedcanincreaseinequality.Ourpoliticalsystemhasincreasinglybeenworkinginwaysthatincreasetheinequalityofoutcomesandreduceequalityofopportunity.Thisshouldnotcomeasasurprise:wehaveapoliticalsystemthatgivesinordinatepowertothoseatthetop,andtheyhaveusedthatpowernotonlytolimittheextentofredistributionbutalsotoshapetherulesofthegameintheirfavor,andtoextractfromthepublicwhatcanonlybecalledlarge“gifts.”Economistshaveanamefortheseactivities:theycallthemrentseeking,gettingincomenotasarewardtocreatingwealthbutbygrabbingalargershareofthewealththatwouldotherwisehavebeenproducedwithouttheireffort.(We’llgiveafullerdefinitionoftheconceptofrentseekinglaterinthechapter.)Thoseatthetophavelearnedhowtosuckoutmoneyfromtherestinwaysthattherestarehardlyawareof—thatistheirtrueinnovation.Jean-BaptisteColbert,theadvisertoKingLouisXIVofFrance,reportedlysaid,“Theartoftaxationconsistsinsopluckingthegooseastoobtainthelargestamountoffeatherswiththeleastpossibleamountofhissing.”So,too,fortheartofrentseeking.Toputitbaldly,therearetwowaystobecomewealthy:tocreatewealthortotakewealthawayfromothers.Theformeraddstosociety.Thelattertypicallysubtractsfromit,forintheprocessoftakingitaway,wealthgetsdestroyed.Amonopolistwhooverchargesforhisproducttakesmoneyfromthosewhomheisoverchargingandatthesametimedestroysvalue.Togethismonopolyprice,hehastorestrictproduction.Unfortunately,evengenuinewealthcreatorsoftenarenotsatisfiedwiththewealththattheirinnovationorentrepreneurshiphasreaped.Someeventuallyturntoabusivepracticeslikemonopolypricingorotherformsofrentextractiontogarnerevenmoreriches.Totakejustoneexample,therailroad42 baronsofthenineteenthcenturyprovidedanimportantserviceinconstructingtherailroads,butmuchoftheirwealthwastheresultoftheirpoliticalinfluence—gettinglargegovernmentlandgrantsoneithersideoftherailway.Today,overacenturyaftertherailroadbaronsdominatedtheeconomy,muchofthewealthatthetopintheUnitedStates—andsomeofthesufferingatthebottom—stemsfromwealthtransfersinsteadofwealthcreation.Ofcourse,notalltheinequalityinoursocietyisaresultofrentseeking,orofgovernment’stiltingtherulesofthegameinfavorofthoseatthetop.Marketsmatter,asdosocialforces(likediscrimination).Thischapterfocusesonthemyriadformsthatrentseekingtakesinoursociety,andthenextturnstotheotherdeterminantsofinequality.GENERALPRINCIPLESAdamSmith’sinvisiblehandandinequalityAdamSmith,thefatherofmoderneconomics,arguedthattheprivatepursuitofself-interestwouldlead,asifbyaninvisible5hand,tothewell-beingofall.Intheaftermathofthefinancialcrisis,noonetodaywouldarguethatthebankers’pursuitoftheirself-interesthasledtothewell-beingofall.Atmost,itledtothebankers’well-being,withtherestofsocietybearingthecost.Itwasn’tevenwhateconomistscallazero-sumgame,wherewhatonepersongainsexactlyequalswhattheotherslose.Itwasanegative-sumgame,wherethegainstowinnersarelessthanthelossestothelosers.Whattherestofsocietylostwasfar,fargreaterthanwhatthebankersgained.Thereisasimplereasonforwhyfinanciers’pursuitoftheirintereststurnedouttobedisastrousfortherestofsociety:thebankers’incentiveswerenotwellalignedwithsocialreturns.Whenmarketsworkwell—inthewaythatAdamSmithhypothesized—itisbecauseprivatereturnsandsocialbenefitsarewellaligned,thatis,becauseprivaterewardsandsocialcontributionsareequal,ashadbeenassumedbymarginalproductivitytheory.Inthattheory,thesocialcontributionofeachworkerisexactlyequaltotheprivatecompensation.Peoplewithhigherproductivity—alargersocialcontribution—gethigherpay.AdamSmithhimselfwasawareofoneofthecircumstancesinwhichprivateandsocialreturnsdiffer.Asheexplained,“Peopleofthesametradeseldommeettogether,evenformerrimentanddiversion,buttheconversationendsinaconspiracyagainstthe6public,orinsomecontrivancetoraiseprices.”Marketsbythemselvesoftenfailtoproduceefficientanddesirableoutcomes,andthereisaroleforgovernmentincorrectingthesemarketfailures,thatis,designingpolicies(taxesandregulations)thatbringprivateincentivesandsocialreturnsintoalignment.(Ofcourse,thereareoftendisagreementsaboutthebestwayofdoingit.Butfewtodaybelieveinunfetteredfinancialmarkets—theirfailuresimposetoogreatacostontherestofsociety—orthatfirmsshouldbeallowedtodespoiltheenvironmentwithoutrestriction.)Whengovernmentdoesitsjobwell,thereturnsreceivedby,say,aworkeroraninvestorareinfactequaltothebenefitstosocietythathisactionscontribute.Whenthesearenotaligned,wesaythereisamarketfailure,thatis,markets43 failtoproduceefficientoutcomes.Privaterewardsandsocialreturnsarenotwellalignedwhencompetitionisimperfect;whenthereare“externalities”(whereoneparty’sactionscanhavelargenegativeorpositiveeffectsonothersforwhichhedoesnotpayorreapthebenefit);whenthereexistimperfectionsorasymmetriesofinformation(wheresomeoneknowssomethingrelevanttoamarkettradethatsomeoneelsedoesn’tknow);orwhereriskmarketsorothermarketsareabsent(onecan’t,forinstance,buyinsuranceagainstmanyofthemostimportantrisksthatonefaces).Sinceoneormoreoftheseconditionsexistinvirtuallyeverymarket,thereisinfactlittlepresumptionthatmarketsareingeneralefficient.Thismeansthatthereisanenormouspotentialroleforgovernmenttocorrectthesemarketfailures.Governmentnevercorrectsmarketfailuresperfectly,butitdoesabetterjobinsomecountriesthaninothers.Onlyifthegovernmentdoesareasonablygoodjobofcorrectingthemostimportantmarketfailureswilltheeconomyprosper.GoodfinancialregulationhelpedtheUnitedStates—andtheworld—avoidamajorcrisisforfourdecadesaftertheGreatDepression.Deregulationinthe1980sledtoscoresoffinancialcrisesinthesucceedingthreedecades,ofwhichAmerica’scrisisin2008–09wasonlythe7worst.Butthosegovernmentalfailureswerenoaccident:thefinancialsectoruseditspoliticalmuscletomakesurethatthemarketfailureswerenotcorrected,andthatthesector’sprivaterewardsremainedwellinexcessoftheirsocialcontributions—oneofthefactorscontributingtothebloatedfinancialsectorandtothehighlevelsofinequalityatthetop.ShapingmarketsWe’lldescribebelowsomeofthewaysthatprivatefinancialfirmsacttoensurethatmarketsdon’tworkwell.Forinstance,asSmithnoted,thereareincentivesforfirmstoworktoreducemarketcompetition.Moreover,firmsalsostrivetomakesurethattherearenostronglawsprohibitingthemfromengaginginanticompetitivebehavioror,whentherearesuchlaws,thattheyarenoteffectivelyenforced.Thefocusofbusinesspeopleis,ofcourse,nottoenhancesocietalwell-beingbroadlyunderstood,oreventomakemarketsmorecompetitive:theirobjectiveissimplytomakemarketsworkforthem,tomakethemmoreprofitable.Buttheconsequenceisoftenalessefficienteconomymarkedbygreaterinequality.Fornow,oneexamplewillsuffice.Whenmarketsarecompetitive,profitsabovethenormalreturntocapitalcannotbesustained.Thatissobecauseifafirmmakesgreaterprofitsthanthatonasale,rivalswillattempttostealthecustomerbyloweringprices.Asfirmscompetevigorously,pricesfalltothepointthatprofits(abovethenormalreturntocapital)aredrivendowntozero,adisasterforthoseseekingbigprofits.Inbusinessschoolweteachstudentshowtorecognize,andcreate,barrierstocompetition—includingbarrierstoentry—thathelpensurethatprofitswon’tbeeroded.Indeed,asweshallshortlysee,someofthemostimportantinnovationsinbusinessinthelastthreedecadeshavecenterednotonmakingtheeconomymoreefficientbutonhowbettertoensuremonopolypowerorhowbettertocircumventgovernmentregulationsintendedtoalignsocialreturnsandprivaterewards.Makingmarketslesstransparentisafavoritetool.Themoretransparentmarketsare,themorecompetitivetheyarelikelyto44 be.Bankersknowthis.That’swhybankshavebeenfightingtokeeptheirbusinessinwritingderivatives,theriskyproducts8thatwereatthecenterofAIG’scollapse,intheshadowsofthe“overthecounter”market.Inthatmarket,it’sdifficultforcustomerstoknowwhetherthey’regettingagooddeal.Everythingisnegotiated,asopposedtohowthingsworkinmoreopenandtransparentmodernmarkets.Andsincethesellersaretradingconstantly,andbuyersenteronlyepisodically,sellershavemoreinformationthanbuyers,andtheyusethatinformationtotheiradvantage.Thismeansthatonaverage,sellers(thewritersofthederivatives,thebanks)canextractmoremoneyoutoftheircustomers.Well-designedopenauctions,bycontrast,ensurethatgoodsgotothosewhovaluethemthemost,ahallmarkofefficiency.Therearepubliclyavailablepricesforguidingdecisions.Whilelackoftransparencyresultsinmoreprofitsforthebankers,itleadstolowereconomicperformance.Withoutgoodinformation,capitalmarketscan’texerciseanydiscipline.Moneywon’tgotowherereturnsarehighest,ortothebankthatdoesthebestjobofmanagingmoney.Noonecanknowthetruefinancialpositionofabankorotherfinancialinstitutiontoday—andshadowyderivativetransactionsarepartofthereason.Onewouldhavehopedthattherecentcrisismighthaveforcedchange,butthebankersresisted.Theyresisteddemands,forinstance,formoretransparencyinderivativesandforregulationsthatwouldrestrictanticompetitivepractices.Theserent-seekingactivitieswereworthtensofbillionsofdollarsinprofits.Althoughtheydidn’twineverybattle,theywonoftenenoughthattheproblemsarestillwithus.InlateOctober2011,forinstance,amajor9Americanfinancialfirmwentbankrupt(theeighth-largestbankruptcyonrecord),partlybecauseofcomplexderivatives.Evidentlythemarkethadn’tseenthroughthesetransactions,atleastnotinatimelyway.MovingmoneyfromthebottomofthepyramidtothetopOneofthewaysthatthoseatthetopmakemoneyisbytakingadvantageoftheirmarketandpoliticalpowertofavorthemselves,toincreasetheirownincome,attheexpenseoftherest.Thefinancialsectorhasdevelopedexpertiseinawidevarietyofformsofrentseekingitself.We’vealreadymentionedsome,buttherearemanyothers:takingadvantageofasymmetriesofinformation(sellingsecuritiesthattheyhaddesignedtofail,10butknowingthatbuyersdidn’tknowthat);takingexcessiverisk—withthegovernmentholdingalifeline,bailingthemoutandassumingthelosses,theknowledgeofwhich,incidentally,allowsthemtoborrowatalowerinterestratethantheyotherwisecould;andgettingmoneyfromtheFederalReserveatlowinterestrates,nowalmostzero.Buttheformofrentseekingthatismostegregious—andthathasbeenmostperfectedinrecentyears—hasbeentheabilityofthoseinthefinancialsectortotakeadvantageofthepooranduninformed,astheymadeenormousamountsofmoneybypreyinguponthesegroupswithpredatorylendingandabusivecreditcard11practices.Eachpoorpersonmighthaveonlyalittle,buttherearesomanypoorthatalittlefromeachamountstoagreatdeal.45 Anysenseofsocialjustice—oranyconcernaboutoverallefficiency—wouldhaveledgovernmenttoprohibittheseactivities.Afterall,considerableamountsofresourceswereusedupintheprocessofmovingmoneyfromthepoortotherich,whichiswhyit’sanegative-sumgame.Butgovernmentdidn’tputanendtothesekindofactivities,notevenwhen,around2007,itbecameincreasinglyapparentwhatwasgoingon.Thereasonwasobvious.Thefinancialsectorhadinvestedheavilyinlobbyingandcampaigncontributions,andtheinvestmentshadpaidoff.Imentionthefinancialsectorpartlybecauseithascontributedsopowerfullytooursociety’scurrentlevelof12inequality.Thefinancialsector’sroleincreatingthecrisisin2008–09isapparenttoall.Noteventhosewhoworkinthesectordenyit,thougheachbelievesthatsomeotherpartofthefinancialsectorisreallytoblame.MuchofwhatIhavesaidaboutthefinancialsector,though,couldbesaidaboutotherplayersintheeconomythathavehadahandincreatingcurrentinequities.Moderncapitalismhasbecomeacomplexgame,andthosewhowinatithavetohavemorethanalittlesmarts.Butthosewhowinatitoftenpossesslessadmirablecharacteristicsaswell:theabilitytoskirtthelaw,ortoshapethelawintheirownfavor;thewillingnesstotakeadvantageofothers,eventhepoor;andto13playunfairwhennecessary.Asoneofthesuccessfulplayersinthisgameputit,theoldadage“Winorlose,whatmattersishowyouplaythegame”isrubbish.Allthatmattersiswhetheryouwinorlose.Themarketprovidesasimplewayofshowingthat—theamountofmoneythatyouhave.Winninginthegameofrentseekinghasmadefortunesformanyofthoseatthetop,butitisnottheonlymeansbywhichtheyobtainandpreservetheirwealth.Thetaxsystemalsoplaysakeyrole,aswe’llseelater.Thoseatthetophavemanagedtodesignataxsysteminwhichtheypaylessthantheirfairshare—theypayalowerfractionoftheirincomethandothosewhoaremuchpoorer.Wecallsuchtaxsystemsregressive.Andwhileregressivetaxesandrentseeking(whichtakesmoneyfromtherestofsocietyandredistributesittothetop)areatthecoreofgrowinginequality,especiallyatthetop,broaderforcesexertparticularinfluenceontwootheraspectsofAmericaninequality—thehollowingoutofthemiddleclassandtheincreaseinpoverty.Lawsgoverningcorporationsinteractwiththenormsofbehaviorthatguidetheleadersofthosecorporationsanddeterminehowreturnsaresharedamongtopmanagementandotherstakeholders(workers,shareholders,andbondholders).Macroeconomicpoliciesdeterminethetightnessofthelabormarket—thelevelofunemployment,andthushowmarketforcesoperatetochangetheshareofworkers.Ifmonetaryauthoritiesacttokeepunemploymenthigh(evenifbecauseoffearofinflation),thenwageswillberestrained.Strongunionshavehelpedtoreduceinequality,whereasweakerunionshavemadeiteasierforCEOs,sometimesworkingwithmarketforcesthattheyhavehelpedshape,toincreaseit.Ineacharena—thestrengthofunions,theeffectivenessofcorporategovernance,theconductofmonetarypolicy—politicsiscentral.Ofcourse,marketforces,thebalancingof,say,thedemandandsupplyforskilledworkers,affectedasitisbychangesintechnologyandeducation,playanimportantroleaswell,evenifthoseforcesarepartiallyshapedbypolitics.Butinsteadof46 thesemarketforcesandpoliticsbalancingeachotherout,withthepoliticalprocessdampeningtheincreaseininequalityinperiodswhenmarketforcesmighthaveledtogrowingdisparities,insteadofgovernmenttemperingtheexcessesofthemarket,inAmericatodaythetwohavebeenworkingtogethertoincreaseincomeandwealthdisparities.RENTSEEKINGEarlier,welabeledasrentseekingmanyofthewaysbywhichourcurrentpoliticalprocesshelpstherichattheexpenseoftherestofus.Rentseekingtakesmanyforms:hiddenandopentransfersandsubsidiesfromthegovernment,lawsthatmakethemarketplacelesscompetitive,laxenforcementofexistingcompetitionlaws,andstatutesthatallowcorporationstotakeadvantageofothersortopasscostsontotherestofsociety.Theterm“rent”wasoriginallyusedtodescribethereturnstoland,sincetheowneroflandreceivesthesepaymentsbyvirtueofhisownershipandnotbecauseofanythinghedoes.Thisstandsincontrasttothesituationofworkers,forexample,whosewagesarecompensationfortheefforttheyprovide.Theterm“rent”thenwasextendedtoincludemonopolyprofits,ormonopolyrents,theincomethatonereceivessimplyfromthecontrolofamonopoly.Eventuallythetermwasexpandedstillfurthertoincludethereturnsonsimilarownershipclaims.Ifthegovernmentgaveacompanytheexclusiverighttoimportalimitedamount(aquota)ofagood,suchassugar,thentheextrareturngeneratedasaresultoftheownershipofthoserightswascalleda“quota-rent.”Countriesrichinnaturalresourceareinfamousforrent-seekingactivities.It’sfareasiertogetrichinthesecountriesbygainingaccesstoresourcesatfavorabletermsthanbyproducingwealth.Thisisoftenanegative-sumgame,whichisoneofthereasonswhy,onaverage,suchcountrieshavegrownmoreslowlythancomparablecountrieswithoutthebountyofsuch14resources.Evenmoredisturbing,onemighthavethoughtthatanabundanceofresourcescouldbeusedtohelpthepoor,toensureaccesstoeducationandhealthcareforall.Taxingworkandsavingscanweakenincentives;incontrast,taxingthe“rents”onland,oil,orothernaturalresourceswon’tmakethemdisappear.Theresourceswillstillbetheretobetakenout,ifnottoday,thentomorrow.Therearenoadverseincentiveeffects.Thatmeansthat,inprinciple,thereshouldbeamplerevenuestofinancebothsocialexpendituresandpublicinvestments—in,say,healthandeducation.Yet,amongthecountrieswiththegreatestinequalityarethosewiththemostnaturalresources.Evidently,afewwithinthesecountriesarebetteratrentseekingthanothers(usuallythosewithpoliticalpower),andtheyensurethatthebenefitsoftheresourcesaccruelargelytothemselves.InVenezuela,therichestoilproducerinLatinAmerica,halfofthecountrylivedinpovertypriortotheriseofHugoChavez—anditispreciselythistypeofpovertyinthemidstofrichesthatgivesriseto15leaderslikehim.Rent-seekingbehaviorisnotjustendemicintheresource-richcountriesoftheMiddleEast,Africa,andLatinAmerica.Ithasalsobecomeendemicinmoderneconomies,includingourown.In47 thoseeconomies,ittakesmanyforms,someofwhicharecloselyakintothoseintheoil-richcountries:gettingstateassets(suchasoilorminerals)atbelowfair-marketprices.It’snothardtobecomewealthyifthegovernmentsellsyoufor$500millionaminethat’sworth$1billion.Anotherformofrentseekingistheflipside:sellingtogovernmentproductsatabovemarketprices(noncompetitiveprocurement).Thedrugcompaniesandmilitarycontractorsexcelinthisformofrentseeking.Opengovernmentsubsidies(asinagriculture)orhiddensubsidies(traderestrictionsthatreducecompetitionorsubsidieshiddeninthetaxsystem)areotherwaysofgettingrentsfromthepublic.Notallrentseekingusesgovernmenttoextractmoneyfromordinarycitizens.Theprivatesectorcanexcelonitsown,extractingrentsfromthepublic,forinstance,throughmonopolisticpracticesandexploitingthosewhoarelessinformedandeducated,exemplifiedbythebanks’predatorylending.CEOscanusetheircontrolofthecorporationtogarnerforthemselvesalargerfractionofthefirms’revenues.Here,though,thegovernmenttooplaysarole,bynotdoingwhatitshould:bynotstoppingtheseactivities,bynotmakingthemillegal,orbynotenforcinglawsthatexist.Effectiveenforcementofcompetitionlawscancircumscribemonopolyprofits;effectivelawsonpredatorylendingandcreditcardabusescanlimittheextentofbankexploitation;well-designedcorporategovernancelawscanlimittheextenttowhichcorporateofficialsappropriateforthemselvesfirmrevenues.Bylookingatthoseatthetopofthewealthdistribution,wecangetafeelforthenatureofthisaspectofAmerica’sinequality.Fewareinventorswhohavereshapedtechnology,orscientistswhohavereshapedourunderstandingsofthelawsofnature.ThinkofAlanTuring,whosegeniusprovidedthemathematicsunderlyingthemoderncomputer.OrofEinstein.Orofthediscoverersofthelaser(inwhichCharlesTownesplayeda16centralrole)orJohnBardeen,WalterBrattain,andWilliam17Shockley,theinventorsoftransistors.OrofWatsonandCrick,whounraveledthemysteriesofDNA,uponwhichrestssomuchofmodernmedicine.Noneofthem,whomadesuchlargecontributionstoourwell-being,areamongthosemostrewardedbyoureconomicsystem.Instead,manyoftheindividualsatthetopofthewealthdistributionare,inonewayoranother,geniusesatbusiness.Somemightclaim,forinstance,thatSteveJobsortheinnovatorsofsearchenginesorsocialmediawere,intheirway,geniuses.Jobswasnumber110ontheForbeslistoftheworld’swealthiestbillionairesbeforehisdeath,andMarkZuckerbergwas52.Butmanyofthese“geniuses”builttheirbusinessempiresontheshouldersofgiants,suchasTimBerners-Lee,theinventoroftheWorldWideWeb,whohasneverappearedontheForbeslist.Berners-Leecouldhavebecomeabillionairebutchosenotto—hemadehisideaavailablefreely,whichgreatlyspeededupthe18developmentoftheInternet.Acloserlookatthesuccessesofthoseatthetopofthewealthdistributionshowsthatmorethanasmallpartoftheirgeniusresidesindevisingbetterwaysofexploitingmarketpowerandothermarketimperfections—and,inmanycases,findingbetterwaysofensuringthatpoliticsworksforthemratherthanforsocietymoregenerally.48 We’vealreadycommentedonfinanciers,whomakeupasignificantportionofthetop1or0.1percent.Whilesomegainedtheirwealthbyproducingvalue,othersdidsoinnosmallpartbyoneofthemyriadformsofrentseekingthatwedescribedearlier.Atthetop,inadditiontothefinanciers,whomwehavealready19discussed,arethemonopolistsandtheirdescendantswho,throughonemechanismoranother,havesucceededinachievingandsustainingmarketdominance.AftertherailroadbaronsofthenineteenthcenturycameJohnD.RockefellerandStandardOil.TheendofthetwentiethcenturysawBillGatesandMicrosoft’sdominationofthePCsoftwareindustry.Internationally,thereisthecaseofCarlosSlim,aMexicanbusinessmanwhowasrankedbyForbesasthewealthiestpersonin20theworldin2011.ThankstohisdominanceofthetelephoneindustryinMexico,Slimisabletochargepricesthatareamultipleofthoseinmorecompetitivemarkets.HemadehisbreakthroughwhenhewasabletoacquirealargeshareinMexico’stelecommunicationssystemafterthecountryprivatized21it,astrategythatliesbehindmanyoftheworld’sgreatfortunes.Aswe’veseen,it’seasytogetrichbygettingastateassetatadeepdiscount.ManyofRussia’scurrentoligarchs,forexample,obtainedtheirinitialwealthbybuyingstateassetsatbelow-marketpricesandthenensuringcontinuingprofitsthroughmonopolypower.(InAmericamostofourgovernmentgiveawaystendtobemoresubtle.Wedesignrulesfor,say,sellinggovernmentassetsthatareineffectpartialgiveaways,22butlesstransparentlysothanwhatRussiadid.)Intheprecedingchapter,weidentifiedanotherimportantgroupoftheverywealthy—corporateCEOs,suchasStephenHemsleyfromUnitedHealthGroup,whoreceived$102millionin2010,andEdwardMuellerfromQwestCommunications(nowCenturyLink,afteramerger23in2011),whomade$65.8million.CEOshavesuccessfully24garneredalargerandlargerfractionofcorporaterevenues.Aswe’llexplainlater,itisnotasuddenincreaseintheirproductivitythatallowedtheseCEOstoamasssuchrichesinthelastcoupleofdecadesbutratheranenhancedabilitytotakemorefromthecorporationthattheyaresupposedtobeserving,andweakerqualmsabout,andenhancedpublictolerationof,doingso.Afinallargegroupofrentseekersconsistsofthetop-flightlawyers,includingthosewhobecamewealthybyhelpingothersengageintheirrentseekinginwaysthatskirtthelawbutdonot(usually)landtheminprison.Theyhelpwritethecomplextaxlawsinwhichloopholesareput,sotheirclientscanavoidtaxes,andtheythendesignthecomplexdealstotakeadvantageoftheseloopholes.Theyhelpeddesignthecomplexandnontransparentderivativesmarket.Theyhelpdesignthecontractualarrangementsthatgeneratemonopolypower,seeminglywithinthelaw.Andforallthisassistanceinmakingourmarketsworknotthewaymarketsshouldbutasinstrumentsforthebenefitofthoseatthetop,25theygetamplyrewarded.Monopolyrents:creatingsustainablemonopoliesToeconomistslargefortunesposeaproblem.Thelawsofcompetition,asIhavenoted,saythatprofits(beyondthenormal49 returntocapital)aresupposedtobedriventozero,andquickly.Butifprofitsarezero,howcanfortunesbebuilt?Nichesinwhichthereisn’tcompetition,foronereasonoranother,offer26oneavenue.Butthatgoesonlyalittlewaytoexplainingsustainableexcessiveprofits(beyondthecompetitivelevel).Successwillattractentry,andprofitswillquicklydisappear.Therealkeytosuccessistomakesurethattherewon’teverbecompetition—oratleasttherewon’tbecompetitionforalongenoughtimethatonecanmakeamonopolykillinginthemeanwhile.Thesimplestwaytoasustainablemonopolyisgettingthegovernmenttogiveyouone.Fromtheseventeenthcenturytothenineteenth,theBritishgrantedtheEastIndiaCompanyamonopolyontradewithIndia.Thereareotherwaystogetgovernment-sanctionedmonopolies.Patentstypicallygiveaninventoramonopolyoverthatinnovationforatemporaryperiod,butthedetailsofpatentlawcanextendthelengthofthepatent,reduceentryofnewfirms,andenhancemonopolypower.America’spatentlawshavebeendoingexactlythat.Theyaredesignednottomaximizethepaceofinnovationbut27rathertomaximizerents.Evenwithoutagovernmentgrantofmonopoly,firmscancreateentrybarriers.Avarietyofpracticesdiscourageentry,suchasmaintainingexcesscapacity,sothatanentrantknowsthat,shouldheenter,theincumbentfirmcanincreaseproduction,lowering28pricestothepointthatentrywouldbeunprofitable.IntheMiddleAges,guildssuccessfullyrestrictedcompetition.Manyprofessionshavecontinuedthattradition.Althoughtheyarguethattheyaresimplytryingtomaintainstandards,restrictionsonentry(limitingthenumberofplacesatmedicalschoolorrestrictingmigrationoftrainedpersonnelfromabroad)helpkeep29incomeshigh.Attheturnofthepreviouscentury,concernaboutthemonopoliesthatformedthebasisofmanyofthefortunesofthatperiod,includingRockefeller’s,grewsogreatthatunderthetrust-bustingpresidentTheodoreRoosevelt,Americapassedaslewoflawstobreakupmonopoliesandpreventsomeofthesepractices.Intheyearsthatfollowed,numerousmonopolieswere30brokenup—inoil,cigarettes,andmanyotherindustries.Andyettoday,aswelookaroundtheAmericaneconomy,wecanseemanysectors,includingsomethatarecentraltoitsfunctioning,whereoneorafewfirmsdominate—suchasMicrosoftinPCoperatingsystems,orAT&T,Verizon,T-Mobile,andSprintintelecommunications.Threefactorscontributedtothisincreasedmonopolizationofmarkets.First,therewasabattleoverideasabouttherolethatgovernmentshouldtakeinensuringcompetition.Chicagoschooleconomists(likeMiltonFriedmanandGeorgeStigler)whobelieve31infreeandunfetteredmarketsarguedthatmarketsarenaturally32competitiveandthatseeminglyanticompetitivepracticesreally33enhanceefficiency.Amassiveprogramto“educate”people,andespeciallyjudges,regardingthesenewdoctrinesoflawandeconomics,partlysponsoredbyright-wingfoundationsliketheOlinFoundation,wassuccessful.Thetimingwasironic:Americancourtswerebuyingintonotionsthatmarketswere“naturally”competitiveandplacingahighburdenofproofonanyoneclaimingotherwisejustastheeconomicsdisciplinewasexploringtheories50 thatexplainwhymarketsoftenwerenotcompetitive,evenwhentherewereseeminglymanyfirms.Forinstance,anewandpowerfulbranchofeconomicscalledgametheoryexplainedhowcollusivebehaviorcouldbemaintainedtacitlyoverextendedperiodsoftime.Meanwhile,newtheoriesofimperfectandasymmetricinformationshowedhowinformationimperfectionsimpairedcompetition,andnewevidencesubstantiatedtherelevanceandimportanceofthesetheories.TheinfluenceoftheChicagoschoolshouldnotbeunderestimated.Evenwhenthereareblatantinfractions—likepredatorypricing,whereafirmlowersitspricetoforceoutacompetitorandthenusesitsmonopolypowertoraiseprices—34they’vebeenhardtoprosecute.Chicagoschooleconomicsarguesthatmarketsarepresumptivelycompetitiveandefficient.Ifentrywereeasy,thedominantfirmwouldgainnothingfromdrivingoutarival,becausethefirmthatisforcedoutwouldbequicklyreplacedbyanotherfirm.Butinrealityentryisnotsoeasy,andpredatorybehaviordoesoccur.Asecondfactorgivingrisetoincreasedmonopolyisrelatedtochangesinoureconomy.Thecreationofmonopolypowerwaseasierinsomeofthenewgrowthindustries.Manyofthesesectorsweremarkedbywhatarecallednetworkexternalities.Anobviousexampleisthecomputeroperatingsystem:justasit’sveryconvenientforeveryonetospeakthesamelanguage,it’sveryconvenientforeveryonetousethesameoperatingsystem.Increasinginterconnectivityacrosstheworldnaturallyleadstostandardization.Thosewithamonopolyoverthestandardthatischosenbenefit.Aswehavenoted,competitionnaturallyworksagainsttheaccumulationofmarketpower.Whentherearelargemonopolyprofits,competitorsworktogetashare.That’swherethethirdfactorthathasincreasedmonopolypowerintheUnitedStatescomesin:businessesfoundnewwaysofresistingentry,ofreducingcompetitivepressures.Microsoftprovidestheexampleparexcellence.Becauseitenjoyedanear-monopolyonPCoperatingsystems,itstoodtolosealotifalternativetechnologiesundermineditsmonopoly.ThedevelopmentoftheInternetandthewebbrowsertoaccessitrepresentedjustsuchathreat.Netscapebroughtthebrowsertothemarket,buildingongovernment-funded35research.Microsoftdecidedtosquelchthispotentialcompetitor.Itoffereditsownproduct,InternetExplorer,buttheproductcouldn’tcompeteintheopenmarket.ThecompanydecidedtouseitsmonopolypowerinPCoperatingsystemstomakesurethattheplayingfieldwasnotlevel.ItdeployedastrategyknownasFUD(fear,uncertainty,anddoubt),creatinganxietyaboutcompatibilityamongusersbyprogrammingerrormessagesthatwouldrandomlyappearifNetscapewasinstalledonaWindowscomputer.ThecompanyalsodidnotprovidethedisclosuresnecessaryforfullcompatibilityasnewversionsofWindowsweredeveloped.Andmostcleverly,itofferedInternetExploreratazeroprice—free,bundledinaspartofitsoperatingsystem.It’shardtocompete36withazeroprice.Netscapewasdoomed.Itwasobviousthatsellingsomethingatazeropricewasnotaprofit-maximizingstrategy—intheshortrun.ButMicrosofthadavisionforthelongrun:themaintenanceofitsmonopoly.Forthat,itwaswillingtomakeshort-runsacrifices.Itsucceeded,butsoblatantwereitsmethodsthatcourtsandtribunalsthroughouttheworldchargeditwithengaginginanticompetitive51 practices.Andyet,intheend,Microsoftwon—foritrealizedthatinanetworkeconomy,amonopolyposition,onceattained,ishardtobreak.GivenMicrosoft’sdominanceoftheoperatingsystemmarket,ithadtheincentivesandcapabilitiestodominate37inahostofotherapplications.Nowonder,then,thatMicrosoft’sprofitshavebeensoenormous—anaverageof$7billionperyearoverthelastquartercentury,$14billionoverthepasttenyears,increasingin201138to$23billion—andreapingwealthforthosewhoboughtsharesearlyenough.Theconventionalwisdomhasitthatinspiteofitsdominantpositionandhugeresources,Microsofthasnotbeenarealinnovator.Itdidnotdevelopthefirstwidelyusedwordprocessor,thefirstspreadsheet,thefirstbrowser,thefirstmediaplayer,orthefirstdominantsearchengine.Innovationlayelsewhere.Thisisconsistentwiththeoryandhistoricalevidence:39monopolistsarenotgoodinnovators.LookingattheU.S.economy,weseeinmanysectorslargenumbersoffirms,andthereforeinferthattheremustbecompetition.Butthat’snotalwaysthecase.Taketheexampleofbanks.Whiletherearehundredsofbanks,thebigfourshare40betweenthemalmosthalfofthecountry’sbankingassets,amarkedincreasefromthedegreeofconcentrationfifteenyearsago.Inmostsmallercommunities,thereareatmostoneortwo.Whencompetitionissolimited,pricesarelikelytobefarin41excessofcompetitivelevels.That’swhythesectorenjoysprofitsestimatedtobemorethan$115billionayear,muchofwhichispassedalongtoitstopofficialsandotherbankers—helpingcreateoneofthemajorsourcesofinequalityatthe42top.Insomeproducts,suchasover-the-countercreditdefaultswaps(CDSes),fourorfiveverylargebankstotallydominate,andsuchmarketconcentrationalwaysgivesrisetotheworrythattheycollude,albeittacitly.(Butsometimesthecollusionisnoteventacit—itisexplicit.Thebankssetacriticalrate,calledtheLondonInterbankOfferedRate,orLibor.MortgagesandmanyfinancialproductsarelinkedtoLibor.Itappearsthatthebanksworkedtorigtherate,enablingthemtomakestillmoremoneyfromotherswhowereunawareoftheseshenanigans.)Ofcourse,evenwhenlawsthatprohibitmonopolisticpracticesareonthebooks,thesehavetobeenforced.ParticularlygiventhenarrativecreatedbytheChicagoschoolofeconomics,thereisatendencynottointerferewiththe“free”workingsofthemarket,evenwhentheoutcomeisanticompetitive.Andtherearegoodpoliticalreasonsnottotaketoostrongaposition:afterall,it’santibusiness—andnotgoodforcampaigncontributions—43tobetootoughon,say,Microsoft.Politics:gettingtosettherulesandpicktherefereeIt’sonethingtowinina“fair”game.It’squiteanothertobeabletowritetherulesofthegame—andtowritetheminwaysthatenhanceone’sprospectsofwinning.Andit’sevenworseifyoucanchooseyourownreferees.Inmanyareastoday,regulatoryagenciesareresponsibleforoversightofasector(writingandenforcingrulesandregulations)—theFederalCommunicationsCommission(FCC)intelecom;theSecuritiesandExchange52 Commission(SEC)insecurities;andtheFederalReserveinmanyareasofbanking.Theproblemisthatleadersinthesesectorsusetheirpoliticalinfluencetogetpeopleappointedtotheregulatoryagencieswhoaresympathetictotheirperspectives.44Economistsrefertothisas“regulatorycapture.”Sometimesthecaptureisassociatedwithpecuniaryincentives:thoseontheregulatorycommissioncomefromandreturntothesectorthattheyaresupposedtoregulate.Theirincentivesandthoseoftheindustryarewellaligned,eveniftheirincentivesarenotwellalignedwiththoseoftherestofsociety.Ifthoseontheregulatorycommissionservethesectorwell,theygetwellrewardedintheirpost-governmentcareer.Sometimes,however,thecaptureisnotjustmotivatedbymoney.Instead,themindsetofregulatorsiscapturedbythosewhomtheyregulate.Thisiscalled“cognitivecapture,”anditismoreofasociologicalphenomenon.WhileneitherAlanGreenspannorTimGeithneractuallyworkedforabigbankbeforecomingtotheFederalReserve,therewasanaturalaffinity,andtheymayhavecometosharethesamemindset.Inthebankers’mindset—despitethemessthatthebankershadmade—therewasnoneedtoimposestringentconditionsonthebanksinthebailout.Thebankershaveunleashedenormousnumbersoflobbyiststopersuadeanyandallwhoplayaroleinregulationthattheyshouldnotberegulated—anestimated2.5foreveryU.S.45representative.Butpersuasioniseasierifthetargetofyoureffortsbeginsfromasympatheticposition.Thatiswhybanksandtheirlobbyistsworksostrenuouslytoensurethatthegovernmentappointsregulatorswhohavealreadybeen“captured”inonewayoranother.Thebankerstrytovetoanyonewhodoesnotsharetheirbelief.IsawthisfirsthandduringtheClintonadministration,whenpotentialnamesfortheFedwerefloated,someevenfromthebankingcommunity.Ifanyofthepotentialnomineesdeviatedfromthepartylinethatmarketsareself-regulatingandthatthebankscouldmanagetheirownrisk—therearoseahueandcrysogreatthatthenamewouldn’tbeputforwardor,ifitwasputforward,thatitwouldn’tbe46approved.GovernmentmunificenceWe’veseenhowmonopolies—whethergovernmentgrantedorgovernment“sanctioned,”throughinadequateenforcementofcompetitionlaws—havebuiltthefortunesofmanyoftheworld’swealthiestpeople.Butthereisanotherwaytogetrich.Youcansimplyarrangeforthegovernmenttohandyoucash.Thiscanhappeninmyriadways.Alittle-noticedchangeinlegislation,forexample,canreapbillionsofdollars.Thiswasthecasewhenthe47governmentextendedamuch-neededMedicaredrugbenefitin2003.Aprovisioninthelawthatprohibitedgovernmentfrombargainingforpricesondrugswas,ineffect,agiftofsome$50billionor48moreperyeartothepharmaceuticalcompanies.Moregenerally,governmentprocurement—payingpriceswellabovecosts—isastandardformofgovernmentmunificence.Sometimesgiftsarehiddeninobscureprovisionsoflegislation.Aprovisionofoneofthekeybillsderegulatingthefinancialderivativemarket—ensuringthatnoregulatorcouldtouchit,nomatterhowgreattheperiltowhichitexposedthe53 economy—alsogavederivativesclaims“seniority”intheeventofbankruptcy.Ifabankwentunder,theclaimsonthederivativeswouldbepaidoffbeforeworkers,suppliers,orothercreditorssawanymoney—evenifthederivativeshadpushedthefirminto49bankruptcyinthefirstplace.(Thederivativesmarketplayedacentralroleinthe2008–09crisisandwasresponsibleforthe$150billionbailoutofAIG.)Thereareotherwaysthatthebankingsectorhasbenefitedfromgovernmentmunificence,evidentmostclearlyintheaftermathoftheGreatRecession.WhentheFederalReserve(whichcanbethoughtofasonebranchofthegovernment)lendsunlimitedamountsofmoneytobanksatnear-zerointerestrates,andallowsthemtolendthemoneybacktothegovernment(ortoforeigngovernments)atmuchhigherinterestrates,itissimplygivingthemahiddengiftworthbillionsandbillionsofdollars.Thesearenottheonlywaysthatgovernmentsspurthecreationofenormouspersonalwealth.Manycountries,includingtheUnitedStates,controlvastamountsofnaturalresourceslikeoil,gas,andminingconcessions.Ifthegovernmentgrantsyoutherighttoextracttheseresourcesforfree,itdoesn’ttakeageniustomakeafortune.Thatis,ofcourse,whattheU.S.governmentdidinthenineteenthcentury,whenanyonecouldstakeaclaimtonaturalresources.Today,thegovernmentdoesn’ttypicallygiveawayitsresources;moreoftenitrequiresapayment,butapaymentthatisfarlessthanitshouldbe.Thisisjustalesstransparentwayofgivingawaymoney.Ifthevalueoftheoilunderaparticularpieceoflandis$100millionafterpayingtheextractioncosts,andthegovernmentrequiresapaymentofonly$50million,thegovernmenthas,ineffect,givenaway$50million.Itdoesn’thavetobethisway,butpowerfulinterestsensurethatitis.IntheClintonadministration,wetriedtomaketheminingcompaniespaymorefortheresourcestheytakeoutofpubliclandsthanthenominalamountsthattheydo.Notsurprisingly,theminingcompanies—andthecongressmentowhomtheymakegenerouscontributions—opposedthesemeasures,andsuccessfullyso.Theyarguedthatthepolicywouldimpedegrowth.Butthefactofthematteristhat,withanauction,companieswillbidtogettheminingrightssolongasthevalueoftheresourcesisgreaterthanthecostofextraction,andiftheywinthebid,theywillextracttheresources.Auctionsdon’timpedegrowth;theyjustmakesurethatthepublicgetspaidappropriatelyforwhatistheirs.Modernauctiontheoryhasshownhowchangingthedesignoftheauctioncangeneratemuchmorerevenueforthegovernment.Thesetheoriesweretestedoutintheauctionofthespectrumusedfortelecommunicationsbeginninginthe1990s,andtheyworkedremarkablywell,generatingbillionsforthegovernment.Sometimesgovernmentmunificence,insteadofhandingoverresourcesforpenniesonthedollar,takestheformofrewritingtherulestoboostprofits.Aneasywaytodothisistoprotectfirmsfromforeigncompetition.Tariffs,taxespaidbycompaniesabroadbutnotbydomesticfirms,areineffectagifttodomesticproducers.Thefirmsdemandingprotectionfromforeigncompetitionalwaysprovidearationale,suggestingthatsocietyasawholeisthebeneficiaryandthatanybenefitsthataccruetothecompaniesthemselvesareincidental.Thisisself-serving,ofcourse,andwhilethereareinstancesinwhichsuchpleascontainsometruth,54 thewidespreadabuseoftheargumentmakesithardtotakeseriously.Becausetariffsputforeignproducersatadisadvantage,theyenabledomesticfirmstoraisetheirpricesandincreasetheirprofits.Insomecases,theremaybesomeincidentalbenefitssuchashigherdomesticemploymentandtheopportunityforcompaniestoinvestinR&Dthatwillincreaseproductivityandcompetiveness.Butjustasoften,tariffsprotectoldandtiredindustriesthathavelosttheircompetitivenessandarenotlikelytoregainit,oroccasionallythosethathavemadebadbetsonnewtechnologiesandwouldliketopostponefacingcompetition.Theethanolsubsidyoffersanexampleofthisphenomenon.AplantoreduceourdependenceonoilbyreplacingitwiththeenergyofthesunembeddedinoneofAmerica’sgreatproducts,itscorn,seemedirresistible.Butconvertingplantenergyintoaformthatcanprovideenergyforcarsinsteadofpeopleishugelyexpensive.Itisalsoeasiertodowithsomeplantsthanothers.SosuccessfulhasBrazil’sresearchonsugar-basedethanolbeenthatinorderforAmericatocompete,foryearsithadtotax50Braziliansugar-basedethanol54centsagallon.Fortyyearsaftertheintroductionofthesubsidy,itwasstillinplacetosupportaninfanttechnologythatseeminglywouldnotgrowup.Whenoilpricesfellafterthe2008recession,manyethanolplants51wentbankrupt,evenwithmassivesubsidies.Itwasn’tuntiltheendof2011thatthesubsidyandtariffwereallowedtoexpire.Thepersistenceofsuchdistortionarysubsidiesstemsfromasinglesource:politics.Themain—andforalongwhile,effectivelytheonly—directbeneficiaryofthesesubsidieswerethecorn-ethanolproducers,dominatedbythemegafirmArcherDanielsMidland(ADM).Likesomanyotherexecutives,thoseatADMseemedtobebetteratmanagingpoliticsthanatinnovation.Theycontributedgenerouslytobothparties,sothatasmuchasthoseinCongressmightrailagainstsuchcorporatelargesse,lawmakers52wereslowtotouchtheethanolsubsidies.Aswe’venoted,firmsalmostalwaysarguethatthetruebeneficiariesofanylargessetheyreceivelieelsewhere.Inthiscase,ethanoladvocatesarguedthattherealbeneficiarieswereAmerica’scornfarmers.Butthatwas,forthemostpart,notthecase,especiallyintheearlydays53ofthesubsidy.Ofcourse,whyAmericancornfarmers,whowerealreadytherecipientsofmassivegovernmenthandouts,receivingalmosthalfoftheirincomefromWashingtonratherthanfromthe“soil,”shouldreceivestillfurtherassistanceishardtounderstand,andhardtoreconcilewithprinciplesofafree-marketeconomy.(Infact,thevastpreponderanceofgovernmentmoneysubsidizingagriculturedoesnotgo,asmanybelieve,topoorfarmersorevenfamilyfarms.Thedesignoftheprogramrevealsitstrueobjective:toredistributemoneyfromtherestofustotherich54andcorporatefarms.)Sadly,governmentmunificencetowardcorporationsdoesnotendwiththefewexampleswehavegiven,buttodescribeeachandeveryinstanceofgovernmentapprovedrentseekingwouldrequire55anotherbook.55 CHAPTERTHREEMARKETSANDINEQUALITYTHEPRECEDINGCHAPTEREMPHASIZEDTHEROLEOFrentseekingincreatingAmerica’shighlevelofinequality.Anotherapproachtoexplaininginequalityemphasizesabstractmarketforces.Inthisview,it’sjustthebadluckofthoseinthemiddleandatthebottomthatmarketforceshaveplayedoutthewaytheyhave—withordinaryworkersseeingtheirwagesdecline,andskilledbankersseeingtheirincomessoar.Implicitinthisperspectiveisthenotionthatoneinterfereswiththewondersofthemarketatone’speril:becautiousinanyattemptto“correct”themarket.TheviewItakeissomewhatdifferent.Ibeginwiththeobservationmadeinchapters1and2:otheradvancedindustrialcountrieswithsimilartechnologyandpercapitaincomediffergreatlyfromtheUnitedStatesininequalityofpretaxincome(beforetransfers),ininequalityofaftertaxandtransferincome,ininequalityofwealth,andineconomicmobility.ThesecountriesalsodiffergreatlyfromtheUnitedStatesinthetrendsinthesefourvariablesovertime.Ifmarketsweretheprincipaldrivingforce,whydoseeminglysimilaradvancedindustrialcountriesdiffersomuch?Ourhypothesisisthatmarketforcesarereal,butthattheyareshapedbypoliticalprocesses.Marketsareshapedbylaws,regulations,andinstitutions.Everylaw,everyregulation,everyinstitutionalarrangementhasdistributiveconsequences—andthewaywehavebeenshapingAmerica’smarketeconomyworkstotheadvantageofthoseatthetopandtothedisadvantageoftherest.Thereisanotherfactordeterminingsocietalinequality,onethatwediscussinthischapter.Government,aswehaveseen,shapesmarketforces.Butsodosocietalnormsandsocialinstitutions.Indeed,politics,toalargeextent,reflectsandamplifiessocietalnorms.Inmanysocieties,thoseatthebottomconsistdisproportionatelyofgroupsthatsuffer,inonewayoranother,fromdiscrimination.Theextentofsuchdiscriminationisamatterofsocietalnorms.We’llseehowchangesinsocialnorms—concerning,forinstance,whatisfaircompensation—andininstitutions,likeunions,havehelpedshapeAmerica’sdistributionofincomeandwealth.Butthesesocialnormsandinstitutions,likemarkets,don’texistinavacuum:theytooareshaped,inpart,bythe1percent.THELAWSOFSUPPLYANDDEMANDStandardeconomicanalysislookstodemandandsupplytoexplainwagesandwagedifferencesandtoshiftsindemandandsupplycurvestoexplainchangingpatternsofwagesandincome56 inequality.Instandardeconomictheory,wagesofunskilledworkers,forexample,aredeterminedsoastoequatedemandand1supply.Ifdemandincreasesmoreslowlythansupply,thenwagesfall.Theanalysisofchangesininequalitythenfocusesontwoquestions:(a)Whatdeterminesshiftsindemandandsupplycurves?and(b)Whatdeterminesindividuals’endowments,thatis,thefractionofthepopulationwithhighskillsorlargeamountsofwealth?Immigration,legalandillegalalike,canincreasethesupply.Increasingtheavailabilityofeducationmayreducethesupplyofunskilledlaborandincreasethesupplyofskilledlabor.Changesintechnologycanleadtoreduceddemandsforlaborinsomesectors,orreduceddemandsforsometypesoflabor,andincreasesinthedemandforlaborofothertypes.Inthebackgroundoftheglobalfinancialcrisisweremajorstructuralchangesintheeconomy.OnewasashiftintheU.S.jobmarketstructuresoversometwentyyears,especiallythe2destructionofmillionsofjobsinmanufacturing,theverysectorthathadhelpedcreateabroadmiddleclassintheyearsafterWorldWarII.Thiswaspartlyaresultoftechnologicalchange,advancesinproductivitythatoutpacedincreasesindemand.Shiftingcomparativeadvantagescompoundedtheproblem,astheemergingmarkets,especiallyChina,gainedcompetenciesandinvestedheavilyineducation,technology,andinfrastructure.TheU.S.shareofglobalmanufacturingshrankinresponse.Ofcourse,inadynamiceconomyjobsarealwaysbeingdestroyedandcreated.Butthistimeitwasdifferent:thenewjobstypicallywereoftennotaswell-payingoraslong-lastingastheold.Skillsthatmadeworkersvaluable—andhighlypaid—inmanufacturingwereoflittlevalueintheirnewjobs(iftheycouldgetnewjobs),and,notsurprisingly,theirwagesreflectedthechangedstatus,astheywentfrombeingaskilledmanufacturingworkertobeinganunskilledworkerinsomeothersectoroftheeconomy.Americanworkerswere,inasense,victimsoftheirownsuccess:theirincreasedproductivitydidthemin.Asthedisplacedmanufacturingworkersfoughtforjobselsewhere,wagesinothersectorssuffered.Thestockmarketboomandthehousingbubbleoftheearlytwenty-firstcenturyhelpedtohidethestructuraldislocationthatAmericawasgoingthrough.Therealestatebubbleofferedworkforsomeofthosewholosttheirjobs,butitwasatemporarypalliative.ThebubblefueledaconsumptionboomthatallowedAmericanstolivebeyondtheirmeans:withoutthisbubble,theweakeningofincomesofsomanyinthemiddleclasswouldhavebeenreadilyapparent.ThissectoralshiftwasoneofthekeyfactorsintheincreaseininequalityintheUnitedStates.Ithelpsexplainwhyordinaryworkersaredoingsobadly.Withtheirwagessolow,it’snotasurprisethatthoseatthetop,whogetthelion’sshareoftheprofits,aredoingsowell.Asecondstructuralshiftstemmedfromchangesintechnologythatincreasedthedemandforskilledworkers,andreplacedmanyunskilledworkerswithmachines.Thiswascalledskill-biasedtechnologicalchange.Itshouldbeobviousthatinnovationsorinvestmentsthatreducetheneedforunskilledlabor(forexample,investmentsinrobots)weakenthedemandforunskilledlaborandleadtolowerunskilledwages.Thosewhoattributethedeclineofwagesatthebottomandin57 themiddletomarketforcesthenseeitasthenormalworkingofthebalanceoftheseforces.And,unfortunately,iftechnologicalchangecontinuesasithas,thesetrendsmaypersist.Marketforceshaven’talwaysplayedoutthisway,andthereisnotheorythatsaysthattheynecessarilyshould.Overthepastsixtyyears,supplyanddemandforskilledandunskilledlaborhaveshiftedinwaysthatatfirstdecreased,andthenincreased,3wagedisparities.IntheaftermathofWorldWarII,largenumbersofAmericansreceivedahighereducationthankstotheGIBill.(Collegegraduatesformedonly6.4percentofthelaborforcein41940,butthepercentagehaddoubled,to13.8percent,by1970.)Butthegrowthoftheeconomyandthedemandforhigh-skilljobskeptpacewiththeincreaseinsupply,sothereturntoeducationremainedstrong.Workerswithacollegeeducationstillreceived1.59timeswhatahighschoolgraduatereceived,almostunchangedfromtheratioin1940(1.65).Thediminishedrelativesupplyofunskilledworkersmeantthateventheseworkersbenefited,sowagesacrosstheboardincreased.Americaenjoyedbroadlysharedprosperity,andinfactattimesincomesatthebottomincreasedfasterthanthoseatthetop.ButthenU.S.educationalattainmentstoppedimproving,especiallyrelativetotherestoftheworld.ThefractionoftheU.S.populationgraduatingfromcollegeincreasedmuchmoreslowly,whichmeanttherelativesupplyofskilledworkers,whichhadincreasedatanaverageannualrateofalmost4percentfrom1960to1980,insteadincreasedatthemuchsmallerrateof2.255percentoverthenextquartercentury.By2008theU.S.highschoolgraduationratewas76percent,comparedwith85percent6fortheEU.Amongtheadvancedindustrialcountries,theUnitedStatesisonlyaverageincollegecompletion;thirteenother7countriessurpassit.AndaveragescoresofAmericanhighschoolstudents,especiallyinscienceandmathematics,wereatbest8mediocre.Inthepastquartercentury,technologicaladvances,particularlyincomputerization,enabledmachinestoreplacejobsthatcouldberoutinized.Thisincreasedthedemandforthosewhomasteredthetechnologyandreducedthedemandforthosewhodidnot,leadingtohigherrelativewagesforthosewhohadmastered9theskillsrequiredbythenewtechnologies.Globalizationcompoundedtheeffectsoftechnology’sadvances:jobsthatcouldberoutinizedweresentabroad,wherelaborthatcouldhandlethe10workcostafractionofwhatitcostintheUnitedStates.Atfirst,thebalanceofsupplyanddemandkeptwagesinthemiddlerising,butthoseatthebottomstagnatedorevenfell.Eventually,thedeskillingandoutsourcingeffectsdominated.Over11thepastfifteenyears,wagesinthemiddlehavenotfaredwell.Theresulthasbeenwhatwedescribedinchapter1asthe“polarization”ofAmerica’slaborforce.Low-payingjobsthatcannotbeeasilycomputerizedhavecontinuedtogrow—including“care”andotherservicesectorsjobs—andsohavehigh-skilledjobsatthetop.Thisskill-biasedtechnologicalchangehasobviouslyplayedaroleinshapingthelabormarket—increasingthepremiumonworkerswithskills,deskillingotherjobs,eliminatingstillothers.However,skill-biasedtechnologicalchangehaslittletodowiththeenormousincreaseinwealthattheverytop.Its58 relativeimportanceremainsasubjectofdebate,uponwhichwewillcommentlaterinthischapter.Thereisonemoreimportantmarketforceatplay.Earlierinthechapter,wedescribedhowincreasesinproductivityinmanufacturing—outpacingtheincreaseindemandformanufacturedgoods—ledtohigherunemploymentinthatsector.Normally,whenmarketsworkwell,theworkersdisplacedeasilymovetoanothersector.Theeconomyasawholebenefitsfromtheproductivityincrease,evenifthedisplacedworkerdoesn’t.Butmovingtoothersectorsmaynotbesoeasy.Thenewjobsmaybeinanotherlocationorrequiredifferentskills.Atthebottom,someworkersmaybe“trapped”insectorswithdecliningemployment,unabletofindalternativeemployment.AphenomenonakintowhathappenedinagricultureintheGreatDepressionmaybehappeninginlargeswathsoftoday’sjobmarket.Thenincreasesinagriculturalproductivityraisedthesupplyofagriculturalproducts,drivingdownpricesandfarmincomesrelentlessly,yearafteryear,withanoccasionalexceptionfromabadharvest.Atpoints,andespeciallyatthebeginningoftheDepression,thefallwasprecipitous—adeclineofhalformoreinfarmers’incomeinthreeyears.Whenincomesweredecliningmoregradually,workersmigratedtonewjobsinthecities,andtheeconomywentthroughanorderly,ifdifficult,transition.Butwhenpricesfellprecipitously—andthevalueofhousingandotherassetsthatthefarmersownedfellconcomitantly—peopleweresuddenlytrappedontheirfarms.Theycouldn’taffordtomove,andtheirdecreaseddemandforgoodsmadeinurbanfactoriescausedunemploymentinthecitiesaswell.TodayAmerica’smanufacturingworkershavebeenexperiencing12somethingsimilar.IrecentlyvisitedasteelmillnearwhereIwasborn,inGary,Indiana,andalthoughitproducesthesameamountofsteelthatitdidseveraldecadesago,itdoessowithone-sixththelabor.Andonceagainthereisneitherthepushnorthepulltomovepeopletonewsectors:highercostsofeducationmakeitdifficultforpeopletoobtaintheskillstheyneedforjobsthatwouldpayawagecomparabletotheiroldwage;andamongthesectorswheretheremighthavebeengrowth,lowdemandfromtherecessioncreatesfewvacancies.Theresultisstagnant,orevendeclining,realwages.Asrecentlyas2007,thebasewageofanautoworkerwasaround$28anhour.Now,underatwo-tierwagesystemagreeduponwiththeUnitedAutomobileWorkersunion,new13hirescanexpecttoearnonlyabout$15anhour.BacktotheroleofgovernmentThisbroadnarrativeofwhathashappenedtothemarketandthecontributionofmarketforcestoincreasinginequalityignorestherolethatgovernmentplaysinshapingthemarket.Manyofthejobsthathavenotbeenmechanized,andarenotlikelytobesoon,arepublic-sectorjobsinteaching,publichospitals,andsoon.Ifwehaddecidedtopayourteachersmore,wemighthaveattractedandretainedbetterteachers,andthatmighthaveimprovedoveralllong-termeconomicperformance.Itwasapublicdecisiontoallowpublic-sectorwagestosinkbelowthoseofcomparableprivate-14sectorworkers.Themostimportantroleofgovernment,however,issettingthebasicrulesofthegame,throughlawssuchasthosethatencourageordiscourageunionization,corporategovernancelawsthat59 determinethediscretionofmanagement,andcompetitionlawsthatshouldlimittheextentofmonopolyrents.Aswehavealreadynoted,almosteverylawhasdistributiveconsequences,withsome15groupsbenefiting,typicallyattheexpenseofothers.Andthesedistributiveconsequencesareoftenthemostimportanteffectsof16thepolicyorprogram.Bankruptcylawsprovideanexample.Later,inchapter7,Idescribehow“reforms”inourbankruptcylawsarecreatingpartiallyindenturedservants.Thatreform,togetherwiththelaw17prohibitingthedischargeofstudentdebtinbankruptcy,iscausingimmiserationforlargepartsofAmerica.Liketheeffectsondistribution,theeffectsonefficiencyhavebeenadverse.Thebankruptcy“reform”reducedtheincentivesofcreditorstoassesscreditworthiness,ortoascertainwhethertheindividualislikelytogetareturnfromtheeducationcommensuratewithitscosts.Itincreasedtheincentivesforpredatorylending,sincelenderscouldbemorecertainofrecoveringtheloans,nomatterhowonerousthetermsandhowunproductivetheusestowhichthe18moneywasput.Inlaterchapters,we’llalsoseeotherexamplesofhowgovernmenthelpsshapemarketforces—inwaysthathelpsome,attheexpenseofothers.Andtoooften,theoneswhoarehelpedarethoseatthetop.Itis,ofcourse,notjustlawsthathavelargedistributiveeffects,butalsopolicies.We’veconsideredseveralpoliciesinthepreviouschapter—forexample,ontheenforcementoflawsagainstanticompetitivepractices.Inchapter9we’lllookatmonetarypolicies,whichaffectthelevelofemploymentandthestabilityoftheeconomy.We’llseehowtheyhavebeensetinwaysthatweakenedtheincomeofworkersandenhancedthatofcapital.Finally,publicpolicyaffectsthedirectionofinnovation.Itisnotinevitablethatinnovationbeskillbiased.Innovationcould,forinstance,bebiasedtowardthesavingofnaturalresources.Laterinthisbook,we’lldescribealternativepoliciesthatmightsucceedinredirectinginnovation.GLOBALIZATIONOneaspectofthe“marketforces”theoryhasbeenthecenterofattentionnowformorethanadecade:globalization,orthecloserintegrationoftheeconomiesoftheworld.Nowheredopoliticsshapemarketforcesmorethanintheglobalizationarena.Muchastheloweringoftransportationandcommunicationcostshaspromotedglobalization,changesintherulesofthegamehavebeenequallyimportant:theseincludereducingimpedimentstotheflowofcapitalacrossbordersandtradebarriers(forinstance,reducingtariffsonimportedChinesegoodsthatallowthemtocompetewithAmericanonesonanalmostevenplayingfield).Bothtradeglobalization(themovementofgoodsandservices)andcapitalmarketsglobalization(internationalfinancialmarketintegration)havecontributedtogrowinginequality,butindifferentways.Financialliberalization60 Overthepastthreedecades,U.S.financialinstitutionshavearguedstronglyforthefreemobilityofcapital.Indeed,theyhavebecomethechampionsoftherightsofcapital—overthe19rightsofworkersorevenpoliticalrights.Rightssimplyspecifywhatvariouseconomicplayersareentitledto:therightsworkershavesoughtinclude,forinstance,therighttobandtogether,tounionize,toengageincollectivebargaining,andtostrike.Manynondemocraticgovernmentsseverelyrestricttheserights,butevendemocraticgovernmentscircumscribethem.Sotoo,theownersofcapitalmayhaverights.Themostfundamentalrightoftheownersofcapitalisthattheynotbedeprivedoftheirproperty.Butagain,eveninademocraticsociety,theserightsarerestricted;undertherightofeminentdomain,thestatecantakeawaysomebody’spropertyforpublicpurpose,buttheremustbe“dueprocess”andappropriatecompensation.Inrecentyears,theownersofcapitalhavedemandedmorerights,liketherighttomovefreelyintooroutofcountries.Simultaneously,they’vearguedagainstlawsthatmightmakethemmoreaccountableforhumanrightsabusesinothercountries,suchastheAlienTortsStatute,whichenablesvictimsofthoseabusestobringsuitintheUnitedStates.Asamatterofsimpleeconomics,theefficiencygainsforworldoutputfromthefreemobilityoflaboraremuch,muchlargerthantheefficiencygainsfromthefreemobilityofcapital.Thedifferencesinthereturntocapitalareminusculecomparedwith20thoseonthereturntolabor.Butthefinancialmarketshavebeendrivingglobalization,andwhilethosewhoworkinfinancialmarketsconstantlytalkaboutefficiencygains,whattheyreallyhaveinmindissomethingelse—asetofrulesthatbenefitsthemandincreasestheiradvantageoverworkers.Thethreatofcapitaloutflow,shouldworkersgettoodemandingaboutrightsandwages,21keepsworkers’wageslow.Competitionacrosscountriesforinvestmenttakesonmanyforms—notjustloweringwagesandweakeningworkerprotections.Thereisabroader“racetothebottom,”tryingtoensurethatbusinessregulationsareweakandtaxesarelow.Inonearena,finance,thishasprovenespeciallycostlyandespeciallycriticaltothegrowthininequality.Countriesracedtohavetheleast-regulatedfinancialsystemforfearthatfinancialfirmsmightdecampforothermarkets.SomeintheU.S.Congressworriedabouttheconsequencesofthisderegulation,buttheyfelthelpless:Americawouldlosejobsandamajorindustryifitdidn’tcomply.Inretrospect,however,thiswasamistake.Thelosstothecountryfromthecrisisthatresultedfrominadequateregulationwasordersofmagnitudelargerthanthenumberofjobsinfinancethatweresaved.Notsurprisingly,whereasadecadeagoitwaspartofconventionalwisdomthateveryonewouldbenefitfromfreecapitalmovements,intheaftermathoftheGreatRecessionmanyobservershavetheirdoubts.Theseconcernsarecomingnotjustfromthoseindevelopingcountriesbutalsofromsomeofglobalization’sstrongestadvocates.Indeed,eventheIMF(theInternationalMonetaryFund,theinternationalagencyresponsibleforensuringglobalfinancialstability)hasnowrecognizedthedangersof22unencumberedandexcessivefinancialintegration:aprobleminonecountrycanrapidlyspreadtoanother.Infact,fearsofcontagionhavemotivatedbailoutsofbanksinthemagnitudeoftensandhundredsofbillionsofdollars.Theresponseto61 contagiousdiseasesis“quarantine,”andfinally,inthespringof2011,theIMFrecognizedthedesirabilityoftheanalogousresponseinthefinancialmarkets.Thistakestheformofcapitalcontrols,orlimitingthevolatilemovementofcapitalacross23borders,especiallyduringacrisis.Theironyisthatinthecrisesthatfinancebringsabout,workersandsmallbusinessesbearthebruntofthecosts.Crisesareaccompaniedbyhighunemploymentthatdrivesdownwages,soworkersarehurtdoubly.Inearliercrises,notonlydidtheIMF(typicallywiththesupportoftheU.S.Treasury)insistonhugebudgetcutsfromtroublednations,convertingdownturnsintorecessionsanddepressions,butitalsodemandedthefiresalesofassets,andthefinanciersthenswoopedintomakeakilling.InmyearlierbookGlobalizationandItsDiscontents,IdescribedhowGoldmanSachswasoneofthewinnersinthe1997EastAsiacrisis,asitwasinthe2008crisis.Whenwewonderhowitisthatthefinanciersgetsomuchwealth,partoftheanswerissimple:they’vehelpedwriteasetofrulesthatallowsthemtodowell,24eveninthecrisesthattheyhelpcreate.TradeglobalizationTheeffectsoftradeglobalizationhavenotbeenasdramaticasthoseofthecrisesassociatedwithcapitalandfinancialmarketliberalization,buttheyhavenonethelessbeenoperatingslowlyandsteadily.Thebasicideaissimple:themovementofgoodsisasubstituteforthemovementofpeople.IftheUnitedStatesimportsgoodsthatrequireunskilledworkers,itreducesthedemandforunskilledworkerstomakethosegoodsintheUnitedStates,andthatdrivesdownunskilledworkers’wages.Americanworkerscancompetebyacceptinglowerandlowerwages—orby25gettingmoreandmoreskilled.Thiseffectwouldarisenomatterhowwemanagedglobalization,solongasitledtomoretrade.Thewayglobalizationhasbeenmanaged,however,hasitselfledtostilllowerwagesbecauseworkers’bargainingpowerhasbeeneviscerated.Withcapitalhighlymobile—andwithtariffslow—firmscansimplytellworkersthatiftheydon’tacceptlowerwagesandworseworkingconditions,thecompanywillmoveelsewhere.Toseehowasymmetricglobalizationcanaffectbargainingpower,imagine,foramoment,whattheworldwouldbelikeiftherewasfreemobilityoflabor,butnomobilityof26capital.Countrieswouldcompetetoattractworkers.Theywouldpromisegoodschoolsandagoodenvironment,aswellaslowtaxesonworkers.Thiscouldbefinancedbyhightaxesoncapital.Butthat’snottheworldwelivein,andthat’spartlybecausethe1percentdoesn’twantittobethatway.Havingsucceededingettinggovernmentstosettherulesofglobalizationinwaysthatenhancetheirbargainingpowervis-à-vislabor,corporationscanthenworkthepoliticalleversanddemandlowertaxation.Theythreatenthecountry:unlessyoulowerourtaxes,wewillgoelsewhere,wherewearetaxedatlowerrates.Ascorporationshavepushedapoliticalagendathatshapesmarketforcestoworkforthem,theyhavenot,ofcourse,revealedtheirhand.Theydon’targueforglobalization—forfreecapitalmobilityandinvestmentprotections—sayingthatdoingsowillenrichthemattheexpenseoftherestofsociety.Rather,theymakespeciousargumentsabouthowallwillbenefit.62 Therearetwocriticalaspectstothiscontention.Thefirstisthatglobalizationwillincreasethecountry’soveralloutputasmeasured,forinstance,byGDP.ThesecondisthatifGDPisincreased,trickle-downeconomicswillensurethatallwillbenefit.Neitherargumentiscorrect.Itistruethatwhenmarketsworkperfectly,freetradeallowspeopletomovefromprotectedsectorstomoreefficientunprotectedexportsectors.Therecanbe,asaresult,anincreaseinGDP.Butmarketsoftendon’tworksonicely.Forexample,workersdisplacedbyimportsoftencan’tfindanotherjob.Theybecomeunemployed.Movingfromalow-productivityjobinaprotectedsectortounemploymentlowersnationaloutput.ThisiswhathasbeenhappeningintheUnitedStates.Ithappenswhenthereisbadmacroeconomicmanagement,sotheeconomyfacesahighunemploymentrate,andithappenswhenfinancialsectorsdon’tdotheirjobs,sonewbusinessesaren’tcreatedtoreplacetheoldbusinessesthataredestroyed.Thereisanotherreasonwhyglobalizationmayloweroverall27output;ittypicallyincreasestherisksthatcountriesface.Openingupacountrycanexposeittoallkindsofrisks,fromthevolatilityofcapitalmarketstothatofcommoditymarkets.Greatervolatilitywillinducefirmstomovetolessriskyactivities,andthesesaferactivitiesoftenhavealowerreturn.Insomecases,therisk-avoidanceeffectcanbesolargethat28everyoneismadeworse-off.Buteveniftradeliberalizationleadstoahigheroveralloutputforagiveneconomy,largegroupsinthepopulationcanstillbeworseoff.Considerforamomentwhatafullyintegratedglobaleconomy(withbothknowledgeandcapitalmovingfreelyaroundtheworld)wouldentail:allworkers(ofagivenskill)wouldgetthesamewageeverywhereintheworld.America’sunskilledworkerswouldgetthesamewagethatanunskilledworkergetsinChina.Andthatwouldmean,inturn,thatAmerica’sworkers’wageswouldfallprecipitously.TheprevailingwagewouldbetheaverageofthatofAmericaandtherestoftheworldand,unfortunately,muchclosertothelowerwageprevailingelsewhere.Notsurprisingly,advocatesoffullliberalization,whotypicallybelievethatmarketsfunctionwell,don’tadvertisethisoutcome.Infact,unskilledworkersintheUnitedStateshavealreadytakenabeating.Asglobalizationproceeds,therewillbefurtherdownwardpressuresontheirwages.Idon’tthinkmarketsworksowellthatwageswillbefullyequalized,buttheywill29moveinthatdirection,andfarenoughtobeofseriousconcern.TheproblemisparticularlyseveretodayintheUnitedStatesandEurope:atthesametimethatlabor-savingtechnologicalchangehasreducedthedemandformanyofthe“good”middle-classblue-collarjobs,globalizationhascreatedaglobalmarketplace,puttingthesameworkersindirectcompetitionwithcomparableworkersabroad.Bothfactorsdepresswages.How,then,canglobalization’sadvocatesclaimthateverybodywillbebetter-off?Whatthetheorysaysisthateverybodycouldbebetteroff.Thatis,thewinnerscouldcompensatethelosers.Butitdoesn’tsaythattheywill—andtheyusuallydon’t.Infact,globalization’sadvocatesoftenclaimthatglobalizationmeansthattheycan’tandshouldn’tdothis.Thetaxesthatwouldhavetobeleviedtohelptheloserswould,theyclaim,makethecountrylesscompetitive,andinourhighlycompetitiveglobalizedworldcountriessimplycan’taffordthat.Ineffect,globalizationhurtsthoseatthebottomnotonlydirectlybutalso63 indirectly,becauseoftheinducedcutbacksinsocialexpendituresandprogressivetaxation.Theresultisthatinmanycountries,includingtheUnitedStates,globalizationisalmostsurelycontributingsignificantlytoourgrowinginequality.Ihaveemphasizedthattheproblemsconcernglobalizationasithasbeenmanaged.CountriesinAsiabenefitedenormouslythroughexport-ledgrowth,andsome(suchasChina)tookmeasurestoensurethatsignificantportionsofthatincreasedoutputwenttothepoor,somewenttoprovideforpubliceducation,andmuchwasreinvestedintheeconomy,toprovidemorejobs.Inothercountries,therehavebeenbiglosersaswellaswinners—poorcornfarmersinMexicohaveseentheirincomesdeclineassubsidizedAmericancorndrivesdownpricesonworldmarkets.Inmanycountries,poorlyfunctioningmacroeconomieshavemeantthatthepaceofjobdestructionhasexceededthatofjobcreation.Andthat’sbeenthecaseintheUnitedStatesandEuropesincethefinancialcrisis.AmongthewinnersfromglobalizationintheUnitedStatesandsomeEuropeancountries,asit’sbeenmanaged,arethepeopleatthetop.Amongthelosersarethoseatthebottom,andincreasinglyeventhoseinthemiddle.BEYONDMARKETFORCES:CHANGESINOURSOCIETYSofar,wehavediscussedtherolethatmarketforces,politics,andrentseekingplayincreatingthehighlevelofinequalityinoursociety.Broadersocietalchangesarealsoimportant,changes30bothinnormsandininstitutions.Thesetooareshapedby,andhelpshape,politics.Themostobvioussocietalchangeisthedeclineofunions,from20.1percentofwage-andsalary-earningU.S.workersin1980to3111.9percentin2010.Thishascreatedanimbalanceofeconomicpowerandapoliticalvacuum.Withouttheprotectionaffordedbyaunion,workershavefaredevenmorepoorlythantheywouldhaveotherwise.Marketforceshavealsolimitedtheeffectivenessoftheunionsthatremain.Thethreatofjoblossbythemovingofjobsabroadhasweakenedtheirpower.Abadjobwithoutdecentpayisbetterthannojob.ButjustasthepassageoftheWagnerActduringFranklinDelanoRoosevelt’spresidencyencouragedunionization,Republicansatboththestateandthefederallevels,inthenameoflaborflexibility,haveworkedtoweakenthem.PresidentReagan’sbreakingoftheairtrafficcontrollersstrikein1981representedacriticaljunctureinthebreakingof32thestrengthofunions.Partoftheconventionalwisdomineconomicsofthepastthreedecadesisthatflexiblelabormarketscontributetoeconomicstrength.Iwouldargue,incontrast,thatstrongworkerprotectionscorrectwhatwouldotherwisebeanimbalanceofeconomicpower.Suchprotectionleadstoahigher-qualitylaborforcewithworkerswhoaremoreloyaltotheirfirmsandmorewillingtoinvestinthemselvesandintheirjobs.Italsomakes33foramorecohesivesocietyandbetterworkplaces.ThattheAmericanlabormarketperformedsopoorlyintheGreatRecessionandthatAmericanworkershavedonesobadlyforthree64 decadesshouldcastdoubtonthemythicalvirtuesofaflexiblelabormarket.ButintheUnitedStatesunionshavebeenseenasasourceofrigidityandthusoflabormarketinefficiency.Thishasunderminedsupportforunionsbothinsideandoutsideof34politics.Inequalitymaybeatoncecauseandconsequenceofabreakdowninsocialcohesionoverthepastfourdecades.Thepatternandmagnitudeofchangesinlaborcompensationasashareofnationalincomearehardtoreconcilewithanytheorythatreliessolelyonconventionaleconomicfactors.Forinstance,inmanufacturing,formorethanthreedecades,from1949to1980,productivityandrealhourlycompensationmovedtogether.Suddenly,in1980,theybegantodriftapart,withrealhourlycompensationstagnatingforalmostfifteenyears,beforestartingtorise,againalmostatthepaceofproductivity,untiltheearly2000s,whencompensationagainbeganessentiallystagnating.Oneoftheinterpretationsofthesedataisthatineffect,duringtheperiodswhenwagesgrewsomuchslowerthanproductivity,corporatemanagersseizeda35largershareofthe“rents”associatedwithcorporations.Theextenttowhichthisoccursisaffectednotjustbyeconomicsandsocietalforces(theabilityandwillingnessofCEOstogarnerforthemselvesalargerfractionofthecorporaterevenues),butalsobypoliticsandhowtheyshapethelegalframework.CorporategovernancePolitics—andinparticularhowpoliticsshapesthelawsgoverningcorporations—isamajordeterminantofthefractionofacorporation’srevenuesthatitstopexecutivestakeforthemselves.U.S.lawsprovidethemconsiderablediscretion.Thismeantthatwhensocialmoreschangedinwaysthatmadelargedisparitiesincompensationmoreacceptable,executivesintheUnitedStatescouldenrichthemselvesattheexpenseofworkersorshareholdersmoreeasilythancouldexecutivesinothercountries.AsignificantfractionofU.S.outputoccursincorporationswhosesharesarepubliclytraded.Corporationshavenumerous36advantages—legalprotectionaffordedbylimitedliability,advantagesofscale,oftenlong-establishedreputations—thatallowthemtoearnexcessreturnsoverwhattheywouldotherwisehavetopaytoraisecapital.Wecalltheseexcessreturns“corporaterents,”andthequestionishowtheserentsaredividedamongthevarious“stakeholders”inthecorporation(inparticular,betweenworkers,shareholders,andmanagement).Beforethemid-1970stherewasabroadsocialconsensus:executiveswerewellpaid,butnotfabulouslyso;therentsgotdividedlargelybetweenloyalworkersandmanagement.Shareholdersneverhadmuchsay.America’scorporatelawgiveswidedeferencetomanagement.It’shardforshareholderstochallengewhatthemanagementdoes,37hardtowageatakeoverbattle,hardeventowageaproxybattleforcontrol.Overtheyears,managerslearnedhowtoentrenchandprotecttheirinterests.Therewerenumerouswaysforthemtodothis,includinginvestmentsshroudedinuncertaintythatmadethevalueofthefirmlesscertainandatakeoverbattlethatmuchriskier;poisonpillsthatdecreasedthevalueofthefirmintheeventofatakeover;andgoldenparachutesthatguaranteed38managersalifetimeofcomfortshouldthefirmbetakenover.65 Gradually,beginninginthe1980sand1990s,managementrealizedthatthemeasurestakentofendoffoutsideattacks,combinedwithweakerunions,alsomeantthattheycouldtakealargershareofthecorporaterentsforthemselveswithimpunity.Evensomefinancialleadersrecognizedthat“executivecompensationinourdeeplyflawedsystemofcorporategovernance39hasledtogrosslyexcessiveexecutivecompensation.”Normsofwhatwas“fair”changedtoo:theexecutivesthoughtlittleoftakingabiggersliceofthecorporatepie,awardingthemselveslargeamountsevenastheyclaimedtheyhadtofireworkersandreducewagestokeepthefirmalive.Insomecircles,soengraineddidtheseschizophrenicattitudesto“fairness”becomethatearlyintheGreatRecessionanObamaadministrationofficialcouldsay,withastraightface,thatitwasnecessarytohonorAIGbonuses,evenfortheofficialswhohadledthecompanytoneeda$150billionbailout,becauseofthesanctityofcontracts;minuteslaterhecouldadmonishautoworkerstoacceptarevisionoftheircontractthatwouldhaveloweredtheircompensationenormously.Differentcorporategovernancelaws(evenmodestones,like40givingshareholderssomesayinthepayoftheirCEO)mighthavetamedtheunbridledzealofexecutives,butthe1percentdidn’t—andstilldon’t—wantsuchreformsincorporategovernance,eveniftheywouldmaketheeconomymoreefficient.Andtheyhaveusedtheirpoliticalmuscletomakesurethatsuchreformsdon’toccur.Theforceswehavejustdescribed,includingweakerunionsandweakersocialcohesionworkingwithcorporategovernancelawsthatgivemanagementenormousdiscretiontoruncorporationsfortheirownbenefit,havelednotonlytoadecliningwageshareinnationalincomebutalsotoachangeinthewayoureconomyrespondstoaneconomicdownturn.Itusedtobethatwhentheeconomywentintorecession,employers,wantingtomaintaintheloyaltyoftheirworkersandconcernedabouttheirwell-being,wouldkeepasmanyastheycouldontheirpayroll.Theresultwasthatlaborproductivitywentdown,andtheshareofwageswentup.Profitsborethebruntofthedownturn.Wageshareswouldthenfallaftertheendofarecession.Butinthisandtheprevious(2001)recession,thepatternchanged;thewagesharedeclinedintherecession,aswellasintheensuingyears.Firmspridedthemselvesontheirruthlessness—cuttingoutsomanyworkersthat41productivityactuallyincreased.DiscriminationOneothermajorsocietalforceaffectsinequality.ThereiseconomicdiscriminationagainstmajorgroupsinAmericansociety—againstwomen,againstAfricanAmericans,againstHispanics.Theexistenceoflargedifferencesinincomeandwealthacrossthesegroupsisclear.Wagesofwomen,AfricanAmericans,andHispanics42areallmarkedlylowerthanthoseofwhitemales.Differencesineducation(orothercharacteristics)accountforaportionofthe43disparity,butonlyaportion.Someeconomistshavearguedthatdiscriminationwasimpossible44inamarketeconomy.Inacompetitiveeconomy,sothetheorywent,aslongastherearesomeindividualswhodonothaveracial(orgenderorethnic)prejudices,theywillhiremembersofthe66 discriminated-againstgroupbecausetheirwageswillbelowerthanthoseofsimilarlyqualifiedmembersofthenotdiscriminated-againstgroup.Thisprocesswillcontinueuntilthewage/incomediscriminationiseliminated.Prejudicemightleadtosegregatedworkplaces,butnottoincomedifferentials.Thatsuchargumentsgainedcurrencyintheeconomicsprofessionsaysalotaboutthestateofthediscipline.Toaneconomistlikemewhogrewupinthemidstofacityandcountrywherediscriminationwasobvious,suchargumentsprovidedachallenge:somethingwaswrongwithatheorythatsaiddiscriminationcouldn’texist.Overthepastfortyyears,anumberoftheorieshavebeendevelopedtohelp45explainthepersistenceofdiscrimination.Game-theoreticmodels,forinstance,haveshownhowtacitcollusivebehaviorofadominantgroup(whites,men)canbeusedtosuppresstheeconomicinterestsofanothergroup.Individualswhobreakwiththediscriminatorybehaviorarepunished:otherswillrefusetobuyfromtheirstore,workforthem,supplytheminputs;socialsanctions,likeostracism,canalsobeeffective.Thosewhodon’tpunishtransgressorsaresubjectedtothesame46punishment.Relatedresearchhasshownhowothermechanisms(associatedwithimperfectinformation)canleadtodiscriminatoryequilibriaeveninacompetitiveeconomy.Ifitisdifficulttoassessthetrueabilityofanindividualandthequalityofhiseducation,thenemployersmayturntorace,ethnicity,orgender—whetherjustifiedornot.Ifemployersbelievethatthosewhobelongtoaparticulargroup(women,Hispanics,AfricanAmericans)arelessproductive,thentheywillpaythemlowerwages.Theresultofdiscriminationistoreduceincentivesformembersofthegrouptomaketheinvestmentsthatwouldleadtohigherproductivity.Thebeliefsareself-reinforcing.Thisissometimescalledstatisticaldiscrimination—butofaparticularform,wherethediscriminationactuallyleadstothedifferencesthatarebelievedtoexist47betweengroups.Inthetheoriesofdiscriminationjustdescribed,individualsconsciouslydiscriminate.Recently,economistshavesuggestedanadditionaldriverofdiscriminatorybehavior:“implicitdiscrimination,”whichisunintentionalandoutsidetheawarenessofthoseengagingindiscrimationandatvariancewithwhatthey48(explicitly)thinkorfavorfortheirorganization.Psychologistshavelearnedtomeasureimplicitattitudes(thatis,attitudesofwhichindividualsarenotconsciouslyaware).Thereispreliminaryevidencethattheseattitudespredictdiscriminatorybehaviorbetterthanexplicitattitudes,especiallyinthepresenceoftimepressure.Thatfindingshedsnewlighton49studiesthathaveshownsystematicracialdiscrimination.Thisisbecausemanyreal-worlddecisions,suchasjoboffers,areoftenmadeundertimepressure,withambiguousinformation—conditionsthatgivegreaterscopeforimplicitdiscrimination.Astrikingexample,fromastudybythesociologistDevah50Pager,isofthestigmatizingeffectofacriminalrecord.Inherfieldstudy,matchedpairsoftwenty-three-year-oldsappliedforrealentry-leveljobsinordertotestthedegreetowhichacriminalrecord(anonviolentdrugoffense)affectssubsequentemploymentopportunities.Alltheindividualspresentedroughlyidenticalcredentials,includingahighschooldiploma,sothatdifferencesexperiencedamonggroupscanbeattributedtothe67 effectsofraceorcriminalstatus.Afteraninvitedinterview,theratioofcallbacksforwhitenonoffenderstowhiteex-offendersis2:1,thissameratioforblacksisnearly3:1.Andawhitemanwithacriminalrecordisslightlymorelikelytobeconsideredforajobthanablackmanwithnocriminalpast.Thus,onaverage,beingblackreducesemploymentopportunitiessubstantially,andmoresoforex-offenders.Theseeffectscanrepresentimportantbarrierstoblackmentryingtobecomeeconomicallyself-sufficient,sinceroughlyoneinthreeblackmenwillspendtimeinprisoninhislifetime.Therearestronginteractionsbetweenpoverty,race,andgovernmentpolicies.Ifcertainminoritiesaredisproportionatelypoor,andifthegovernmentprovidespooreducationandhealthcaretothepoor,thenmembersoftheminoritywillsufferdisproportionatelyfrompooreducationandhealth.Healthstatistics,forinstance,aretelling:lifeexpectancyatbirth51forblacksin2009was74.3comparedwith78.6forwhites.TheGreatRecessionhasnotbeengoodformembersofthegroupsthathavebeentraditionallydiscriminatedagainst,aswesawinchapter1.Thebankssawthemaseasytargets,becausetheyhadaspirationsofupwardmobility;owningahomewasasignthattheyweremakingitintoAmerica’smiddleclass.Unscrupulousvendorspushedmortgagesonhouseholdsthatwerebeyondtheirabilitytopay,ill-suitedfortheirneeds,andcarryinghightransactionscosts.Todaylargefractionsofthesepopulationshavelostnotonlytheirhomesbutalsotheirlifesavings.Thedataonwhathashappenedtotheirwealtharetrulydisturbing:intheaftermathofthecrisis,thetypicalblackhouseholdhadanetworthofonly52$5,677,atwentiethofthatofatypicalwhitehousehold.Oureconomicsystemrewardsprofits,nomatterhowthey’remade,andinamoney-centriceconomyit’snotsurprisingtoseemoralscruplesputtotheside.Occasionally,oursystemholdsthosewhohavebehavedwronglyaccountable,thoughonlyafteralongandexpensivelegalbattle.Eventhen,it’snotalwaysclearwhetherthepenaltiesdomorethantakebackapartoftheprofitsthatthebankshavemadebytheirunscrupulousbehavior.Inthat53case,evenamongthosewhoarepunished,crimepays.InDecember2011,fourtosevenyearsafterthesubprimelendingoccurred,BankofAmericaagreedtoa$335millionsettlementforitsdiscriminatorypracticesagainstAfricanAmericansandHispanics,thelargestsettlementeveroverresidentialfairlendingpractices.WellsFargoandotherlendershavebeensimilarlyaccusedofdiscriminatorypractices;Wells,thecountry’slargesthomemortgagelender,paidtheFed$85milliontosettlechargesthatithadbrought.Inshort,discriminationinlendingwasnotlimitedtoisolatedinstances,butwasapervasivepractice.LendingandhousingdiscriminationhasthuscontributedtoloweringstandardsoflivingofAfricanAmericansandtheirwealth,compoundingtheeffectsofthelabormarketdiscriminationdiscussedearlier.ROLEOFGOVERNMENTINREDISTRIBUTIONWehaveexaminedhowmarketforces,shapedbypoliticsandsocietalchanges,haveplayedaroleinbringingaboutthelevel68 ofinequalityinbefore-taxincomesandtransfers.Theironyisthatjustasmarketsstarteddeliveringmoreunequaloutcomes,taxpolicyaskedlessofthetop.Thetopmarginaltaxratewasloweredfrom70percentunderCarterto28percentunderReagan;itwentupto39.6percentunderClintonand54downfinallyto35percentunderGeorgeW.Bush.Thisreductionwassupposedtoleadtomoreworkandsavings,55butitdidn’t.Infact,Reaganhadpromisedthattheincentiveeffectsofhistaxcutswouldbesopowerfulthattaxrevenueswouldincrease.Andyet,theonlythingthatincreasedwasthedeficit.GeorgeW.Bush’staxcutsweren’tanymoresuccessful:savingsdidnotincrease;insteadthehouseholdsavingsratefelltoarecordlow(essentiallyzero).Themostegregiousaspectofrecenttaxpolicywastheloweringoftaxratesoncapitalgains.ThishappenedfirstunderClintonandagainunderBush,makingthelong-termcapitalgainstaxrateonly15percent.Inthiswaywehavegiventheveryrich,whoreceivealargefractionoftheirincomeincapitalgains,closetoafreeride.Itdoesn’tmakesensethatinvestors,letalonespeculators,shouldbetaxedatalowerratethansomeonewhoworkshardforhisliving,yetthat’swhatourtaxsystemdoes.Andcapitalgainsarenottaxeduntiltheyarerealized(thatis,untiltheassetissold),sothereisanenormousbenefitfrom56thisdeferraloftaxes,especiallywheninterestratesarehigh.Furthermore,iftheassetsarepassedonatdeath,thecapitalgainsmadeduringtheindividual’slifetimeescapetaxation.Indeed,thetaxlawyersforrichpeoplelikeRonaldLauder,whoinheritedhisfortunefromhismother,EstéeLauder,evenfiguredouthowto“haveyourcakeandeatittoo,”thatis,ineffect,57sellyourstockandnotpaythetax.Theirplan,andothersimilartax-avoidanceschemes,involvescomplicatedtransactionsincludingshortselling(sellingborrowedstock)andderivatives.Thoughthisparticularloopholewaseventuallyclosed,taxlawyersforthericharealwaysseekingtooutsmarttheIRS.Theinequalityindividendsisgreaterthanthatinwagesandsalaries,andtheinequalityincapitalgainsisgreaterthanthatinanyotherformofincome,sogivingataxbreaktocapitalgainsis,ineffect,givingataxbreaktotheveryrich.Thebottom90percentofthepopulationgetslessthan10percentof58allcapitalgains.Under7percentofhouseholdsearninglessthan$100,000receiveanycapitalgainsincome,andforthesehouseholdscapitalgainsanddividendincomecombinedmakeupan59averageof1.4percentoftheirtotalincome.Salariesandwagesaccountedforonly8.8percentoftheincomeofthetop400,capitalgainsfor57percent,andinterestanddividendsfor16percent—so73percentoftheirincomewassubjecttolowrates.Indeed,thetop400taxpayersgarnercloseto5percentofthe60country’sentiredividends.Theypostedanaverageof$153.7millioningainseach(atotalof$61.5billioningains)in2008,$228.6millioneach(foratotalof$91.4billion)in2007.Loweringthetaxoncapitalgainsfromtheordinaryrateof35percentto15percentthusgaveeachofthese400,onaverage,agiftof$30millionin2008and$45millionin2007,anditloweredoveralltaxrevenuesby$12billionin2008and$1861billionin2007.Theneteffectisthatthesuperrichactuallypayonaveragea69 lowertaxratethanthoselesswell-off;andthelowertaxratemeansthattheirrichesincreasefaster.Theaveragetaxratein2007onthetop400householdswasonly16.6percent,considerablylowerthanthe20.4percentfortaxpayersingeneral.(Itincreasedslightlyin2008,thelastyearforwhichdataareavailable,to18.1percent.)Whiletheaveragetaxratehasdecreasedlittlesince1979—goingfrom22.2percentto20.4percent,thatofthetop1percenthasfallenbyalmostaquarter,62from37percentto29.5percent.Mostcountrieshaveadoptedestatetaxes,notjusttoraiserevenuefromthosewhoaremoreabletoafforditbutalsotopreventthecreationofinheriteddynasties.Theabilityofonegenerationtopassonitswealthtoanothermoreeasilytiltstheplayingfieldoflifechances.Ifthewealthyescapetaxation(astheyincreasinglydo)andifestatetaxesarelowered(astheywereunderPresidentBush—actuallyabolishedin2010,thoughonlyforoneyear),thentheroleofinheritedwealthwillbecomemore63important.Underthesecircumstances,andwithmoreandmoreofthewealthconcentratedintheupper1percent(ortheupper0.1percent),Americahasthepotentialofbecomingincreasinglyalandofaninheritedoligarchy.Therichandsuperrichoftenusecorporationstoprotectthemselvesandsheltertheirincome,andtheyhaveworkedhardtoensurethatthecorporateincometaxrateislowandthetaxcodeisriddledwithloopholes.Somecorporationsmakesuchextensive64useoftheseprovisionsthattheydon’tpayanytaxes.EventhoughtheUnitedStatessupposedlyhasahighercorporatetaxratethanmuchoftheworld,reaching35percentaccordingtostatute,therealaveragetaxthatfirmspayisonparwiththatofmanyothercountries,andcorporatetaxrevenuesasashareofGDParesmallerthantheyare,onaverage,inotheradvancedindustrialcountries.Loopholesandspecialprovisionshaveevisceratedthetaxtosuchadegreethatithasgonefromproviding30percentoffederalrevenuesinthemid-1950stoless65than9percenttoday.IfanAmericanfirminvestsabroadthroughaforeignsubsidiary,itsprofitsarenottaxedbytheUnitedStatesuntilthemoneyisbroughthome.Whileagreatdealforthefirm(ifitinvestsinalow-taxjurisdictionlikeIreland),ithastheperverseeffectofencouragingreinvestmentabroad—creatingjobsoutsidetheUnitedStatesbutnotinit.ButthenthecorporationsdupedPresidentBushintogivingthemataxholiday—moneytheybroughtbackduringtheholiday,supposedlyforinvestment,wouldbetaxedatonly5.25percent;theywouldbringthemoneybackandreinvestitinAmerica.WhenBushputinplaceaone-yearholidayatthatrate,theydidbringtheirmoney66back;Microsoftalonebroughtbackmorethan$32billion.Buttheevidenceshowsthatlittleadditionalinvestmentwasgenerated.Allthathappenedisthattheymanagedtoavoidpaying67mostofthetaxesthattheyshouldhavepaid.Atthestatelevel,thingsareevenworse.Manystatesdon’tevenmakeapretenseatprogressivity,thatis,havingataxsystemthatmakesthe1percent,whocanaffordit,payalargerfractionoftheirincomethanthepoorhavetopay.Instead,thesalestaxoffersamajorsourceofrevenue,andbecausethepoorspendalargerfractionoftheirincome,suchtaxesareoften68regressive.Whiletaxpoliciescaneitherlettherichgetricheror70 restrainthegrowthofinequality,expenditureprogramscanplayanespeciallyimportantroleinpreventingthepoorfrombecomingpoorer.SocialSecurityhasalmosteliminatedpovertyamongtheelderly.Recentresearchhasshownhowlargetheseeffectscanbe:theearned-incometaxcredit,whichsupplementstheincomeofpoorworkingfamilies,byitselflowersthepovertyrateby2percentagepoints.Housingsubsidies,foodstamps,andschool69lunchprogramsallhavebigeffectsinloweringpoverty.Aprogramliketheprovisionofhealthinsuranceforpoorkidscanbringbenefitstomillionsandhelpensurethatthesechildrenhavealowerriskofbeinghandicappedforlifebyanillnessorotherhealthproblem;thisstandsinmarkedcontrasttosomeofthecorporatesubsidiesortaxloopholesthatcostmuchmoreandthebenefitsofwhichgotofarfewerpeople.TheUnitedStatesspentfarmoreonitsbigbankbailout,whichhelpedthebankstomaintaintheirgenerousbonuses,thanitspenttohelpthosewhowereunemployedasaresultoftherecessionthatthebigbanksbroughtabout.Wecreatedforthebanks(andothercorporations,likeAIG)amuchstrongersafetynetthanwecreatedforpoorAmericans.WhatisstrikingabouttheUnitedStatesisthatwhilethelevelofinequalitygeneratedbythemarket—amarketshapedanddistortedbypoliticsandrentseeking—ishigherthaninotheradvancedindustrialcountries,itdoeslesstotemperthisinequalitythroughtaxandexpenditureprograms.Andasthemarket-generatedinequalityhasincreased,ourgovernmenthasdone70lessandless.GovernmentandopportunityAmongthemoredisturbingfindingsrecitedinchapter1isthattheUnitedStateshasbecomeasocietyinwhichthereislessequalityofopportunity,lessthanitwasinthepast,andlessthaninothercountries,includingthoseofoldEurope.Marketforcesdescribedearlierinthischapterplayarole:asthereturnstoeducationhaveincreased,thosewithagoodeducationhavefaredwell,those(andespeciallymen)withahighschooleducationorlesshavedonemiserably.Thisisevenmoretruetoday,inourdeepeconomicdownturn.Whiletheunemploymentrateamongthosewithacollegedegreeorhigherwasonly4.2percent,thosewithlessthanahighschooldiplomafacedanunemploymentratethreetimeshigher,at12.9percent.Thepictureforrecenthighschooldropoutsandevengraduatesnotenrolledincollegeisfarmoredismal:joblessratesof42.7percentand33.4percent,71respectively.Butaccesstogoodeducationdependsincreasinglyontheincome,wealth,andeducationofone’sparents,aswesawinchapter1,andforgoodreason:acollegeeducationisbecomingmoreandmoreexpensive,especiallyasstatescutbackonsupport,andaccesstothebestcollegesdependsongoingtothebesthighschools,gradeschools,andkindergartens.Thepoorcan’taffordhigh-qualityprivateprimaryandsecondaryschools,andtheycan’taffordtoliveintherichsuburbsthatprovidehigh-qualitypubliceducation.Manyofthepoorhavetraditionallylivedincloseproximitytotherich—partlybecausetheyprovidedservicestothem.Thisphenomenoninturnledtopublicschoolswithstudentsfromdiversesocialandeconomicbackgrounds.Asa71 recentstudybyKendraBischoffandSeanReardonofStanfordUniversityshows,thatischanging:fewerpoorarelivinginproximitytotherich,andfewerricharelivinginproximityto72thepoor.U.S.neighborhoodsareevensegregatedbetweenhomeownersandrenters.Thispatterncannotbeexplainedbyraceorthepresenceofchildreninthehousehold,becauseitoccurswithinracialgroupsandamonghouseholdswithchildren.ThesegregationinAmericanmetropolitanareasintohomeownercommunitiesandrentercommunitiescanproducecommunitieswithstarklydifferentcivicenvironments.Communityqualitydependsonresidents’effortstopreventcrimeandimprovelocalgovernance,andthepayofftoanindividualmakingthateffortisgreaterforhomeownersthanforrenters,andgenerallygreaterforthosewholiveincommunitieswheremanyotherresidentsmakesimilareffortstorenderlocalgovernmentmoreresponsivetocommunitymembers.Thusthereareeconomicforcesthatleadfromdifferencesinhouseholdwealth(andhomeownership)todifferencesinthecivicqualityofthe73communityinwhichahouseholdlives.U.S.policytoincreaselow-incomeownershipratesreflectstheunderstandingthathomeownershipratesaffectneighborhoodqualityandthatgrowingupinaviolent,crime-riddenneighborhoodimpairshealth,personaldevelopment,andschooloutcomes.Buthomeownership—amajorwayintheUnitedStatesthathouseholdsaccessbetterneighborhoodsandalsoaccumulatewealth—isnotsustainableforhouseholdswithnowealthtostartwithandlittleincome.Wealsonotedinchapter1thatevenamongcollegegraduates,thosewhoarefortunateenoughtohavewealthierandbetter-educatedparentshavebetterprospects.Thismaybepartlybecauseofnetworking—makingconnections—whichmaybecomeespeciallyimportantwhenjobsarescarce,asnow.Butitisalsopartlybecauseoftheincreasingroleofinternships.Inalabormarketsuchastheonewehavehadsince2008,therearemanyjobseekersforeveryjob,andhavingexperiencecounts.Firmsareexploitingthisimbalancebyprovidingunpaidorlowpaidinternships,whichaddsanimportantelementtoaresume.Butnotonlyaretherichinabetterpositiontogettheinternship;theyareinabetter74positiontoaffordunpaidworkforayearortwo.Whilegovernmenthasbeendoinglesstocountervailthesemarketforcesthatleadtogreaterinequalityofopportunity,onthebasisofdifferentialaccessto“humancapital”andjobs,ithasalso,aswehavenoted,beendoinglesstoleveltheplayingfieldinfinancialcapital,asaresultoflessprogressivetaxationandespeciallylowerinheritancetaxes.Inshort,wehavecreatedaneconomicandsocialsystem,andapolitics,inwhich,goingforward,currentinequalitiesarenotonlylikelytobeperpetuatedbuttobeexacerbated:wecananticipateinthefuturemoreinequalitybothinhumancapitalandinfinancialcapital.THEBIGPICTUREEarlierinthischapterandinchapter2wesawhowtherulesofthegamehavehelpedcreatetherichesofthoseatthetopandhavecontributedtothemiseriesofthoseatthebottom.Governmenttodayplaysadoubleroleinourcurrentinequality:itispartlyresponsiblefortheinequalityinbefore-tax72 distributionofincome,andithastakenadiminishedrolein“correcting”thisinequalitythroughprogressivetaxandexpenditurepolicies.Asthewealthygetwealthier,theyhavemoretolosefromattemptstorestrictrentseekingandredistributeincomeinordertocreateafairereconomy,andtheyhavemoreresourceswithwhichtoresistsuchattempts.Itmightseemstrangethatasinequalityhasincreasedwehavebeendoinglesstodiminishitsimpact,butit’swhatonemighthaveexpected.It’scertainlywhatoneseesaroundtheworld:themoreegalitariansocietiesworkhardertopreservetheirsocialcohesion;inthemoreunequalsocieties,governmentpoliciesandotherinstitutionstendtofosterthepersistenceofinequality.Thispatternhasbeenwell75documented.JustifyinginequalityWebeganthechapterbyexplaininghowthoseatthetophaveoftensoughttojustifytheirincomeandwealth,andhow“marginalproductivitytheory,”thenotionthatthosewhogotmoredidsobecausetheyhadmadeagreatercontributiontosociety,hadbecometheprevailingdoctrine,atleastineconomics.Butwe76noted,too,thatthecrisishadcastdoubtonthistheory.Thosewhoperfectedthenewskillsofpredatorylending,whohelpedcreatederivatives,describedbythebillionaireWarrenBuffettas“financialweaponsofmassdestruction,”orwhodevisedtherecklessnewmortgagesthatbroughtaboutthesubprimemortgagecrisiswalkedawaywithmillions,sometimeshundredsofmillions,77ofdollars.Butevenbeforethat,itwasclearthatthelinkbetweenpayandsocietalcontributionwas,atbest,weak.Aswenotedearlier,thegreatscientistswhohavemadediscoveriesthatprovidedthebasisofourmodernsocietyhavetypicallyreapedforthemselvesnomorethanasmallfractionofwhattheyhavecontributed,andreceivedamerepittancecomparedwiththerewardsreapedbythefinancialwizardswhobroughttheworldtothebrinkofruin.Butthereisadeeperphilosophicalpoint:onecan’treallyseparateoutanyindividual’scontributionsfromthoseofothers.Eveninthecontextoftechnologicalchange,mostinventionsentailthesynthesisofpreexistingelementsratherthaninventiondenovo.Today,atleastinmanycriticalsectors,alargefractionofalladvancesdependonbasicresearchfundedbythegovernment.GarAlperovitzandLewDalyconcludedin2009that“ifmuchofwhatwehavecomestousasthefreegiftofmanygenerationsofhistoricalcontribution,thereisaprofoundquestionastohowmuchcanreasonablybesaidtobe‘earned’byanyoneperson,78noworinthefuture.”Sotoo,thesuccessofanybusinesspersondependsnotjustonthis“inherited”technologybutontheinstitutionalsetting(theruleoflaw),theexistenceofawell-educatedworkforce,andtheavailabilityofgoodinfrastructure(transportationandcommunications).Isinequalitynecessarytogivepeopleincentives?73 Anotherargumentisoftenprofferedbythosewhodefendthestatusquo:thatweneedthecurrenthighlevelofinequalitytogivepeopleincentivestowork,save,andinvest.Thisconfusestwopositions.Oneisthatweshouldhavenoinequality.Theotheristhatwewouldbebetter-offifwehadlessinequalitythanwehavetoday.Iand,asfarasIknow,mostprogressives—donotargueforfullequality.Werealizethatthatwouldweakenincentives.Thequestionis,Howseriouslywouldincentivesbeweakenedifwehadalittlebitlessinequality?Inthenextchapter,Iwillexplainwhy,tothecontrary,lessinequalitywouldactuallyenhanceproductivity.Ofcourse,muchofwhatiscalledincentivepayisn’treallythat.It’sjustanamegivenittojustifythehugeinequality,andtodeludetheinnocenttothinkthatwithoutsuchinequalityoureconomicsystemwouldn’twork.Thatwasmadeevidentwhen,intheaftermathofthefinancialdebacleof2008,thebanksweresoembarrassedaboutcallingwhattheypaidtheirexecutives“performancebonuses”thattheyfeltcompelledtochangethenameto“retentionbonus”(eveniftheonlythingbeingretainedwasbadperformance).Underincentivecompensationschemes,payissupposedtoincreasewithperformance.Whatthebankersdidwascommonpractice:whentherewasadeclineinmeasuredperformanceaccordingtotheyardsticksthatweresupposedtobeusedtodeterminecompensation,thecompensationsystemchanged.Theeffectwasthat,inpractice,paywashighwhenperformancewas79good,andpaywashighwhenperformancewasbad.ParsingoutthesourcesofinequalityEconomistsarepronetoquibbleabouttherelativeimportanceofvariousfactorsleadingtoAmerica’sgrowinginequality.Increasinginequalityinwagesandcapitalincomeandanincreasingshareofincomegoingtothoseformsofincomethataremoreunequallydistributedcontributedtogreaterinequalityinmarketincome,and,aswesawearlierinthechapter,lessprogressivetaxandexpenditurepoliciescontributedtoanevenlargerincreaseinafter-taxandtransferincome.Theexplanationfortheincreaseindispersionofwagesandsalarieshasbeenparticularlycontentious.Somefocusonchangesintechnology—skill-biasedtechnologicalchange.Othersonsocialfactors—theweakeningofunions,thebreakdownofsocialnormsrestrainingexecutivepay.Stillothersfocusonglobalization.Somefocusontheincreasingroleoffinance.Strongvestedinterestsinformeachoftheseexplanations:thosefightingtoopenupmarketsseeglobalizationasplayingaminorrole;thosearguingforstrongerunionsseetheweakeningofunionsascentral.Someofthedebateshavetodowiththedifferentaspectsofinequalitythatarebeingfocusedupon:theincreasingroleoffinancemayhavelittletodowiththepolarizationofwagesinthemiddle,butagreatdealtodowiththeincreasesofincomeandwealthatthetop.Atdifferenttimes,differentforceshaveplayeddifferentroles:globalizationhasprobablyplayedamoreimportantrolesince,say,2000thanitdidintheprecedingdecade.Still,thereisagrowingconsensusamongeconomiststhatitishardtoparseoutcleanlyandpreciselytherolesofdifferentforces.Wecan’tconductcontrolledexperiments,tosee74 whatinequalitywouldhavebeenif,keepingeverythingelsethesame,wehadhadstrongerunions.Moreover,theforcesinteract:thecompetitiveforcesofglobalization—thethreatofjobsmoving80elsewhere—hasbeenimportantinweakeningunions.Tome,muchofthisdebateisbesidethepoint.ThepointisthatinequalityinAmerica(andsomeothercountriesaroundtheworld)hasgrowntowhereitcannolongerbeignored.Technology(skill-biasedtechnologicalchange)maybecentraltocertainaspectsofourcurrentinequalityproblem,especiallytothepolarizationofthelabormarket.Butevenifthatisthecase,wedon’thavetositidlybyandaccepttheconsequences.Greedmaybeaninherentpartofhumannature,butthatdoesn’tmeanthereisnothingwecandototempertheconsequencesofunscrupulousbankerswhowouldexploitthepoorandengageinanticompetitivepractices.Wecanandshouldregulatebanks,forbidpredatorylending,makethemaccountablefortheirfraudulentpractices,andpunishthemforabusesofmonopolypower.Sotoo,strongerunionsandbettereducationmightmitigatetheconsequencesofskill-biasedtechnologicalchange.Andit’snoteveninevitablethattechnologicalchangecontinuesinthisdirection:makingfirmspayfortheenvironmentalconsequencesoftheirproductionmightencouragefirmstoshiftawayfromskill-biasedtechnologicalchangetoresource-savingtechnologicalchange.Lowinterestratesmayencouragefirmstorobotize,replacingunskilledjobsthatcaneasilyberoutinized;soalternativemacroeconomicandinvestmentpoliciescouldslowthepaceofthedeskillingofoureconomy.Sotoo,whileeconomistsmaydisagreeaboutthepreciserolethatglobalizationhasplayedintheincreaseininequality,theasymmetriesinglobalizationtowhichwecallattentionputworkersataparticulardisadvantage;andwecanmanageglobalizationbetter,inwaysthatmightleadtolessinequality.WehavealsonotedhowthegrowthinthefinancialsectorasashareoftotalU.S.income(sometimesreferredtoastheincreasedfinancializationoftheeconomy)hascontributedtoincreasedinequality—toboththewealthcreatedatthetopandthepovertyatthebottom.JamieGalbraithhasshownthatcountrieswithlargerfinancialsectorshavemoreinequality,andthelinkisnot81anaccident.Wehaveseenhowderegulationandhiddenandopengovernmentsubsidiesdistortedtheeconomy,notonlyleadingtoalargerfinancialsectorbutalsoenhancingitsabilitytomovemoneyfromthebottomtothetop.Wedon’thavetoknowpreciselythefractionofinequalitythatshouldbeattributedtotheincreasedfinancializationoftheeconomytounderstandthatachangeinpoliciesisneeded.Eachofthefactorsthathavecontributedtoinequalityhastobeaddressed,withespecialemphasisonthosethatsimultaneouslycontributedirectlytotheweakeningofoureconomy,suchasthepersistenceofmonopolypowerandofdistortionaryeconomicpolicies.Inequalityhasbecomeingrainedinoureconomicsystem,anditwilltakeacomprehensiveagenda—describedmorefullyinchapter10—touprootit.AlternativemodelsofinequalityInthischapter,wehaveexplainedthattherearealternativetheoriesofinequality,insomeofwhichinequalityseemsmore”justified,”theincomeofthoseatthetopmoredeserved,andthecostsofcheckingtheinequalityandredistributiongreater75 thanothers.The“achievement”modelofincomedeterminationfocusesontheeffortsofeachindividual;andifinequalitywerelargelytheresultofdifferencesineffort,itwouldbehardtofaultit,anditwouldseemunjust,andinefficient,nottorewardit.TheHoratioAlgerstoriesthatwedescribedinchapter1belongtothistradition:inthemorethanahundredtalesofragstoriches,itwasbydintoftheindividual’sowneffortsthattheheroofeachtalepulledhimselfoutofpoverty.Theymaycontainagrainoftruth,butitisonlyagrain.Wesawinchapter1thatthemajordeterminantofanindividual’ssuccesswashisinitialconditions—theincomeandeducationofhisparents.Luckalsoplaysanimportantrole.Thecentralthesisofthischapterandtheprecedingoneisalsothatinequalityisnotjusttheresultoftheforcesofnature,ofabstractmarketforces.Wemightlikethespeedoflighttobefaster,butthereisnothingwecandoaboutit.Butinequalityis,toaverylargeextent,theresultofgovernmentpoliciesthatshapeanddirecttheforcesoftechnologyandmarketsandbroadersocietalforces.Thereisinthisanoteofbothhopeanddespair:hopebecauseitmeansthatthisinequalityisnotinevitable,andthatbychangingpolicieswecanachieveamoreefficientandamoreegalitariansociety;despairbecausethepoliticalprocessesthatshapethesepoliciesaresohardtochange.Thereisonesourceofinequality,especiallyatthebottom,aboutwhichthischapterhashadlittletosay:asthisbookgoestopress,wearestillintheworsteconomicdownturnsincetheGreatDepression.Macro-mismanagement,inallofitsguises,isamajorsourceofinequality.Theunemployedaremorelikelytojointhoseinpoverty,themoreso,thelongertheeconomicdownturn.Thebubblegaveafewofthepooranillusionofwealth,butonlyforamoment;aswehaveseen,whenthebubbleburst,itwipedoutthewealthofthoseatthebottom,creatingnewlevelsofwealthinequalityandheighteningthefragilityofthoseatthebottom.Chapter9willlayouthowthemacroeconomic(andespeciallymonetary)policiesthattheUnitedStatesandmanyothercountriespursuedreflectedtheinterestsandideologiesofthetop.Anotherthemeofthisbookisthatof“adversedynamics,”“viciouscircles.”Wesawinthelastchapterhowgreaterinequalityledtolessequalityofopportunity,leadinginturntomoreinequality.Inthenextchapter,we’llseesomefurtherexamplesofdownwardspirals—howmoreinequalityunderminessupportforcollectiveaction,thekindsofactionsthatensurethateveryonelivesuptohisorherpotential,asaresult,forinstance,ofgoodpublicschools.We’llexplainhowinequalityfostersinstability,whichitselfgivesrisetomoreinequality.76 CHAPTERFOURWHYITMATTERSWESAWINCHAPTER1THATTHEAMERICANECONOMYhasnotbeendeliveringformostcitizensforyears,eventhough,withtheexceptionof2009,GDPpercapitahasbeenincreasing.Thereasonissimple:growinginequality,anincreasinggapbetweenthetopandtherest.Wesawinchapter2thatoneofthereasonsthatthetophasdonesowellisrentseeking—whichentailsseizingalargershareofthepieand,indoingso,makingthesizeofthepiesmallerthanitotherwisewouldbe.Wearepayingahighpriceforourlargeandgrowinginequality,andbecauseourinequalityislikelytocontinuetogrow—unlesswedosomething—thepricewepayislikelytogrowtoo.Thoseinthemiddle,andespeciallythoseatthebottom,willpaythehighestprice,butourcountryasawhole—oursociety,ourdemocracy—alsowillpayaveryhighprice.Widelyunequalsocietiesdonotfunctionefficiently,andtheireconomiesareneitherstablenorsustainableinthelongterm.Whenoneinterestgroupholdstoomuchpower,itsucceedsingettingpoliciesthatbenefititself,ratherthanpoliciesthatwouldbenefitsocietyasawhole.Whenthewealthiestusetheirpoliticalpowertobenefitexcessivelythecorporationstheycontrol,much-neededrevenuesaredivertedintothepocketsofafewinsteadofbenefitingsocietyatlarge.Buttherichdonotexistinavacuum.Theyneedafunctioningsocietyaroundthemtosustaintheirpositionandtoproduceincomefromtheirassets.Therichresisttaxes,buttaxesallowsocietytomakeinvestmentsthatsustainthecountry’sgrowth.Whenlittlemoneyisinvestedineducation,forlackoftaxrevenues,schoolsdonotproducethebrightgraduatesthatcompaniesneedtoprosper.Takentoitsextreme—andthisiswherewearenow—thistrenddistortsacountryanditseconomyasmuchasthequickandeasyrevenuesoftheextractiveindustrydistortoil-ormineral-richcountries.Weknowhowtheseextremesofinequalityplayoutbecausetoomanycountrieshavegonedownthispathbefore.TheexperienceofLatinAmerica,theregionoftheworldwiththehighestlevelof1inequality,foreshadowswhatliesahead.Manyofthecountriesweremiredincivilconflictfordecades,sufferedhighlevelsofcriminalityandsocialinstability.Socialcohesionsimplydidnotexist.ThischapterexplainsthereasonswhyaneconomylikeAmerica’s,inwhichmostcitizens’wealthhasfallen,medianincomeshavestagnated,andmanyofthepoorestcitizenshavebeendoingworseyearafteryear,isnotlikelytodowelloverthelonghaul.Wewilllookfirstattheeffectsofinequalityonnationaloutputandeconomicstability,thenatitsimpactoneconomicefficiencyandongrowth.Theeffectsaremultipleand77 occurthroughanumberofchannels.Somearecausedbytheincreaseinpoverty;otherscanbeattributedtotheeviscerationofthemiddleclass,stillmoretothegrowingdisparitybetweenthe1percentandtherestofus.Someoftheseeffectsarisethroughtraditionaleconomicmechanisms,whileothersaretheconsequenceofinequality’sbroaderimpactonourpoliticalsystemandsociety.We’llalsoexaminethefallaciousideasthatinequalityisgoodforgrowth,orthatdoinganythingaboutinequality—likeraisingtaxesontherich—wouldharmtheeconomy.INSTABILITYANDOUTPUTItisperhapsnoaccidentthatthiscrisis,liketheGreat2Depression,wasprecededbylargeincreasesininequality:whenmoneyisconcentratedatthetopofsociety,theaverageAmerican’sspendingislimited,oratleastthatwouldbethecaseintheabsenceofsomeartificialprop,which,intheyearsbeforethecrisis,cameintheformofahousingbubblefueledbyFedpolicies.Thehousingbubblecreatedaconsumptionboomthatgavetheappearancethateverythingwasfine.Butaswesoonlearned,itwasonlyatemporarypalliative.Movingmoneyfromthebottomtothetoplowersconsumptionbecausehigher-incomeindividualsconsumeasmallerproportionoftheirincomethandolower-incomeindividuals(thoseatthetopsave15to25percentoftheirincome,thoseatthebottomspend3alloftheirincome).Theresult:untilandunlesssomethingelsehappens,suchasanincreaseininvestmentorexports,totaldemandintheeconomywillbelessthanwhattheeconomyiscapableofsupplying—andthatmeansthattherewillbeunemployment.Inthe1990sthat“somethingelse”wasthetechbubble;inthefirstdecadeofthetwentieth-firstcentury,itwasthehousingbubble.Nowtheonlyrecourseisgovernmentspending.Unemploymentcanbeblamedonadeficiencyinaggregatedemand(thetotaldemandforgoodsandservicesintheeconomy,fromconsumers,fromfirms,bygovernment,andbyexporters);insomesense,theentireshortfallinaggregatedemand—andhenceintheU.S.economy—todaycanbeblamedontheextremesofinequality.Aswe’veseen,thetop1percentofthepopulationearnssome20percentofU.S.nationalincome.Ifthattop1percentsavessome20percentofitsincome,ashiftofjust5percentagepointstothepoorormiddlewhodonotsave—sothetop1percentwouldstillget15percentofthenation’sincome—wouldincreaseaggregatedemanddirectlyby1percentagepoint.Butasthatmoneyrecirculates,outputwouldactuallyincreasebysome1½to24percentagepoints.Inaneconomicdownturnsuchasthecurrentone,thatwouldimplyadecreaseintheunemploymentrateofacomparableamount.Withunemploymentinearly2012standingat8.3percent,thiskindofashiftinincomecouldhavebroughttheunemploymentratedowncloseto6.3percent.Abroaderredistribution,say,fromthetop20percenttotherest,wouldhavebroughtdowntheunemploymentfurther,toamorenormal5to6percent.There’sanotherwayofseeingtheroleofgrowinginequalityinweakeningmacroeconomicperformance.Inthelastchapter,weobservedtheenormousdeclineinthewageshareinthisrecession;78 5thedeclineamountedtomorethanahalftrilliondollarsayear.That’sanamountmuchgreaterthanthevalueofthestimuluspackagepassedbyCongress.Thatstimuluspackagewasestimatedtoreduceunemploymentby2to2½percentagepoints.Takingmoneyawayfromworkershas,ofcourse,justtheoppositeeffect.SincethetimeofthegreatBritisheconomistJohnMaynardKeynes,governmentshaveunderstoodthatwhenthereisashortfallofdemand—whenunemploymentishigh—theyneedtotakeactiontoincreaseeitherpublicorprivatespending.The1percenthasworkedhardtorestraingovernmentspending.Privateconsumptionisencouragedthroughtaxcuts,andthatwasthestrategyundertakenbyPresidentBush,withthreelargetaxcutsineightyears.Itdidn’twork.TheburdenofcounteringweakdemandhasthusbeenplacedontheU.S.FederalReserve,whosemandateistomaintainlowinflation,highgrowth,andfullemployment.TheFeddoesthisbyloweringinterestratesandprovidingmoneytobanks,which,innormaltimes,lendittohouseholdsandfirms.Thegreateravailabilityofcreditatlowerinterestratesoftenspursinvestment.Butthingscangowrong.Ratherthanspurringrealinvestmentsthatleadtohigherlong-termgrowth,thegreateravailabilityofcreditcanleadtobubbles.Abubblecanleadhouseholdstoconsumeinanunsustainableway,onthebasisofdebt.Andwhenabubblebreaks,itcanbringonarecession.Whileitisnotinevitablethatpolicymakerswillrespondtothedeficiencyindemandbroughtaboutbythegrowthininequalityinwaysthatleadtoinstabilityandawasteofresources,ithappensoften.Howthegovernment’sresponsetoweakdemandfrominequalityledtoabubbleandevenmoreinequalityForinstance,theFederalReserverespondedtothe1991recessionwithlowinterestratesandthereadyavailabilityofcredit,helpingtocreatethetechbubble,aphenomenalincreaseinthepriceoftechnologystocksaccompaniedbyheavyinvestmentinthesector.Therewas,ofcourse,somethingrealunderlyingthatbubble—technologicalchange,broughtaboutbythecommunicationsandcomputerrevolution.TheInternetwasrightlyjudgedtobeatransformativeinnovation.Buttheirrationalexuberanceonthepartofinvestorswentwellbeyondanythingthatcouldbejustified.Inadequateregulation,badaccounting,anddishonestandincompetentbankingalsocontributedtothetechbubble.Banksfamouslyhadtoutedstocksthattheyknewwere“dogs.”“Incentive”payprovidedCEOswithincentivestodistorttheiraccounting,toshowprofitsthatwerefarlargerthantheyactuallywere.Thegovernmentcouldhavereinedthisinbyregulatingthebanks,byrestrictingincentivepay,byenforcingbetteraccountingstandards,andbyrequiringhighermargins(theamountofcashthatinvestorshavetoputdownwhentheybuystock).Butthebeneficiariesofthetechbubble—andespeciallythecorporateCEOsandthebanks—didn’twantthegovernmenttointervene:therewasapartygoingon,anditwasapartythatlastedforseveralyears.Theyalsobelieved(correctly,asitturnedout)thatsomebodyelsewouldcleanupthemess.Butthepoliticiansoftheerawerealsobeneficiariesofthebubble.Thisirrationalinvestmentdemandduringthetechboom79 helpedtooffsettheotherwiseweakdemandcreatedbythehighinequality,makingtheBillClintoneraoneofseemingprosperity.Taxrevenuesfromcapitalgainsandotherincomegeneratedbythebubbleevengavetheappearanceoffiscalsoundness.And,tosomeextent,theadministrationcouldclaim“credit”forwhatwasgoingon:Clinton’spoliciesoffinancialmarketderegulationandcutstocapitalgainstaxrates(increasingthereturnsto6speculatingonthetechstocks)addedfueltothefire.Whenthetechbubblefinallyburst,thedemandbyfirms(especiallytechnologyfirms)formorecapitaldiminishedmarkedly.Theeconomywentintorecession.Somethingelsewouldhavetorekindletheeconomy.GeorgeW.BushsucceededingettingataxcuttargetedattherichthroughCongress.Muchofthetaxcutbenefitedtheveryrich:acutintherateondividends,whichwasreducedfrom35percentto15percent,afurthercutincapitalgainstaxrates,from20percentto15percent,anda7gradualeliminationoftheestatetax.Butbecause,aswehavenoted,therichsavesomuchoftheirincome,suchataxcutprovidedonlyalimitedstimulustotheeconomy.Indeed,aswediscussnext,thetaxcutshadevensomeperverseeffects.Corporations,realizingthatthedividendtaxratewasunlikelytoremainsolow,hadeveryincentivetopayoutasmuchastheyfeltthattheycoulddosafely—withoutjeopardizingtoomuchthefutureviabilityofthefirm.Butthatmeantsmallercashreservesleftonhandforanyinvestmentopportunitiesthatcamealong.8Investment,outsideofrealestate,actuallyfell,contraryto9whatsomeontherighthadpredicted.(Partofthereasonfortheweakinvestment,ofcourse,wasthatduringthetechbubblemanyfirmshadoverinvested.)Bythesametoken,thecutintheestatetaxmayhavediscouragedspending;therichcouldnowsafelystowawaymoremoneyfortheirchildrenandgrandchildren,andtheyhadlessincentivetogiveawaymoneytocharitiesthatwouldhave10spentthemoneyongoodcauses.Strikingly,theFedanditschairmanatthetime,AlanGreen-span,didn’tlearnthelessonsofthetechbubble.Butthiswasinpartbecauseofthepoliticsof“inequality,”whichdidn’tallowalternativestrategiesthatcouldhaveresuscitatedtheeconomywithoutcreatinganotherbubble,suchasataxcuttothepoororincreasedspendingonbadlyneededinfrastructure.Thisalternativetotherecklesspaththecountrytookwasanathematothosewhowantedtoseeasmallergovernment—onetooweaktoengageinprogressivetaxationorredistributivepolicies.FranklinDelanoRoosevelthadtriedthesepoliciesinhisNewDeal,andtheestablishmentpilloriedhimforit.Instead,lowinterestrates,laxregulations,andadistortedanddysfunctionalfinancialsectorcametotherescueoftheeconomy—foramoment.TheFedengineered,unintentionally,anotherbubble,thisonetemporarilymoreeffectivethanthelastbutinthelongrunmoredestructive.TheFed’sleadersdidn’tseeitasabubble,becausetheirideology,theirbeliefthatmarketswerealwaysefficient,meantthattherecouldn’tbeabubble.Thehousingbubblewasmoreeffectivebecauseitinducedspendingnotjustbyafewtechnologycompaniesbutbytensofmillionsofhouseholdsthatthoughtthattheywerericherthantheywere.Inoneyearalone,closetoatrilliondollarsweretakenoutinhomeequity11loansandmortgages,muchofitspentonconsumption.Butthebubblewasmoredestructivepartlyforthesamereasons:itleft80 initswaketensofmillionsoffamiliesonthebrinkoffinancialruin.Beforethedebacleisover,millionsofAmericanswilllosetheirhomes,andmillionsmorewillfacealifetimeoffinancialstruggle.Overleveragedhouseholdsandexcessrealestatehavealreadyweigheddowntheeconomyforyearsandarelikelytodosoformoreyears,contributingtounemploymentandamassivewasteofresources.Atleastthetechbubbleleftsomethingusefulinitswake—fiberopticsnetworksandnewtechnologythatwouldprovidesourcesofstrengthfortheeconomy.Thehousingbubbleleftshoddilybuilthouses,locatedinthewrongplacesandinappropriatetotheneedsofacountrywheremostpeople’seconomicpositionwasindecline.It’stheculminationofathree-decadestretchspentcareeningfromonecrisistoanotherwithoutlearningsomeveryobviouslessonsalongtheway.Inademocracywheretherearehighlevelsofinequality,politicscanbeunbalanced,too,andthecombinationofanunbalancedpoliticsmanaginganunbalancedeconomycanbelethal.DeregulationThereisasecondwaythatunbalancedpoliticsdrivenbyextremesofinequalityleadstoinstability:deregulation.Deregulationhasplayedacentralpartintheinstabilitythatwe,andmanyothercountries,haveexperienced.Givingcorporations,andespeciallythefinancialsector,freereinwasintheshortsightedinterestofthewealthy;theyusedtheirpoliticalweight,andtheirpowertoshapeideas,topushderegulation,firstinairlinesandotherareasoftransportation,thenintelecom,andfinally,andmost12dangerously,infinance.Regulationsaretherulesofthegamethataredesignedtomakeoursystemworkbetter—toensurecompetition,topreventabuses,toprotectthosewhocannotprotectthemselves.Withoutrestraints,thekindsofmarketfailuresdescribedinthelastchapter—wheremarketsfailtoproduceefficientoutcomes—arerampant.Inthefinancialsector,forinstance,therewillbeconflictsofinterestandexcesses,excesscredit,excessleverage,excessrisktaking,andbubbles.Butthoseinthebusinesssectorseethingsdifferently:withouttherestraints,theyseeincreasesinprofits.Theythinknotofthebroad,andoftenlong-term,socialandeconomicconsequences,butoftheirnarrower,short-termself-interest,theprofitsthattheymight13garnernow.IntheaftermathoftheGreatDepression,aneventprecededbysimilarexcesses,thecountryenactedstrongfinancialregulations,includingtheGlass-SteagallActin1933.Theselaws,effectivelyenforced,servedthecountrywell:inthedecadesfollowingpassage,theeconomywassparedthekindoffinancialcrisisthathadrepeatedlyplaguedthiscountry(andothers).Withthedismantlingoftheseregulationsin1999,theexcessesreturnedwithevengreaterforce:bankersquicklyputtouseadvancesintechnology,finance,andeconomics.Theinnovationsofferedwaystoincreaseleveragethatcircumventedtheregulationsthatremainedandthattheregulatorsdidn’tfullyunderstand,newwaysofengaginginpredatorylending,andnewwaystodeceiveunwarycreditcardusers.ThelossesfromtheunderutilizationofresourcesassociatedwiththeGreatRecessionandothereconomicdownturnsare81 enormous.Indeed,thesheerwasteofresourcesbroughtonbythiscrisiscausedbytheprivatesector—ashortfalloftrillionsofdollarsbetweenwhattheeconomycouldhaveproducedandwhatithasproduced—isgreaterthanthewasteofanydemocraticgovernment,ever.Thefinancialsectorclaimedthatitsinnovationshadledtoamoreproductiveeconomy—aclaimforwhichthereisnoevidence—butthereisnodoubtingtheinstabilityandinequalityforwhichitisresponsible.Evenifthefinancialsectorhadledtoaquarterpercenthighergrowthforthreedecades—aclaimthatisbeyondthatofeventhemostexaggeratedsupportersofthesector—itwouldbarelyhavemadeupforthelossesthatitsmisbehaviorprecipitated.Wehaveseenhowinequalitygivesrisetoinstability,asaresultofboththederegulatorypoliciesthatareenactedandthepoliciesthataretypicallyadoptedinresponsetothedeficienciesinaggregatedemand.Neitherisanecessaryconsequenceofinequality:ifourdemocracyworkedbetter,itmighthaveresistedthepoliticaldemandforderegulationandmighthaverespondedtotheweaknessesinaggregatedemandinways14thatenhancedsustainablegrowthratherthancreatingabubble.Therearefurtheradverseeffectsofthisinstability:itincreasesrisk.Firmsareriskaverse,whichmeansthattheydemandcompensationforbearingtherisk.Withoutcompensation,15firmswillinvestless,andsotherewillbelessgrowth.Theironyisthatwhileinequalitygivesrisetoinstability,theinstabilityitselfgivesrisetomoreinequality,oneoftheviciouscyclesthatweidentifyinthischapter.Inchapter1,wesawhowtheGreatRecessionhasbeenparticularlyhardonthoseatthebottom,andeventhoseinthemiddle,andthisistypical:ordinaryworkersfacehigherunemployment,lowerwages,declininghouseprices,alossofmuchoftheirwealth.Sincethericharebetterabletobearrisk,theyreaptherewardthatsociety16providesforcompensatingforthegreaterrisk.Asalways,theyseemtobethewinnersfromthepoliciesthattheyadvocatedandthatimposedsuchhighcostsonothers.Inthewakeofthe2008globalfinancialcrisis,thereisnowanincreasingglobalconsensusthatinequalityleadsto17instability,andthatinstabilitycontributestoinequality.TheInternationalMonetaryFund(IMF),theinternationalagencychargedwithmaintainingglobaleconomicstability,whichIhavestronglycriticizedforpayinginsufficientattentiontotheconsequencesofitspoliciesforthepoor,belatedlyacknowledgedthatitcannotignoreinequalityifitistofulfillitsmandate.Ina2011study,theIMFconcluded,“Wefindthatlongergrowthspellsarerobustlyassociatedwithmoreequalityintheincomedistribution….Overlongerhorizons,reducedinequalityand18sustainedgrowthmaythusbetwosidesofthesamecoin.”InAprilofthatyearitsformermanagingdirector,DominiqueStrauss-Kahn,emphasized,“Ultimately,employmentandequityarebuildingblocksofeconomicstabilityandprosperity,ofpoliticalstabilityandpeace.ThisgoestotheheartoftheIMF’smandate.19Itmustbeplacedattheheartofthepolicyagenda.”HIGHINEQUALITYMAKESFORALESSEFFICIENTANDPRODUCTIVEECONOMY82 Beyondthecostsoftheinstabilitytowhichitgivesrise,thereareseveralotherreasonswhyhighinequality—thekindthatnowcharacterizestheUnitedStates—makesforalessefficientandproductiveeconomy.Wediscussinturn(a)thereductioninbroadlybeneficialpublicinvestmentandsupportforpubliceducation,(b)massivedistortionsintheeconomy(especiallyassociatedwithrentseeking),inlaw,andinregulations,and(c)effectsonworkers’moraleandontheproblemof“keepingupwiththeJoneses.”LoweringpublicinvestmentThecurrenteconomicmantrastressestheroleoftheprivatesectorastheengineofeconomicgrowth.It’seasytoseewhy:whenwethinkofinnovationwethinkofApple,Facebook,Google,andahostofothercompaniesthathavechangedourlives.Butbehindthescenesliesthepublicsector:thesuccessofthesefirms,andindeedtheviabilityofourentireeconomy,dependsheavilyonawell-performingpublicsector.Therearecreativeentrepreneursallovertheworld.Whatmakesadifference—whethertheyareabletobringtheirideastofruitionandproductstomarket—isthegovernment.Foronething,thegovernmentsetsthebasicrulesofthegame.Itenforcesthelaws.Moregenerally,itprovidesthesoftandhardinfrastructurethatenablesasociety,andaneconomy,tofunction.Ifthegovernmentdoesn’tprovideroads,ports,education,orbasicresearch—orseetoitthatsomeoneelsedoes,oratleastprovidestheconditionsunderwhichsomeoneelsecould—thenordinarybusinesscannotflourish.Economistscallsuchinvestments“publicgoods,”atechnicaltermreferringtothefactthateveryonecanenjoythebenefitsof,say,basicknowledge.Amodernsocietyrequirescollectiveaction,thecountryactingtogethertomaketheseinvestments.Thebroadsocietalbenefitsthatflowfromthemcannotbecapturedbyanyprivateinvestor,whichiswhyleavingittothemarketwillresultinunderinvestment.TheUnitedStatesandtheworldhavebenefitedgreatlyfromgovernment-sponsoredresearch.Inearlierdecadesresearchconductedthroughourstateuniversitiesandagriculturalextensionservicescontributedtoenormousincreasesin20agriculturalproductivity.Today,government-sponsoredresearchhaspromotedtheinformationtechnologyrevolutionandadvancesinbiotechnology.ForseveraldecadesAmericahassufferedfromunderinvestmentininfrastructure,basicresearch,andeducationatalllevels.Furthercutbacksintheseareaslieahead,giventhecommitmentbybothpartiestobringingdownthedeficitandtherefusaloftheHouseofRepresentativestoraisetaxes.Thecutscomedespiteevidencethattheboosttheseinvestmentsgivetotheeconomyfarexceedstheaveragereturnintheprivatesector,andiscertainly21higherthanthecostoffundstothegovernment.Indeed,theboomyearsofthe1990swerebuoyedbyinnovationsmadeinpreviousdecadesthatfinallytooktheirplaceinoureconomy.Butthewellfromwhichtheprivatesectorcandraw—forthenextgenerationoftransformationalinvestments—isdryingup.Appliedinnovationsdependonbasicresearch,andwesimplyhaven’tbeen83 22doingenoughofit.Ourfailuretomakethesecriticalpublicinvestmentsshouldnotcomeasasurprise.Itistheendresultofalopsidedwealthdistributioninsociety.Themoredividedasocietybecomesintermsofwealth,themorereluctantthewealthyaretospendmoneyoncommonneeds.Therichdon’tneedtorelyongovernmentforparksoreducationormedicalcareorpersonalsecurity.Theycanbuyallthesethingsforthemselves.Intheprocess,theybecomemoredistantfromordinarypeople.Thewealthyalsoworryaboutastronggovernment—onethatcoulduseitspowertoadjusttheimbalancesinoursocietybytakingsomeoftheirwealthanddevotingittopublicinvestmentsthatwouldcontributetothecommongoodorthatwouldhelpthoseatthebottom.WhilethewealthiestAmericansmaycomplainaboutthekindofgovernmentwehaveinAmerica,intruthmanylikeitjustfine:toogridlockedtoredistribute,toodividedtodoanythingbutlowertaxes.Livinguptopotential:theendofopportunityOurunderinvestmentinthecommongood,includingpubliceducation,hascontributedtothedeclineineconomicmobilitythatwenotedinchapter1.Thisinturnhasimportantconsequencesforthecountry’sgrowthandefficiency.Wheneverwediminishequalityofopportunity,wearenotusingoneofourmostvaluableassets—ourpeople—inthemostproductivewaypossible.Inearlierchapterswesawhowtheprospectsofagoodeducationforthechildrenofpoorandmiddle-incomefamilieswerefarbleakerthanthoseofthechildrenoftherich.Parentalincomeisbecomingincreasinglyimportant,ascollegetuitionincreasesfarfasterthanincomes,especiallyatpubliccolleges,whicheducate70percentofAmericans.But,onemightask,don’texpandedstudentloanprogramsfillthegap?Theanswer,unfortunately,isno;andagain,thefinancialsectorismorethanalittleatfault.Today,themarketischaracterizedbyasetofperverseincentives,which,togetherwiththeabsenceofregulationsthatpreventabuse,meanthatthestudentloanprograms,ratherthanupliftingthepoor,can(andtoooftendo)leadtotheirfurtherimmiseration.Thefinancialsectorsucceededinmakingstudentloansnon-dischargeableinbankruptcy,whichmeantthatthelendershadlittleincentivetoseetoitthattheschoolsforwhichthestudentswereborrowingmoneywereactuallyprovidingthemwithaneducationthatwouldenhancetheirincome.Meanwhile,privatefor-profitschoolswithrichlycompensatedexecutiveshavedefeatedattemptstoimposehighstandardsthatwouldmakeschoolsthatexploitthepoorandillinformed—bytakingtheirmoneyandnotprovidingthemwithaneducationthatenablesthemtogetjobstorepaytheloans—ineligiblefor23loans.Itistotallyunderstandablethatayoungperson,seeinghowtheburdenofdebtiscrushinghisparents’lives,wouldbereluctanttotakeonstudentloans.Itis,infact,remarkablethatsomanyarewillingtodoso,tothepointthattheaverage24collegegraduatenowhasadebtofover$25,000.Theremaybeanotherfactoratplaythatisdecreasingmobilityandthat,overthelongrun,willdecreasethenation’sproductivity.Studiesofeducationalattainmentstressthe84 importanceofwhathappensinthehome.Asthoseinthemiddleandatthebottomstruggletomakealiving—astheyhavetoworkmoretogetby—familieshavelesstimetospendtogether.Parentsarelessabletosupervisetheirchildren’shomework.Familieshavetomakecompromises,andamongthemislessinvestmentintheirchildren(thoughtheywouldn’tusethosewords.)Adistortedeconomy—rentseekingandfinancialization—andalesswell-regulatedeconomyAcentralthemeoftheprecedingchapterswasthatmuchoftheinequalityinoureconomywastheresultofrentseeking.Intheirsimplestform,rentsarejustredistributionsfromtherestofustotherentseekers.That’sthecasewhenoilandminingcompaniessucceedingettingrightstooilandmineralsatpriceswellbelowwhattheyshouldbe.Themainwasteofresourcesisonlyonlobbying:therearemorethan3,100lobbyistsworkingforthehealthindustry(nearly6foreverycongressperson),and2,100lobbyistsworkingfortheenergyandnaturalresourcesindustries.Alltold,morethan$3.2billionwasspentonlobbyingin201125alone.Themaindistortionistoourpoliticalsystem;themainloser,ourdemocracy.Butoftenrentseekinginvolvesarealwasteofresourcesthatlowersthecountry’sproductivityandwell-being.Itdistortsresourceallocationsandmakestheeconomyweaker.Abyproductofeffortsdirectedtowardgettingalargershareofthepieisshrinkageofthepie.Monopolypowerandpreferentialtax26treatmentforspecialinterestshaveexactlythiseffect.Themagnitudeof“rentseeking”andtheassociateddistortionsinoureconomy,whilehardtoquantifyprecisely,areclearlyenormous.Individualsandcorporationsthatexcelatrentseekingareamplyrewarded.Theymaygarnerimmenseprofitsfortheirfirms.Butthisdoesnotmeanthattheirsocialcontributionisevenpositive.Inarent-seekingeconomysuchasoursisbecoming,privateandsocialreturnsarebadlymisaligned.Thebankerswhogainedlargeprofitsfortheircompanieswereamplyrewarded,but,asIhaverepeatedlysaid,thoseprofitswereephemeralandunconnectedtosustainableimprovementsintherealeconomy.Thatsomethingwaswrongshouldhavebeenevident:thefinancialsectorissupposedtoservetherestoftheeconomy,nottheotherwayaround.Yetbeforethecrisis,40percentofall27corporateprofitswenttothefinancialsector.Creditcardcompanieswouldextractmoremoneyfromtransactionfeesthanthestorewouldprofitfromthesaleofitsgoods.Forthemovementofafewelectronsupontheswipeofacard,somethingthatcostsatmostafewpennies,thefinancecompanyreceivedasmuchmoneyasthestoredidformanagingacomplexoperationthatmadeawide28varietyoffoodavailableatalowprice.Rentseekingdistortsoureconomyinmanyways—nottheleastofwhichisthemisallocationofthecountry’smostvaluableresource:itstalent.Itusedtobethatbrightyoungpeoplewereattractedtoavarietyofprofessions—sometoservingothers,asinmedicineorteachingorpublicservice;sometoexpandingthefrontiersofknowledge.Somealwayswentintobusiness,butintheyearsbeforethecrisisanincreasinglylargefractionofthecountry’sbestmindschosefinance.Andwithsomanytalented85 youngpeopleinfinance,it’snotsurprisingthattherewouldbeinnovationinthatsector.Butmanyofthese“financialinnovations”weredesignedtocircumventregulations,andactuallyloweredlong-runeconomicperformance.Thesefinancialinnovationsdonotcomparewithrealinnovationslikethetransistororthelaserthatincreasedourstandardofliving.Thefinancialsectorisnottheonlysourceofrentseekinginoureconomy.Whatisstrikingistheprevalenceoflimitedcompetitionandrentseekinginsomanykeysectorsoftheeconomy.Earlierchaptersreferredtothehi-techsector(Microsoft).Twoothersthathavedrawnattentionarethehealthcaresectorandtelecommunications.Drugpricesaresomuchhigherthanthecostsofproductionthatitpaysdrugcompaniestospendenormousamountsofmoneytopersuadedoctorsandpatientstousethem,somuchsothattheynowspendmoreonmarketingthanon29research.Andmuchoftheso-calledresearchitselfisrentseeking—producingame-toodrugthatwilldividethehighprofitsofarivalfirm’sblockbusterdrug.Imaginehowcompetitiveoureconomymightbe—andhowmanyjobsmightbecreated—ifallthatmoneywasinvestedinrealresearchandrealinvestmentstoincreasethenation’sproductivity.Wheneverrentsaregeneratedbymonopolypower,alargedistortionintheeconomyoccurs.Pricesaretoohigh,andthatinducesashiftfromthemonopolizedproducttoothers.ItisremarkablethateventhoughtheUnitedStatesisallegedlyahighlycompetitiveeconomy,certainsectorsseemtocontinuetoreapexcessprofits.Economistsmarvelatourhealthcaresectoranditsabilitytodeliverlessformore:healthoutcomesareworseintheUnitedStatesthaninalmostallotheradvancedindustrialcountries,andyettheUnitedStatesspendsabsolutelymorepercapita,andmoreasapercentageofGDP,byaconsiderableamount.We’vebeenspendingmorethanone-sixthofGDPonhealthcare,whileFrancehasbeenspendinglessthananeighth.PercapitaspendingintheUnitedStateshasbeentwoandahalftimeshigherthantheaverageoftheadvancedindustrial30countries.Thisinefficiencyissolargethatafteritistakenintoaccount,thegapbetweenincomepercapitaintheUnited31StatesandinFranceshrinksbyaboutathird.Whiletherearemanyreasonsforthisdisparityintheefficiencyofthehealthcaresystem,rentseeking,inparticularonthepartofhealthinsurancecompaniesanddrugcompanies,playsasignificantrole.Earlier,wecitedthemostnotoriousexample:aprovisioninthe2003BushMedicareexpansionthatledtomuchhigherdrugpricesintheUnitedStatesandtoawindfallgain(arent)forthedrugcompaniesestimatedat$50billionormoreayear.Well,onemightsay,whatis$50billionamongfriends?Ina$1532trillioneconomy,itamountstolessthanathirdof1percent.ButasEverettDirksen,thesenatorfromIllinois,isreputedtohavesaid:abillionhere,abillionthere,andprettysoon33you’retalkingrealmoney.Inthecaseofourrent-seekingcorporations,it’smorelike$50billionhere,$50billionthere,andprettysoonyou’retalkingverybigmoney.Whencompetitionisveryrestricted,therealeffectofcompetitionisoftenwaste,asthecompetitorsfightoverwhogetstoexploittheconsumer.Accordingly,highprofitsarenottheonlysignofrentseeking.Indeed,distorted,oligopolisticcompetitionamongfirmscanevenleadtodissipationofrents,but86 noteconomicefficiency;whenprofits(aboveanormalreturn)aredriventoornearzero(ortowherethereturnoncapitalisnormal),itisnotnecessarilyevidenceofanefficienteconomy.Weseeevidenceofrentseekinginthehighexpenditurestorecruitcreditcardorcellphonecustomers.Heretheobjectbecomestoexploitcustomersasmuchandasfastaspossible,withfeesandchargesthatareneitherunderstandablenorpredictable.Companiesworkhardtomakeitdifficulttocomparethecostsofusing,say,onecreditcardversusanotherbecausetodosowouldenhancecompetition,andcompetitionwoulderodeprofits.Americanbusinesses,too,havetopaymuchmoretothecreditcardcompaniesthandobusinessesinothercountriesthathavemanagedtocurbsomeoftheanticompetitivepractices—andthehighercostsfacedbybusinessesgetpassedontoAmericanconsumers,loweringstandardsofliving.Thesameholdsforcellphones:Americanspayhighercellphonerates,andgetpoorerservice,thanpeopleincountriesthathavesucceededincreatingamoretrulycompetitivemarketplace.Sometimesthedistortionsoftherentseekersaresubtle,notwellcapturedinthediminutionofGDP.ThisisbecauseGDPdoesn’tadequatelycapturecoststotheenvironment.Itdoesn’tassessthesustainabilityofthegrowththatisoccurring.WhenGDParisesfromtakingresourcesoutoftheground,weshouldmakenotethatthecountry’swealthisdiminished,unlessthatwealthisreinvestedabovegroundinhumanorphysicalcapital.Butourmetricsdon’tdothat.Growththatarisesfromdepletingfishstocksorgroundwaterisephemeral,butourmetricsdon’ttellusthat.Ourpricesystemisflawed,becauseitdoesn’treflectaccuratelythescarcityofmanyoftheseenvironmentalresources.AndsinceGDPisbasedonmarketprices,ourGDPmetricsarealsoflawed.Industrieslikecoalandoilwanttokeepitthatway.Theydon’twantthescarcityofnaturalresourcesorthedamagetoourenvironmenttobepriced,andtheydon’twantourGDPmetricstobeadjustedtoreflectsustainability.Notchargingthemforthecoststheyimposeontheenvironmentis,ineffect,ahiddensubsidy,littledifferentfromtheothergiftstheindustryreceivesinfavorabletaxtreatmentandacquiringresourcesatbelowfairmarketprices.WhenIwaschairoftheCouncilofEconomicAdvisersunderPresidentClinton,ItriedtohavetheUnitedStatesissuea“GreenGDPaccount,”whichwouldreflectthedepletionofourresourcesandthedegradationofourenvironment.Butthecoalindustryknewwhatitwouldmean—andituseditsenormousinfluenceinCongresstothreatentocutofffundingforthoseengagedinthisattempttodefineGreenGDP,andnotjustforthisproject.Whentheoilindustrypushesformoreoffshoredrillingandsimultaneouslypushesforlawsthatfreecompaniesfromthefullconsequencesofanoilspill,itis,ineffect,askingforapublicsubsidy.Andsuchsubsidiesdomorethanproviderents;theyalsodistortresourceallocations.GDP,andmorebroadly,societalwelfare,isdiminished—aswasmadesoevidentbythe2010BPoilspillintheGulfofMexico.Becausetheoilandcoalcompaniesthatusetheirmoneytoinfluenceenvironmentalregulation,weliveinaworldwithmoreairandwaterpollution,inanenvironmentthatislessattractiveandlesshealthy,thanwouldotherwisebethecase.ThecostsshowupaslowerstandardsoflivingforordinaryAmericans,thebenefitsashigherprofits87 fortheoilandcoalcompanies.Again,thereisamisalignmentbetweensocialreturns(whichmayinfactbenegative,asaresultoftheloweringofourstandardoflivinginthewakeofenvironmentaldeterioration)andprivaterewards(whichareoften34huge).Asweexplainedinthelasttwochapters,oneobjectiveofrentseekersistoshapelawsandregulationstotheirbenefit.Todothat,youneedlawyers.IfitcanbesaidthatAmericahasagovernmentofthe1percent,bythe1percent,andforthe1percent,itcanbesaidwithevenmoreconvictionthatAmericahasagovernmentofthelawyers,bythelawyers,andforthelawyers.Twenty-sixofAmerica’sforty-fourpresidentshavebeenlawyers,and36percentofthelegislatorsintheHousehaveabackgroundinlaw.Eveniftheyarenotnarrowlypursuingwhatisinthefinancialinterestsoflawyers,theymaybe“cognitivelycaptured.”Thelegalframeworkissupposedtomakeoureconomymoreefficientbyprovidingincentivesforindividualsandfirmsnottobehavebadly.Butwehavedesignedalegalsystemthatisanarmsrace:thetwoprotagonistsworkhardtoout-lawyereachother,whichistosayoutspendeachother,sincegoodandcleverlawyersareexpensive.Theoutcomeisoftendeterminedlessbythemeritsofthecaseorissuethanbythedepthofthepockets.Intheprocess,thereismassivedistortionofresources,notjustinthelitigationbutinactionstakentoaffecttheoutcomeoflitigationandtopreventlitigationinthefirstplace.ThemacroeconomiceffectofAmerica’slitigioussocietywassuggestedbysomestudiesthatshowedthatcountrieswithfewer35lawyers(relativetotheirpopulation)grewfaster.Otherresearchsuggeststhatthemainchannelthroughwhichahighproportionoflawyersinasocietyhurtstheeconomyisthediversionoftalentawayfrommoreinnovativeactivities(likeengineeringandscience),afindingconsistentwithourearlier36discussionoffinance.ButIshouldbeclear:giventhesuccessofthefinancialsectorandcorporationsmoregenerallyinstrippingawaytheregulationsthatprotectordinarycitizens,thelegalsystemisoftentheonlysourceofprotectionthatpoorandmiddle-classAmericanshave.Butinsteadofasystemwithhighsocialcohesion,highlevelsofsocialresponsibility,andgoodregulationsprotectingourenvironment,workers,andconsumers,wemaintainaveryexpensivesystemofexpostaccountability,whichtotoolargeanextentreliesonpenaltiesforthosethatdoinjury(say,totheenvironment)afterthefactratherthanrestrictingaction37beforethedamageisdone.Corporationssuccessfullybeatbackregulationsintheirbattlewiththerestofsociety,buthavemettheirmatchwiththelawyers.Bothgroupsspendheavilyonlobbyingtoensurethattheycancontinuetheirrent-extractingactivities.Inthecourseofthisarmsrace,abalanceappearstohavebeenstruck—thereareatleastsomecountervailingpowerscheckingthebehaviorofcorporations.Whilethebalanceisbetterthanwhatwouldemergeif,say,thecorporationswrotetheirownrules—wherethevictimsoftheiractionswouldhavenorecourse—thecurrentsystemisstillenormouslycostlytooursociety.The1percentthatshapesourpoliticsnotonlydistortsoureconomybynotdoingwhatitshould,inaligningprivateandsocialincentives,butalsobyencouragingittodowhatit88 shouldn’t.Therecurrentbankbailouts,whichencouragebanksto38engageinexcessiverisktaking,offerthemostobviousexample.Butmanyarguethatevenmorecostlyarethedistortionsinforeignpolicy.MorepersuasiveasanexplanationoftheIraqWarthanBush’savoweddeterminationtoeliminateonedictatorwastheattractionofIraqioil(andperhapsthehugeprofitsthatwouldaccruetoBushdevotees,includingVicePresidentRichard39Cheney’sHalliburtonCorporation).Whilethoseatthetopmaydisproportionatelybeamongthebeneficiariesofwar,theybeardisproportionatelylessofthecost.Membersofthetop1percentrarelyserveinthemilitary—therealityisthattheall-volunteerarmydoesnotpayenoughtoattracttheirsonsanddaughters.Thewealthiestclassfeelsnopinchfromhighertaxeswhenthenationgoestowar:borrowed40moneypaysforit,andifbudgetsgettight,middle-classtaxbenefitsandsocialprogramsaregiventheax,notthepreferentialtaxtreatmentandmanifoldloopholesfortherich.Foreignpolicyis,bydefinition,aboutthebalancingofnationalinterestsandnationalresources.Withthetop1percentinchargeandpayingnopriceforwars,thenotionofbalanceandrestraintgoesoutthewindow.Thereisnolimittotheadventureswecanundertake;corporationsandcontractorsstandonlytogain.Atthelocallevelaroundtheworld,contractorsloveroadsandbuildings,fromwhichtheycanbenefitenormously,especiallyiftheymaketherightpoliticalcontributions.ForU.S.contractors,themilitaryhasprovidedabonanzabeyondimagination.EfficiencywagetheoryandalienationAcentralthemeofthischapteristhatmuchoftheinequalityinoursocietyarisesbecauseprivaterewardsdifferfromsocialreturns,andthatthehighlevelofinequalitythatnowcharacterizestheUnitedStates,andthewidespreadacceptanceofthatlevelofinequality(despitetheencouragingsignsfromtheOccupyWallStreetmovement),makesitdifficultintheUnitedStatestoadoptgoodpolicies.Policyfailuresincludethoseinmacroeconomicstabilization,industryderegulation,andunderinvestmentininfrastructure,publiceducation,socialprotection,andresearch.Wenowconsideranaltogetherdifferentreasonwhythehighinequalitymakesforalessefficientandproductiveeconomythanwecouldotherwiseachieve.Peoplearenotlikemachines.Theyhavetobemotivatedtoworkhard.Iftheyfeelthattheyarebeingtreatedunfairly,itcanbehardtomotivatethem.Thisisoneofthecentraltenetsofmodernlaboreconomics,encapsulatedintheefficiencywagetheory,whicharguesthathowfirmstreattheirworkers—includinghowmuchtheypaythem—affectsproductivity.Itwas,infact,atheoryelaboratednearlyacenturyagobyAlfredMarshall,thegreateconomistwhowrotein1895that“highlypaidlabourisgenerallyefficientandthereforenotdearlabour,”thoughheadmittedthat“afactwhich,thoughitismorefullofhopeforthefutureofthehumanracethananyotherthatisknowntous,willbefoundtoexercise41averycomplicatinginfluenceonthetheoryofdistribution.”Therevivalofthistheorybeganindevelopmenteconomics,wheretheoristsrecognizedthatmalnourishedworkersareless89 42productive.Buttheinsightappliesaswelltomoreadvancedindustrialcountries,asAmericadiscoveredinWorldWarIIwhenitfoundthatmanyrecruitsweresufficientlymalnourishedthatitmightimpairtheireffectivenessinthemilitary.Educationscholarshaveshownthathungerandinadequatenutritionimpede43learning.That’swhyschoollunchprogramsaresoimportant.WithoneofsevenAmericansfacingfoodinsecurity,manypoorAmericanchildrenalsofaceimpairedlearning.Inamoderneconomy,efficiencyisaffectednotsomuchbymalnutritionasbyahostofotherfactors.Theimmiserationofthebottomandthemiddleofthepopulationhasforceduponthemahostofanxieties:Willtheylosetheirhome?Willtheybeabletogivetheirchildrenaneducationthatwillallowthemtosucceedinlife?Howwilltheparentssurviveinretirement?Themoreenergythatisfocusedontheseanxieties,thelessenergythereisforproductivityattheworkplace.TheeconomistSendhilMullainathanandpsychologistEldarShafirhavefoundevidencefromexperimentsthatlivingunderscarcityoftenleadstochoicesthatexacerbatetheconditionsofscarcity:“Thepoorborrowatgreatcostandstaypoor.Thebusy[thetime-poor]postponewhentheyhavelittletimeonlytobecome44busier.”Resultsofaverysimplesurveyillustratethecognitiveresourcesthatthepoorexpendforday-to-daysurvivalandthatthebetter-offdonot.Inthesurvey,individualswhohavejustexitedagrocerystoreareaskedwhattheyhadspentintotalatthestoreandwhatthepriceofafewoftheitemsintheirshoppingbagswere.Thepoortypicallycouldanswerthesequestionsprecisely,whereasthenonpooroftendidnotknow.Anindividual’scognitiveresourcesarelimited.Thestressofnothavingenoughmoneytomeeturgentneedsmayactuallyimpairtheabilitytotakedecisionsthatwouldhelpalleviatethesituation.Thelimitedstockofcognitiveresourcesisdepletedandthiscanleadpeopletomakeirrationaldecisions.Stressandanxietycanalsoimpairtheacquisitionofnewskillsandknowledge.Ifthatlearningisimpaired,productivityincreaseswillbeslower,andthisbodesillforthelong-runperformanceoftheeconomy.Equallyimportantinmotivatingworkersistheirsensethattheyarebeingfairlytreated.Whileitisnotalwaysclearwhatisfair,andpeople’sjudgmentsoffairnesscanbebiasedbytheirself-interest,thereisagrowingsensethatthepresentdisparityinwagesisunfair.Whenexecutivesarguethatwageshavetobereducedorthattherehavetobelayoffsinorderforcorporationstocompete,butsimultaneouslyincreasetheirownpay,workersrightlyconsiderthatwhatisgoingonisunfair.Thatwillaffectboththeirefforttoday,theirloyaltytothefirm,theirwillingnesstocooperatewithothers,andtheirwillingnesstoinvestinitsfuture.Asanyfirmknows,ahappierworkerisamoreproductiveworker;andaworkerwhobelievesthatafirmispayingsenioremployeestoomuchrelativetowhat45everyoneelsereceivesisnotlikelytobeahappyworker.AdetailedcasestudybyKruegerandMasoftheplantsthatmanufacturedBridgestone/Firestonetiresprovidesaparticularlychillingillustration.Afteraprofitableyearmanagementdemandedmovingfromaneight-hourtoatwelve-hourshift,whichwouldrotatebetweendaysandnights,andcuttingpayfornewhiresby30percent.Thedemandcreatedtheconditionsthatledtotheproductionofmanydefectivetires.Defectivetireswererelated90 tooveronethousandfatalitiesandinjuriesuntiltherecallof46Firestonetiresin2000.InRussiaundercommunism,thewidespreadsensebyworkersthattheywerenotbeingadequatelypaidplayedamajorroleinthecollapseoftheireconomy.AstheoldRussianadagehadit,“Theypretendedtopayus,andwepretendedtowork.”Recentexperimentsineconomicshaveconfirmedtheimportanceoffairness.Oneexperimentshowedthatraisingwagesofworkerswhofeltthattheywerebeingtreatedunfairlyhadasubstantialeffectonproductivity—andnoeffectonthosewhofelttheywerebeingtreatedfairly.Ortakeanothersituation,involvingagroupofworkersperformingasimilarjob.Onemighthaveexpectedthatincreasingthewagesofsomeandloweringthatofotherswouldincreaseproductivityofthehigher-wageworker,andlowerthatofthelower-wageworkersinoffsettingways.Buteconomictheory—confirmedbytheexperiments—holdsthatthedecreaseinproductivityofthelow-wageworkerisgreaterthantheincreaseinproductivityofthehigh-wageworker,sototalproductivity47diminishes.ConsumerismWehavedescribedhowinequalityadverselyaffectstheeconomy’sgrowthandefficiency—andsocietalwell-being,inboththeshortandthelongrun—throughavarietyofwhatmightbeviewedaseconomicmechanisms,reinforcedandshapedbypoliticsandpublicpolicy.Buttherearedeeper,distortingeffectsofinequalityonoursociety.Trickle-downeconomicsmaybeachimera,buttrickle-downbehaviorismisveryreal.Peoplebelowthetop1percentincreasinglyaspiretoimitatethoseabovethem.Ofcourse,forthoseattheverybottom,livinglikethewealthiest1percentisunimaginable.Butforthoseinthesecondpercentile,the1percentprovidesanaspiration,forthoseinthethirdpercentile,thesecondpercentileprovidesanaspiration,andsoondowntheline.Economiststalkabouttheimportanceof“relativeincome”andrelativedeprivation.Whatmatters(foranindividual’ssenseofwell-being,forinstance)isnotjustanindividual’sabsolute48income,buthisincomerelativetothatofothers.Theimportanceofrelativeincomeindevelopedcountriesissogreatthatitisacompletelyunsettledquestionamongeconomistswhetherthereisanylong-runrelationshipbetweenGDPgrowthand49subjectivewell-beinginthosecountries.Individuals’concernswiththeirconsumptionrelativetothatofothers—theproblemof“keepingupwiththeJoneses”—helpsexplainwhysomanyAmericanslivebeyondtheirmeans—andwhysomanyworksohardandsolong.ManyyearsagoKeynesposedaquestion.Forthousandsofyears,mostpeoplehadtospendmostoftheirtimeworkingjusttosurvive—forfood,clothing,andshelter.Then,beginningwiththeIndustrialRevolution,unprecedentedincreasesinproductivitymeantthatmoreandmoreindividualscouldbefreedfromthechainsofsubsistenceliving.Forincreasinglylargeportionsofthepopulation,onlyasmallfractionoftheirtimewasrequiredtoprovideforthenecessitiesoflife.Thequestionwas,How50wouldpeoplespendtheproductivitydividend?Theanswerwasnotobvious.Theycoulddecidetoenjoymoreand91 moreleisure,ortheycoulddecidetoenjoymoreandmoregoods.Economictheoryprovidesnoclearprediction,thoughonemighthaveassumedthatreasonablepeoplewouldhavedecidedtoenjoybothmoregoodsandmoreleisure.ThatiswhathappenedinEurope.ButAmericatookadifferentturn—lessleisure(perhousehold,aswomenjoinedthelaborforce)andmoreandmoregoods.America’shighinequality—andindividuals’sensitivitytoothers’consumption—mayprovideanexplanation.Itmaybethatweareworkingmoretomaintainourconsumptionrelativetoothers,andthatthisisaratrace,whichisindividuallyrationalbutfutileintermsofthegoalthatitsetsforitself.AdamSmithpointedoutthatpossibility250yearsago:in“thisgeneralscrambleforpreeminence,whensomegetup,othersmust51necessarilyfallundermost.”Whilethereisno“right”answertoKeynes’squestionaccordingtostandardeconomictheory,there52issomethingdisturbingaboutAmerica’sanswer.Individualssaytheyareworkingsohardforthefamily,butastheyworksohardthereislessandlesstimeforthefamily,andfamilylifedeteriorates.Somehow,themeansproveinconsistentwiththestatedend.THEALLEGEDINEQUALITYEFFICIENCYTRADE-OFFInthepreviouspages,Iexplainedhowinequality—inallofitsdimensions—hasbeenbadforoureconomy.Aswesawinearlierchapters,thereisalsoacounternarrative,advancedprimarilybythoseonthepoliticalright,whichfocusesonincentives.Inthisviewincentivesareessentialformakinganeconomywork,andinequalityistheinevitableconsequenceofanyincentivesystem,sincesomewillproducemorethanothers.Anyprogramofredistributionwillaccordinglynecessarilyattenuateincentives.Proponentsofthisviewargue,too,thatitiswrongtofixateontheinequalityofoutcomes,particularlyinanysingleyear.Whatmattersislifetimeinequality,andwhatmattersevenmoreisopportunity.Theythenmaintainthatthereisatrade-offbetweenefficiencyandequality.Whiledifferentpeoplemaydifferinhowmuchefficiencyonewouldbewillingtogiveuptogetmoreequality,intheviewoftheRightthepricewehavetopayforanymoreequalityinAmericaisjusttoogreat.Indeed,it’ssohighthateventhemiddleandthebottom,especiallythosewhodependongovernmentprograms,wouldlikelysuffer;withaweakereconomy,incomesforallwouldbedown,taxrevenueswouldbelower,andgovernmentprogramswouldhavetobecut.Wehavearguedinthischapter,tothecontrary,thatwecouldhaveamoreefficientandproductiveeconomywithmoreequality.Inthissection,Irecaptheessentialpointsofdivergence:TheRighthasinmindaperfectlycompetitiveeconomywithprivaterewardsequaltosocialreturns;weseeaneconomymarkedbyrentseekingandotherdistortions.TheRightunderestimatestheneedforpublic(collective)action,tocorrectpervasivemarketfailures.Itoverestimatestheimportanceoffinancialincentives.And,asaresultofallofthesemistakes,theRightoverestimatesthecostsandunderestimatesthebenefitsofprogressivetaxation.Rentseekingandtheinequality/efficiencytrade-off92 AcentralthesisofthisbookisthatrentseekingispervasiveintheAmericaneconomy,andthatitactuallyimpairsoveralleconomicefficiency.Thelargegapsbetweenprivaterewardsandsocialreturnsthatcharacterizearent-seekingeconomymeanthatincentivesthatindividualsfaceoftenmisdirecttheiractions,andthatthosewhoreceivehighrewardsarenotnecessarilythosewhohavemadethelargestcontributions.Inthoseinstanceswhereprivaterewardsofthoseatthetopexceedbyaconsiderableamounttheirmarginalsocialcontribution,redistributioncould53bothreduceinequalityandincreaseefficiency.Makingmarketsworkbetter,byaligningthetwoandreducingthescopeforrentseeking,andbycorrectingothermarketfailures,whoseeffectsareespeciallyhardfeltatthebottomandinthemiddle,wouldalsosimultaneouslyreduceinequalityandincreaseefficiency—justtheoppositeofwhattheRightcontends.Marketfailuresandtheinequality/efficiencytrade-offTheRighthasunderestimatedtheimportanceofotherimperfectionsinoureconomy:ifcapitalmarketswereperfect,theneachindividualwouldbeabletoinvestinhimselfuptothepointwhereadditionalreturnsequalthecostofcapital.Butcapitalmarketsarefarfromperfect.Individualsdonothaveeasyaccesstocapitalandcannotdivestthemselvesofrisk.Alackofwealthrestrictsfamilies’opportunitiestobeproductiveinavarietyofways.Itreducestheirabilitytoinvestintheirchildren,tobecomehomeownersandtherebyparticipateinthefinancialrewardsofimprovingtheirneighborhoods,andtooffercollateralthatcancrediblyshowlendersthattheusestowhichtheywillputborrowedfundsaresound—whichisusefulforobtainingbankcreditonaffordableterms.Wealthintheformofcollateralplaysakindofcatalyticroleratherthanaroleofinputthatgetsusedupintheprocessof54producingoutput.Themostimportantconsequenceoftheseimperfectionsisthatinaworldinwhichmanyfamilieshavelittleornowealth,andinwhichonlylimitededucationalopportunityisprovidedbythegovernment,thereisunderinvestmentinhumancapital.Theresultisthat,especiallywithoutagoodpubliceducationsystem,parentalwealth(education,income)willbeaprimarydeterminantofthatoftheirchildren.Itisnotasurprise,then,thatAmerica,withitshighlevelofwealthandincomeinequality,isalsoasocietywithalackofequalityofopportunity,aswesawinchapter1.Increasingequalityandequalityofopportunity,bythesametoken,wouldenhancethenation’sproductivity.Thereisstillanotherreasonwhytheallegedinequality/inefficiencytrade-offmaynotexist.Riskmarkets—givingindividualstheabilitytobuyinsuranceintheprivatemarketagainsttheimportantrisksthatindividualsface,likeunemployment—areimperfectandabsent;thatimposesahugeburdenonthosewithlimitedresources.Becauseriskmarketsareimperfect,intheabsenceofsocialprotection,individualwelfareislower—andthewillingnesstoundertakehigh-returnandhigh-riskventuresislower.Providingbettersocialprotectioncanhelpcreateamoredynamiceconomy.93 Theadverseeffectsofso-calledincentivepayTheRight,likemanyeconomists,tendstooverestimatethebenefitsandunderestimatethecostsofincentivepay.Therearecertainlycontextsinwhichmonetaryprizeshavethepotentialtofocusmindsonathornyproblemanddeliverasolution.AfamousexampleisdetailedinDavaSobel’sLongitude:TheTrueStoryofaLoneGeniusWhoSolvedtheGreatestScientificProblemofHisTime.Asshereports,intheLongitudeActof1714,theBritishParliamentset“aprizeequaltoaking’sransom(severalmilliondollarsintoday’scurrency)fora‘PracticableandUseful’meansofdetermininglongitude.”Thiswascriticaltothesuccessoftransoceanicnavigation.JohnHarrison,awatchmakerwithnoformaleducationbutamechanicalgenius,devotedhislifetothisquestandultimatelyclaimedtheprizein551773.However,itisagreatleapfromthepowerofmonetaryincentivestofocusmindsonagreatquesttotheideathatmonetaryincentivesarethekeytohighperformanceingeneral.Theabsurdityofincentivepayinsomecontextsismadeclearbythinkingofhowitmightapplytomedicaldoctors.Isitconceivablethatadoctorperformingheartsurgerywouldexertmorecareoreffortifhispaydependedonwhetherthepatientsurvivedthesurgeryoriftheheartvalvesurgerylastsformorethanfiveyears?Doctorsworktomakesureeachsurgeryistheirabsolutebest,forreasonsthathavelittletodowithmoney.Interestingly,insomeareaswerecognizethedangersofincentivepay:expertwitnessesinlitigationarenotallowedtobepaidcontingentontheoutcomeofthecase.Becausefinancialincentivesystemscanneverbeperfectlydesigned,theyoftenleadtodistortedbehavior,anoveremphasis56onquantityandanunderemphasisonquality.Asaresult,inmostsectorsoftheeconomysimplistic(anddistorting)incentiveschemeslikethoseusedinfinanceandthoseprovidedtoCEOsarenotused.Instead,assessmentstakeintoaccountperformancerelativetoothersinasimilarposition;thereisanevaluationoflong-termperformanceandpotential.Rewardsoftentaketheformofpromotions.Butitisassumed,especiallyforhigher-leveljobs,thatemployeeswilldotheirbestandnotholdback,evenin57theabsenceof“incentivepay.”Incentivepay,especiallyasitwasimplementedinthefinancialsector,illustrateshowdistortingsuchcompensationcanbe:thebankershadanincentivetoengageinexcessiverisktaking,shortsightedbehavior,anddeceptiveandnontransparent58accounting.Ingoodyearsthebankerscouldwalkoffwithalargefractionoftheprofits;inbadyearstheshareholderswereleftwiththelosses;andinreallybadyearssowerethebondholdersandtaxpayers.Itwasaone-sidedpaysystem:headsthebankerswon,tailseveryoneelselost.Evenifthebankers’paysystemhadmadesensebeforetheGreatRecession,itdidn’tafterward,whenthebankswereputonlife-supportsystemsprovidedbythepublic.Idescribedearlierhowthegovernmentessentiallygavethemblankchecks—lendingthemmoneyatnear-zerointerestratesthattheycould“invest”inbondspayingmuchhigherreturns.Asonebankerfriendputittome,anyone,evenhistwelve-year-oldson,couldhavemadeafortuneifthegovernmenthadbeenwillingtolendmoneytohimatthoseterms.Butthebankerstreatedtheresultingprofitsasif94 theywerearesultoftheirgenius,fullydeservingofthesamecompensationtowhichtheyhadbecomeaccustomed.Butwhilethebankers’compensationschemesdemonstratedsomeofwhatwaswrongwiththeso-calledincentivepaysystems,theproblemsweremorepervasive.Stockoptionswereasone-sidedasbankers’compensation—executivesdidwellwhenthingswentwell,butdidn’tsuffercommensuratelywhenstockswentdown.Butstockoptionsalsoencourageddishonestaccountingthatmadeitseemthatthecompanywasdoingwell,sothestockpricewouldgoup.Partofthecreativelydishonestaccountinginvolvedaccountingforthestockoptionsthemselves,soshareholderswouldn’tknowhowmuchthevalueoftheirshareswasbeingdilutedbynewlyissuedoptions.WhentheFinancialAccountingStandardsBoard(thenominallyindependentboardthatsetsaccountingstandards),supportedbytheSecuritiesandExchangeCommissionandtheCouncilofEconomicAdvisers,triedtoforcecompaniestoprovidehonestaccountingofwhattheyweregivingtheirexecutives,theCEOsrepliedwithavehemencethatdemonstratedtheircommitmenttodeception.Theproposedreformsdidn’trequirefirmstodoawaywithstockoptions,butonlytorevealwhatwasbeinggiventotheirexecutivesinawaythattheirshareholderscouldeasilygrasp.Wewantedtomakemarketsworkbetter,byhavingbetterinformation.Itisbecauseaccountingstandardsaffecthowmarketsperceivefirms’futureprospects,andbecausefirmswantstandardsthatmakethemlookgood—leadingtoahigherstockprice,atleastintheshortrun—thatwecreatedanindependentboardtosetthesestandards.Butthencorporationsusedtheirtrumpcard—theirpoliticalinfluence—asseniorgovernmentofficialsweighedin,inaprocessthatissupposedtobeindependentandnonpolitical,to59maintainthedeception.Thepressureworked.Indeed,ifonewerereallyinterestedinincentives—andnotindeception—onewouldhavedesignedaquitedifferentcompensationsystem.Stockoptionincentivepayrewardedexecutiveswhentherewasastockmarketboomforwhichtheycouldfairlyclaimnocredit.ItalsogaveCEOsabigbonuswheneverthepriceofwhattheysoldsoaredorthepriceofacriticalinputfell—regardlessofwhethertherewasanythingtheyhaddonetobringthesepricechangesabout.Fuelcostsarecriticalforairlines,meaningthatairlineCEOsgotabonusanytimethepriceofoilfell.Agoodincentivesystemmightbasepayonhowthecompanyperformsrelativetoothersintheindustry,butfewfirmsdothis.That’stestimonyeithertotheirlackofunderstandingofincentivesortotheirlackofinterestinhavingarewardstructurethatis60relatedtoperformance,ortoboth.Thelackofwell-designedcompensationschemes,suchasonebasedonrelativeperformance,comparedtoagroupofcomparablepeers,reflectsanothermarketfailure,towhichwecalledattentioninthelastchapter:deficienciesincorporategovernancethatprovidescopeforexecutivestodowhatisintheirinterests—includingadoptingcompensationsystemsthatenrichthemselves—ratherthanintheinterestsofsociety,orevenofshareholders.ThecriticismsofincentivepaythatIhavediscussedsofararewellwithintheconfinesoftraditionaleconomicanalysis.Butincentivesareaboutmotivatingpeople,forinstance,toworkhard.Psychologists,laboreconomists,andothersocialscientistshavestudiedcloselywhatmotivatespeople,anditappearsthat,95 atleastinmanycircumstances,economistshavegottenitallwrong.Individualscanoftenbebettermotivatedbyintrinsicrewards—bythesatisfactionofdoingajobwell—thanbyextrinsicrewards(money).Totakeoneexample,thescientistswhoseresearchandideashavetransformedourlivesinthepasttwohundredyearshave,forthemostpart,notbeenmotivatedbythepursuitofwealth.Thisisfortunate,foriftheyhad,theywouldhavebecomebankersandnotscientists.Itisthepursuitoftruth,thepleasureofusingtheirminds,thesenseofachievementfromdiscovery—andtherecognitionoftheirpeers—thatmatters61most.Ofcourse,thatdoesn’tmeanthattheywillturndownmoneyifit’sgiventothem.And,aswenotedearlier,anindividualpreoccupiedwithwherehisandhisfamily’snextmealwillcomefromwillbetoodistractedtodogoodresearch.Insomecircumstances,afocusonextrinsicrewards(money)canactuallydiminisheffort.Most(oratleastmany)teachersentertheirprofessionnotbecauseofthemoneybutbecauseoftheirloveforchildrenandtheirdedicationtoteaching.Thebestteacherscouldhaveearnedfarhigherincomesiftheyhadgoneintobanking.Itisalmostinsultingtoassumethattheyarenotdoingwhattheycantohelptheirstudentslearn,andthatbypayingthemanextra$500or$1,500,theywouldexertgreatereffort.Indeed,incentivepaycanbecorrosive:itremindsteachersofhowbadtheirpayis,andthosewhoareledtherebytofocusonmoneymaybeinducedtofindabetter-payingjob,leavingbehindonlythoseforwhomteachingistheonlyalternative.(Ofcourse,ifteachersperceivethemselvestobebadlypaid,thatwillunderminemorale,andthatwillhaveadverseincentiveeffects.)Anoftentoldstoryprovidesanotherexample:acooperativedaycenterhadaproblemwithcertainparents’pickinguptheirchildreninatimelyway.Itdecidedtoimposeacharge,toprovideanincentiveforthemtodoso.Butmanyparents,includingthosewhohadoccasionallybeenlate,hadstruggledtopickuptheirchildrenontime;theydidaswellastheydidbecauseofthesocialpressure,thedesiretodothe“rightthing,”eveniftheywerelessthanfullysuccessful.Butchargingafeeconvertedasocialobligationintoamonetarytransaction.Parentsnolongerfeltasocialresponsibility,butassessedwhetherthebenefitsofbeinglateweregreaterorless62thanthefine.Latenessincreased.Thereisanotherdefectofstandardincentivepaycompensationschemes.Inbusinessschoolweemphasizetheimportanceofteamwork.Mostemployersrecognizethatteamworkisabsolutelyessentialforthesuccessofthecompany.Theproblemisthatindividualincentivescanunderminethiskindofteamwork.There63canbedestructiveaswellasconstructivecompetition.Bycontrast,cooperationcanbefacilitatedbypaythatdependson64“teamperformance.”Ironically,standardeconomictheoryalwaysdisparagedsuchrewardsystems,arguingthatindividualswouldhavenoincentives,becausetypicallytheimpactofeachindividual’seffortsonteamperformance(iftheteamisofevenmoderatesize)isnegligible.Thereasonthateconomictheoryfailedtogaugeaccuratelytheeffectivenessofteamincentivesisthatitunderestimatedthe65importanceofpersonalconnectiveness.Individualsworkhardto96 pleaseothersintheirteam—andbecausetheybelieveitistherightthingtodo.Economistsoverestimate,too,theselfishnessofindividuals(thoughthereisconsiderableevidencethateconomistsaremoreselfishthanothers,andthateconomics66trainingdoesmakeindividualsmoreselfishovertime).Itisthusperhapsnotsurprisingthatfirmsownedbytheirworkers—andwhothereforeshareintheprofits—haveperformedbetterinthe67crisisandlaidofffeweremployees.Theblindersineconomictheoriesinthisarenaarerelatedtoabroaderdeficiencyinthefield.Theprevailingapproachtobehaviorinstandardeconomictheoryfocusesonrationalindividualism.Eachindividualassesseseverythingfromaperspectivethatpaysnoattentiontowhatothersdo,howmuchtheygetpaid,orhowtheyaretreated.Humanemotionssuchasenvy,jealousy,orasenseoffairplaydonotexistor,iftheydo,havenoroleineconomicbehavior;andiftheydoappear,theyshouldn’t.Economicanalysisshouldproceedasiftheydidnotexist.Tononeconomists,thisapproachseemsnonsensical—andtome,itdoestoo.Ihaveexplained,forinstance,howindividualsmaydecreaseeffortiftheyfeeltheyarebeingunfairlytreated,andhowteamspiritcanspurthemon.Butthisindividual-centered,bottom-lineeconomics,tailor-madeforAmerica’sshort-termfinancialmarkets,isunderminingtrustandloyaltyinoureconomy.Inshort,contrarytotheassertionoftheRightthatincentivepayisnecessarytothecountry’smaintainingitshighlevelofproductivity,thekindsofincentivepayschemesemployedbymanycorporations,whiletheycreatemoreinequality,areactuallycounterproductive.Overestimatingthecosts,andunderestimatingthebenefits,ofmore-progressivetaxationTheRighthasnotonlyunderestimatedthecostsofinequalityandignoredthebenefitsthatwehavedescribedineliminatingthemarketdistortionsthatgiverisetoit.Ithasalsooverestimatedthecostsofcorrectinginequalitythroughprogressivetaxation,andunderestimatedthebenefitsofpublicspending.WeobservedinthelastchapterthatPresidentReagan,forinstance,claimedthatbymakingthetaxsystemlessprogressive—loweringtaxesatthetop—onewouldactuallyraisemoremoney,becausesavingsandworkwouldincrease.Hewaswrong:taxrevenuesfellsignificantly.PresidentBush’staxcutsfarednobetter;they,likethoseofReagan,simplyincreasedthedeficit.PresidentClintonraisedtaxesatthetop,andAmericaexperiencedaperiodofrapidgrowthandaslightdiminutionininequality.Ofcourse,theRightisrightinnotingthatifmarginaltaxrateswerenear100percenttaxrates,incentiveswouldbesignificantlyweakened,buttheseexamplesshowthatwe’renowherenearthepointwherethisshouldbeofconcern.Indeed,UniversityofCaliforniaprofessorEmmanuelSaez,ThomasPikettyoftheParisSchoolofEconomics,andStefanieStantchevaoftheMITDepartmentofEconomics,carefullytakingintoaccounttheincentiveeffectsofhighertaxationandthesocietalbenefitsofreducinginequality,haveestimatedthatthetaxrateatthetopshouldbearound70percent—whatitwasbeforePresidentReaganstartedhis68campaignfortherich.97 Buteventhesecalculationsdonotfullyreflect,Ibelieve,thebenefitfrommore-progressivetaxation,forthreereasons.First,wenotedearlierthatincreasingfairness(andtheperceptionoffairness)increasesproductivity,andinkeepingwithmosteconomicanalyses,thosecalculationsignoredthis.Second,thesensethatoureconomicandpoliticalsystemisunfairunderminestrust,whichisessentialforthefunctioningofoursociety.Inthenextchapter,we’llexplainingreaterdetailhowinequalityandthewayinwhichithasarisenintheUnitedStateshasunderminedtrust,andhowtheweakeningoftrustweakensoureconomyandourdemocracy.Amore-progressivetaxsystemmightcontributealittletoarestorationinconfidencethatoursystemis,afterall,fair.Thatcouldhaveenormoussocietalbenefits,includingtooureconomy.Third,aswenotedinthelastchapter,muchofthelackofprogressivity—thelowratesfacedbythoseatthetop,includingthepresidentialcandidateMittRomney—comesfromspecialprovisionsofthetaxcode,likethelowratesoncapitalgains69taxation,thebroaddefinitionofcapitalgains,andloopholesinbothcorporateandindividualincometaxes.Thesedistorttheeconomy,loweringproductivity.Aswecommented,oneofthereasonsthatsomanyofourcorporationspaysolittleisthattheyarenottaxedonincomeofforeignsubsidiariesuntiltheybringithome,aprovisionofthetaxcodethatencouragesthesefirmstoinvestabroadratherthanintheUnitedStates.EliminatingtheseprovisionswouldbothincreaseprogressivityandstrengthentheU.S.economy.Moreover,totheextentthatincomesatthetoparisefromrentsandtotheextentthatitispossibletotargettheserents,againonecanhaveamore-progressivetaxsystemwithoutanyadverseeffectsonincentives.Thefactthattaxcutsfortherichhaveincreasedthedeficitandthenationaldebtsubstantiallyhasanothereffect:ithascreatedpressuretoreducegovernmentsupportforinvestmentsineducation,technology,andinfrastructure.TheRighthasunderestimatedtheimportanceofthesepublicinvestments,whichnotonlycanyieldhighreturnsdirectlybutprovidethebasisofhigh-returnprivate-sectorinvestment.EarlierImentionedthecontributionthatgovernmentinvestmentsinresearchandtechnologyhadmade(includingthefirsttelegraphlinethatspannedNorthAmericainthenineteenthcentury,andthecreationoftheInternetandthefoundationsofthefirstbrowserinthetwentieth).RecentresearchhasshownthattheyearsbeforeWorldWarIIwereyearsofhighproductivityincrease,whichsetthestageforevenmoreproductivityincreasesinsubsequentyears.Amongthereasonsforthisisgovernmentinvestmentinroads(whichinterestinglyplayedanimportantroleinincreasing70productivityinrailroads).Suchpublicinvestmentscanbefinancedsustainablyonlythroughtaxation,andgiventhelevelofinequality,whatisrequirediswell-designedprogressivetaxationthatcanbelessdistortionarythanregressivetaxation.AcorporateCEOwillnotexertlessefforttomakethecompanyworkwellsimplybecausehistake-homepayis$10millionayearratherthan$12million.Inanycase,thepossiblelossofeffortinsociallyproductiveactivitiesfromtaxingthefewinthetop1percent—which,becauseofthehugeinequalityinoursociety,raiseslargeamountsofmoney—palesincomparisonwiththeeffectsonthemanymorenumerouswhowouldhavetofacehigher98 71taxratestoraisethesameamountofmoney.CONCLUDINGCOMMENTSSomeoftheadverseeffectsofinequalitymightbesmallerifthosewhoarepoortodaywererichtomorrow,orifthereweretrueequalityofopportunity.AstheOccupyWallStreetmovementdrewattentiontothegrowinginequality,theresponseoftheRightwastosay,almostproudly,thatunliketheDemocrats,whobelieveinequalityofoutcomes,theywerecommittedtoequalityofopportunity.AccordingtoPaulRyan,theWisconsinRepublicanwhoheadstheHouseBudgetCommittee,responsibleformakingthecriticalbudgetarydecisionsaffectingthecountry’sfuture,acentraldifferencebetweenthepartiesis“[w]hetherweareanationthatstillbelievesinequalityofopportunity,orwhetherwearemovingawayfromthat,andtowardsaninsistenceon72equalityofoutcome.”Hewentontosay,“Let’snotfocusonredistribution;let’sfocusonupwardmobility.”Therearetwofactualproblemswiththisperspective.First,itsuggeststhatwhilewearefailinginequalityofoutcomes,wearesucceedinginequalityofopportunity.Chapter1showedthatthatwasnottrue.ThequipofJonathanChaitseemstofithere:“The73factsshouldn’tgetinthewayofapleasantfantasy.”Thesecondfactualproblemistheclaimthattheprogressiveperspectivearguesforequalityofoutcome.AsChaitexpressedit,therealityisthattheDemocratsarenotarguingforequalityofoutcome,onlyforpolicies“thatleaveinplaceskyrocketinginequalityofincome,justeversoslightlyamelioratedby74government.”Perhapsthemostessentialpointisthis:noonesucceedsonhisown.Thereareplentyofbright,hardworking,energeticpeopleindevelopingcountrieswhoremainpoor—notbecausetheylackabilitiesorarenotmakingsufficienteffort,butbecausetheyworkineconomiesthatdon’tfunctionwell.Americansallbenefitfromthephysicalandinstitutionalinfrastructurethathasdevelopedfromthecountry’scollectiveeffortsovergenerations.What’sworryingisthatthoseinthe1percent,inattemptingtoclaimforthemselvesanunjustproportionofthebenefitsofthissystem,maybewillingtodestroythesystemitselftoholdontowhattheyhave.Thischapterhasexplainedthatwearepayingahighpricefortheinequalitythatisincreasinglyscarringoureconomy—lowerproductivity,lowerefficiency,lowergrowth,moreinstability—andthatthebenefitsofreducingthisinequality,atleastfromthecurrenthighlevels,faroutweighanycoststhatmightbeimposed.Wehaveidentifiednumerouschannelsthroughwhichtheadverseeffectsofinequalityoperate.Thebottomline,though,thathigherinequalityisassociatedwithlowergrowth—controllingforallotherrelevantfactors—hasbeenverifiedbylookingatarangeofcountriesandlookingoverlongerperiodsof75time.Ofallthecostsimposedonoursocietybythetop1percent,perhapsthegreatestisthis:theerosionofoursenseofidentityinwhichfairplay,equalityofopportunity,andasenseofcommunityaresoimportant.Americahaslongprideditselfonbeingafairsociety,whereeveryonehasanequalchanceof99 gettingahead,butthestatisticstoday,aswe’veseen,suggestotherwise:thechancesthatapoororevenamiddle-classAmericanwillmakeittothetopinAmericaaresmallerthaninmanycountriesofEurope.Andasinequalityitselfcreatesaweakereconomy,thechancecanonlygrowslimmer.ThereisanothercostofAmerica’sinequality,beyondthislossofasenseofidentityandbeyondthewayitisweakeningoureconomy:ourdemocracyisbeingputatperil,asubjecttowhichweturninthenexttwochapters.100 CHAPTERFIVEADEMOCRACYINPERILWEHAVESEENHOWAMERICA’SCURRENTINEQUALITY,andthatofmanyothercountries,didnotarisespontaneouslyfromabstractmarketforcesbutwasshapedandenhancedbypolitics.Politicsisthebattlegroundforfightsoverhowtodividenation’seconomicpie.Itisabattlethatthe1percenthavebeenwinning.Thatisn’thowit’ssupposedtobeinademocracy.Inasystemofonepersononevote,100percentofthepeoplearesupposedtocount.Modernpoliticalandeconomictheorypredictedthattheoutcomesofelectoralprocesseswithonepersonhavingonevotewouldreflecttheviewsoftheaveragecitizen—notthatoftheelites.Moreprecisely,standardtheory,basedonindividualswithwell-definedpreferenceswhoarevotingintheirself-interest,predictsthattheoutcomeofdemocraticelectionswouldreflecttheviewsofthe“median”voter—thepersoninthemiddle.Inthecaseofpublicexpenditures,forinstance,itsaysthathalfwouldwantmore1spendingandhalfless.Butpollsconsistentlyshowthattherearelargediscrepanciesbetweenwhatmostvoterswantandwhatthepoliticalsystemdelivers.IntheaftermathoftheGreatRecessionthereisdisillusionmentnotonlywiththeglobaleconomicsystembutalsowithhowthepoliticalsystemsinmanyWesterndemocracieshavebeenworking.ThisdisillusionmentfoundexpressionintheOccupyWallStreetandindignadomovementsaroundtheworld.Thattherearemajorfailuresinoureconomicsystemisobvious;butitisequallyevidentthattheAmericanpoliticalsystemhasnotevenbeguntofixthem.MostAmericansdon’tthinkthenewfinancialregulations(Dodd-Frank)wentfarenough,andthey’reright.Evenbeforethecrisis,therewasanawarenessofwidespreadpredatorylendingpractices.ItwasintheinterestsofmostAmericanstocurbthoseaswellastheabusivecreditcardpractices.Butthatdidn’thappen.Thefederalgovernmenthasdonelittletoprosecutebanksthatviolatedthelaw—aswewillseeinchapter7,muchlessthanitdidinthemuchlessseriousSavingsandLoancrisistwodecadesago.TheNewYorkTimeshasdescribedhowtheSecuritiesandExchangeCommission,whichissupposedtoprotectinvestorsfromfraud,“hasrepeatedlyallowedthebiggestfirmstoavoidpunishmentsspecificallymeanttoapplytofraud2cases.”Whyhasn’tthemiddlehadthepoliticalinfluencethatstandardtheorypredictsitshouldhave,andwhydoesourcurrentsystemseemtooperateon“onedollar”onevoteinsteadofonepersononevote?Inearlierchapters,wesawhowmarketsareshapedbypolitics:politicsdeterminestherulesoftheeconomicgame,andtheplayingfieldisslantedinfavorofthe1percent.101 Atleastpartofthereasonisthattherulesofthepoliticalgame,too,areshapedbythe1percent.Thisstoryhastwocriticalelements.One,shapingindividuals’perceptions—sothatthe99percentadopttheinterestsofthe1percentastheirown—isthefocusofthenextchapter.Thecurrentchapterfocusesontheeconomicsandpoliticsofvotingitself.UNDERMININGDEMOCRATICPOLITICALPROCESSESThevotingparadoxandvoterdisillusionmentOneofthepuzzlesinmodernpoliticaleconomyiswhyanyonevotesatall.Veryfewelectionsactuallyturnonthevoteofasingleindividual.Thereisacosttovoting—althoughnoAmericanstatehasanexplicitchargeforvotingtoday,ittakestimeandefforttogettothevotingbooth.Registrationcanalsobeaburden,requiringplanningwellinadvanceofelections.PeoplewholiveinsprawlingWesterncitieswithpoorpublictransportationmaybeatadisadvantageforreachingtheirpollingstations.Peoplewithlimitedmobilitymayfinditdifficulttogettothepollingstationevenwhenitisnearby.Forvoters’troubles,thereislittlepersonalbenefit.Indeed,italmostneverhappensthattheindividual’svoteispivotal,thatis,makesanydifferencetothefinaloutcome.Modernpoliticalandeconomictheoriesassumerationalself-interestedactors.Onthatbasis,whyanyonevotesisamystery.Theanswer,ofcourse,isthatwe’vebeenindoctrinatedwithnotionsof“civicvirtue.”Itisourresponsibilitytovote.Eachindividualcontemplatingnotvotingworriesaboutwhatwouldhappenifeveryoneactedlikehim:“IfIandotherlike-mindedpeopledidn’tvote,thatwouldleavetheoutcometobedeterminedbyotherswithwhomIdisagree.”Suchcivicvirtueshouldnotbetakenforgranted.Ifthebelieftakesholdthatthepoliticalsystemisstacked,thatit’sunfair,individualswillfeelreleasedfromtheobligationsofcivicvirtue.Whenthesocialcontractisabrogated,whentrustbetweenagovernmentanditscitizensfails,disillusionment,3disengagement,orworsefollows.IntheUnitedStatestoday,andinmanyotherdemocraciesaroundtheworld,mistrustis4ascendant.Theironyisthatthewealthywhoseektomanipulatethepoliticalsystemfortheirownendswelcomesuchanoutcome.Thosewhoturnouttovotearethosewhoseethepoliticalsystemworking,oratleastworkingforthem.Soifthepoliticalsystemworkssystematicallyinfavorofthoseatthetop,itistheywho(disproportionately)areinducedtoengageinpolitics,andinevitablythesystemservesbestthosewhosevoicesareheard.Moreover,ifvotershavetobeinducedtovotebecausetheyaredisillusioned,itbecomesexpensivetoturnoutthevote;themoredisillusionedtheyare,themoreitcosts.Butthemoremoneythatisrequired,themorepowerthatthemoneyedinterestswield.Forthosewithmoney,spendingittoshapethepoliticalprocessisnotamatterofcivicvirtue;itisaninvestment,fromwhichtheydemand(andget)areturn.Itisonlynaturalthattheyendupshapingthepoliticalprocessintheirinterests.That,inturn,102 increasesthesenseofdisillusionmentthatpervadestherestoftheelectorateandbooststhepowerofmoneyfurther.LoweringtrustIhaveemphasizedhowthecountryhastoacttogether,cooperatively,ifthecountry’sproblemsaretobesolved.Governmentistheformalinstitutionthroughwhichweacttogether,collectively,tosolvethenation’sproblems.Inevitably,individualswilldifferintheirviewsofwhatshouldbedone.That’soneofthereasonsthatcollectiveactionissodifficult.Thereneedstobecompromise,andcompromisehastobebasedontrust:onegroupgivesintoday,intheunderstandingthatanotherdoesinanotheryear.Theremustbetrustthatallwillbetreatedfairly,andifmattersturnoutdifferentlyfromhowtheproponentsofameasureclaimitwill,therewillbechangetoaccommodatetheunexpectedcircumstances.Butit’seasiertoacttogetheriftheinterestsandperspectivesofthemembersofagroupareatleastlooselyaligned;ifeveryoneis,asitwere,inthesameboat.Butitisevidentthatthe1percentandtherestarenotinthesameboat.Cooperationandtrustareimportantineverysphereofsociety.Weoftenunderestimatetheroleoftrustinmakingoureconomyworkortheimportanceofthesocialcontractthatbindsustogether.Ifeverybusinesscontracthadtobeenforcedbyoneparty’stakingtheothertocourt,oureconomy,andnotjustourpolitics,wouldbeingridlock.Thelegalsystemenforcescertainaspectsof“goodbehavior,”butmostgoodbehaviorisvoluntary.Oursystemcouldn’tfunctionotherwise.Ifwelitteredeverytimewecouldgetawaywithit,ourstreetswouldbefilthy,orwewouldhavetospendaninordinateamountonpolicingtokeepthemclean.Ifindividualscheatedoneverycontract—solongastheycouldgetawaywithit—lifewouldbeunpleasantandeconomicdealingswouldbefractious.Throughouthistorytheeconomiesthathaveflourishedarethose5whereaman’swordishishonor,whereahandshakeisadeal.Withouttrust,businessdealsbasedonanunderstandingthatthecomplexdetailswillbeworkedoutlaterarenolongerfeasible.Withouttrust,eachparticipantinadeallooksaroundtoseehowandwhenthosewithwhomheisdealingwillbetrayhim.Toprotectagainsttheseoutcomes,individualsspendenergyandresourcesobtaininginsurance,makingcontingencyplans,andtakingactionstoensurethat,shouldtheybe“betrayed,”theconsequencesarelimited.Somesocialscientiststrytoaccountfortheeffectof“trust”ontheoveralleconomybyreferringtosocialcapital.Aneconomywithmore“socialcapital”ismoreproductive,justlikeaneconomywithmorehumanorphysicalcapital.Socialcapitalisabroadconceptthatincludesthosefactorsthatcontributetogoodgovernanceinboththepublicandtheprivatesectors.Buttheideaoftrustunderliesallnotionsofsocialcapital;peoplecanfeelconfidentthattheywillbetreatedwell,withdignity,fairly.Andtheyreciprocate.Socialcapitalisthegluethatholdssocietiestogether.Ifindividualsbelievetheeconomicandpoliticalsystemisunfair,thegluedoesn’tworkandsocietiesdon’tfunctionwell.AsI’vetraveledaroundtheworld,partlyinmyjobaschiefeconomistoftheWorldBank,I’veseeninstanceswheresocial103 capitalhasbeenstrongandsocietieshaveworkedtogether.I’vealsoseeninstanceswheresocialcohesionhasbeendestroyedandsocietieshavebecomedysfunctional.Bhutan,theremoteHimalayanstatetothenortheastofIndia,forinstance,isprotectingitsforestsaspartofabroadercommitmenttotheenvironment.Eachfamilyisallowedtocutdownafixednumberoftreesforitsownuse.Inthissparselypopulatedcountry,Iasked,howcouldoneenforcesuchanedict?Theanswerwassimpleandstraightforward:inourjargon,socialcapital.TheBhutanesehaveinternalizedwhatis“right”whenitcomestotheenvironment.Itwouldbewrongtocheat,andsotheydon’t.Communitiesthatrelyonirrigation—whetherit’sinthehillsandmountainsofBaliorintheAtacamaDesertofnorthernChile—havetoworktogethertomanagetheirwaterandtomaintaintheirrigationcanals.Thesecommunities,too,seemtodevelopstrongbonds,astrongsenseofsocialcapital,withlittleornocheatingonthe“socialcontract.”Attheotherextreme,whenIvisitedUzbekistanafterthefalloftheSovietempire,Isawtheconsequencesoftheerosionofsocialcapital.Mostgreenhouseshadnoglass,makingthemtotallyineffective.IwastoldthatasUzbeksocietyandeconomydecayed,eachfamilylookedoutforitself.Theglasswasstolenfromthegreenhouses.Nobodywassurewhattheywoulddowiththestolenglass,butitprovidedsomelimitedsecurity,andtheyweresurethatiftheydidn’tstealit,somebodyelsewould.Moregenerally,intheaftermathofthebreakdownoftheSovietUnion,Russiaexperiencedamarkeddeclineinoutput.Thispuzzledmosteconomists.Afterall,therewasthesamephysical,human,andnaturalcapitalafterthebreakdownthattherehadbeenbeforethecrisis.Eliminatingtheolddistortionarycentralizedplanningsystemandreplacingitwithamarketeconomyshouldhavemeantthatthoseresourceswould,atlast,bemoreefficientlyused.Butwhattheanalysisfailedtoincorporatewashowseventy-fouryearsofCommunistPartyrule,alongwiththesuppressionofcivilsocietyinstitutions,haderodedsocialcapital.Theonlythingthathadheldthecountrytogetherwasacentralplanningsystemandanoppressivedictatorship.Whentheseinstitutionscrumbled,thesocialcapitalrequiredtoholdthecountryandtheeconomytogetherjustwasn’tthere.Russiabecamethe“WildEast,”morelawlessthanAmerica’sWildWestbeforeitwastamed.Russiawas“caughtupinasystemicvacuumwithneithertheplannorthe6market.”Recentadvancesinthestudyofsocialnormsshowthatmanyorevenamajorityofpeoplewillabstainfromanindividuallybeneficialbutsociallyharmfulactioniftheyperceivethatmostpeopledotoo.Buttheconverseisalsotrue.Thishasanimportantconsequence:desirablebehaviorcanquicklydegradewhen7peopleareexposedtoasufficientnumberof“transgressions.”InAmericatherehasbeenanenormouserosionoftrustin8recentyears.Withintheeconomythebankingsectorhasbeenattheforefrontofthetrend.Anentireindustrythatwasoncebasedontrusthaslostit.Pickupthenewspaperonarandomday,andtherewillalmostsurelybemorethanonearticledescribingsomebankorsomeonefromanotherpartofthefinancialsectorbeingaccusedorconvictedofengaginginsomefraud,aidingandabettingsometaxevasionscheme,orparticipatinginsomecreditcardabuse,someinsidertrading,somemortgagescandal.104 TheheadofGoldmanSachs,LloydBlankfein,madeitperfectlyclear:sophisticatedinvestorsdon’t,oratleastshouldn’t,relyontrust.Thosewhoboughttheproductsthebankssoldwereconsentingadultswhoshouldhaveknownbetter.TheyshouldhaveknownthatGoldmanSachshadthemeans,andtheincentives,todesignproductsthatwouldfail,thattheyhadthemeansandtheincentivestocreateasymmetriesofinformation—wheretheyknewmoreabouttheproductsthanthebuyersdid—andthattheyhadthemeansandtheincentivestotakeadvantageoftheseasymmetries.Thosewhofellvictimtotheinvestmentbankswere,forthemostpart,well-offinvestors(thoughtheyincludedpensionfundsmanagingthemoneyofordinarycitizens).ButdeceptivecreditcardpracticesandpredatorylendinghavemadeeveryAmericanunderstandthatthebanksarenottobetrusted.Onehastoreadthefineprint—andeventhatwon’tbeenough.Shortsightedfinancialmarkets,focusingonquarterlyreturns,havealsobeencentralinunderminingtrustwithintheworkplace.Inoldeconomics,mostfirmsheldontotheirgoodworkersthroughtheupsanddownsofthebusinesscycle,andthoseworkersreturnedthefavorwithloyaltyandinvestmentofhumancapitalinthefirm,toincreasethefirm’sproductivity.Thiswascalled9“laborhoarding,”anditmadegoodeconomicsense.Butasmarketsbecamemoreshortsighted,suchhumanepolicesnolongerseemedprofitable.Theextraprofitability—frominvestmentsinhumancapital,fromlowerturnovercosts,andfromgreaterloyaltyamongworkers—wouldn’tbefeltforyearstocome,especiallyifthedownturnwentonforsometime.SloughingoffworkerswasrelativelyeasyinAmerica’sflexiblelabormarket,andthatrenderedthemanotherdisposableinput.Thathelpsexplainoneoftheunusualaspectsofthe2008recession(andotherrecentdownturns)thatIdiscussedinthebeginningofchapter2.Undertheoldmodel,inaneconomicdownturn,productivitywouldgodownbecausesomanyworkerswereretained.Insteadofgoingdownatthebottomofthecycle,productivitynowwentup:allthosegoodworkersaboutwhomthefirmworried,wonderingwhethertheyshouldorshouldnotbeterminated,weregiventheax.Thetaskofrestoringteamspirit,loyalty,andhumancapitalwouldbeleftto10afuturemanager.Morebroadly,notonlyareworkershappierinworkplacesthattreatthemwell—includingduringdownturns—butproductivityis11enhanced.Theimportanceofasenseofwell-beingintheworkplaceshouldnotbeunderestimated:mostpeoplespendasubstantialfractionoftheirlifetimeattheworkplace,andwhat12happenstherespillsoverstronglyintotherestoftheirlives.Thebreakingofthesocialbondsandtrust—seeninourpolitics,inourfinancialsector,andintheworkplace—will,inevitably,havebroadersocietalconsequences.Trustandreciprocalgoodwillarenecessarynotonlyforthefunctioningofmarketsbutalsoforeveryotheraspectofsocietalcooperation.Wehaveexplainedhowthelong-termsuccessofanycountryrequiressocialcohesion—akindofsocialcontractthatbindsmembersofsocietytogether.Experienceselsewherehaveshown,however,thefragilityofsocialcohesion.Whenthesocialcontractgetsbroken,socialcohesionquicklyerodes.Governmentsandsocietiesmakedecisions—expressedthroughpolicies,laws,andbudgetarychoices—thateitherstrengthenthatcontractorweakenit.Byallowinginequalitytometastasize105 unchecked,Americaischoosingapathofthedestructionofsocialcapital,ifnotsocialconflict.Aswehaveemphasized,thearenainwhichsocialcooperationisabsolutelyessentialispolitics,foritisherethatcollectivedecisionsaffectingallaretaken.Ofcourse,thereareotherwaysoforganizinglife:policestatesproviderulesandpunishmentsfordisobeying.Itisasystemofcompliancebasedon“incentives”—theincentivesofthreats.Butsuchsocietiestypicallydonotfunctionwell.Theenforcerscannotbeeverywheretomakegoodonthethreats,andifthereisasensethattherulesandregulationsareunfair,therewillbeattemptsatcircumvention.Itwillbeexpensivetoachievecompliance,andeventhenitwillbeonlypartial.Productivitywillbelow,andlifewillbeunpleasant.Thedemocraticalternativeentailstrustandasocialcompact,anunderstandingoftheresponsibilitiesandrightsofdifferentindividuals.Wetellthetruthbecauseitistherightormoralthingtodo—knowingthecostsimposedonothersofthebreakdownofthesystemoftrust.We’veseenhowtheerosionoftrusthurtstheeconomy.Butwhatishappeninginthesphereofpoliticsmaybeevenworse:thebreakingofthesocialcontractmayhaveevenmoreinvidiouseffectsonthefunctioningofourdemocracy.FairnessanddisillusionmentTomostAmericansitisobviousthatfairnessisimportant.Indeed,oneoftheaspectsofoursocietythatAmericansweremostproudofwasthatoureconomicsystemwasfair—itgaveopportunitytoeverybody.Recentresearchhasilluminatedjusthowimportantfairnessistomostindividuals(thougheconomistscontinuetofocusalmostexclusivelyonefficiency).InaseriesofexperimentsinitiallyconductedbythreeGermaneconomists,WernerGüth,RolfSchmittberger,andBerndSchwarze,asubjectwasgivenacertainamountofmoney,say$100,andwastoldtodivideitbetween13himselfandtheotherplayerinthegame.Inthefirstversion,calledthedictatorgame,thesecondplayerhastoacceptwhatheisgiven.Standardeconomictheoryprovidesaclearprediction:thefirstplayerkeepsallofthe$100forhimself.Yetinpractice,thefirstplayergivesthesecondsomething,though14usuallylessthanhalf.Arelatedexperimentgivesevenstrongerevidenceoftheimportancethatindividualsattachtofairness:mostindividualswouldratheracceptaninefficientoutcome—evenhurtingthemselves—thananunfairone.Inwhatisknownastheultimatumgame,thesecondplayerhastherighttovetothedivisionproposedbythefirstplayer.Ifthesecondplayerexerciseshisveto,neitherpartygetsanything.Standardeconomictheorysuggestsaclearstrategy:thefirstplayerkeeps99dollarsforhimself,giving1dollartotheotherplayer,whoacceptsit,because1dollarisbetterthanzero.Infact,offerstypicallyaverageabout30to40dollars(or30–40percentofthetotalsuminagamewithdifferentquantities),andthesecondplayertends15tovetotheallocationifheisofferedlessthan20dollars.Heiswillingtoacceptsomeinequity—herealizesheisinthelesspowerfulposition—butthereisalimittohowmuchinequityhewillstandfor.Hewouldratherhavezerothan,say,$20—a4-to-1106 16splitistoounfair.Perceptionsofunfairnessaffectbehavior.Ifindividualsbelievethattheiremployeristreatingthemunfairly,theyare17morelikelytoshirkonthejob.Inthelastchapter,wedescribedexperimentalresultsconfirmingtheimportanceofperceptionsoffairnesstoproductivity.But,aschapter1pointedout,America’seconomicsystemis,inafundamentalsense,nolongerfair.Equalityofopportunityisjustamyth;andAmericansaregraduallyrealizingthis.Onepollshowedthat61percentofAmericansnowbelievethatoureconomicsystemfavorsthewealthy;only36percent—alittleoveroneout18ofthreeAmericans—thinkoursystemisgenerallyfair.(And,perhapsnotsurprisingly,bysimilarnumbers,theythinkunfairnessintheeconomicsystemthatfavorsthewealthyisa19moreseriousproblemthanoverregulation.)Otherresearch,comparingindividuals’viewsaboutwhatagooddistributionofincomemightlooklikewiththeirperceptionsofinequalityintheUnitedStatesconfirmsthatmostthinkthereistoomuchinequality.Andtheseviewswereheldbroadlyacrossverydifferentdemographicgroups,menandwomen,DemocratsandRepublicans,andthoseatthetopandthosewithlowerincomes.Indeed,inmostpeople’sidealdistribution,thetop40percenthadlesswealththanthetop20percentcurrentlyholds.Equallystriking,whenaskedtochoosebetweentwodistributions(shownonapiechart),participantsoverwhelminglychoseonethatreflectedthedistributioninSwedenoverthatintheUnitedStates(9220percentto8percent).Viewsthatourpoliticalsystemisriggedareevenstrongerthanthosethatoureconomicsystemisunfair.Thepoor,especially,believethattheirvoiceisnotbeingheard.ThewidespreadsupportexpressedfortheOccupyWallStreetmovement(discussedinthepreface)bearstestimonytotheseconcerns.Thebelief(andthereality)thatourpoliticalandeconomicsystemisunfairweakensboth.Whilethemostimmediatesymptomisdisillusionmentleadingtoalackofparticipationinthepoliticalprocess,thereisalwaysaworrythatvoterswillbeattractedtopopulistsandextremists21whoattacktheestablishmentthathascreatedthisunfairsystemandwhomakeunrealisticpromisesofchange.Distrust,themedia,anddisillusionmentAmongeconomists,noonedoubtstheimportanceofacompetitivemarketplaceforgoodsandservices.Evenmoreimportantforoursocietyandourpoliticsisacompetitivemarketplaceofideas.Andunfortunately,thatmarketplaceis—andisperceivedtobe—22distorted.Citizenscan’tmakeinformeddecisionsasvotersiftheydon’thaveaccesstotherequisiteinformation.Butifthemediaarebiased,theywon’tgetinformationthatisbalanced.Andevenifthemediawerebalanced,citizensknowthattheinformationthatthegovernmentdisclosestothemediamaynotbe.JohnKennethGalbraithsomesixtyyearsago,recognizingthatfewmarketswereanywhereclosetotheeconomistsideaof“perfectcompetition,”wroteabouttheimportanceof23“countervailingpowers.”We’llneverhavetrulycompetitive107 mediaintheUnitedStates,withaplethoraofnewspapersandTVstationsrepresentingadiversityofviews,butwecoulddobetter.Wecouldhavemoreforcefulpolicingofantitrustlaws,recognizingthatwhatisatstakeismorethanjustcontrolover,say,themarketforadvertising,butalsocontroloverthemarketforideas.Wecouldbeespeciallyvigilantaboutattemptsbymediafirmstocontrolnewspapers,TV,andradio.Andwecouldprovidepublicsupportforthemediathatwouldhelpdiversifyit.Afterall,thepublicgoodisapublicgood—thatis,allbenefitfromensuringthatourgovernmentperformswell.Abasicinsightofeconomicsisthatprivatemarkets,ontheirown,spendtoolittleonpublicgoods,sincethesocietywidebenefitsarefargreaterthanthebenefitstheindividualhimselfenjoys.Ensuringthatwehaveawell-informedpubliccitizenryisimportantforawell-functioningdemocracy,andthatinturnrequiresanactiveanddiversemedia.Othercountrieshaveattemptedtoensurethisdiversity—withsomesuccess—byprovidingbroadpublicsupportformedia,rangingfromnationalpublicbroadcastingstationstocommunityradiostationstosupportforsecondnewspapers,evenin24smallercommunities.Wecouldalsohavemorebalancedmedia.Asitis,themediaarearealmwherethoseinthe1percenthavetheupperhand.Theyhavetheresourcestobuyandcontrolcriticalmediaoutlets,andsomeofthemarewillingtodosoataloss:it’saninvestment25inmaintainingtheireconomicposition.Likethepoliticalinvestmentsofthebanks,theseinvestmentsmayyieldfarhigherprivatereturnsthanordinaryinvestments—ifoneincludesimpacts26onthepoliticalprocess.Thisisanotherelementinthecreationofdistrustanddisillusionment:notonlyisn’ttheretrustinthefairnessofourpoliticalandeconomicsystem;thereisn’teventrustintheinformationthatisprovidedaboutourpoliticalandeconomic27system.DisenfranchisementThepoliticalbattleisnotjustfoughtovergettingsupportersandgettingthemtovote.It’salsofoughtovernotallowingthosewhodisagreewithyoutovote—areturntothemindsetoftwocenturiesago,whenthevotingfranchisewasseverelyrestricted.Thereluctanceoftheelitestoextendthevotingfranchise,howeverobjectionablefromcurrentperspectives,isunderstandable.IntheUK,untiltheReformActof1832,onlylargepropertyownersorpeopleofconsiderablewealthcouldvote.Theelitesdidn’ttrustwhatmighthappenifvotingrightswereextended.IntheJimCrowSouthattheendofthenineteenthcentury,whitepoliticiansdevisedpolltaxesthatweredesignedtodisenfranchisetheformerslavesandtheirdescendants,who28wouldn’thavethewherewithaltopay.Thosetaxes,combinedwithliteracytestsandsometimesviolenceandterror,succeededbothinsubstantiallyloweringelectoralturnoutsandin29increasingtheDemocraticvoteshare.InEcuador,before1979,onlytheliteratecouldvote,andtherulingelitemadesurethattheindigenouspeopledidn’thavesufficienteducationtoqualify.Ineachcaseelitesfearedtheywouldlosetheirpositionofpowerandprivilege,andeventheir108 wealth,iftheyextendedthevotingfranchise.Manyoftheeffortsatdisenfranchisement,nowandinthepast,havebeendirectedatdisenfranchisingthepoor;inthe1930s,pauperexclusionlawsdisenfranchisedjoblessmenandwomenwho30werereceivingrelief.ThepoliticalsciencescholarWalterDeanBurnhamhasdetailedthelonghistoryofwhathecallseffortsatvoter“demobilization”targetedatvariousgroups:againsturbanworkers,byupstateagrariansandsmalltowners;againstleftistparties,bythemajorparties;againstpopulists,bytheurbancorporateelites;againstthepoor,bythemiddle-andupper-31incomegroups.Manyofthesemeasuresmaybethoughtofasdisenfranchisementbystealth.Ofcourse,thosetryingtodisenfranchisethepoordon’tdescribeitthatway.Economistsandstatisticiansdistinguishtwokindsoferrors:someonewhoisqualifiedtovotenotbeingallowedtovote,andsomeonewhoisnotqualifiedtovotebeingallowedtovote.Republicanstendtoclaimthatthelatteristhemoreimportantproblem,Democratsthatit’stheformer.ButtheRepublicanclaimisdisingenuous:thebarriersthattheyseektocreatetocatchthelattermistakearereallyeconomicbarriers,notbarriersbasedonthelikelihoodofbeingqualifiedtovote.Requiringagovernment-issuedphotoID—typicallyadriver’slicenseoranidentificationcardissuedbytheDepartmentofMotorVehicles—discriminatesbetweenthosewhohavesufficientmeans,time,andaccesstoinformationtogettotheDMV,and32thosewhodonot.Obtainingvoteridentificationmayalsonecessitatehavingabirthcertificateorotherdocumentation,whichrequiresevenmoretime,money,andknowledgeofbureaucracy.WhilethedaysofoutrightexclusionfromthevotingprocessaremostlybehindusintheUnitedStates,thereremainsasteadystreamofinitiativestolimitparticipation,invariablytargetingthepoorandlesswellconnected.Authoritiescanuseevenmoresubtlemethodstodiscouragecertaingroups’politicalparticipation,whetheritisconductinginadequatevoteroutreachtopoororimmigrantneighborhoods,poorlystaffingpollingplaces,orpreventingsomefelonsfromvoting.Insomecases,itisdifficulttodistinguishneglectfromwillfuldisenfranchisement,buttheeffectsarethesame:depressingvoterturnout,oftenofatargetedgroup.Thesemeasureswillchipawayatvoterparticipation,evenwhentheydonotpresentabsolutebarrierstoregisteringorvoting—especiallyamongtheleastprivilegedpartsofthepopulation,whereenthusiasmforvotingisalreadylowandmistrustoftheofficialsystemrunshigh.Theresultisthatoneinfourofthoseeligibletovote—51million33Americansormore—arenotregistered.Ontheotherhand,certainmeasurescanmakeiteasiertoregisterandwillmakeitmorelikelythatthosewhoarequalifiedtovotedoso.Allowingindividualstoregistertovoteatthesametimethattheyapplyforadriver’slicenselowerstransactionscost,andthusfacilitatesvoterregistration.Moreflexibleschedulesatpollingcentersandmorevotingboothsfacilitatetheactofvotingitself.Theseattemptsatdisenfranchisementhaveadoubleeffect.Totheextentthattheysucceed,theyensurethatthevoicesofsomecitizensarenotheard;andtheperceptionthatthereissuchastruggletoreversealong-acceptedprinciplethatallcitizens109 haveeffectiveaccesstothevotereinforcesdisillusionmentinthepoliticalsystemandincreasespoliticalalienation.DisempowermentWesawearlierhowtherulesoftheeconomicgame,setbythepoliticalprocess,stackthecardsinfavorofthe1percent.Sotoofortherulesofthepoliticalgame.Theperceptionthattheyaresetinwaysthatareunfair—thattheygivedisproportionatepowertoeconomicelites,inawaythatfurtherstrengthenstheeconomicpowerofthoseatthetop—reinforcespoliticalalienationandasenseofdisempowermentanddisillusionment.Thesenseofdisempowermentoccursatmyriadlevelsofengagementwithgovernment.The2010decisioninthecaseofCitizensUnitedv.FederalElectionCommission,inwhichtheSupremeCourtessentiallyapprovedunbridledcorporatecampaignspending,representeda34milestoneinthedisempowermentofordinaryAmericans.Thedecisionallowscorporationsandunionstoexercise“freespeech”insupportingcandidatesandcausesinelectionstothesamedegreeasindividualhumanbeings.SincecorporationshavemanymillionsoftimestheresourcesofthevastmajorityofindividualAmericans,thedecisionhasthepotentialtocreateaclassofsuper-wealthypoliticalcampaignerswithaone-dimensionalpoliticalinterest:enhancingtheirprofits.ItwashardtojustifytheCourt’sdecisiononphilosophicalterms.Corporationsarelegalentities,createdforaspecificpurposeandendowedbyman-madelawswithspecificrightsandobligations.Theyhavetheadvantage,forinstance,oflimitedliability,butincertaininstancesthecorporateveilcanbepierced.Therecanstillbeindividualculpabilityforcriminalacts.Butcorporationsaren’tpeople,andtheydon’thaveanyinalienablerights.TheSupremeCourt,ingivingthemcarteblanchetoshapepowerandourpoliticalsystem,seemedtothinkotherwise.TheCourt’sdecisioninbalancingtheinterestsoffreespeechwiththeinterestsofabalanceddemocracy,gaveshortshrifttothelatter.Itisgenerallyrecognizedthatprovidingmoney(support)conditionalonacandidate’sprovidingafavor(supportingabill)iscorruption.Corruptionunderminesfaithinourdemocracy.Butthereislittledifferencebetweenthatandwhatactuallyoccurs—candidateswho,say,supportabillthatanoilcompanywantstohaveimmunityfromliabilityfromanoilspillaregivenmoney,andthecandidate,andeveryoneelse,knowsthatthatmoneywillbewithdrawnifhevotesdifferently.Thereisnoformalquidproquo;buttheeffectisthesame.Andmostimportantly,theperceptionbyordinarycitizensisthesame,soitweakensfaithinourdemocracylittlelessthanblatant35corruptiondoes.TheCourt’sactionwas,inasense,justanotherreflectionofthesuccessofthemoneyedinterestsincreatingasystemof“onedollaronevote”:theyhadsucceededinelectingpoliticianswhointurnappointedjudgeswhowouldenshrineacorporation’sright36tounbridledspendinginthepoliticalarena.Therulesofthepoliticalgamecanalsomakeindividualsfeel,rightly,thattheyaredisenfranchised.Gerrymanderingcanmakeitmorelikelythatanindividual’svotedoesn’tcount:theoutlinesofvotingdistrictsaredrawnsothattheoutcomeofthe110 electionisalmostpreordained.Thefilibustergivesinordinatepowertoaminorityofsenators.Inthepast,itwasusedwithdiscretion.Therewasanunderstandingthatitwouldbeusedonlyonissuesthatwereofintenseconcern:ironically,itwasusedmostfrequentlytostopthepassageofcivilrightslawsthatwouldensureeveryonetherighttovote.Butthosedaysaregone.Nowthefilibusterisusedasamatterofcoursetoobstruct37legislation.Laterwe’lldiscussonemoreexampleofdisempowerment,theroleoftheFederalReserveBankinsettingmacroeconomicpolicy.Governmenthasentrustedtheresponsibilityforamatterofvitalconcerntoordinarycitizens—monetarypolicy,whichaffectsthelevelofunemploymentandeconomicactivity—toagroupthatconsistsinsignificantmeasureofthoseelectedbybanksandthebusinesscommunitythemselves,withinsufficientdemocraticaccountability.ThepatternofgrowinginequalityintheUnitedStatesmaybeparticularlybadforourdemocracy.Thereisawidespreadunderstandingthatthemiddleclassisthebackboneofourdemocracy.Thepoorareoftensoalienatedthatgettingthemtovoteprovesespeciallyhard.Therichdon’tneedaruleoflaw;theycananddoshapetheeconomicandpoliticalprocessestoworkforthemselves.Themiddleclassismostlikelytounderstandwhyvotingissoimportantinademocracyandwhyafairruleoflawisnecessaryforoureconomyandsociety.Inthemiddleofthelastcentury,itsmembersbelievedthattheeconomicandpoliticalsystemwasbasicallyfair,andtheirbeliefin“civicengagement”wasseeminglyrewardedbyaburstofgrowththatbenefitedthem—andeveryoneelse.Butnowallthatischanging.Aswesawinchapter3,thepolarizationofourlabormarkethasbeenhollowingoutthemiddleclass,andthedwindlingmiddleclassisitselfbecomingdisillusionedwithapoliticalprocessthatisobviouslynotservingitsmemberswell.WhyweshouldcareInthischapterwehavedescribedtheconstructionofapoliticalsystemthat,thoughnominallybasedontheprincipleofonepersononevote,hasturnedouttoservetheinterestsofthoseatthetop.Anotherviciouscirclehasbeensetinplay:politicalrulesofthegamehavenotonlydirectlybenefitedthoseatthetop,ensuringthattheyhaveadisproportionatevoice,buthavealsocreatedapoliticalprocessthatindirectlygivesthemevenmorepower.Wehaveidentifiedawholeseriesofforcescontributingtothedisillusionmentwithpoliticsanddistrustofthepoliticalsystem.Theyawningdivideinoursocietyhasmadeitdifficulttoreachcompromise,contributingtoourpoliticalgridlock.This,inturn,hascontributedtounderminingtrustinourinstitutions,boththeireffectivenessandtheirfairness.Attemptsatdisenfranchisement,arecognitionthatourpoliticalandeconomicsystemsareunfair,theknowledgethattheflowofinformationiscontrolledbyamediathatitselfiscontrolledbythoseatthetop,andtheapparentroleofmoneyinpolitics,reflectedinunbridledcampaigncontributions,haveonlyenhanceddisillusionmentwithourpoliticalsystem.Disillusionmenthasdecreasedpoliticalparticipation,especiallyatthebottom,everybitaseffectivelyastheoutrightattemptsatdisenfranchisementintiltingtheelectoratetowardthetop.Thishasprovidedmore111 scopeforinfluenceofthoseinthe1percentandtheirmoney—reinforcingthelackoftrust,andthedisillusionment.Withsuchdisillusionment,itcostsmoneytogetoutthevote—andeffortstogetoutthevotecanbetargetedatthosewhoseinterestscoincidewiththetop.TheeffectcanbeseenintheUnitedStates,wherevoterturnoutlooksdismalincomparisonwiththatofotheradvancedsocieties.Averagevoterturnoutforthepresidentialelections38hasbeen57percentinrecentyears,butvotingfortheHouseofRepresentativesinnonpresidentialyearshasaveragedonly37.539percent.Giventheextentofyouthdisillusionment—especiallyafterthe2008elections,whenexpectationsweresohigh—itisnowonderthatinthe2010electionyouthturnoutwasevenmore40dismal,ataround20percent.41Turnoutsinprimaryelectionsareevenpoorer—andbiased—withtheresultthattheelectoralchoicesvotersfaceinthegeneralelectionsseemdisappointing,contributinginturntolowvoterturnoutinthoseelections.Disillusionmentwithourpoliticalsystem—andthebeliefthatitisunfair—cangiverisetoagitationoutsidethepoliticalsystem,evidencedintheOccupyWallStreetmovement.Whenthisthenleadstoareformofthepoliticalsystem,theeffectscanbepositive.Whenthepoliticalsystemrebuffsthesereforms,itreinforcesalienation.Earlierinthechapter,Idiscussedtheimportanceoftrust,cooperation,socialcapital,andasenseoffairnesstothefunctioningoftheeconomyandsocietymoregenerally.Thesefailuresinourpoliticalsystemhaveimportantspillovers.Itisanotherchannelthroughwhichoursocietyandoureconomywillpayagreatpriceforthehighandgrowinginequality.ReformingourpoliticalprocessMostAmericansnowrealizehowessentialitisthatourpoliticalprocessbereformedinwaysthatmakeitmoreresponsivetothewishesofthemajorityandthatdiminishthepowerofmoney.Wehavedescribedhowthepoliticalrulesofthegamegivethoseatthetopoutsizeinfluence.Changingtherulesofthegamecancreateamoredemocraticdemocracy.Wecan,andshould,forinstance,changetherulestomakesuretheelectoratereflectsourcitizenry—stoppingtheeffortsatdisenfranchisement,makingiteasier,evenforthepoor,tovote.Practiceslikegerrymandering,designedtoreducetheresponsivenessofthepoliticalsystem,needtobecircumscribed.Somustpracticeslikerevolvingdoors(whichallowsomeonefromthebankingsectortomovesmoothlybetweenWallStreetandWashingtonandbacktoWallStreet).Ruleslikemandatoryvoting(asinAustralia)lead,notsurprisingly,tohighervoterparticipation,andagreaterlikelihoodthattheoutcomesof42electionsreflecttheviewsofsocietymoregenerally.Mostimportantly,thereisaneedforcampaignfinancereform.EvenifCitizensUnitedisnotreversed,corporationsshouldbeallowedtomakecampaigncontributionsonlyiftheirowners—theshareholders—votetodoso.Itshouldn’tbejustlefttothetopmanagers,whohaveusedtheirpowernotmerelytopaythemselvesoutsizerewardsbutthenalsotousetheirpowertomaintainasystemthatallowsthemtodoso.Andthegovernmentshoulduseitsfinancial112 resourcestomakesurethatthereisalevelplayingfieldinthe“marketplaceofideas,”oratleastamorelevelplayingfield43thanexiststoday.Weknowwhattodo—andevenifthereformswouldnotfullycreatetheone-person-one-votedemocracythatwewouldlike,theycouldmoveusinthatdirection.Buteffortstodosohavebeenstymied,fortheobviousreason:moneyedinterestshavetheincentivesandresourcestoensurethatthesystemcontinuestoservethoseinterests.WhenIwaschairoftheCouncilofEconomicAdvisers,theClintonadministrationmadeavaliantefforttocurbtheneedforcampaignfinance.ThepublicownstheairwavesthattheTVstationsuse.RatherthangivingtheseawaytotheTVstationswithoutrestriction—ablatantformofcorporatewelfare—weshouldsellaccesstothem;andwecouldsellitwiththeconditionthatacertainamountofairtimebemadeavailableforcampaignadvertising.Withfreeadvertisingpoliticianswouldneedlessmoney,andwecouldconstrainthoseacceptingthefreeadvertisingintheamountandnatureofcampaigncontributionsthattheyaccepted.ButtheTVstationsthatmakesuchmoneyfromcampaignadvertising—andfromtheirfreegiftsofspectrum—vehementlyandsuccessfullyopposedthereform.TheeviscerationofourdemocracyDemocracy—atleastasmostofusconceiveofit—isbasedontheprincipleofonepersononevote.Muchofthepoliticalrhetoricfocusesonthe“middle”“independent”voter,asstandardpoliticaltheorysuggestsshouldbethecase.ButnoonewouldsuggestthattheoutcomeofAmerica’spoliticsreallyreflectsthemedianvoter’sinterests.Themedianvoterhasnointerestincorporatewelfare.Themedianvoterdidn’tprevailinthebattleoverfinancialregulatoryreform,wherethevastmajority(some44two-thirdsaccordingtosomeopinionpolls)wantedtighterregulation,butthebigbanksdidn’t.Intheend,wegotregulatoryreformthatwaslikeSwisscheese—fullofholes,exceptions,andexemptionsthatcouldn’tbejustifiedbyanysetofprinciples.Therewasnogoodreasonfortighterconsumerprotectiononallloansexceptautoloans;itwasjustthatthoselenderssucceededinmakingthenecessarypoliticalinvestments.ItwasnowonderthattheHouseFinancialServicesCommittee,chargedwithwritingthenewregulations,hadsixty-onemembers,almost15percentofalltherepresentatives.TheDodd-Frankbillpassedin2010representedacarefullybalancedcompromisebetweenthetenbiggestbanksandthe200millionAmericanswhowantedtighterregulation.(History,Iamafraid,willprovethatthevastmajorityofAmericanswereright.)PaulKrugmanputitforcefullywhenhewrote,“[E]xtremeconcentrationofincomeisincompatiblewithrealdemocracy.Cananyoneseriouslydenythatourpoliticalsystemisbeingwarpedbytheinfluenceofbigmoney,andthatthewarpingisgettingworse45asthewealthofafewgrowseverlarger?”IntheGettysburgAddress,PresidentAbrahamLincolnsaidthatAmericawasfightingaGreatCivilWarsothat“Governmentofthepeople,bythepeople,andforthepeopleshallnotperishfromthisearth.”Butifwhathasbeenhappeningcontinues,thatdream46isinperil.Webeganthischapterwithadiscussionofthepuzzleofthe113 medianvoter—whyourdemocracyseemsnottoreflecttheviewsofthoseinthemiddleasmuchastheviewsofthoseatthetop.Thischapterhasprovidedapartialexplanation:themedianvoter(thevotersuchthathalfthevotershaveanincomehigherthanhis,halflower)isricherthanthemedianAmerican.Wehaveabiasedelectorate,tiltedtowardthetop.Butthisdoesn’tfullyexplainwhat’sbeengoingoninAmericanpolitics.Thebiasintheoutcomes—theextenttowhichthepoliticalsystemfavorsthoseatthetop—isgreaterthancanbeexplainedbythebiasintheelectorate.Anotherpartofthispuzzleisexplainedbythebiasinperceptionsandbeliefs—thatthetophaspersuadedthoseinthemiddletoseetheworldinadistortedway,leadingthemtoperceivepoliciesthatadvancetheinterestsofthoseatthetopasconsonantwiththeirowninterests.Howthetopdoesthisisthesubjectofthenext47chapter.ButfirstIwanttodiscussglobalization,howithasbeenmismanagedbyourelitesinwaysthathavebenefitedthemattheexpenseofmostAmericans,but,evenmoreimportantly,howthewayithasbeenmanagedintheUnitedStates,andevenmoresoelsewhere,hasundermineddemocracy.Moreover,theweakeninganddistortionofourdemocracythatI’vejustdescribedisunderminingourroleingloballeadership,andthusourabilitytocreateaworldthatismoreinaccordwithourvaluesandourinterests,morebroadlyunderstood.GLOBALIZATION,INEQUALITY,ANDDEMOCRACYTheseoutcomesshouldnotbesurprising:globalization,ifmanagedforthe1percent,providesamechanismthatsimultaneouslyfacilitatestaxavoidanceandimposespressuresthatgivethe1percenttheupperhandnotjustinbargainingwithinafirm(aswesawinchapter3)butalsoinpolitics.Increasingly,notonlyhavejobsbeenoffshoredbutso,inasense,haspolitics.ThistrendisnotlimitedtotheUnitedStates;itisaglobalphenomenon,andinsomecountriesmattersarefarworsethanintheUnitedStates.Themostvividexampleshavearisenincountriesthathave48becomeoverindebted.Thelossof“control”bydebtorcountriesoftheirowndestiny—turningoverpowertocreditors—datesbacktotheearlierdaysofglobalization.Inthenineteenthcentury,poorcountriesthatowedmoneytobanksintherichnationswereconfrontedwithamilitarytakeover,orbombardment:Mexico,Egypt,andVenezuelawereallvictims.Thiscontinuedthroughthetwentiethcentury:inthe1930sNewfoundlandgaveupitsdemocracyasitwentintoreceivershipandbecameadministeredbyits49creditors.Inthepost–WorldWarIIera,theIMFwastheinstrumentofchoice:countriesturnedover,ineffect,theireconomicsovereigntytoanagencythatrepresentedtheinternationalcreditors.Itwasonethingfortheseeventstooccurinpoordevelopingcountries;it’sanotherforthemtooccurinadvancedindustrialeconomies.That’swhathasbeenhappeninglatelyinEurope,asfirstGreeceandthenItalyallowedtheIMF,togetherwiththeEuropeanCentralBankandtheEuropeanCommission(allunelected),todictateparametersofpolicyandthenappointtechnocratic114 50governmentstooverseetheimplementationoftheprogram.WhenGreeceproposedtosubmitthetoughausterityprogramthathadbeenpreparedtoapopularreferendum,therearoseashoutof51horrorfromEuropeanofficialsandthebankers:Greekcitizensmightrejecttheproposal,andthatmightmeanthatthecreditorswouldnotberepaid.Thesurrendertothedictatesoffinancialmarketsisbroaderandmoresubtle.Itappliesnotonlytothosecountriesonthebrinkofdisasterbutalsotoanycountrythathastoraisemoneyfromcapitalmarkets.Ifthecountrydoesn’tdowhatthefinancialmarketslike,theythreatentodowngradetheratings,topullouttheirmoney,toraiseinterestrates;thethreatsareusuallyeffective.Thefinancialmarketsgetwhattheywant.Theremaybefreeelections,but,aspresentedtothevoters,therearenorealchoicesinthemattersthattheycaremostabout—theissuesofeconomics.Twiceinthe1990sLuizInácioLuladaSilvawasonthevergeofbeingelectedpresidentofBrazil,andtwiceWallStreetobjected,exercisingwhatamountedtoaveto.Itsignaledthatifhewereelected,itwouldpullmoneyoutofthecountry,theinterestratesthatthecountrywouldhavetopaywouldsoar,thecountrywouldbeshunnedbyinvestors,anditsgrowthwouldcollapse.Thethirdtime,in2002,theBrazilianssaid,ineffect,52thattheywouldnotbedictatedtobyinternationalfinanciers.AndPresidentLulamadeanexcellentpresident,maintainingeconomicstability,promotinggrowth,andattackinghiscountry’sextremeinequality.Hewasoneofthefewpresidentsaroundtheworldwho,aftereightyears,stillenjoyedthepopularsupportthathehadinthebeginning.Thisisjustoneofmanyinstancesinwhichthejudgmentsofthefinancialmarketswerebadlyflawed.Proponentsoffinancialmarketsliketoclaimthatoneofthevirtuesofopencapitalmarketsisthattheyprovide“discipline.”Butthemarketsareafickledisciplinarian,givinganAratingonemomentandturningaroundwithanFratingthenext.Evenworse,thefinancialmarkets’interestsfrequentlydonotcoincidewiththoseofthecountry.Themarketsareshortsightedandhaveapoliticalandeconomicagendathatseekstheadvancementofthewell-beingoffinanciersratherthanthatofthecountryasawhole.Itdoesn’thavetobethisway.Financialmarketscanthreatentopullmoneyoutofacountryovernightlargelybecauseoftheirtotalopenness,especiallytoshort-termcapitalflows.Butinspiteofthefinancialmarket’sideologicalcommitmenttowhatiscalledcapitalmarketliberalization(allowingcapitaltomovefreelyinandoutofacountry)—anideologyconsistentwiththemarkets’self-interest—infactsuchliberalizationdoesn’tpromoteeconomicgrowth;itdoes,however,leadtoincreased53instabilityandinequality.TheproblemsthatI’veoutlinedrundeeperandareinfactmorewidespread.Asoneoftheworld’sexpertsonglobalization,theHarvardUniversityprofessorDaniRodrikhaspointedout,onecannotsimultaneouslyhavedemocracy,nationalself-determination,54andfullandunfetteredglobalization.Often,internationalcompanieshaveattemptedtoobtainintheinternationalarenawhattheycannotgetathome.TheFinancialServicesAgreementoftheWorldTradeOrganization(WTO)hastriedtoforcefinancialmarketliberalization,requiringgovernmentsto115 allowforeignbanksintotheircountriesandrestrainingtheabilitytoimposeregulationsthatwouldensurethatthefinancialsystemisstableandactuallyservestheeconomyandsocietyinthewayitshould.TheUruguayRoundTradeAgreementhassuccessfullyforceduponcountriesaroundtheworldaversionofintellectualpropertyrightsthatisbadforAmericanscience,badforglobalscience,badfordevelopingcountries,andbadforaccesstohealth.Designedbycorporateintereststopreventthefreeflowofknowledge,theagreementstrengthensmonopolypower—helpingcreaterents,and,aswesawinchapter2,rentsarethe55sourceofsomuchoftoday’sinequality.Whetheroneagreesornotwiththisassessmentofthisparticularinternationalagreement,itisclearthatithasimposedsevere—unnecessarilysevere—stricturesonthedesignofeachcountry’sintellectualpropertyregime.Ithasunderminedthecountries’self-determinationandthepoweroftheirdemocracies.Theycannotchooseanintellectualpropertyregimethatreflectstheirviewofwhatwillbestpromotetheadvanceofknowledgeintheircountry,balancingconcernsaboutaccesstoknowledgeandtolife-savingmedicineswiththenecessityofprovidingincentivesforresearchandinnovation;theyhavetochoosearegimethatconformswith56thedictatesoftheWTO.Otherexamplesabound.TheUnitedStates,initsbilateraltradeagreementwithSingapore,attemptedtorestrictthatcountry’sregulationsconcerningchewinggum:itwasworriedthattheymightdiscourageU.S.exportsofoneofour“major”exportcommodities,chewinggum.InitsbilateralagreementwithChile,theUnitedStatesattemptedtopreventtheimpositionofcapitalcontrols,rulesthatthecountryhadusedsuccessfullytostabilizeitseconomy.Otheragreementshavetriedtopreventcountriesfromdiscouragingthepurchaseofgasoline-guzzlingvehicles,becausethosearethekindsofcarsinwhichAmericaspecializes.Chapter11oftheNorthAmericanFreeTradeAgreementandotherbilateralinvestmentagreements(andothereconomicagreementsthattheUnitedStatesandEuropehavesignedwithdevelopingcountries)arguablyprovidescompensationtofirmsforlossofprofitsincurredasaresultofaregulatorychange,somethingthatbothCongressandtheU.S.courtshaverefusedtodo.Itisaprovisiondesignedtodiscourageenvironmentalregulationsbymakingtheimpositionofsuchregulationscostlyto57thegovernment’sbudget.Formanydevelopingcountries—and,morerecently,evenforEuropeancountries—thatareindebtedandhavetoturntotheIMF,theconsequencesoftheirlossofeconomicsovereigntyhavebeenserious.AtleastwithintheUnitedStatesandmostEuropeancountries,the1percentnormallydoesn’tgetitswaywithoutafight.ButfinanceministriesoftenusetheIMFtoenforcetheirperspectives,toadopttheinstitutionalarrangementsandtheregulatoryandmacroeconomicframeworksthatareintheinterestsofthe1percent.EvenGreece,tosecureits2011bailoutbytheEuropeanUnion,wasforcedtopasslawsaffectingnotonlythebudgetbutalsothehealthsector,therightsofunionsincollectivebargaining,andtheminimumwage.Evenwhenglobalizationdoesn’tcircumscribedemocracythroughglobalagreementsoraspartofaninternational“rescue,”itcircumscribesdemocracythroughcompetition.Oneofthereasons,weweretold,thatwehadtohaveweakfinancialregulationswasthatifwedidn’t,financialfirmswouldmoveoverseas.In116 responsetoaproposaltotaxbankbonuses,Londonfirmsthreatenedtoleavethecountry.Inthesecases,onemightargue:goodriddance.Thecosttosociety—thebailouts,theeconomicdisruption,theinequality—ofthefinancialsector’sexcessesfaroutweighsthefewjobsthatcompaniesinthesectorcreate.Thespeculatorswillleave;butthoseengagedinthekindoffinancethatreallymatters—lendingtolocalfirms—willstay.Thesehavetobehere.Thearenainwhichdemocracyismostcircumscribedisintaxation,especiallyinthedesignoftaxsystemsthatreduceinequality.Whatiscalledtaxcompetition—theracebetweendifferentpolitiestohavethelowesttaxesaround—limitsthescopeforprogressivetaxation.Firmsthreatentoleaveiftaxesaretoohigh.Sodowealthyindividuals.HeretheUnitedStateshasatleastoneadvantageoverothercountries:wearetaxedonourworldwideincome.AGreekcitizen,havingbenefitedfromthatcountry’spublicschoolsanduniversities,andhavingenjoyedthebenefitofitshospitalsandhealthcaresystem,cantakeupresidenceinLuxembourg,dobusinessinallofEuropefreely,andavoidanyresponsibilityofpayingtaxes—eventorepaythecostsofhereducation.Weareoftentoldthatthisisthewayithastobe,thatglobalizationgivesusnochoice.Thisfatalism,whichservesthosebenefitingfromthecurrentsystem,obscuresreality:thepredicamentisachoice.Thegovernmentsofourdemocracieshavechosenaneconomicframeworkforglobalizationthathasactuallytiedthehandsofthosedemocracies.The1percentwasalwaysworriedthatdemocracieswouldbetemptedtoenact“excessively”progressivetaxationundertheinfluence,say,ofapopulistleader.Nowcitizensaretoldtheycan’tdoso,notiftheywanttopartakeofglobalization.Inshort,globalization,asit’sbeenmanaged,isnarrowingthechoicesfacingourdemocracies,makingitmoredifficultforthemtoundertakethetaxandexpenditurepoliciesthatarenecessaryifwearetocreatesocietieswithmoreequalityandmoreopportunity.Buttyingthehandsofourdemocraciesisexactlywhatthoseatthetopwanted:wecanhaveademocracywithonepersononevote,andstillgetoutcomesthataremoreinaccordwithwhatwemightexpectinasystemwithonedollarone58vote.DiminishingAmerica’sinfluenceAmerica’sglobalstrengthisitssoftpower,thepowerofitsideas,aneducationalsystemthateducatesleadersfromallovertheworld,themodelthatitprovidesforotherstofollow.IraqandAfghanistanhaveshownthelimitsofmilitarypower;notevenalargecountryspendingasmuchonthemilitaryasalloftherestoftheworldcombinedcantrulypacifyorconqueracountrywithone-tenthitspopulationand0.1percentofitsGDP.Thecountryhaslongexerteditsinfluencebythestrengthofitseconomyandtheattractivenessofitsdemocracy.ButtheAmericanmodelislosingsomeofitsluster.It’snotjustthattheAmericanmodelofcapitalismdidn’tprovidesustainedgrowth.It’smorethatothersarebeginningtorealizethatmostcitizenshavenotbenefitedfromthatgrowth,andsuchamodelisnotverypoliticallyattractive.Andtheyaresensing,too,thecorruption(Americanstyle)ofourpoliticalsystem,rife117 withtheinfluenceofspecialinterests.Ofcourse,there’smorethanalittleschadenfreudehere.Welecturedcountriesallaroundtheworldabouthowtoruntheireconomy,aboutgoodinstitutions,aboutdemocracy,aboutfiscalrectitudeandbalancedbudgets.Weevenlecturedthemabouttheirexcessiveinequalityandrentseeking.Nowourcreditabilityisgone:weareseentohaveapoliticalsysteminwhichonepartytriestodisenfranchisethepoor,inwhichmoneybuyspoliticiansandpoliciesthatreinforcetheinequalities.Weshouldbeconcernedabouttheriskofthisdiminishedinfluence.EvenifthingshadbeengoingbetterintheUnitedStates,thegrowthoftheemergingmarketswouldnecessitateanewglobalorder.Therewasjustashortperiod,betweenthefalloftheBerlinWallandthecollapseofLehmanBrothers,whentheUnitedStatesdominatedinvirtuallyeveryrealm.Nowtheemergingmarketsaredemandingalargervoiceininternationalforums.WemovedfromtheG-8,wheretherichestindustrialcountriestriedtodetermineglobaleconomicpolicy,totheG-20,becausewehadto:theglobalrecessionprovidedtheimpetus,butonecouldnotdealwithglobalissues,likeglobalwarmingorglobaltrade,withoutbringingothersin.Chinaisalreadythesecond-largestglobaleconomy,thesecond-largesttradingeconomy,thelargestmanufacturingeconomy,thelargestsaver,andthelargestcontributortogreenhousegasemissions.Americahasbeenextraordinarilyinfluentialinspreadingideas—ofequality,ofhumanrights,ofdemocracy,ofthemarket.Havingaworldthatsharesthesevalueshasbeenpartofthecountry’smission.Butitisalsoinourself-interest.Iobservedearlierthatourrealsourceofpowerisoursoftpower;butthatpowerarisesonlybecauseothersseethingsthroughlensesthatarenottoodissimilarfromours.WemaytrytoenforceapaxAmericana,butwehaveseenhowdifficultandcostlythatis.Farbetterforotherstoseetheirinterestsascoincidentwithours,increatingdemocraticandprosperoussocieties.Themanagementofglobalizationrequiresglobalagreements,intrade,finance,investment,theenvironment,health,andthemanagementofknowledge.InthepasttheUnitedStateshadenormousinfluenceinshapingtheseagreements.Wehavenotalwaysusedthatinfluencewell;wehaveoftenusedittoadvancesomeofourspecialinterests,aidingandabettingtherent-seekingactivitiesthatplaysuchalargeroleinthecreationofinequalities.Althoughintheearlydaysofmodernglobalization,thatwasnotfullygrasped,todayitis.Thereisademandforachangeinthegovernanceoftheglobaleconomicinstitutionsandarrangements,and,combinedwiththenewbalanceofglobaleconomicpower,changesareinevitable.Eventhen,ourinfluenceislikelytoremainlarge,almostsurelydisproportionatetoourpopulationoroureconomy.Buttheextenttowhichtheglobaleconomyandpolitycanbeshapedinaccordwithourvaluesandinterestswilldepend,toalargeextent,onhowwelloureconomicandpoliticalsystemisperformingformostcitizens.Asdemocraciesgrowinmanyotherpartsoftheworld,aneconomicandpoliticalsystemthatleavesmostcitizensbehind—asourshasbeendoing—willnotbeseenasasystemtobeemulated,andtherulesofthegamethatsuchacountryadvocateswillbeapproachedwithjaundicedeyes.118 CONCLUDINGCOMMENTSTheUnitedStatesplayedacentralroleincreatingthecurrentrulesofthegameandtheUnitedStates,stilltheworld’slargesteconomy,canuseitseconomicpowerandinfluencetoshapenewrulesthatcreateafairerglobaleconomy.Itmayormaynot59beintheinterestsofthe1percenttodoso,butitisinourbroadernationalinterests.Aswesawearlier,currentrulesofglobalizationarecontributingtoourgrowinginequality.Someday,perhapssoon,wetoowillseehowglobalizationascurrentlymanagedpromotesneitherglobalefficiencynorequity;evenmoreimportantly,itputsourdemocracyinperil.Anotherworldispossible:therearealternativewaysofmanagingglobalizationthatarebetterforbothoureconomyandourdemocracy;buttheydonotentailunfetteredglobalization.Wehavelearnedtherisksofunfetteredmarketsforoureconomyandhowtotempercapitalismsothatitservesthemajorityofcitizens,notatiny,powerfulfraction.Sotoo,wecantemperglobalization;indeed,wemustifwewanttopreserveourdemocracy,preventourrampantinequalityfromgrowingworse,andmaintainourinfluencearoundtheworld.119 CHAPTERSIX1984ISUPONUSTHEBIGPUZZLEWEPRESENTEDINTHELASTCHAPTERwashow,inademocracysupposedlybasedononepersononevote,the1percentcouldhavebeensovictoriousinshapingpoliciesinitsinterests.Wedescribedaprocessofdisempowerment,disillusionment,anddisenfranchisementthatproduceslowvoterturnout,asysteminwhichelectoralsuccessrequiresheavyinvestments,andinwhichthosewithmoneyhavemadepoliticalinvestmentsthathavereapedlargerewards—oftengreaterthanthereturnstheyhavereapedontheirotherinvestments.Thereisanotherwayformoneyedintereststogetwhattheywantoutofgovernment:convincethe99percentthattheyhavesharedinterests.Thisstrategyrequiresanimpressivesleightofhand;inmanyrespectstheinterestsofthe1percentandthe99percentdiffermarkedly.Thefactthatthe1percenthassosuccessfullyshapedpublicperceptiontestifiestothemalleabilityofbeliefs.Whenothers1engageinit,wecallit“brainwashing”and“propaganda.”Welookaskanceattheseattemptstoshapepublicviews,becausetheyareoftenseenasunbalancedandmanipulative,withoutrealizingthatthereissomethingakingoingonindemocracies,too.Whatisdifferenttodayisthatwehavefargreaterunderstandingofhowtoshapeperceptionsandbeliefs—thankstotheadvancesinresearchinthesocialsciences.Incontradistinctiontotherealitythatperceptionsandpreferencescanbeshaped,mainstreameconomicsassumesthatindividualshavewell-definedpreferencesandfullyrationalexpectationsandperceptions.Individualsknowwhattheywant.Butinthisrespect,traditionaleconomicsiswrong.Ifitweretrue,2therewouldbelittlescopeforadvertising.Corporationsuserecentadvancesinpsychologyandeconomicsthatextendourunderstandingofhowpreferencesandbeliefscanbeshapedtoinducepeopletobuytheirproducts.Inthischapterwe’llseehowthoseinthe1percenthaveshapedbeliefsaboutwhatisfairandefficient,aboutthestrengthsandweaknessesofgovernmentandthemarket,andevenabouttheextentofinequalityinAmericatoday.Itisclearthatmany,ifnotmost,Americanspossessalimitedunderstandingofthenatureoftheinequalityinoursociety:Theybelievethatthereislessinequalitythanthereis,they3underestimateitsadverseeconomiceffects,theyunderestimatetheabilityofgovernmenttodoanythingaboutit,andtheyoverestimatethecostsoftakingaction.Theyevenfailtounderstandwhatthegovernmentisdoing—manywhovaluehighlygovernmentprogramslikeMedicaredon’trealizethattheyarein4thepublicsector.120 Inarecentstudyrespondentsonaveragethoughtthatthetopfifthofthepopulationhadjustshortof60percentofthewealth,whenintruththatgroupholdsapproximately85percentofthewealth.(Interestingly,respondentsdescribedanidealwealthdistributionasoneinwhichthetop20percentholdjustover30percentofthewealth.Americansrecognizethatsomeinequalityisinevitable,andperhapsevendesirableifoneistoprovideincentives;butthelevelofinequalityinAmericansocietyis5wellbeyondthatlevel.)NotonlydoAmericansmisperceivethelevelofinequality;theyunderestimatethechangesthathavebeengoingon.Only42percentofAmericansbelievethatinequalityhasincreasedinthepastten6years,wheninfacttheincreasehasbeentectonic.Misperceptionsareevident,too,inviewsaboutsocialmobility.Severalstudieshaveconfirmedthatperceptionsofsocialmobility7areoverlyoptimistic.Americansarenotaloneintheirmisperceptionsofthedegreeofinequality.Lookingacrosscountries,itappearsthatthereisaninversecorrelationbetweentrendsininequalityandperceptionsofinequalityandfairness.OnesuggestedexplanationisthatwheninequalityisaslargeasitisintheUnitedStates,itbecomeslessnoticeable—perhapsbecausepeoplewithdifferent8incomesandwealthdon’tevenmix.Thesemistakenbeliefs,whatevertheirorigins,arehavinganimportanteffectonpoliticsandeconomicpolicy.Perceptionshavealwaysshapedreality,andunderstandinghowbeliefsevolvehasbeenacentralfocusofintellectualhistory.Muchasthoseinpowermightliketoshapebeliefs,andmuchastheydoshapebeliefs,theydonothavefullcontrol:ideashavealifeoftheirown,andchangesintheworld—inoureconomyandtechnology—impactideas(justasideashaveanenormouseffectinshapingoureconomy).Whatisdifferenttodayisthatthe1percentnowhasmoreknowledgeabouthowtoshapepreferencesandbeliefsinwaysthatenablethewealthytobetteradvancetheircause,andmoretoolsandmoreresourcestodoso.Inthischapter,Idescribesomeoftheresearchineconomicsandpsychologythatextendsourunderstandingofthelinksbetweenperceptionsandreality.Ishowhowthe1percenthasusedtheseadvancestoalterperceptionsandachieveitsaims—tomakeourinequalityseemlessthanitisandmoreacceptablethanitshouldbe.SOMEBASICSOFMODERNPSYCHOLOGYANDECONOMICSUnderstandinghowpeopleactuallybehave—ratherthanhowtheywouldbehaveif,forinstance,theyhadaccesstoperfectinformationandmadeefficientuseofitintheirattemptstoreachtheirgoals,whichtheythemselvesunderstoodwell—isthesubjectofanimportantbranchofmoderneconomicscalledbehavioraleconomics.Thisschoolholdsthatevenifbehaviorisnotconsistentwiththestandardtenetsofrationality,itstillmaybepredictable.Andifwecanunderstandwhatdetermines9behavior,wecanshapeit.Workinmodernpsychologyandbehavioraleconomicshasobservedthat,incertainarenas,therearesystematicmisperceptions.Thereareconsistentbiasesinjudgments.Andtheworkhassetout121 toexplainwhatdeterminesthosebiasesandmisperceptions.FramingandmisperceptionsThisresearchhasemphasizedhowmuchourperceptionsareaffectedby“framing,”forinstance,thecontextinwhichtheanalysisisposed.Policelineupsarenotorious:evenifnoneoftheaccusedcouldhavebeenatthesceneofthecrime,eyewitnesseswillidentifyoneofthemastheculprit,withconviction.Muchofthebattleinpoliticstodayisoverframing.Theframesthatdifferentpartsofoursocietybringtobearaffecttheirjudgments.Onecanmanipulateframesandthusperceptionsandbehavior.10Theseframesandperceptionscanbeself-reinforcing.Onesetofexperimentsshowshow“fragile”andeasilyaffectedourbeliefscanbe.Individualsareaskedtodrawanumberoutofahat.Theyarethenaskedaquestionaboutwhichtheyhaverelativelylittleinformation,suchasthenumberofshipsthatpassedthroughthePanamaCanallastyear.Theanswer,itturnsout,issystematicallyrelatedtotherandomnumbertheypreviouslypulledoutofthehat—thosewhopulledoutalarger11numbersystematicallyrespondwithahighernumber.Standardeconomictheorybegins,aswehavenoted,withthepresumptionthatindividualshavewell-definedpreferencesandbeliefs.Theymakedecisionsabouthowmuchtosaveonthebasisofacarefulevaluationofthebenefitsofconsumingtodayversusconsuminginthefuture.Therealityisotherwise.Whenemployersaskindividualshowmuchoftheirincometheywouldliketoputintotheirretirementaccounts,theanswerdependsheavilyonhowtheemployer“frames”thequestion.Ifshesays,forinstance,that10percentwillbedeductedfromincomeandputintoaretirementaccountunlesstheemployeeelectstosavemore(15percent)orless(5percent),overwhelminglytheworkerchooses10percent.Butiftheemployersaysthat15percentwillbedeductedunlesstheemployeechoosesasmallernumber(5percentor10percent),thenumber15percentischosenmuchmorefrequently.Ifsheposesthequestionstilldifferently,givingadditionaloptionsof20percentor25percent,theseoptions—irrelevantformostindividuals,becausetheywouldn’t,inanycase,bechosen—12stillaffecttheemployee’schoice.Suchbehaviorshouldnotcomeasasurprise(atleastnottosomeonewhoisnotaneconomist).Individualsdon’treallyknowwhatlifewillbelikefortyyearsfromnowandthereforehavelittlebasisformakingajudgmentabouthowmuchtosavenow.Thestandardmodelineconomicshasindividualsmakingchoicesrepeatedly—say,betweenredlettuceandgreenlettuce,experimentinganddiscoveringwhattheytrulylike.Butunlessthereisreincarnation,thereisnowaythatanindividualcanrepeatedlygothroughthesavingsexperimentovertime:ifhesavestoolittle,hemaylivetoregretit,buthewon’tbeabletolivehislifeoveragain;thesameappliesifhesavestoomuch.Andtoday’sworldissodifferentfromyesterday’sthatthereislittlethathecanlearnfromhisparentsaboutlifecyclesavingsandlittlethathischildrencanlearnfromhim.Equilibriumfictions122 Thereisasecondimportantpropositionfrompsychologicalresearch:individualsprocessinformationthatisconsistentwiththeirpriorbeliefsdifferentlyfromhowtheyprocessinformation13thatisinconsistent.Informationthatisconsistentisremembered,seenasrelevant,andreinforcesbeliefs.Informationthatisinconsistentismorelikelytobeignored,discounted,or14forgotten.Thisdistortioniscalled“confirmatorybias.”The“equilibriumfictions”thatcanresultfromthisprocessarebeliefsthataremaintainedstronglybecausetheevidencethatpeoplesee—astheyperceiveandprocessit—isfullyconsistent15withthosebeliefs.BehavioraleconomicsandmodernmarketingShapingbehaviorisacentralgoalofmarketing.Overtheyears,firmshaveworkedhardtounderstandwhatdeterminesconsumers’buyingdecisions;foriftheyunderstandthat,theycaninducepeopletobuymoreoftheirproducts.Thus,themajorobjectiveofadvertisingisnottoconveyinformation,buttoshapeperceptions.Thebest-knownexamplesconjurealifestyle—whichmayevenbeatoddswiththatoftherealusersoftheproduct—thatconsumersaspireto.TheMarlboroManoffersanegregious16exampleofthisstrategy.PerceptionsaffectbehaviorandmarketequilibriumBeliefsandperceptions,whethertheyaregroundedinrealityornot,affectbehavior.Ifpeopleseethe“Marlboroman”asthetypeofpersontheyaspiretobe,theymaychoosethatcigaretteoverothers.Ifindividualsoverestimatesomerisk,theymaytakeexcessiveprecautions.Butimportantasperceptionsandbeliefsareinshapingindividualbehavior,theyareevenmoreimportantinshapingcollectivebehavior,includingpoliticaldecisionsaffectingeconomics.Economistshavelongrecognizedtheinfluenceofideasinshapingpolicies.AsKeynesfamouslyputit,Theideasofeconomistsandpoliticalphilosophers,bothwhentheyarerightandwhentheyarewrong,aremorepowerfulthaniscommonlyunderstood.Indeedtheworldisruledbylittleelse.Practicalmen,whobelievethemselvestobequiteexemptfromanyintellectualinfluence,areusuallythe17slavesofsomedefuncteconomist.Socialscienceslikeeconomicsdifferfromthehardsciencesinthatbeliefsaffectreality:beliefsabouthowatomsbehavedon’taffecthowatomsactuallybehave,butbeliefsabouthowtheeconomicsystemfunctionsaffecthowitactuallyfunctions.GeorgeSoros,thegreatfinancier,hasreferredtothisphenomenonas18reflexivity,andhisunderstandingofitmayhavecontributedtohissuccess.Keynes,whowasfamousnotjustasagreateconomistbutalsoasagreatinvestor,describedmarketsasabeauty123 contestwherethewinneristheonewhoassessedcorrectlywhattheotherjudgeswouldjudgetobethemostbeautiful.Marketscansometimescreatetheirownreality.Ifthereiswidespreadbeliefthatmarketsareefficientandthatgovernmentregulationsonlyinterferewithefficiency,thenitismorelikelythatgovernmentwillstripawayregulations,andthiswillaffecthowmarketsactuallybehave.Inthemostrecentcrisiswhatfollowedfromderegulationwasfarfromefficient,butevenhereabattleofinterpretationrages.MembersoftheRighttriedtoblametheseemingmarketfailuresongovernment;intheirmindthegovernmentefforttopushpeoplewithlowincomesintohomeownershipwasthesourceoftheproblem.Widespreadasthisbeliefhasbecomeinconservativecircles,virtuallyallseriousattemptstoevaluatetheevidencehaveconcludedthatthereislittlemeritinthisview.Butthelittlemeritthatithadwasenoughtoconvincethosewhobelievedthatmarketscoulddonoevilandgovernmentscoulddonogoodthattheirviewswerevalid,19anotherexampleof“confirmatorybias.”PerceptionsofinequalityandindividualbehaviorAswediscussedinchapter4,ifindividualsbelievethattheyarebeingtreatedunfairlybytheiremployer,theyaremorelikelytoshirkonthejob.Ifindividualsfromsomeminorityarepaidlowerwagesthanotherequallyqualifiedindividuals,theywillandshouldfeelthattheyarebeingtreatedunfairly—butthelowerproductivitythatresultscan,andlikelywill,leademployersto20paylowerwages.Therecanbea“discriminatoryequilibrium.”Evenperceptionsofrace,caste,andgenderidentitiescanhavesignificanteffectsonproductivity.InabrilliantsetofexperimentsinIndia,low-andhigh-castechildrenwereaskedtosolvepuzzles,withmonetaryrewardsforsuccess.Whentheywereaskedtodosoanonymously,therewasnocastedifferenceinperformance.Butwhenthelowcasteandhighcastewereinamixedgroupwherethelow-casteindividualswereknowntobelowcaste(theyknewit,andtheyknewthatothersknewit),low-caste21performancewasmuchlowerthanthatofthehighcaste.Theexperimenthighlightedtheimportanceofsocialperceptions:low-casteindividualssomehowabsorbedintotheirownrealitythebeliefthatlower-casteindividualswereinferior—butonlysointhepresenceofthosewhoheldthatbelief.PerceptionsoffairnessandthepoliticsofinequalityIexplainedearlierhowourperceptionsareaffectedby“framing,”andthusit’snotsurprisingthatmuchofthebattletodayisovertheframingofinequality.Fairness,likebeauty,isatleastpartlyintheeyesofthebeholder,andthoseatthetopwanttobesurethattheinequalityintheUnitedStatestodayisframedinwaysthatmakeitseemfair,oratleastacceptable.Ifitisperceivedtobeunfair,notonlymaythathurtproductivityintheworkplacebutitmightleadtolegislationthatwouldattempttotemperit.Inthebattleoverpublicpolicy,whatevertherealpolitikofspecialinterests,publicdiscoursefocusesonefficiencyand124 fairness.Inmyyearsingovernment,Ineverheardanindustrysupplicantlookingforasubsidyaskforitsimplybecauseitwouldenrichhiscoffers.Instead,thesupplicantsexpressedtheirrequestsinthelanguageoffairness—andthebenefitsthatwouldbeconferredonothers(morejobs,hightaxpayments).ThesamegoesforthepoliciesthathaveshapedthegrowinginequalityintheUnitedStates—boththosethathavecontributedtotheinequalityinmarketincomesandthosethathaveweakenedtheroleofgovernmentinbringingdownthelevelofinequality.Thebattleabout“framing”firstcentersonhowweseethelevelofinequality—howlargeisit,whatareitscauses,howcanitbejustified?CorporateCEOs,especiallythoseinthefinancialsector,havethustriedtopersuadeothers(andthemselves)thathighpaycanbejustifiedasaresultofanindividual’slargercontributiontosociety,andthatitisnecessarytomotivatehimtocontinuemakingthosecontributions.Thatiswhyitiscalledincentivepay.Butthecrisisshowedtoeveryonewhateconomicresearchhadlongrevealed—theargumentwasasham.Aswenotedinchapter4,whatwascalledincentivepaywasanythingbutthat:paywashighwhenperformancewashigh,butpaywasstillhighwhenperformancewaslow.Onlythenamechanged.Whenperformancewaslow,thenamechangedto“retentionpay.”Iftheproblemsofthoseatthebottomaremainlyoftheirownmakingandifthosecollectingwelfarecheckswerereallylivinghighontherestofsociety(asthe“welfaredeadbeats”and“welfarequeen”campaigninthe1980sand1990ssuggested),thenthereislittlecompunctioninnotprovidingassistancetothem.Ifthoseatthetopreceivehighincomesbecausetheyhavecontributedsomuchtooursociety—infact,theirpayisbutafractionoftheirsocialcontribution—thentheirpayseemsjustified,especiallyiftheircontributionsweretheresultofhardworkratherthanjustluck.Otherideas(theimportanceofincentivesandincentivepay)suggestthattherewouldbeahighpricetoreducinginequality.Stillothers(trickle-downeconomics)suggestthathighinequalityisnotreallythatbad,sinceallarebetteroffthantheywouldbeinaworldwithoutsuchahighlevelofinequality.Ontheothersideofthisbattlearecounteringbeliefs:fundamentalbeliefsinthevalueofequality,andanalysessuchasthosepresentedinearlierchaptersthatfindthatthehighlevelofinequalityintheUnitedStatestodayincreasesinstability,reducesproductivity,andunderminesdemocracy,andthatmuchofitarisesinwaysthatareunrelatedtosocialcontributions,thatitcomes,rather,fromtheabilitytoexercisemarketpower—theabilitytoexploitconsumersthroughmonopolypowerortoexploitpooranduneducatedborrowersthroughpracticesthat,ifnotillegal,oughttobe.Theintellectualbattleisoftenfoughtoverparticularpolicies,suchaswhethertaxesshouldberaisedoncapitalgains.Butbehindthesedisputesliesthisbiggerbattleoverperceptionsandoverbigideas—liketheroleofthemarket,thestate,andcivilsociety.Thisisnotjustaphilosophicaldebatebutabattleovershapingperceptionsaboutthecompetenciesofthesedifferentinstitutions.Thosewhodon’twantthestatetostoptherentseekingfromwhichtheybenefitsomuch,anddon’twantittoengageinredistributionortoincreaseeconomicopportunityandmobility,emphasizethestate’sfailings.(Remarkably,thisistrueevenwhentheyareinofficeandcouldandshoulddo125 somethingtocorrectanyproblemofwhichtheyareaware.)Theyemphasizethatthestateinterfereswiththeworkingsofthemarkets.Atthesametimethattheyexaggeratethefailuresofgovernment,theyexaggeratethestrengthsofmarkets.Mostimportantlyforourpurposes,theystrivetomakesurethattheseperceptionsbecomepartofthecommonperspective,thatmoneyspentbyprivateindividuals(presumably,evenongambling)isbetterspentthanmoneyentrustedtothegovernment,andthatanygovernmentattemptstocorrectmarketfailures—suchastheproclivityoffirmstopolluteexcessively—causemoreharmthan22good.ThisbigbattleiscrucialforunderstandingtheevolutionofinequalityinAmerica.ThesuccessoftheRightinthisbattleduringthepastthirtyyearshasshapedourgovernment.Wehaven’tachievedtheminimaliststatethatlibertariansadvocate.Whatwe’veachievedisastatetooconstrainedtoprovidethepublicgoods—investmentsininfrastructure,technology,andeducation—thatwouldmakeforavibranteconomyandtooweaktoengageintheredistributionthatisneededtocreateafairsociety.Butwehaveastatethatisstilllargeenoughanddistortedenoughthatitcanprovideabountyofgiftstothewealthy.Theadvocatesofasmallstateinthefinancialsectorwerehappythatthegovernmenthadthemoneytorescuethemin2008—andbailoutshaveinfactbeenpartofcapitalismfor23centuries.Thesepoliticalbattles,inturn,restonbroaderideasabouthumanrights,humannature,andthemeaningofdemocracyandequality.DebatesandperspectivesontheseissueshavetakenadifferentcourseintheUnitedStatesinrecentyearsthaninmuchoftherestoftheworld,especiallyinotheradvancedindustrialcountries.Twocontroversies—thedeathpenalty(whichisanathemainEurope)andtherighttoaccesstomedicine(whichinmostcountriesistakenasabasichumanright)—areemblematicofthesedifferences.Itmaybedifficulttoascertaintherolethegreatereconomicandsocialdividesinoursocietyhasplayedincreatingthesedifferencesinbeliefs;butwhatisclearisthatifAmericanvaluesandperceptionsareseentobeoutoflinewiththoseintherestoftheworld,ourglobalinfluencewillbediminished,aswesuggestedinthelastchapter.HowideasevolveChangingideasaboutthesefundamentalsarebothcauseandconsequenceofachangingsocietyandeconomy—includingchangesinsocietalinequality.Thehistoryofideasdescribeshowideasevolve.Noone24controlstheevolution.Changeismoreorganic.Ideasemergefromavarietyofsources—ofteninresponsetotheeventsofthe25moment,sometimesaspartofanaturalevolutionaryprocess.Ideasgetthrownout(onecanthinkofthemasintellectualmutations),andsomefindfertileground:theyhelppeopleunderstandtheworld,especiallyasitisintheirself-interesttounderstandit.Inthepast,beliefssometimeschangedinwaysthatenhancedthewell-beingoftheelites,aswhenideasthatjustifiedslaveryorinequalitybecameprevalent.Sometimesbeliefschangedinwaysthatworkedagainsttheirinterests.SurelyelitesintheUKwould126 havepreferredthatEnlightenmentideashadnotcrossedtheAtlantic.SlaveownersintheSouthwouldhavelikedtokeeptheexpression“allmenarecreatedequal”morenarrowlydefined.Thattherewereatleastsomeinstancesinwhichbeliefsevolvedinwaysthatwerecountertotheinterestsoftheelitessuggeststhat,atleastinthepast,theelitesdidn’tinfactfullycontroltheirevolution.Globalizationhas,forinstance,broughtnewideastomanycountries,includingideasaboutdemocracy,humanrights,andequality.Achangeintechnologyormarketstructure—themovefromagriculturetomanufacturing,orfrommanufacturingtoaservicesectoreconomy—inevitablyisaccompaniedbysocietalchangesofenormousmagnitude,includingideasabouthowsocietyandtheeconomyshouldbeorganized.Thedevelopmentofmanufacturingrequiredamoreeducatedlaborforce,anditwasdifficulttomakeanargumentnottoextendvotingrightstothewelleducated,eveniftheywerenotmembersofearlierelites.Successesandfailuresofgovernmentsandmarketshaveplayedanimportantroleintheevolutionofideasabouttheroleofeachinthepastcentury.WiththeGreatDepression,whenoneoutoffourworkerswasoutofajob,itwashardforanyonebutadevotedideologuetoseemarketsasalwaysefficient.Itwasnotsurprisingthatunderthosecircumstances,theideathatgovernmentshouldplayamoreimportantroleinmacromanagementgainedstrength.Before1960,inmostdevelopingcountriesaroundtheworld,markets(atleastasshapedbycolonialpowers)bythemselveswerenotdeliveringgrowth.Itwasnaturalthatmanyinthesesocietiescametotheconclusionthatgovernmentshouldplayamoreimportantroleindevelopment.Withthefailuresofcommunism,though,itwassimilarlyhardforanybutadevotedideologuetobelievethatgovernmentshouldtakeadominantroleintheeconomy.Outoftheseexperiences,outofobservationsthatmarketsoftenfail,butsodogovernments,theideaadvocatedhere—thatthereneedstobeabalancedrolebetweenmarkets,thestate,andcivilsociety—naturallyevolved.Whatthatbalancewouldbecoulddifferacrosscountriesandovertime.InEastAsiatherearosetheideaofthedevelopmentalstate,onethatorchestrateddevelopment,butusedmarketmechanisms.Thereweresomeenormoussuccesses,thefastestsustainedgrowthever,withhugereductionsinpoverty,andlargegainsforthevastmajorityofcitizens.Butideasandinterpretationsofhistoricaleventsarealwayscontested.Somelookattheseexperiencesand,somehow,comeupwithalternativeinterpretations.Some(liketheNobellaureateandUniversityofChicagoeconomistMiltonFriedman)constructedaninterpretationoftheGreatDepressionthatfocusedongovernmentfailure,justastheRightlooksattheGreatRecessionandseekstoputblameongovernmenteffortstopromotehousingforthepoor.SomelookedattheenormoussuccessesoftheUnitedStatesintheyearsafterWorldWarII—itsrelativestability,itsrapidgrowth,agrowthfromwhichallshared—andsaidthatgrowthcouldbeevenfaster,ifonlywederegulatedandloweredtaxes.(Ofcourse,asearlierchapterspointedout,thatdidn’thappen:growthintheeraofderegulationandlowertaxeswasslower,andthecountrygrewapart.)Asourdiscussionofequilibriumfictionsemphasized,evidencedoesn’talwaysresolvethesedisputes:theadvocatesofdifferentperspectivesseeevidenceindifferentways.EvenifgrowthintheeraofderegulationandlowtaxeswasslowerandmostAmericans127 didn’tdowell,somethingelsecanbeblamed—therewerestilltoomanyregulationsandtoomuchuncertaintycausedbythoseadvocatingmoreregulations.AnalysesshowingthatFannieMaeandFreddieMacwerenotatthecenteroftheGreatRecessionare26simplydismissed.Someideasaretransformative,butforthemostpartsocietalchangeandchangeinbeliefsoccursslowly.Sometimes,thereisadisparitybetweenthepaceofchangeofideasandofsociety;sometimesthedisparitybetweenbeliefsandrealityissostartlingitforcesarethinkingofideas—orachangeinsociety.Changeoftenoccurslessrapidlythanitseemsthatitshould,andtheslowevolutionofideasisoneofthereasonsthatsocietiessometimeschangeslowly.TheDeclarationofIndependencemayhaveenunciatedclearlyin1776theprinciplethatallmenwerecreatedequal,butitwouldbealmosttwocenturiesbeforetheUnitedStatesadoptedcivilrightslegislationthatwouldembracethisprinciple,andfullequalityhasyettobeachieved.Oneofthereasonsthatideaschangeslowlyisthatideasandperceptionsaresocialconstructs.Mywillingnesstoholdabeliefisrelatedtoothers’holdingsimilarbeliefs.AsItravelaroundthecountryandtheworld,Iamoftenstruckhowinsomeplacesonesetofideasispartofconventionalwisdom—suchasthatgovernmentisnecessarilyinefficientorthatgovernmentcausedtherecessionorthatglobalwarmingisafiction—andinothersjusttheoppositeistakentobethe“truth.”Mostindividualsdon’tthemselvesexaminetheevidence.Fewhavethecapabilitiesofassessingtheevidenceonglobalwarmingeveniftheyhadthetime.Butthefactthatothersthattheytalktoandtrustholdcertainbeliefsreinforcestheirconvictionintheircorrectness.Someofthesesociallyconstructedideasandperceptionsprovidethelensthroughwhichweseetheworld.Categories,likeraceandcaste,arerelevantinsomesocieties,butnotinothers.Butaswehavenoted,these“ideas”haverealconsequences,whichcanpersist.Societiescanget“stuck”inaparticularsetofbeliefs,witheachindividual’sbeliefschangingonlyifenoughothers’change;butthosebeliefswon’tchange,ifthoseoftherestdon’t.Thenotionthatideasandperceptionsaresocialconstructsalsohelpsexplainhowsocietalbeliefssometimescanchangeratherrapidly.If,somehow,enoughpeoplefindtheideaattractive,theremaybeatippingpoint:itbecomespartofanew“socialconstructionofreality,”thenewconventionalwisdom.Thenotionofracialdifferencesmovesthenfromaconcepttobeproventoaconcepttobedisproved.OrthereisaswitchinbeliefsfromthenotionthatinequalityisnecessaryforthefunctioningofamarketeconomytothebeliefthatthelevelofinequalityinAmericatodayimpairsthefunctioningofoureconomyandoursociety.Thenewideasbecomepartoftheconventionalwisdom—untilsomeotherintellectualorrealcurrentarrivestodisturbtheintellectualequilibrium.Thesocialcontextofbeliefsiscritical.Ifdifferentgroupsinteractlittle,theycandevelopdifferingperceptionsofreality.Soitiswiththedebateaboutthelegitimacyandeventhemagnitudeofinequality.Insomegroups(includingbothrichandpoor),thericharebelievedtohaveobtainedtheirwealthlargelythroughtheirownhardwork,withcontributionsfromothersandluckplayingmerelyaminorrole;amongothers,the128 27beliefisjusttheopposite.Notsurprisingly,thesegroupshavedifferentviewsabouttaxpolicy.Ifanindividualbelieveswhathehasisaresultjustofhisownefforts,heislesswillingtosharethatwealthwithotherswhohethinkschosetoexertlesseffort.Ifanindividualseeshissuccessasaresultlargelyofgoodluck,heismorewillingtosharethatgoodfortune.ShapingperceptionsaboutpoliciesTodaythosewhowishtopreservesocieties’inequalitiesactivelyseektoshapeperceptionsandbeliefstomakesuchinequalitiesmoreacceptable.Theyhavetheknowledge,thetools,theresources,andtheincentivestodoso.Evenif,inthepast,thereweremanyattemptstoshapesocietalperceptions,todaythereisincreasedsophisticationindoingso.Thosewhoseektodosoknow,forinstance,moreabouthowtomanipulateideasandpreferences.Theydon’thavetojusthopeandpraythatthe28evolutionofideasworksoutintheirfavor.Thefactthatthoseatthetopcanshapeperceptionsrepresentsanimportantcaveattotheideathatnoonecontrolstheevolutionofideas.Controlcanhappeninseveralways,whichwewillexploreingreaterdepthinthissection.Oneisthroughaccesstoeducationandthemedia.Ifonegroupisgreatlydisadvantagedinopportunitiesforeducationoraccesstopublicofficeandtothemedia,thenitwillnotparticipateonequaltermsinthedeliberativespaceinwhichthe“conventionalwisdom”emerges.Someideaswillthereforenotemerge;otherideascanbeeffectivelysuppressed.Asecondwayisthroughthecreationofsocialdistance.Ifonegroup’seconomicopportunitiesleaveitmuchpoorerthanothergroups,thentheinteractionsofthefirstgroupwithpeoplefromothergroupswillbelimited,anditislikelytodevelopadifferentculture.Thenideasaboutintrinsicdifferencesofthepoorgrouparemorelikelytotakerootandtopersist.AsInoted29inearlierworkoncognitiveframes,partofthepowerofsociallyconstructedcategoriesdependsupontheirnotseemingtobesociallyconstructed.Peopleputindifferentcategoriescometoactdifferentlyandthustoappearintrinsicallydifferent.Mostimportantly,ifgoodscanbemarketed,socanideasandespeciallytheideasthatunderpinpolicies.Modernmarketinghastaughttheartandscienceofshapingperceptions—andforthosewithenoughresources(disproportionatelythewealthy)therearetoolstodoso.Inpromotingproducts,manyfirmshavefeltfewqualmsaboutprovidingdistortedinformation—orevenlying.Thusthecigarettecompaniessucceededincastingdoubtonthescientificevidenceofthehealthhazardsofsmoking,eventhoughtheyhadintheirownpossessionevidencetothecontrary.Similarly,Exxonexhibitednocompunctioninsupportingso-calledthinktankscastingdoubtonthescientificevidenceontherisksofglobalwarming—eventhoughtherewasoverwhelmingevidencetothecontrary.Truth-in-advertisinglawstrytocircumscribefirmbehavior,butin30promotingideasandpolicies,thereisnosuchthing.We’vealreadyseenseveralexamples—suchastheclaimthatwhileAmericamaynotbeasequalasothers,itoffersmoreequalityofopportunity,orthatitwasgovernmenteffortstopromotehousingforthepoorthatwereattherootoftheGreatRecession—and129 we’lltakeacloserlookatothers.Education,ofcourse,alsoshapesbeliefsandperceptions,andperhapswithnogroupisthatmorethecasethanwitheconomists.Thereisnowconsiderableevidencethateconomists’perceptions,say,aboutfairness,aremarkedlydifferentfromthoseoftherestofsociety.TheChicagoeconomistRichardThalerreportsthatwhile82percentofrespondentsinthegeneralpopulationbelieveditwasunfairtoincreasethepriceofsnowshovelsafterastorm,31amonghisMBAstudents,only24percentheldthatview.Itcouldbepartlybecauseeconomicsattractsthosewho,amongthepopulation,putlessweightonnotionsoffairness.Butthereisevidenceaswellthattrainingineconomicsshapesperceptions—andgiventherolethateconomistshaveincreasinglyhadinpublicpolicy,theirperceptionsofwhatisfairandtheirviewsoftrade-offsbetweenequityandefficiencymayhavehaddisproportionateconsequences.TheRighthasrecognizedtheimportanceofeducationinshapingperceptions,whichiswhyithasbeenactiveintryingtoinfluencethedesignofcurriculainschoolsandembarkedonan“education”programtomakejudgesmore“economicliterate,”thatis,toseetheworldthroughthenarrowlensofconservative32economics.Oneofthemosteffectivewaysofinfluencingpublicopinionistocapturepoliticians.Afterall,politiciansaremerchantsofideas.(Persuadingpoliticianstoadoptone’sperspectivesandperceptionshasadoubleadvantage:notonlydotheyselltheideastothepublic;theytranslatetheideasintolegislationandregulation.)Forthemostpart,politiciansdon’toriginateideas;rather,theytakethoseemanatingfromacademiaandfrompublicintellectuals,andfromwithingovernmentsandfromnongovernmentalorganizations(NGOs).Theyputtogetherapasticheoftheseideasthataccordwiththeirworldview,oratleastinacombinationthattheythinktheirconstituentswillfavor.InAmerica’smoneyedpolitics,notallconstituentsarecreatedequal.Politicianshaveanincentivetoespouseideasthatservethemoneyedinterests.Insomeothercountries,politicianscanbedirectlybought.ButAmericanpoliticiansare,forthemostpart,notsocrass.Theydon’tacceptstuffedbrownenvelopes.Moneygoestotheirelectioncampaignsandintothecoffersoftheirparty.Thishascometobecalled“corruptionAmericanstyle.”Somewillreapmonetaryrewardsaftertheyleaveoffice,partoftheprocessofrevolvingdoorsthatisendemicintheUnitedStates;forothers,thepleasuresofpowertodaysuffice.Backinguptheseideasarearmiesof“experts”willingtoprovidetestimony,arguments,andstoriestoshowtherightnessoftheseviews.Thisbattleofideasoccurs,ofcourse,inmanyplayingfields.Thepoliticianshavetheirsurrogates,theirminionswhoarenotrunningforofficebutwhoadvancevariantsoftheseideas,andchallengethoseofrivals.Evidenceandargumentationonbothsidesareassembled.This“battleofideas”hastwoobjectives(likeadvertisingmoregenerally)—tomobilizethosewhoarealreadytruebelieversandtopersuadethosewhohavenotyetmadeuptheirminds.Theformerentailsrallyingthetroopsandreinvigoratingcommitment.InanexpensiveelectoraldemocracyliketheUnitedStates,arousingthe“base”isimportantbecausetheoutcomeofelectionsoftenhingesonraisingcampaignfundsandgettingout130 thevote.Labelingarivalasa“liberal”ora“neoconservative”canhelpmotivatevoting,evenwhenone’sowncandidateislackluster.Muchofthebattleofpersuasionisfor“independentvoters.”Towinthemoversimple,distortedstories,oftenrepeated,canbemoreeffectivethanlongerandmoresubtleones.Messagingthatappealstofeelingsisoftenmoreeffectivethanappealstoreason.Advertisersaregoodatdistillingamessagedowntoasixty-secondadthatstrikesjusttherightnotes—anemotional33responseseeminglyreinforcedby“reason.”THEWEAPONSOFWARThereisarealbattlefieldofideas.Butitdoesnot,forthemostpart,involveabattleofideasasacademicswouldunderstandit,whereevidenceandtheoryonbothsidesarecarefullyweighed.Itisabattlefieldof“persuasions,”of“framing,”ofattemptsnotnecessarilytogettothetruthofthematterbuttounderstandbetterhowordinarycitizens’perceptionsareformedandtoinfluencethoseperceptions.Inthisbattleofideas,certainweaponsplayacentralrole.Inthelastchapter,wediscussedoneoftheseweapons—themedia.Itshouldbeobviousthatimbalancesinthemediacanleadtoabattlefieldinthewarofideasthatisfarfromlevel.Howeverideasgetdisseminated,muchofthebattleis,asIhavesuggested,overframing;andinthatbattle,wordsarepivotal.Thewordsweusecanconveynotionsoffairness,legitimacy,positivefeelings;ortheycanconveynotionsofdivisivenessandselfishnessandillegitimacy.Wordsalsoframeissuesinotherways.InAmericanparlance,“socialism”isakintocommunism,andcommunismistheideologywebattledforsixtyyears,triumphingonlyin1989withthefalloftheBerlinWall.Hence,labelinganythingas“socialism”isthekissofdeath.America’shealthcaresystemfortheaged,Medicare,isasingle-payersystem—thegovernmentpaysthebill,buttheindividualgetstochoosetheprovider.MostoftheelderlyloveMedicare.Butmanyarealsosoconvincedthatgovernmentcan’tprovideservicesefficientlythattheybelievethatMedicaremustbeprivate.InthetumultuousdiscussionofhealthcarereformduringPresidentObama’sfirstyearinoffice,onemanwasheardtosay,34“KeepyourgovernmenthandsoffmyMedicare.”TheRightattacksextendingtheMedicareprogramtotherestofthepopulationas“socialism.”Thatendsthedebate.Onedoesn’thavetodiscusswhetherit’sefficientorinefficient,whetherthequalityofcareisgoodorbad,orwhetherthereischoiceornot.Americanshavecometobelieveinmarkets,andincentivesmakemarketswork.Hencelabelingpayas“incentivepay”putsahalooverit;itprovidesjustificationregardlessoftheamount.Theissueofoutsizepayhascomeupepisodically.In1993,atthebeginningoftheClintonadministration,theintensityofcriticismwassohighthattheadministrationdecidedtoimposeasurtaxonsalariesinexcessofamilliondollars.Butthenan35exceptionwasmadeforpayrelatedtoperformance.That,ofcourse,providedanincentivetolabelallhighpaymentsincentivepay.Butaswesawinearlier,italsoprovidedawholesetof131 distortedincentivesthathadimpactsbeyondmerecompensation.Totakeanotherexample,creditcardcompaniesimposerulesonmerchantsthataccepttheircards.Onesuchruleisknownasthe“nosurchargerule.”Itforbidsmerchantsfrompassingonthecostofcreditcardtransactionfeestotheircustomers.Butthepricesystemworksonlyifindividualsseethecostsassociatedwiththechoicestheymake.Whenindividualsmakeapurchase,theymakeachoiceofapaymentmechanism.Noonewouldsayitisa“surcharge”tochargemoreforanexpensiveproductthanacheapone.Butbylabelinganychargeasasurcharge,creditcardcompaniesareattemptingto“frame”thecharge,tomakeitseemunreasonable.Theywantcustomerstobelievethatsuchachargeissounreasonableastowarrantswitchingawayfrommerchantswhodoimposesuchcharges,andthustoinducemerchantsnotto“charge.”Theabsenceofanexplicit(sur)chargemeansthatthecreditcardcompaniescanraisethefeestheychargemerchantstohighlevels—neartothe“breakingpoint,”wherethemerchantwouldratherlosethecustomerthanpaythefee.Afinalexampleconcernsthepricediscoveryfunctionofmarkets.Inwell-functioningmarkets,demandisequatedtosupply,andtheresultingequilibriumprice“reveals”themarginalvalueofthegoodtothebuyerandthemarginalcosttotheseller.Thisinformationisofvalueinmakingdecisions.Manyeconomistsargued,byanalogy,thatinastockmarket,thepricesthatemergereflectthetruevalueoftheasset.Thisiscalledthe“pricediscovery”roleofmarkets.Thewordsareemotive:discoveringthetruevalueofanassetispresumablyvaluable,andmarketsaretobecommendedforperformingthisimportantsocialfunction.Indeed,marketadvocatesclaimedthatmarketswerefullyefficient—pricesrevealedalltheinformationavailabletomarketparticipants.Thiswasamatterofreligiousbelief,anarticleoffaith.Theuseoflanguagewasimportant:because“efficiency”wasgood,itwasobviousthatfullyefficientmarketsweregood.Butthisnotionwasbasedondeeplyflawedlogic.Indeed,ifmarketsfullyrevealedalltheinformationtoallmarketparticipants,noonewouldhaveanyincentivetogatherinformationaboutpubliclytradedassets,sincethosewhodidnotspendthemoneywouldhaveequalaccesstotheinformation.Iftheefficient-marketshypothesisweretrue,itwouldironicallymeanthatstockmarketswouldnecessarilybeveryinefficient,sinceno36onewouldgatheranyinformation.IntheaftermathoftheGreatRecession,theefficient-markets37modelhastakenabeating.Inthemeanwhile,though,somemarketadvocatescontinuetousethe“pricediscovery”argumentfordefendingchangesinmarketsthatwereactuallymakingitmorevolatileandlessefficient.Amajorchangeoccurredinmarketsaroundtheturnofthiscentury:mosttrading(some61percentin2009,53percentin2010)onthestockexchangewasdonebycomputerstradingwithothercomputers,usingcertainalgorithms.Offerstobuyandsellwerebasednotonmarketresearch,oninformedviewsabouttheprospectsof,say,steelortheefficiencyofaparticularsteelcompany,butratheronextractinginformationfromthepatternofpricesandtrades,andonwhateverotherinformationacomputercouldabsorbandprocessonthefly.Offerstobuyandsellwereheldopenforananosecond.Theresponsetothesuggestionthatanyfirmmakinganofferto,say,buyastockataparticularpriceholdopenthatofferforonesecondwas:“Doyouwanttogo132 backtotheMiddleAges.”Ofcourse,thepricesthatweredeterminedinthosenanosecondswereofnorelevancetoanyrealdecisionmaking.Nosteelfirmwouldbaseitsdecisiononwhethertoexpandorcontractonthesemicroadjustmentsofstockprices.Thealgorithmictradersclaimedthattheyweremakingmarketsmoreliquid(“deeper”),butitwasaliquiditythatdisappearedwhenitwasneeded,whenarealdisturbanceoccurredtowhichthemarketneededtoadjust.Theresultwasthatthemarketbegantoexhibitunprecedentedvolatility.Ononedayalone,May6,2010,stockmarketpricesplummetedsomuchthattheDowJonestemporarilylostabout10percentofitsvalue,includinganearly38600-pointdropinafive-minuteperiod.Beforetheendoftheday,themarketregainedmuchofitsvaluenearlyasfastasithadbeenlost.Noonecouldclaimthattherealvalueofthecountry’sassetshaddiminishedinthatshortperiodoftime.Yet,constantreferenceto“pricediscovery”and“efficientmarkets”providedthehalothatmadethiskindofflashtradingseemnotonlyacceptablebutevendesirable.Infact,therearereasonstobelievethatflashtradingactuallymakesmarketsnotjustmorevolatilebutalsoless“informative.”Computersattempttousecomplexmathematicalalgorithmstoextractwhateverinformationisinthemarket,inamodernandmoresophisticatedversionoffrontrunning,theold-styleillegalactivitiesbywhichbrokerstrytouseinformationtheygleanfromthoseplacingorderstoenhancetheirownprofits.Ofcourse,marketparticipantsknowthis.Ifsomemarketresearcherdiscoveredthatsomecompanywasgoingtodowell(hadjustmadeavaluablediscovery),hemightrush,placingalargeorder.Butthecomputertraderswouldimmediatelysensethisandtrytousehisinformationfortheirownpurpose.Today,ofcourse,thefirsttraderknowsthegamehe’splaying,sohewouldneverplacealargeorder,butwouldplaceamyriadofsmallorders.There’sbeenanarmsrace,wherethosedoingthehardworkofresearchtrytokeeptheirinformationawayfromthealgorithmictraders,andthealgorithmictraderstrytobreaktheircode.Onemightsayit’sjustawasteofresources—afightovertherentsassociatedwithearlyinformation.Nodecisiongetsmadeinthenanosecondsoftherefinedpricediscovery.Butit’sworsethanthat.Totheextentthatthealgorithmictraderssucceedinoutwittingthosewhodotherealresearch,thereturnstoresearchfall;therewillbelessinvestmentininformation,andmarketsactuallywillconveylessoftheinformationthatwecareabout.THEBATTLEOVERPOLICIESASABATTLEOVERPERCEPTIONSTheextenttowhichthebattleoverpoliciesisabattleoverperceptionsisparticularlystriking.Thefollowingparagraphsconsiderthreebigbattlesthatoccurredinrecentyears—overtherepealoftheestatetax,thebankbailout,andmortgagerestructuring.Thelattertwowere,ofcourse,frontandcenterindiscussionsovertheresponsetothe2007–08financialcrisis.AllarecriticaltoourunderstandingofhowAmericahascometobesounequal.Withoutanestatetax,wecreateanewplutocracy,markedbydynastiesthatareself-perpetuating.Thebailoutprovidedmoneytothefinancialsector—oneoftheimportant133 sourcesofmoneyatthetop.Andthefailuretodoenoughaboutmortgagerestructuringhascontributedtoeconomicstressatthebottomandinthemiddle.Estatetaxes39Aswe’veseen,theRighthasbeenabletopersuademanyAmericanstosupportpoliciesthatarenotintheirself-interest.Theestatetax,whichisimposedonthosewhohavelargeestatespassedontoheirs,providesthequintessentialexample.Criticsoftheestatetaxcallitadeathdutyandsuggestthatitisunfairtotaxdeath.Undercurrentlaw,thetaxisleviedonlyontheamountpassedonthatisinexcessof$5million(usually$1040millionforamarriedcouple),sothatitisunlikelythatmostAmericanswouldeverbetouchedbythetax,evenwiththeir41overoptimisticviewofmobilityinAmericansociety.Yet,becauseoftheconcentrationofwealthinoursociety,thetaxcanraiselargeamountsofmoney.Moreover,intheorya“fair”societywouldputeveryoneonalevelplayingfieldatthestart.Weknowthatthat’simpossible;butthetaxisdesignedtolimittheextentof“inherited”inequality—tocreateaslightlymorelevelplayingfield.ItshouldbeobviousthatthetaxisintheinterestsofmostAmericans,andyettheRighthaspersuadedlarge42numberstoopposeit—againsttheirowninterests.Forabriefmoment,in2010,itwastotallyrepealedasaresultoftaxcutspassedin2001undertheGeorgeW.Bushadministration.TheRighttalksabouthowmuchthetaxaffectssmallbusinesses,yetthevastmajorityofsmallbusinessesaretoosmalltobetouched;andprovisionswithintheestatetaxallowforspreadingthepaymentoverfourteenyears,preciselysothatitwillnotbe43disruptive.BankrecapitalizationAsthefinancialcrisisunfolded,wesawhowthebanksmanagedperceptions.Weweretoldthatwehadtosavethebankstosavetheeconomy—toprotectourjobsnomatterhowunsavorythebailoutsfeltatthetime;thatifweputconditionsonthebanksitwouldroilthemarkets,andwewouldallbetheworseforit;andthatweneededtosavenotonlythebanksbutalsothebankers,thebank’sshareholders,andthebanks’bondholders.Therewere,ofcourse,countrieslikeSwedenthathaddoneotherwise,thathadplayedbytherulesof“capitalism”andputbankswhosecapitalwasinadequateintoconservatorship,aprocessakin(forbanks)tobankruptcy,focusedonprotectingdepositorsand“conserving”thebanksassets;butthosewere“socialist”countries.TofollowSwedenwasnotthe“Americanway.”Obamanotonlyboughtintothisline;byrepeatingit,helentitan44auraofauthenticity.Butthislinehadnofactualbasisandwasdesignedtomaketheworld’smostmassivetransferofwealthacceptable:neverinthehistoryoftheplanethadsomanygivensomuchtosofewwhoweresorichwithoutaskinganythinginreturn.Thequestioncouldhavebeenframedverydifferently.ItcouldhavebeenarguedthattherealAmericanwayistheruleoflaw.Thelawwasclear:ifabankcan’tpaywhatitowesandwhat134 depositorsdemandback,thenitisrestructured;shareholdersloseeverything.Bondholdersaremadethenewshareholders.Ifthereisstillnotenoughmoney,thegovernmentstepsin.Bondholdersandunsecuredcreditorsthenloseeverything,butinsureddepositorsgetbackwhattheyhavebeenpromised.Thebankissaved,butthegovernment,asthenewownerofthebank,willeventuallydecidetowinditdown,reprivatizeit,ormergeitwithahealthierbank.It’sobjectiveinpartistorecoverasmuchforthetaxpayeraspossible.Wedon’twait,ofcourse,untilthebankhasnomoneytotakethesedrasticactions.WhenyougotothebankandputinyourATMcard,ifthelightflashes,“insufficientfunds,”wewantittobebecauseyouraccount,ratherthanthebankitself,hadinsufficientfunds.Thisisthewaybankingissupposedtowork;butitwasn’tthewaythingsworkedintheUnitedStatesduringtheBushandObamaadministrations.Theysavednotonlythebanks—therewasarationalefordoingthat—butalsotheshareholders,bondholders,andotherunsecuredcreditors.Thiswasavictoryinthebattleofperceptions.Therewasanalternativewaytoframethepolicyquestion.ThisnarrativewouldhavebegunnotwiththesuggestionthatwhatSwedendidwasnotinour“tradition”butwithananalysisofwhateconomictheoryandhistoryhadshown.Thatanalysiswouldhavedemonstratedthatwecouldhavesavedthebankingsector,protecteddepositors,andmaintainedaflowofcredit,allatlesscosttothegovernment,byfollowingtheordinaryrulesofcapitalism.Thiswas,infact,whatSwedenandtheUnitedStateshaddoneinothersituationswhenbanksgotintotrouble.Putsimply,theeconomy’sinterestcouldhavebeenbetterprotectedandasenseoffairnessinoursystembetterpreserved,ifObamaandBushhadplayedbytherulesofordinarycapitalism,ratherthanmakinguptherulesastheywentalong—iftheyhad,inasense,abidedbytheruleoflaw.Instead,thebankersgottheirmoneywithoutconditions.Themoneywassupposedtorecapitalizethebanks,andrecapitalizingthebankswassupposedtoleadtomorelending.Butmoneygiventothebanksthatwenttopaybonusescouldn’tsimultaneouslybeusedtorecapitalizethebanks.Thebankersandtheirbackerswonthemomentarybattle—theygotthemoneyintothecoffersofthebanksandthebankers.Buttheylostthelong-runbattleofperceptions:virtuallyeveryoneseeswhatwasdoneasunfair—andunjustifiedevenbytheunusualeconomiccircumstances.Itisthis,asmuchasanything45else,thathasprovidedtheimpetustothecurrentbacklash.RestructuringmortgagesWhenthehousingbubbleburst,manyhomeownersfoundthemselves“underwater”:theyowedmoreontheirhomethanthehomewasworth.Thebankbailoutandthecaseformortgagerestructuringprovideaclearcontrastinthebattleofperceptions:inonecase,theperceptionthatshapedgovernmentactionwasthatalargebailoutisdesirable,whileintheother,theperceptionthatshapedgovernmentactionwasthatalargerestructuringisundesirable.Todaythebailoutsofthebanksarewidelyseenasfarfromdesirable.Andironically,thereisincreasingrecognitionthatwithoutdoingmoreforthehousing/mortgagemarket,oureconomywon’trecover.Whathashappenedinthemortgagemarkethasbeenfarfrom135 efficient.Whenforeclosureforcesfamiliesoutoftheirhomes,everyoneloses.Thecosttothefamily—thedisruptiontotheirlives,thelossoftheirlifesavings—isobvious.Worsestill,anemptyhome,uncaredfor,decreasesthevalueofneighboringhomes.Moreofthemwillgounderwater.Communitieswithlargenumbersofforeclosuresinevitablysuffer.Thebanklosestoo:themostimportantdeterminantofforeclosuresistheextenttowhichthehomeisunderwater.Foreclosuresbegetforeclosures:bymakingmorehousesgounderwater,thebanksincreaseforeclosuresandtheirresultinglosses;theylosestillmorefromthesubstantiallegalfeesthataccompanyeachforeclosure.Therearebetterwaysofdealingwiththisunfortunatespiral:awrite-downoftheprincipal(whatthehomeownerowes),perhapswithadebt-to-equityconversionthatgivesthelenderashareinthecapitalgainwhenthehouseissold.Homeownersstillhaveanincentivetomaintaintheirhomes;housesaren’tthrownontothemarket,depressinghousingprices;thecostlyforeclosureprocessisaverted.Communitiesareprotected.It’stoeveryone’sadvantagetogivehomeownersafreshstart.Thelendergetsasmuchormorethanshewouldhaveotherwise.Executingthisstrategywouldhaverequiredmodificationstoexistinglaw,butthebankers—andtheObamaadministration—rejectedthisapproach46outofhand,atleastuntilthe2012electionapproached.Thebankssawthatrestructuringmortgageswouldmakethemrecognizetheirlosses,anoutcometheyhadsuccessfullykeptatbaywithdeceptivebutlegalaccountingmaneuversthattreatedimpairedmortgages—thoseinwhichtheborrowerwasnotkeepingupwithhispayments—asiftheyeventuallywouldberepaid.Thetruemarketvalueofthesenonperformingmortgageswasoftenafractionofthefacevalue.Butrecognizingthelosseswouldhaverequiredthebankstocomeupwithmorecapital,andtheywerestrugglingtogetenoughcapitalunderthecurrentregulations,letalonethenewregulations(calledBaselIII)adoptedinfall2010.Ofcourse,theObamaadministrationandthebankersdidn’t47presenttheircasethisway.Twomainargumentswereadvancedfornotdoingmuchforhomeowners.Itwouldbe“unfair”tohelpthosewhowerestrugglingwiththeirmortgageswhenthereweresomanygoodandresponsiblecitizenswhohadworkedhardandpaidofftheirmortgage,orwereabletomaketheircurrentpayments.Furthermore,offeringrelieftohomeownerswouldexacerbatetheproblemofmoralhazard:ifindividualswereleftoffthehook,it48wouldundermineincentivestorepay.Whatwascuriousabouttheseargumentswasthattheycouldhaveappliedjustaseasily,andwithgreaterforce,tothebanks.Thebankshadrepeatedlybeenbailedout.TheMexicanbailoutof1995,theIndonesian,Thai,andKoreanbailoutsof1997–98,theRussianbailoutof1998,theArgentineanbailoutof2000,theseandotherswereallreallybankbailouts,thoughtheycarriedthenameofthecountrywherebankshadlentexcessively.Then,in2008–09,theU.S.governmentwasengagedinyetanotherbailout,thisonethemostmassiveever.Thebankshadproventherelevanceofmoralhazard—bankbailoutshadrepeatedlyandpredictablyledtoexcessiverisktakingbybanks—andyetboththeBushandtheObamaadministrationsignoreditandrefusedtodiscouragefuture49badbehaviorby,forinstance,firingexecutives(astheUKdid)50ormakingshareholdersandbondholderstakeahit.Unlikethebanks,mostofthepeoplelosingtheirhomeswerenotrepeat136 offenders.Yettheywereaskedtolosealloftheequitythattheyhadputintotheirhome,whilebankshareholdersandbondholders51weregivenamassivegift.Moreover,fewhomeownerswouldhavebeenwillingtoputthemselvesthroughtheanguishthattheyhaveexperienced—worriesaboutlosingtheirlifesavingsaswellastheirhome—hadtheyknownwhatwasinstoreforthem;theirmistakewastotrustthebankers,whoseemedtounderstandmarketsandrisk,andwhohadassuredthemthattheriskstheywereundertakingwereeasilymanageable.Thebankersandtheiralliesunleashedtiradesagainstthehomeownerswhowerelosingtheirhomes.Theywerelabeledashavingbeenreckless.Asmallpercentagehadboughtmultiplehouses,and,inanattempttotarnishallofthoselosingtheirhomes,theywerelabeled“speculators.”Ofcourse,whatelsemightonecallthegamblingofsomanyofthebanks?Theirrecklessspeculationlayattheheartofthecrisis.Butthegreatestironywastheclaimthathelpingsomepoorhomeownersandnothelpingotherswouldbe“unfair.”Yettheseinequitiespaleincomparisonwiththosethatarosefromthehundredsofbillionsofdollarsthrownatthefinancialsector.Inequitiesrelatedtothebankbailoutswerenevermentioned,andifacriticraisedthem,theyweredismissedastheunfortunatebutnecessarypricetoresuscitatetheeconomy.Therewasnomentionoftheideathatstoppingthefloodofforeclosuresmightbeagoodthingforresuscitatingtheeconomy—andhelpingordinarycitizens.Therewerewaysofhelpinghomeownersthatwouldnothavecosttaxpayersadimeandthatwouldhavelefthomeownerswhohadmanagedtheirdebtsprudentlyfarbetter-offthanthosewho52hadn’t;butthebankersresistedanyandallsuchproposals.Wesawinchapter1partoftheconsequenceofthecombinationofthebankbailoutwithoutconstraintsandtheabsenceofhelpforhomeowners:theincreaseintheinequalityofwealth,includingthedramaticreductioninthewealthofthoseinthe53bottomhalfofthepopulation.THEBATTLEOVERTHEBIGIDEAS:GOVERNMENTVERSUSMARKETFAILUREIhaveillustratedthefightoverperceptionsinthecontextofquitespecificbattles,butthebattlesragemostintenselyinthefieldofbigideas.Onesuchbattleinvolvesononesidethosewhobelievethatmarketsmostlyworkwellontheirownandthatmostmarketfailuresareinfactgovernmentfailures.Ontheothersidearethosewhoarelesssanguineaboutmarketsandwhoargueforanimportantroleforgovernment.Thesetwocampsdefinethemajorideologicalbattleofourtime.Itisanideologicalbattle,becauseeconomicscience—boththeoryandhistory—providesaquitenuancedsetofanswers.Thisbattleplaysoutineveryrealmofpublicpolicy.Itaffectstherolethatgovernmenttakesinensuingmacrostability,inregulatingmarkets,ininvestinginpublicgoods,inprotectingconsumers,investors,andtheenvironment,andinprovidingsocialprotection.Ourfocushere,though,ismorenarrow:thisisthebigbattletheoutcomeofwhichwillhavemuchtosayabouttheevolutionofinequalityintheUnitedStates,whetheritcontinues137 toincrease,asithasbeen,orstartstodiminish.Acentralthesisofchapters2and3isthatmarketfailures—andthefailureofgovernmenttocircumscribethem—playakeyroleinexplaininginequalityinAmerica.Atthetoptherearerents(suchasmonopolyrents);atthebottomthereisunderinvestmentinhumancapital.Hiddensubsidiesthatdistortthemarketandrulesofthegamethatgiveanupperhandtothoseatthetophavecompoundedtheproblems.Aswenotedinchapter3,economictheoryhasshownthatmarketsdon’texistintheabstract.Attheveryleast,thereisaneedforgovernmenttoenforcecontractsandtoprovidethebasiclegalstructure.Buthowgovernmentsdothismakesadifference,bothforefficiencyandfordistribution.TheRightwantsthe“right”rulesofthegame—thosethatadvantagethewealthyattheexpenseoftherest.They’vetriedtoshapethedebate,tosuggestthatthereisasinglesetofrulesthatwouldbebestforall.But,throughoutthebook,we’veseenhowthat’sjustnottrue.Economictheoryhasshownthatmarketsworkwellwhenprivateandsocialreturnsarewellaligned,anddon’twhentheyarenot.Marketfailuresarepervasive.Externalities,forinstance,arenotlimitedtotheenvironment.Ourbankspollutedtheglobaleconomywithtoxicmortgages,andtheirfailuresbroughttheglobaleconomytothebrinkofruin,imposinghugecostsonworkersandcitizensthroughouttheworld.Someofthesemarketfailuresareeasy,inprinciple,tocorrect:afirmthatispollutingcanbechargedforthepollutionitcreates.Butthedistortionscausedbyimperfectandasymmetricinformationarepresenteverywhere,andarenotsoeasilycorrected.Managersdonotalwaysactintheinterestsof“stakeholders”(includingshareholders),andthere’slittlethattheycandoaboutit.Aswesawinchapter4,incentivepaythatwassupposedtoaligntheirinterestsdidn’tdoso;themanagersbenefited,atthe54expenseofeveryoneelse.ButifyoulistenedonlytoargumentsfromtheRight,youwouldhavethoughtthatmarketsalwaysworkedandgovernmentalwaysfailed.Theyworkedhardtocreatethisperceptionwithinthepublic,mostsimplybyignoringprivatemarketfailuresandgovernmentsuccesses.Andthey’vetriedtoignore—andtogetotherstoignore—thedistributiveconsequencesofthesemarketfailures,whogainsandwholoseswhenprivaterewardsandsocialreturnsarenotwellaligned.Thecrisisprovidedaninstancewhereitwaseasytoseethewinnersandlosers;butinalmosteverycase,whetherit’senvironmentalpollutionorpredatorylendingorabusesofcorporategovernance,itisthoseatthetopwhoarethewinners,andtherestwhoarethelosers.Ofcourse,noteverygovernmenteffortissuccessful,orassuccessfulasitsadvocateswouldhaveliked.Indeed,whenthegovernmentundertakesresearch(orsupportsnewprivate-sectorventures),thereshouldbesomefailures.Alackoffailuresmeansyouarenottakingenoughrisks.Successoccurswhenthereturnsfromthoseprojectsthatsucceedaremorethanenoughtooffsetthelossesonthosethatfail.Andtheevidenceinthecaseofgovernmentresearchventuresisunambiguouslyandoverwhelminglythatthereturnsfromgovernmentinvestmentsintechnologyonaveragehavebeenvery,veryhigh—justthinkabouttheInternet,theHumanGenomeProject,jetairplanes,thebrowser,thetelegraph,theincreasesinproductivityinagricultureinthe138 nineteenthcentury,thatprovidedthebasisfortheUnitedStates’movingfromfarmingtomanufacturing.WhenIwaschairmanoftheCouncilofEconomicAdvisers,weassessedtheaveragesocialreturnsongovernmentR&D,anditturnedouttobewellinexcessof50percent,farhigherinotherareasofinvestment55(includingprivatesectorR&D).Governmentsarehumaninstitutions,andallpeople,andtheinstitutionstheycreate,arefallible.Therearegovernmentfailuresjustastherearemarketfailures.Recenteconomictheoryhasexplainedwheneachoftheseismorelikelytofail,andhowgovernmentsandmarkets(andothercivilinstitutions,includingthosethatserveaswatchdogsonbothcorporationsandgovernment)cancomplementeachotherandprovideasystemofchecksandbalances.Wehaveseenmyriadinstancesofthiskindofcomplementarity:agovernmentinitiativecreatedtheInternet,butprivate-sectorfirmslikeGooglebuiltmanyofproductsandapplicationsthathaveplaceditatthecenterofpeople’slivesandoureconomy.Governmentmayhavecreatedthefirstwebbrowser,buttheprivatesectorandopen-sourcemovementhaverefinedit.Thattherearesuccessesandfailuresinboththepublicandtheprivatesectorisclear.Andyetmanyontherightseemtothinkonlythegovernmentcanfail.Partofthereasonforthesedisparateperceptionsaboutmarketsandgovernmentshastodowiththetheoryofequilibriumfictionsdescribedearlier.Thosewhobelieveinmarketsdiscountinformationaboutmarketfailurewhileassigninghighsaliencytoexamplesofgovernmentfailure.Theycaneasilyrecallexamplesoffailedgovernmentprograms,butthemassivefailuresofourfinancialsystemintherun-uptotheGreatRecessionarequicklyforgotten,describedasananomaly,orblamedonthegovernment.Thefactofthematteristhattherehasbeennosuccessfullargeeconomyinwhichthegovernmenthasnotplayedanimportantrole,andinthecountrieswiththemostrapidgrowth(suchasChina)andinthosewiththehigheststandardsofliving(suchas56thoseinScandinavia),thegovernmentplaysaveryimportantrole.Yettheprevailingideologyontherightissostrongthattherecontinuestobeapushforasmallgovernment,forcontractingoutgovernmentservicesandprivatizationandevenaresistancetoregulation.ThisRightfailstonotenotonlythesuccessesofgovernmentbutthefailuresofmarkets.Intheaftermathofthecrisisof2008,however,itishardtoignoretherepeatedfinancialcrises57thathavemarkedcapitalismsinceitsorigins.Repeatedbankbailoutshaveimposedhighcostsontaxpayers.Ifweaddupthelossesfromthefinancialsector’smisallocationofcapitalbeforethecrisisandtheshortfallbetweentheeconomy’spotentialoutputandactualoutputafterthebubbleburst,wegetanumberinthetrillionsofdollars.AftertheGreatDepression,governmentsucceededinregulatingthefinancialsector,producingalmostfourdecadesoffinancialstabilityandrapidgrowth,withbanksfocusingonlending,providingthemoneyneededfortherapidexpansionofourenterprises.Governmenthelpedmakemarketsactthewaymarketsaresupposedtofunction,byreducingthescopeforfraudandconsumerdeceptionandenhancingcompetition.ButbeginningwithPresidentReaganandcontinuingthroughPresidentClinton,governmentsteppedback.Thederegulationledtoinstability;with139 lessoversight,therewasmorefraudandlesscompetition.Noristhistheonlyexample.Privatehealthinsurancecompaniesaremuchlessefficientthanthegovernment-runMedicare58program.Privatelifeinsurancecompaniesaremuchless59efficientthanthegovernment’sSocialSecurityprogram.Totakeanotherexample:arecentstudyshowedthat,onaverage,contractors“chargedthefederalgovernmentmorethantwicetheamountitpaysfederalworkers”forperforming60comparableservices.AsmuchasoneoutoffourdollarsspentoncontractinginIraqandAfghanistanwaswastedormisspent,accordingtotheCommissiononWartimeContractinginIraqand61Afghanistan.Inanearlierstudy,LindaBilmesandIshowedhowthegovernmentcouldhavesavedbillionsbyhavingthearmed62forcesprovidetheseservices.Butthis—andotherexperiences—suggeststhatitwasnotjustideologythatdrovethecontracting/privatizationagenda:itwasrentseeking.LiberalizationandprivatizationTheironyisthatadvocatesofprivatization(turningoverpreviouslypubliclyrunenterprisestotheprivatesector)andliberalization(strippingawayregulations)havelongclaimedthatthesepoliciesarenecessarytorestrainrentseeking.Theynotecorruptioninthepublicsectorbutseldomacknowledgethatontheothersideofeverypublic-sectoremployeewhotakesabribeisabriber,andthatbriberistypicallyaprivateparty.Theprivatesectorisfullyinvolvedinthecorruption.Worsestill,inafundamentalsense,theagendaofprivatizationandliberalizationhasitselfbeencorrupt:ithasgarneredhighrentsforthosewho63usedtheirpoliticalinfluencetopushit.Aroundtheworld,theexamplesoffailedprivatizationsarelegion—fromroadsinMexicotorailroadsintheUK.ThemajorprivatizationintheUnitedStatesofrecentyears—ofthecompanythatmakesenricheduranium,usedfornuclearpowerplantsandmakingatomicbombs(USEC,theU.S.EnrichmentCorporation)—hasbeenplaguedwithcriticismsofdishonestdealing.Whiletheformergovernmentofficialswhoengineeredtheprivatizationandtheinvestmentbankthatfacilitateditmademillions,thecompanywasneverabletoturnaprofit.Formorethanadecadeandahalfafterprivatization,governmentsubsidieswereatthecenteroftheirbusinessmodel.Theresultshavebeensotroublingthattherehavebeenproposalstorenationalize64USEC.ButhadPresidentGeorgeW.Bushhadhisway,therewouldhavebeenamuch,muchbiggerprivatization—the(partial)privatizationofSocialSecurity,atthecenterofhisStateoftheUnionaddressof2005.Americansare,ofcourse,nowthankfulthathiseffortsfailed.Foriftheyhadsucceeded,America’selderlywouldhavebeeninanevenworsepositionthantheyaretoday:thosewhohadputtheirmoneyinthestockmarketwouldhaveseenmuchoftheirretirementwealthgone;thosewhoputtheirmoneyinsafeT-billswouldbestrugglingtosurvive,astheFedpushesinterestratesdowntonear-zerolevels.Butevenbeforethecrisis,itshouldhavebeenobviousthatprivatizationwasabaddealformostAmericans.WenotedbeforethatSocialSecurityismoreefficientthanprivateprovidersofannuities.140 Privateinsurancecompanieshavemuchhighertransactionscosts.Infact,thatwasthewholepointofprivatization:fortheelderly,transactionscostsareabadthing;butforthefinancialsector,theyareagoodthing.That’stheirincome.That’swhattheyliveoffof.Theirhopewastogetasliceofthehundredsof65billionsofdollarsthatpeopleputeveryyearintotheirSocial66Securityaccounts.Liberalization/deregulationinitiativeshavehadasmixedarecordasthoseofprivatization—withthemostnotoriousbeingfinancialsectorderegulationandcapitalmarketliberalization.ForthosedevotedtotheideologyoftheRight,thesefailuresareamystery.Tothosemoreapprisedofthelimitationsofthemarket,theyarepredictable—andoftenpredicted.Thisalsoappliestoliberalizationinitiatives,includingthedisastrousliberalizationofelectricpowerinCalifornia.Enron,oneofthebigadvocatesoftheliberalizationandanoutspokenadvocateofthewondersofthemarket(beforeitwentdownin2001,thelargestcorporatebankruptcyeverrecordeduptothatpoint),manipulatedtheCaliforniaelectricitymarkettomakemillionsandmillionsforitself,atransferofmoneyfromordinarycitizensofthatstatetoKenLay,itsCEO,andtheotherswhoranthecompany.BushofficialsblamedtheshortagesthatEnronhadmanagedtocreateonexcessiveenvironmentalregulationthatdiscouragednewconstruction.Therealitywasotherwise:assoonasEnron’smarketmanipulationstoinflatepriceswereexposedandregulationswererestored,theshortagesdisappeared.InnovationandtheresistancetoregulationOpponentsofregulationalwayscomplainthatit’sbadforbusiness.Regulationsthatpreventpollution,ofcourse,arebadforbusinessesthatwouldhaveotherwisepolluted.Regulationsthatpreventchildlaborarebadforbusinessesthatwouldhaveexploitedchildren.RegulationsthatpreventAmericancompaniesfromengaginginbriberyorabusesofhumanrightsmaybebadforbusinessesthatengageinbriberyorhumanrightsabuses.Aswe’veseen,privaterewardsandsocialreturnsoftendiffer;andwhentheydo,marketsdon’tworkwell.Thetaskofgovernmentistoalignthetwo.Ifitweretrue,assomehaveclaimed,thatnewbankingregulationswillstifleinnovation,westillwouldhavetoweighthebenefitsoftheregulationagainstthecosts.Ifregulationscanpreventanothernear-collapseofthebankingsystem,thebenefitswouldbeenormous,possiblyinthetrillionsofdollars.Andwell-designedregulationsdidsucceedinensuringthestabilityofourfinancialsystemfordecades,soregulationscanwork.Moreover,thisperiodoftightfinancialregulationwasalsooneofrapideconomicgrowth,aperiodinwhichthefruitsofthatgrowthweremorewidelysharedthantheyaretoday.Bycontrast,intheperiodof“liberalization”thegrowthofatypicalcitizen’sincomewasfarlowerthanintheperiodofregulation.Thereisasimplereasonforthefailureofliberalization:whensocialreturnsandprivaterewardsaremisaligned,alleconomicactivitygetsdistorted,includinginnovation.Theinnovationofthefinancialsectorwasdirectednottoimprovingthewell-beingofAmericansbuttoimprovingthewell-beingofbankers.Atleastforatime,itsucceededindoingthat;butit141 failedmiserablyinimprovingtheplightoftheordinaryAmericanorevenspurringgrowthintheAmericaneconomyasawhole.SUCCESSESINTHEBATTLEOFIDEASIhavedescribedthewarofideas—includingthoseideasthatarecentraltothepoliciesthatdeterminesocietalinequality—andwhilethewealthy(andcorporations)havebeenenormouslysuccessfulinshapingperceptionsinwaysthatbenefitthem,theyhavelost,orarelosing,atleastsomeofthebattles.Themarketplaceofideas,whilefarfromperfect,isstillcompetitive.Thisisareasonforhope.InthefollowingparagraphsIdescribethreesuchbattlesinwhichthetidehasbeenturning:thatovercorporatewelfare;thatovertheIMF,itsgovernance,andsomeofthepoliciesthatitusedtopursue;andthatovertheultimateobjectivesofpublicpolicy.ClasswarfareandcorporatewelfareWhenPresidentClintonenteredoffice,therewasbothhighunemploymentandalargedeficit,thoughtheunemploymentanddebtlevelspaleincomparisonwiththoseoftoday.Itwasnaturalforustolookforbudgetcutsthatwouldincreaseefficiencywithoutendangeringthecoreagendaof“puttingpeoplefirst”andperhaps,byredirectingspending,evenstimulatetheeconomy.ObviouscandidatesforcuttingwerelargeexpendituresonwhatRobertReich(thensecretaryoflabor)andIcalledcorporatewelfare,subsidiestoAmericancorporations.TheCouncilofEconomicAdviserswastaskedwithdrawingupalistofcuts—notaseasyasitmightseem,becausemuchofthecorporatewelfareishiddenwithinthetaxcode.Eventhen,towardthetopofthelistweresubsidiestothebanks(forinstance,viaIMFbailouts),toagriculture,andtothecoalandothernaturalresourcecompanies.Ithoughtthattherewouldbebroadconsensuswithintheadministrationontheprinciple,butconsiderablereservationonthepolitics.Iexpectedthedepartmentsthatdoledoutthesubsidiestotrytodefendtheirturf.WhatsurprisedmewasthestrongreactionfromtheheadoftheNationalEconomicCouncil(later,secretaryofTreasury)BobRubin:hesuggestedthatweweretryingtowageclasswarfare.Itwas,ofcourse,nothingofthekind.ForaDemocraticadministrationtryingtofocusitsattentiononeconomicrecoveryandhelpingpeople,expensivesubsidiesthatdistortedtheeconomyandincreasedinequalitymadenosense.Besides,topretendthattherewerenotlargeinequalities,largedivisions,inoursocietywasputtingone’sheadinthesand.WarrenBuffettputitcorrectlywhenhesaid,“There’sbeenclasswarfaregoingonforthelast20yearsand67myclasshaswon.”Buttheaccusationofclasswarfaresuggestedthatthosewhoweretryingtoreducecorporatewelfarewerebeingdivisive.IntheClintonadministration,wemadeonlyalittleprogressincuttingoutcorporatewelfare.Thebigsubsidiesforagricultureandenergyremained.Sodidthesmaller,buthighlysymbolic,subsidiesforcorporatejets.Butduringthe2008crisis,corporatewelfarereachednew142 heights.InthegreatbailoutoftheGreatRecession,onecorporationalone,AIG,gotmorethan$150billion—morethanwas68spentonwelfaretothepoorfrom1990to2006.Asdeficitshavebecomelarger,therehasbeenincreasingscrutinyofthebudget,andcutbacksofcorporatewelfare—whetherbythatnameornot—havebeenonthetable.Somecutbackshavealreadyoccurred—aswenotedearlier,inthebeginningof2012the$6billionethanolsubsidy,inplaceforthreedecades,ended.ButIsuspectthatthemorepowerfulindustriesandfirmswillbeabletoretainmuchofwhattheyreceive.Thereisaroleforgovernmentinprovidingasafetynet,in“socialprotection,”butitshouldbeprotectingindividualsandfamiliesagainsttherisksthattheyface,especiallythoseagainstwhichtheycannotinsure;itshouldnotbeprotectingcorporationsfromfacingtheconsequencesofbadbusinessjudgmentsorprovidingsubsidiestoenrichtheircoffers.Marketscan’tworkifthereisn’tsomediscipline—ifcompaniesgetonlytheupsideoftherisks,withtaxpayersbearingthelosses.TheIMF:theemperorhasnoclothesInGlobalizationandItsDiscontents,IdescribedtheintensebattlesbetweentheIMFandsomeofthoseindevelopingcountriesandemergingmarketsinavarietyofarenas—indevelopmentalpolicy,inthepoliciesoftransitionfromcommunismtoamarketeconomy,andinthemanagementoftheEastAsiacrisis.IexplainedhowtheIMFhadimposedcontractionarypoliciesoncountriesfacingeconomicdownturns,andIexplainedhowits“structuraladjustment”policies—forcingprivatizationandliberalization—hadoftenlednottogrowthbutinsteadtohardship,especiallyamongthepoor.AtthetimeIwrotethebook,theIMFwasviewedastheauthorityonthesematters,especiallyintheWest.Manyinthedevelopingworldwereskeptical:theysawthatthepoliciespushedbytheIMFoftenfailed.TheyperceivedtheIMFasadvancingtheinterestsoftheglobalfinancialsectorandcorporateinterestsintheadvancedindustrialcountries.ButtheytypicallyfelttheyhadnochoiceexcepttofollowtheIMF’sstrictures.Theyneededitsmoney.Isetouttoshowthattheemperorhadnoclothes:thatthefavoredIMFpolicieswerenotbasedonthebesteconomicscience;tothecontrary,manyofthedoctrinesthattheyhadpushedhadbeenthoroughlydiscreditedbyresearchineconomicsovertheprecedingquartercentury.Ialsosoughttoexposebothsomeoftheintellectualinconsistenciesandthefailuresingovernance.Overthisperiod,theIMFincreasinglyhadfocusedon“governance,”yetitsowngovernanceleftmuchtobedesired.Thefinancialsectorhadtoomuchinfluence,thedevelopingcountrieshadtoolittle.TheexcessiveinfluenceofthefinancialsectorhelpedexplaintheIMF’sdevotiontocontractionarypolicies—itsfirstprioritywastogetWesterncreditorsrepaid,andthatmeantcountrieshadtocutbacktheirspending,sothatmoremoneywouldbelefttorepaydebts.Italsohelpedexplainitsadvocacyofcapitalmarketliberalization,thestrippingawayofregulationsthataffectedtheflowsofmoney(especiallyshort-termhotmoney)intoandoutofacountry.Whiletherewaslittleevidencethatcapitalmarketliberalizationledtofastergrowth,therewasampleevidencethatitledtomoreinstability.Butfromtheperspectiveofthe143 advancedindustrialcountries,itwasstilldesirable,becauseitgavemorescopeforWesternfinancialfirmstocomeintodevelopingcountries—andmakemoreprofitsthere.Evidently,theIMFhadbeencapturedbyaself-reinforcingcombinationofideologyandinterests.Notsurprisingly,theIMFdidnottakekindlytotheseperspectives—andtheresponsewaspersonalandvituperative.ThesuggestionthatundercertaincircumstancescapitalcontrolsmightbedesirablewasgreetedwithsuggestionsthatIwastryingtosellsnakeoil.Tenyearslater,thebattlefieldlooksdifferent.Therehasbeenamajorchangeinperceptions,towhichmybookmayhavecontributed,andthereisabroadconsensusontheneedforgovernancereform—withsomealreadyunderway,andmorescheduledforthefuture.TheIMFhasadmittedthatcapitalcontrolsmaybedesirable69undercertaincircumstances.Insomeofitsprograms,suchasthatforIceland,ithasacceptedcapitalcontrolsandhaspushedformuchlessausteritythanwasitswont.Behindthescenes,insomeoftheEuropeancountriesincrisis,itpushedfordebtrestructurings—makingcreditorsbearmoreofthecosts,taxpayersless.Buttherehavebeenpowerfulforcesontheotherside,includingtheEuropeanCentralBank.WhileinGreecethenotionthatadeepdebtrestructuringwasfinallyaccepted,inIrelandevenunsecuredbondholderswereprotected—theygotthehighreturn,supposedlyforbearingrisk,butintheend,theywereprotected,atgreatexpensetoIrishtaxpayers.InpursuitofthewronggoalsAmericahasbeenhotinpursuitofthewronggoals.We’velostourway.WethoughtthatsimplybyincreasingGDPallwouldbenefit,butthathasnotbeenthecase.EveniftheAmericaneconomyproducesmoregoodsandservices,if,yearafteryear,mostAmericanshavelowerandlowerincomes,oureconomyisnotperformingwell.Itisobviousnowthatthestandardwayofmeasuringeconomicperformance,thelevelofrealpercapitaGDP(thesumofallofthegoodsandservicesproducedinsidethecountry,dividedbythenumberofpeopleinthecountry,adjustedforinflation)andtherateatwhichitisgrowing,isnotagoodmeasureofsuccess.AmericahasbeendoingfairlywellintermsofrealpercapitaGDP,andthosenumberslulleditintothinkingthatallwasgoingwell.(Eventhen,theUnitedStateswasnotthetopperformer—LuxembourgNorway,Switzerland,Denmark,and“socialist”7071SwedenhadahigherGDPpercapitain2010.)TotakeoneexampleofhowGDPcangiveafalseimpressionofacountry’ssuccess,GDPpercapitamismeasuresthevalueofgoodsandservicesproducedinseveralsectors,includinghealthandthepublicsector—twosectorswhoseimportancetodayismuchgreaterthanwhenGDPfirststartedtobemeasuredahalfcenturyago.America,forinstance,getsworsehealthoutcomes,intermsoflongevityorvirtuallyanyothermeasureofhealthperformance,butspendsmoremoney.Ifweweremeasuringperformance,thelowerefficiencyofAmerica’ssectorwouldcountagainsttheUnitedStates,andFrance’shealthcaresectoroutputwouldbehigher.Asitis,it’sjustthereverse:theinefficiencyhelpsinflateAmerica’sGDPnumber.144 Ourstandardmeasureofperformance,GDP,doesn’ttakeintoaccountsustainability—bothindividualsandcountriescanlivebeyondtheirmeans,butonlyforatime.That,ofcourse,wasthecasefortheUnitedStates.Notonlyweremostindividualsborrowingtosustaintheirlivingstandards;sowasthecountryasawhole.Ahousingbubblekepttheeconomygoingformuchofthefirstdecadeofthiscentury—akindofartificiallife-supportsystemthatgaverisetounsustainableconsumption.Mostimportantlyforthepurposesofthisbook,ourconventionalmeasuresofincomedon’tadequatelyreflectabroadersenseofwhat’shappeningtomostcitizens.Aswesawinchapter1,GDPpercapitacouldbegoingup,andyetmostcitizensinthecountrycouldbestagnatingorevenbecomingworse-off,yearafteryear:preciselywhathasbeenhappeningintheUnitedStates.Andjustastherearelargeinequalitiesinincome,therearelargedisparitiesinalmostalloftheotherdimensionsthatcontributetoourgeneralwelfare,andnoneofthesearereflectedinGDPasameasureofeconomicperformance.Take,forinstance,health,education,ortheenvironment.Theenvironmentaljusticemovementhascalledattentiontotheadverseenvironmentalconditionsunderwhichmanyofthepoorlive—theonlyhousingtheycanaffordisnearpollutingfactoriesornoisyairportsand72trains.Howwemeasureperformanceisanaspectofthebattleoverperceptionsandmakesadifference,especiallyinourperformance-orientedsociety.Oursystemsofmeasurementaffectourperceptionofhowwellwearedoing—andoftherelativeperformanceofdifferenteconomicsystems.Ifwemeasurethewrongthing,wewillbetemptedtodothewrongthing,andtomakethewronginferencesaboutwhatisagoodeconomicsystem.IfwemeasureoursuccessbyGDP,that’swhatwe’llpushfor,andwe’llpayinsufficientattentiontowhat’shappeningtomostAmericans.Totakeanotherexample:criticsof,say,environmentalregulationssuggestthattheyarecostly,thattheyreducegrowth.Buthowweseethattrade-offdependsonhowwemeasureoutput.IfinourmeasurementsofGDP,wetakeintoaccountthecostofenvironmentaldegradation,thenbetterenvironmentalregulationmayactuallyimproveGDPcorrectlymeasured.ForyearsthestandardmeasureofeconomicperformancewasGNP,grossnationalproduct,roughlyequaltothegrossincomeofthecitizensofacountry.Butthen,around1990,therewasaswitchtoGDP,grossdomesticproduct,thevalueofthegoodsandservicesproducedwithinacountry.Foracountryinisolation,nottradingwithothercountriesorreceivinginwardinvestments,thetwonumbersareequivalent.Buttheswitchoccurredjustasthepaceofglobalizationwasincreasing.Thishadsomeprofoundeffects:iftheincomeassociatedwithgoodsproducedinthecountrywentelsewhere,GDPcouldgoupwhileGNPdecreased.Andthiswasnotjustatheoreticalnicety.PapuaNewGuinea’s(PNG)goldminesweredevelopedbyforeigncompanies,fromAustralia,Canada,andelsewhere.Mostofthevalueofwhatwasproducedaccruedtotheforeigncompanies.PNGgotapittance—notenougheventocompensateitforthedestructionofitsenvironment,orotheradverseeffectsonitseconomyorthehealthofits73people.AfocusonGDPencouragedcountriestoundertakesuchprojects—themeasureoftheirsuccesswasimproved.Buthadtheoldmeasure,GNP,beenthefocus,suchprojectsmighthavebeen145 rejected.WhenIwaschairmanoftheCouncilofEconomicAdvisers,ItriedtoencouragetheUnitedStatestoaddresssomeoftheseproblems,forinstance,byconstructing“GreenGDP”accounts,whichwouldtakeintoconsiderationthedepletionofnaturalresourcesandthedegradationoftheenvironment.IknewthatIhadhitonsomethingimportantwhenthecoalindustryrespondedwithvehemence,andwhencongressionalrepresentativesofthecoalstateseventhreatenedtocutofffundingforworkonthisarea.Thecoalindustryrealizedthatperceptionsmattered:ifitbecamewidelyrecognizedthat,correctlymeasured,thecoalindustrymighthavebeenmakinganegativecontributiontothenation’soutput,thatwouldhavehadsignificantpolicyimplications.Todaythereisalmostuniversalrecognitionthatwehavetochangeourmetrics.PresidentSarkozyofFrancesetuptheInternationalCommissionontheMeasurementofEconomic74PerformanceandSocialProgress,whichIchaired.Expertsweredrawnfromstatistics,economics,politicalscience,andpsychology,andthegroupincludedthreeNobelPrizewinners.WeunanimouslyagreednotonlythatGDPwasabad,andpotentially75badlymisleading,measurebutthatitcouldbeimprovedupon.Icannotsay,atthispoint,thatwehavefullywonthisbattle,butthetidehasturned.EventheUnitedStateshasbegunworkinbroadeningitsmeasures.TheG-20endorsedworktofindbettermetrics.TheOECD,theorganizationoftheadvancedindustrialcountries,hasundertakenalargeprojectfollowinguponourwork.Andcountriesaroundtheworld—Australia,NewZealand,Scotland,theUK,Germany,France,Korea,Italy,andmanyothers—havebeguninitiativesalongtheselines.Indemocraticsocieties,evengiventhepowerofthewealthytocontrolthemediaandshapeperceptions,itisimpossibletocompletelysuppressideas.Andwhentheseideasresonatewithsomanycitizens,theycantakeonalifeoftheirown.CONCLUDINGCOMMENTSInpolitics,perceptionsarecrucial.Devotedideologuesoneachsidewillcherry-pickexamplesanddrawfromthembroadgeneralizations.Aswe’vetriedtoargue,manyindividualswillperceiveorrememberonlytheevidencethatisconsistentwiththeirinitialbeliefs.Thisissoperhapsespeciallyinideologicallychargedissues,suchastheroleofgovernment,particularlyindealingwithinequality.ThatitselfmaybeareflectionofthehighinequalityintheUnitedStates.Agreatdealofmoneyisatstakeforthe1percentinwinningthisdebate.Giventhat,itbecomesharder,noteasier,toweighallconsiderationsinabalancedway.Inthischapter,I’vetriedtopresentacaseforanuancedandbalancedapproachtotheproperroleofthemarketandthegovernment.Wedon’tdecidewhetheragivenmedicalinterventionisgoodorbadbyconsideringonlythesuccessesoronlythehorrorstories.Instead,wetrytounderstandtheconditionsunderwhichamedicalinterventionislikelytoworkornot.Whataretherisksofdoingnothing?Whatarethelimitationsofintervening?Thesamecareshouldbetakenwithboththe“big”ideaswehavebeendiscussingandthemorespecificpolicyinterventions.146 Thepowerfultrytoframethediscussioninawaythatbenefitstheirinterests,realizingthat,inademocracy,theycannotsimplyimposetheirruleonothers.Inonewayoranother,theyhaveto“co-opt”therestofsocietytoadvancetheiragenda.Hereagainthewealthyhaveanadvantage.Perceptionsandbeliefsaremalleable.Thischapterhasshownthatthewealthyhavetheinstruments,resources,andincentivestoshapebeliefsinwaysthatservetheirinterests.Theydon’talwayswin—butit’sfarfromanevenbattle.We’veseenhowthepowerfulmanipulatepublicperceptionbyappealstofairnessandefficiency,whiletherealoutcomesbenefitonlythem.Inthenextchapter,we’llseehowtheyachievethisnotonlyinthecourtofpublicopinionbutalsoinAmerica’scourts.147 CHAPTERSEVENJUSTICEFORALL?HOWINEQUALITYISERODINGTHERULEOFLAWEVERYMORNING,STUDENTSTHROUGHOUTAMERICApledgetheirallegiancetotheflagoftheUnitedStatesand“totheRepublicforwhichitstands,onenation,underGod,withlibertyandjusticeforall.”Thatimplicitpromise,libertyandjusticeforall,capturesoneoftheessentialvaluesthathelpdefineAmerica’ssenseofidentity.Atourbest,weareacountrywheretheruleoflawprevails,whereanindividualisinnocentuntilprovenguilty,andwhereallpeoplestandequalbeforethelaw.ThesevaluesalsoarecentraltoourunderstandingofAmerica’splaceintheworld.Wehavechampionedthemtoothercountries.Yetwhatthepledgereallymeansisseldomtakenup.Norisastilllargerquestionbroached:whetherAmericahasreallydeliveredonitspromises.Thischapterexploresoneofthreecrucialbattlefieldsuponwhichthefighttocreateamoreequal,ormoreunequal,societyisfought—thebattleoverthelawsandregulationsthatgovernoureconomyandhowtheyareenforced.Thenextchapterconsidersthebattleofthebudget,andchapter9examinestheconductofmonetarypolicyandmacroeconomics.Thechapterbeginsbyaskingaratherabstract,butkey,setofquestions:Whatisthepurposeofthelawsandregulationsthatarecentraltothefunctioningofoureconomy?Whydoweneedaruleoflaw?Istheremorethanonepossible“ruleoflaw,”and,ifso,whatdifferencesdothechoicesmake?Thecentralmessageechoesthatofearlierchapters:Therearealternativelegalframeworks.Eachhasconsequencesforefficiencyanddistribution.Thewrongkindofruleoflawcanhelppreserveandextendinequities.Whileagood“ruleoflaw”issupposedtoprotecttheweakagainstthepowerful,we’llseehowtheselegalframeworkshavesometimesdonejusttheopposite,andtheeffecthasbeenalarge1transferofwealthfromthebottomandmiddletothetop.Ironically,whiletheadvocatesoftheselegalframeworksarguedforthemaspromotinganefficienteconomy,theyhaveactuallyledtoadistortedeconomy.WHYWENEEDARULEOFLAWAstheoldpoemgoes,“Nomanisanisland.”Inanysocietywhatonepersondoesmayhurt,orbenefit,others.Economistsreferto148 theseeffectsasexternalities.Whenthosewhoinjureothersdon’thavetobearthefullconsequencesoftheiractions,theywillhaveinadequateincentivesnottoinjurethem,andtotakeprecautionstoavoidrisksofinjury.Wehavelawstoprovideincentivesforeachofustoavoidinjuriestoothers—totheirproperty,theirheath,andthepublicgoods(suchasnature)thattheyenjoy.Economistshavefocusedonhowbesttoprovideincentivessothatindividualsandfirmstakeintoaccounttheirexternalities:steelproducersshouldbeforcedtopayfortheirpollution,andthosewhocauseaccidentsshouldpayfortheconsequences.Weembodytheseideas,forinstance,inthe“polluterpaysprinciple,”whichsaysthatpollutersshouldpayforthefullconsequencesoftheiractions.Notpayingthefullconsequencesofone’saction—forinstance,forthepollutioncausedbyproduction—isasubsidy.Itisequivalenttonotpayingthefullcostoflabororcapital.Somecorporationsthatresistpayingforthepollutionthattheycreatetalkaboutthepossiblelossofjobs.Noeconomistwouldsuggestthatdistortionarysubsidiestolabororcapitalshouldbepreservedtosavejobs.Notpayingthecostsimposedontheenvironmentisaformofsubsidythatshouldbenomoreacceptable.Theresponsibilityformaintainingtheeconomyatfullemploymentlieselsewhere—withmonetaryandfiscalpolicy.Thesuccesscorporationsoftenhavehadinavoidingthefullconsequencesoftheiractionsisanexampleofhowtheyshapetherulesoftheeconomicgameintheirfavor.Asaresultoflawsthatlimittheextentoftheirliabilities,nuclearpowerplantsandoffshoreoilrigsareshieldedfrombearingthefullcosts2shouldtheyexplode.Theconsequenceisthatwehavemorenuclearpowerplantsandoffshorerigsthanwewouldotherwise—infact,it’squestionablewhether,withoutawholesetofgovernment3subsidies,therewouldbeanynuclearpowerplantsatall.Sometimes,thecoststhatfirmsimposeonothersaren’tapparentrightaway.Corporationsoftentakebigrisks,andnothingmaygowrongforyearsandyears.Butwhensomethingdoesgowrong(aswiththeTEPCOnuclearpowerplantinJapanorwiththeUnionCarbideplantinBhopal,India),thousandscansuffer.Forcingcorporationstocompensatethoseinjureddoesn’treallyundotheharm.Evenifthefamilyofsomeonewhodiesbecauseofunsafeworkconditionsiscompensated,thepersonisn’tbroughtbacktolife.That’swhywecan’trelyjustonincentives.Somepeoplearerisktakers—especiallywhenothersbearmostoftherisk.TheexplosionaboardtheDeepwaterHorizoninApril2010beganaspillthatspewedmillionsofbarrelsofBritishPetroleumoilintotheGulfofMexico.BPexecutiveshadgambled:skimpingonsafetyincreasedimmediateprofits.Inthiscase,theygambledandlost—buttheenvironmentandresidentsofLouisianaandtheotherGulfstateslostevenmore.Intheresultinglitigation,corporationsthatdocausedamagemayhaveastrongerhandthanthepeoplewhoarehurt.Theymaybeinapositiontonickel-and-dimethosewhosufferdamage,sincemanypeoplecannotholdoutforadequatecompensation,norcantheyaffordlawyerstomatchthoseofthecompany.Oneroleofgovernmentistorebalancethescalesofjustice—andinthecaseoftheBPdisaster,itdid,butverygently,andintheend,itbecameclearthatmanyofthevictimswerelikelytoreceive4compensationthatwasbutafractionofwhattheysuffered.149 RonaldCoase,aChicagoNobelPrize–winningeconomist,explainedhowdifferentwaysofassigningpropertyrightswereequallyefficientforaddressingexternalities,oratleastwould5beinahypotheticalworldwithnotransactionscosts.Inaroomwithsmokersandnonsmokers,onecouldassignthe“airrights”tothesmokers,andifthenonsmokersvaluedcleanairmorethanthesmokersvaluedsmoking,theycouldbribethesmokersnottosmoke.Butonecouldalternativelyassigntheairrightstothenonsmokers.Inthatcase,smokerscouldbribethenonsmokerstoallowthemtosmokesolongastheyvaluedtherighttosmokemorethanthenonsmokersvaluedcleanair.Inaworldoftransactionscosts—therealworld,where,forinstance,itcostsmoneytocollectmoneyfromonegrouptopayanother—oneassignmentcanbe6muchmoreefficientthantheother.Butmoretothepoint,therecanbelargedistributiveconsequencesofalternativeassignments.Givingnonsmokerstheairrightsbenefitsthemattheexpenseofthesmokers.Tryasonemight,onecannotescapeissuesofdistribution,evenwhenitcomestothesimplestproblemsinorganizingan7economy.Theflipsideoftheintertwiningofthese“propertyrights”/externalitiesissuesanddistributionisthatnotionsof“liberty”and“justice”cannotbeseparated.Eachindividual’slibertieshavetobecurtailedwhentheyimposeharmsonothers.Oneperson’slibertytopollutedeprivesanotherofherhealth.Oneperson’slibertytodrivefastdeprives8anotherofhisrightnottobeinjured.Butwhoselibertiesareparamount?Toanswerthisfundamentalquestion,societiesdeveloprulesandregulations.Theserulesandregulationsbothaffecttheefficiencyofthesystemanddistribution:somegainattheexpenseofothers.That’swhy“power”—politicalpower—matterssomuch.Ifeconomicpowerinacountrybecomestoounevenlydistributed,politicalconsequenceswillfollow.Whilewetypicallythinkoftheruleoflawasbeingdesignedtoprotecttheweakagainstthestrong,andordinarycitizensagainsttheprivileged,thosewithwealthwillusetheirpoliticalpowertoshapetheruleoflawto9provideaframeworkwithinwhichtheycanexploitothers.Theywillusetheirpoliticalpower,too,toensurethepreservationofinequalitiesratherthantheattainmentofamoreegalitarianandmorejusteconomyandsociety.Ifcertaingroupscontrolthepoliticalprocess,theywilluseittodesignaneconomicsystemthatfavorsthem:throughlawsandregulationsthatapplyspecificallytoanindustry,throughthosethatgovernbankruptcy,competition,intellectualpropertyortaxation,or,indirectly,throughcostsofaccessingthecourtsystem.Corporationswillargue,ineffect,thattheyhavetherighttopollute—andtheywillaskforsubsidiesnottopollute;orthattheyhavetherighttoimposetheriskofnuclearcontaminationonothers—andtheywillaskfor,ineffect,hiddensubsidies,limitationsinliabilitytoprotectthemselvesagainstbeingsuediftheirplantexplodes.Myexperienceingovernmentsuggeststhatthosewhoholdpositionsofpowerwanttobelievethattheyaredoingtherightthing—thattheyarepursuingthepublicinterest.Buttheirbeliefsareatleastmalleableenoughforthemtobeconvincedby“specialinterests”thatwhattheywantisinthepublicinterest,whenitisinfactintheirownintereststosobelieve.150 Intherestofthischapter,weexaminethisthemeinthreecontextswhererulesandregulationsplayacentralroleindetermininghowAmerica’smarketeconomyhasbeenworkinginrecentyears:predatorylending,bankruptcylaw,andtheforeclosureprocess.PREDATORYLENDINGEarlyoninthehousingbubble,itbecameclearthatthebankswereengagednotonlyinrecklesslending—sorecklessthatitwouldendangertheentireeconomicsystem—butalsoinpredatorylending,takingadvantageoftheleasteducatedandfinanciallyunsophisticatedinoursocietybysellingthemcostlymortgagesandhidingdetailsofthefeesinfineprintincomprehensibletomostpeople.Somestatestriedtodosomethingaboutit.Forinstance,inOctober2002theGeorgialegislature,afterobservingthatmortgagelendinginthestatewasriddledwithfraudandpredation,triedtocallahalttoitwithaconsumerprotectionlaw.Theresponsefromthefinancialmarketswasquickandfurious.Theratingsagencies,todaybestknownfortheirroleincallingpoolsofF-ratedmortgagesA-ratedsecurities,alsohadahandinsustainingfraudulentlendingpractices.TheyshouldhavewelcomedtheactionsofstateslikeGeorgia:thelawmeantthattheagencieswouldnotneedtoassesswhethermortgagesinagivenpoolwerefraudulentorinappropriate.Instead,Standard&Poor’s,oneoftheleadingratingagencies,threatenednottorateanyofGeorgia’smortgages.Withouttheseratings,themortgageswouldhavebeenhardtosecuritizeandwithoutsecuritization(inthebusinessmodeloftheday)mortgagelendinginthestatemightdryup.Evidently,theratingagencieswereworriedthatifthepracticespreadtootherstates,theflowofbadmortgagesfromwhichtheymadesomuchmoney“rating”wouldbegreatlydiminished.S&P’sthreatwaseffective:thestate10quicklyreversedthelaw.Insomeotherstates,too,therewereattemptstostoppredatorylending,andineachoftheseinstancesbanksusedalltheirpoliticalmuscletostopstatesfromenactinglawsaimedat11curtailingpredatorylending.Theresult,asweknownow,wasnotonlymassivefraudbutalsobadlending:toomuchindebtedness,withfinancialproductsthatcouldexplodewithachangeininterestratesorinthebroadereconomicconditions,12andindeedmanydidexplode.Inasimplerworld,theadagecaveatemptor(“letthebuyerbeware”)mighthavebeenappropriate;butnotintoday’scomplexworld.Aregulatoryagencyforfinancialproductsisneededtopreventnotjustfraudbutalsoabusive,deceptive,and13inappropriateproducts.Evenmanyfinancialinstitutionsrecognizedthatsomeregulationwasneeded:withoutbankandinsuranceregulationsensuringthesoundnessoftheseinstitutions,individualswouldbereluctanttoturnovertheirmoneytobanksandinsurancecompanies,lesttheynevergetitback.Individualsontheirownwouldneverbeabletoassessthefinancialconditionsoftheselargeandcomplexinstitutions;ithasprovenhardenoughfor14experiencedgovernmentregulatorstodoso.151 ButtheU.S.bankingsectorresistedthesuggestionthatregulationbeextendedtoprotectconsumers,inspiteofitsterriblerecordofbadlendingandpoorcreditpracticesbeforethecrisis,whichhadledtowidespreadpublicsupportforanagencytodoso.AndwhenaprovisioncreatingsuchanagencywasincludedintheDodd-Frankbill,financialinstitutionscampaignedtomakesurethatElizabethWarren,aHarvardlawprofessorwithallthecredentialsnecessarytorunsuchanagency,includingtheexpertiseandcommitmenttoprotectconsumers,wasnotchosentoheadit.Thebankswon.(Shewasin,infact,widelycitedastheoriginatoroftheideaofsuchanagency,andatirelesscampaignerforit,asinforwhichthefinancialcommunitycouldnotforgiveher.Evenworse,sheservedaschairoftheCongressionalOversightPanel,overseeingthegovernment’sbailoutprogram.Thepanelrevealedthattheadministrationwasgivingthebanksagreatdeal—gettingbackfromthebankspreferredsharesworthabouthalfofwhatthegovernmentwas15givingthem.)BANKRUPTCYLAWAhostofotherlawsandregulationsshapethemarketandtherebyaffectthedistributionofincomeandwell-being.Bankruptcylaw(whichspecifieswhathappenswhenanindividualoracorporationcan’tpaybackwhatisowed)hasparticularrelevancetotwopartsofoursociety—thoseatthetop(thebankers)andthoseatthebottom,whostruggletomakeendsmeet.Bankruptcylawisdesignedtogiveindividualsafreshstart.ThenotionthatundercertainconditionsdebtsshouldbeforgivenhasalongtraditionthatgoesbackatleastasfarastheBookofLeviticus,wheredebtswereforgivenintheJubileeyear.Virtuallyeverymoderneconomyhasabankruptcylaw.Theselawscanbeeithermoredebtorormorecreditorfriendly,makingiteasierormoredifficulttodischargedebts.Howtheyareshapedobviouslyhasstrongdistributionalconsequences,buttheincentiveeffectscanbeequallypowerful.Ifdebtscan’tbedischarged,orcan’tbedischargedeasily,lendershavelessofanincentivetobecarefulinlending—andmoreofanincentivetoengageinpredatorylending.In2005,justassubprimemortgageswerestartingtoboom,Congresspassedanewcreditor-friendlybankruptcylawthatgavethebanksevenmoreofanupperhand,makingitmoredifficultfordistressedborrowerstodischargetheirdebts.Thechangeinthelawintroducedasystemof“partialindenturedservitude.”Anindividualwith,say,debtsequalto100percentofhisincomecouldbeforcedtohandovertothebank25percentofhisgross,pretaxincomefortherestofhislife.Thisisbecausethebankcouldaddon,say,30percentinteresteachyeartowhatapersonowed.Intheend,amortgageholderwouldowefarmorethanthebankeverlent.Thedebtorwouldendupworking,ineffect,one-16quartertimeforthebank.Everyloanhasawillinglenderandawillingborrower;thebanksaresupposedtobefinanciallysophisticated,toknowhowmuchdebtindividualscanmanage.Butadistortedfinancialsystemputmoreemphasisontheup-frontfeesthatshowedupquicklyinthebanks’bottomlinethanonthelossesthatmightbeincurredfurtherdowntheline.Emboldenedbythenewbankruptcylaw,they152 felttheycouldsomehowsqueezemoneyoutoftheirhaplessborrowers,whateverhappenedtothehousingmarketandunemployment.Thisrecklesslending,combinedwithdeceptivepracticesandsometimesusuriousinterestrates,hasputmanyhouseholdsonthebrinkoffinancialruin.Inspiteofso-calledreforms,banksstillsometimeschargeratesnearing30percentayear(whichmeansthata$100debtcangrowto$1,000inashortspanofnineyears).Ontopofthis,theycanimposecripplingfees.Whilesomeoftheworstabuseshavebeencurbed,suchasthoseassociatedwithoverdrafts(whichgeneratedliterally17billionsofdollarsayearinprofits—moneytakenoutofthepocketsofordinarycitizens),manycontinue.Whenthenewbankruptcylawwaspassed,propertyrightswerechanged,butinawaythatfavoredthebanks.Atthetimetheborrowershadincurredtheirdebt,amorehumanebankruptcylawgavethemachanceforafreshstartiftheburdenofdebtrepaymentbecametooonerous.Thebanksdidn’tcomplainaboutthischangeinpropertyrights;afterall,theyhadpushedforitvociferously.Whenthingsgotheotherway,ofcourse,theownersofpropertycomplainthattherulesofthegamearebeingchanged18midcourseanddemandcompensation.StudentloanprogramsWesawearlierthatinequalityintheUnitedStateshasbeenrisingsteeplyandislikelytocontinuetoincrease.Oneofthereasonsisthegrowinginequalityofopportunity,relatedinparttoeducationalopportunity.Youngpeopleandtheirparentsknowtheimportanceofeducation,butwehavecreatedasystemwherethestrivingforeducationmayactuallybeleadingtomoreinequality.Onereasonforthisisthatoverthepasttwenty-fiveyears,thestateshavebeenwithdrawingsupportfromhigher19education.Thisproblemgrewintherecession.Anotherreasonisthataspiringstudentsarebecoming20increasinglyindebted.The2005bankruptcylawmadeitimpossibleforstudentstodischargetheirstudentdebtsevenin21bankruptcy.Thisevisceratesanyincentivesforbanks,andthefor-profitschoolsthattheyworkwith,toprovideaneducation22thatwillyieldareturn.Eveniftheeducationisworthless,theborrowerisstillonthehook.Andformanystudents,theeducationisfrequentlyalmostworthless.Some80percentofthe23studentsdonotgraduate,andtherealfinancialrewardsofeducationcomeonlyuponcompletionoftheprograms—andeventhentheymaynotmaterialize.Butinthisconspiracybetweenthefor-profitschools(manyownedpartlyorlargelybyWallStreetfirms)andthefor-profitbanks,thestudentsareneverwarned.Ratherthan“Satisfactionguaranteedoryourmoneyback,”therealityis“Dissatisfactionisalmostguaranteed,butyouwillbesaddledwiththesedebtsfortherestofyourlife.”Neithertheschoolsnorthelenderssay,“Youarealmostcertainnottogetagoodjob,ofthekindyoudreamof.Weexploityourdreams;wedon’tdeliveronourpromise.”Whenthegovernmentproposedstandards—schoolswouldqualifyforgovernmentbackedloansonlyiftherewasanadequatecompletionrateandenoughstudentsatisfaction,withatleastaminimalnumberofstudentsgettingthejobsthatwerepromised—theschoolsandthebanksfoughtback,largely153 successfully.Itwasn’tasifthegovernmentwastryingtoregulateaprivateindustrythatwasseeminglydoingwellonitsown(thoughpartlybyexploitingthepoorandlessinformed).Thefor-profitschoolsexistedlargelybecauseofthefederalgovernment.Schoolsinthe$30billionayearfor-profiteducationindustryreceiveasmuchas90percentoftheirrevenuefromfederalstudentloanprogramsandfederalaid.Theywereenjoyingthemorethan$26billiontheyweregettingfromthefederalgovernment;itwasenoughmoneytomakeitworthwhiletoinvestheavilyinlobbyingandcampaigncontributions,tomakesurethattheywerenotheld24accountable.Inthecaseofstudentloans,thebanksmanagedforyearstogetrewardswithalmostnorisk:inmanyinstances,thegovernmentguaranteedtheloans;inothers,thefactthattheloanscanneverbedischarged—theyarebankruptcyproof—makesthemsaferthanotherloanstosimilarindividuals.Andyettheinterestratechargedtostudentswasincommensuratewiththeserisks:thebankshaveusedthestudentloanprograms(especiallythosewithgovernmentguarantees)asaneasysourceofmoney—somuchsothatwhenthegovernmentfinallyscaleddowntheprogramin2010,thegovernmentandthestudentscould,betweenthem,pockettensof25billionsofdollarsthatpreviouslyhadgonetothebanks.Americasetsthepattern26Usury(chargingexorbitantinterestrates),ofcourse,isnotlimitedtotheUnitedStates.Infact,aroundtheworldthepooraresinkingindebtasaresultofthespreadofthesameroguecapitalism.Indiahaditsownversionofasubprimemortgagecrisis:thehugelysuccessfulmicrocreditschemesthathaveprovidedcredittopoorfarmersandtransformedtheirlivesturneduglyoncetheprofitmotivewasintroduced.InitiallydevelopedbyMuhammadYunusoftheGrameenBankandSirFazleHasanAbedofBRACinBangladesh,microcreditschemestransformedmillionsoflivesbygivingthepoorest,whohadneverbanked,accesstosmallloans.Womenwerethemainbeneficiaries.Allowedtoraisechickensandengageinotherproductiveactivities,theywereabletoimprovelivingstandardsintheirfamiliesandtheircommunities.Butthenfor-profitbanksdiscoveredthatthere“was27moneyatthebottomofthepyramid.”Thoseonthebottomrunghadlittle,buttheyweresonumerousthattakingasmallamountfromeachofthemwasworthit.Banksallovertheworldenthusiasticallyembracedmicrofinanceforthepoor.InIndiathebanksseizeduponthenewopportunities,realizingthatpoorIndianfamilieswouldpayhighinterestratesforloansnotjusttoimprovelivelihoodsbuttopayformedicinesforsickparents28ortofinanceaweddingforadaughter.Theycouldcloaktheseloansinamantleofcivicvirtue,describingthemas“microcredit,”asiftheywerethesamethingthatGrameenandBRACweredoinginneighboringBangladesh—untilawaveofsuicidesfromfarmersoverburdenedwithdebtcalledattentiontothefactthattheywerenotthesame.THEMORTGAGECRISISANDTHE154 ADMINISTRATIONOFTHERULEOFLAWWhenthesubprimemortgagecrisisfinallybrokewideopen,precipitatingtheGreatRecessionof2008,thecountry’sresponsetotheensuingfloodofforeclosuresprovidedatestofAmerica”s“ruleoflaw.”Atthecoreofpropertyrightsandconsumerprotectionarestrongproceduralsafeguards(suchasrecordkeeping)toprotectthosewhoenterintocontracts.Suchsafeguardswereinplacetoprotecthomeownersaswellaslenders.Ifthebankclaimedthatapersonoweditmoney,thenbylawithadtoprovideproofbeforeitcouldjustthrowsomeoneoutintothestreets.Whenamortgage(anIOUfromahomeownertoalender)istransferredfromonelendertoanother,thenbylawaclearrecordofwhattheborrowerhasrepaid,andwhatheowes,mustaccompanythemortgage.Thebankshadissuedsomanymortgages,sorapidly,thattheyhadgivenshortshrifttobasicproceduralsafeguards.Andasthebanksandotherlendersrushedtolendmoreandmoremoney,notsurprisinglyfraudulentpracticesbecameendemic.FBI29investigationsspiked.Thecombinationoffrequentfraudulentpracticesandadisregardofproceduralsafeguardswaslethal.Thebankswantedaspeedierandlesscostlywayoftransferringclaims,sotheycreatedtheirownsystem,calledMERS(MortgageElectronicRegistrySystem),but,likesomuchofwhatthebankshaddoneinthegoldrushdays,itprovedtobeadeficientsystem,withoutsafeguards,andamountedtoanendrunaroundalegalsystemintendedtoprotectdebtors.Asonelegalexpertputit,“MERSanditsmembersbelievedthattheycouldrewrite30propertylawwithoutademocraticmandate.”Whenthehousingbubblefinallyburst,thedangersofbanks’recklessnessinlendingandrecordkeepingbecameapparent.Bylaw,banksweresupposedtobeabletoprovetheamountsowed.Itturnedoutthatinmanycases,theysimplycouldnot.Allofthishascomplicatedtheprocessofcleaninguptheensuingmess.Thesheernumbersofmortgagesindefault,runninginthemillions,madethetaskevenworse.Theimmensityofthetaskledthebankstoinvent“robo-signing.”Insteadofhiringpeopletoexaminerecords,toverifythattheindividualdidowetheamountclaimed,signinganaffidavitattheendthattheyhaddoneso,manybanksarrangedforasinglepersontosignhundredsoftheseaffidavitswithoutevenlookingattherecords.Checkingrecordstocomplywithlegalprocedurewouldhurtthebank’sbottomline.Thebanksadoptedapolicyoflyingtothecourt.Bankofficersknewthis—thesystemwassetupinawaythatmadeitimpossibleforthemtoexaminetherecords,astheyclaimedtohavedone.Thisbroughtanewtwisttotheolddoctrineoftoo-big-to-fail.Thebigbanksknewthattheyweresobigthatiftheylostontheirgamblesofriskylendingtheywouldhavetobebailedout.Theyalsoknewthattheyweresobigthatiftheygotcaughtlying,theyweretoobigandpowerfultobeheldaccountable.Whatwasthegovernmenttodo?Reversethemillionsofforeclosuresthathadalreadyoccurred?Finethebanksbillionsofdollars—astheauthoritiesshouldhavedone?Butthiswouldhaveputthebanksagaininaprecariousposition,requiringanothergovernmentbailout,forwhichithadneitherthemoneynorthepoliticalwill.Lyingtoacourtisnormallyaveryseriousmatter.Lyingtothecourtroutinely,hundredsoftimes,shouldhavebeenaneven155 greateroffense.Therewasatruepatternofcrime.If31corporationshadbeenpeopleinastatethatenforceda“threestrikes”rule(threeinstancesofshoplifting,andonefacesamandatorylifesentence),theserepeatoffenderswouldhavebeensentencedtomultiplelifesentences,withoutparole.Infact,nobankofficerhasgonetojailfortheseoffenses.Indeed,asthisbookgoestopress,neitherAttorneyGeneralEricHoldernoranyoftheotherU.S.districtattorneyshavebroughtsuitsforforeclosurefraud.Bycontrast,followingthesavingsandloancrisis,by1990,theDepartmentofJusticehadbeensent7,000criminalreferrals,resultingin1,100chargesby1992,and83932convictions(ofwhicharound650ledtoaprisonsentence).Todaythebanksaresimplynegotiatingwhattheirfinesshouldbe—andinsomecasesthefinesmaybelessthantheprofitsthat33theyhavegarneredfromtheirillicitactivity.Whatthebanksdidwasnotjustamatteroffailingtocomplywithafewtechnicalities.Thiswasnotavictimlesscrime.Tomanybankers,theperjurycommittedastheysignedaffidavitstorushtheforeclosureswasjustadetailthatcouldbeoverlooked.Butabasicprincipleoftheruleoflawandpropertyrightsisthatyoushouldn’tthrowsomeoneoutofhishomewhenyoucan’tproveheowesyoumoney.Butsoassiduouslydidthebankspursuetheirforeclosuresthatsomepeoplewerethrownoutoftheirhomeswhodidnotoweanymoney.TosomelendersthisisjustcollateraldamageasthebankstellmillionsofAmericanstheymustgiveuptheirhomes—someeightmillionsincethecrisisbegan,andan34estimatedthreetofourmillionstilltogo.Thepaceofforeclosureswouldhavebeenevenhigherhaditnotbeenforgovernmentinterventiontostoptherobo-signing.Thebanks’defense—thatmostofthepeoplethrownoutoftheirhomesdidowemoney—wasevidencethatAmericahadstrayedfromtheruleoflawandfromabasicunderstandingofit.Oneissupposedtobeinnocentuntilprovenguilty.Butinthebanks’logic,thehomeownerhadtoprovethathewasnotguilty,thathedidn’towemoney.Inoursystemofjusticeitisunconscionabletoconvictaninnocentperson,anditshouldbeequallyunconscionabletoevictanyonewhodoesn’towemoneyonherhome.Wearesupposedtohaveasystemthatprotectstheinnocent.TheU.S.justicesystemrequiresaburdenofproofandestablishesproceduralsafeguardstohelpmeetthatrequirement.Butthebanksshort-circuitedthesesafeguards.Infact,thesystemwehadinplacemadeiteasyforthemtogetawaywiththeseshortcuts—atleastuntiltherewasapopularuproar.Inmoststates,homeownerscouldbethrownoutoftheirhomeswithoutacourthearing.Withoutahearing,anindividualcannoteasily(oratall)forestallanunjustforeclosure.Tosomeobservers,thissituationresembleswhathappenedinRussiainthedaysofthe“WildEast”afterthecollapseofcommunism,wheretheruleoflaw—bankruptcylegislationinparticular—wasusedasalegalmechanismtoreplaceonegroupofownerswithanother.Courtswerebought,documentsforged,andtheprocesswentsmoothly.InAmerica,thevenalityoperatesatahigherlevel.Itisnotparticularjudgeswhoareboughtbutthelawsthemselves,throughcampaigncontributionsandlobbying,inwhathascometobecalled“corruption,American-style.”Insomestatesjudgesareelected,andinthosestatesthere’sanevencloserconnectionbetweenmoneyand“justice.”Moniedinterestsusecampaigncontributionstogetjudgeswhoaresympathetictotheir156 35causes.Theadministration’sresponsetothemassiveviolationsoftheruleoflawbythebanksreflectsournewstyleofcorruption:theObamaadministrationactuallyfoughtagainstattemptsbystatestoholdthebanksaccountable.Indeed,oneofthefederal-government36controlledbanksthreatenedtoceasedoingbusinessinMassachusettswhenthatstate’sattorneygeneralbroughtsuitagainstthebanks.MassachusettsattorneygeneralMarthaCoakleyhadtriedtoreachasettlementwiththebanksforoverayear,buttheyhadprovedintransigentanduncooperative.Tothemthecrimestheyhadcommittedwerejustamatterfornegotiation.Thebanks(shecharged)hadactedbothdeceptivelyandfraudulently;theyhadnotonlyimproperlyforeclosedontroubledborrowers(citingfourteeninstances),relyingtodosoonfraudulentlegaldocumentation,buttheyhadalso,inmanycases,promisedtomodifyloansforhomeownersandthenrenegedonthepromise.Theproblemswerenotaccidentalbutsystematic,withtheMERSrecordingsystem“corrupting”theframeworkputintoplacebythestateforrecordingownership.TheMassachusettsattorneygeneralwasexplicitinrejectingthe“toobigtobeaccountable”argument:“Thebanksmaythinkthattheyaretoobigtofailortoobigtocareabouttheimpactoftheiractions,butwebelievetheyare37nottoobigtohavetoobeythelaw.”InlateFebruary2012,theWallStreetJournaluncoveredanotherunsavoryaspectofAmerica’sforeclosurecrisis.Justaswenotedinchapter3thattherehadbeendiscriminationintheissuanceofmortgages,sotoointheforeclosureprocess—thistimenotonthebasisofracebutonthebasisofincome.Onaverage,ittookbankstwoyearsandtwomonthstoforecloseonmortgagesover$1million,sixmonthslongerthanonthoseunder$100,000.Thereweremanyreasonsforthis,includingbanks’exertinggreatereffortstoaccommodatethesebigdebtorsandborrowers’beingbetterarmedwithlawyerstodefend38themselves.Thediscussionofthischapter,alongwiththatofchapter6,hasshownhowthefinancialsectormadesurethatthe“ruleoflaw”worksinitsfavoralmostalways,andagainstordinaryAmericans.Ithastheresources,theorganization,andtheincentivestodoso;anditaccomplishedwhatitsetouttodo,throughamultifacetedattackthatincludedreformingbankruptcylawstoincreasetheirpoweroverborrowers,ensuringthatprivate,for-profitschoolscouldgetaccesstostudentloans,almostregardlessofstandards,abolishingusurylaws,preventinglegislationtocurtailpredatorylending,andcircumventingtheproceduralsafeguards,weakastheywere,tomakesurethatonlyindividualswhoreallyowedmoneywouldlosetheirhomes.Butinlendingandinforeclosurestheytargetedtheweak,thepoorlyeducated,thepoor.Moralscruplesweresetasideinthegrandquesttomovemoneyfromthebottomtothetop.Inchapter6weexplainedhowtheforeclosurecrisiscoulditselfhavebeenlargelyavoided,ifwehadonlynotletthebankshavesomuchinfluence,byallowinganorderlyrestructuringofdebt,justaswedoforlargecorporations.Ateachstepoftheway,fromtheinitialmakingofloanstothefinalforeclosure,therewerealternativesandregulationsthatwouldhavecurtailedtherecklessandpredatorylendingandenhancedeconomicstability157 —perhapsevenavoidingtheGreatRecessionitself—butwithapoliticalsystemwheremoneymatters,thesealternativeshadnochance.Themortgagedebacleandthepersistenceofpredatorylendingandbankruptcy“reform”haveraiseddeepquestionsabout“theruleoflaw,”whichistheuniversallyacceptedhallmarkofanadvanced,civilizedsociety.Theruleoflawissupposedtoprotecttheweakagainstthestrongandensurefairtreatmentforall.Inthewakeofthesubprimemortgagecrisis,ithasdoneneither.Insteadofaruleoflawthatprotectedtheweak,wehadlawsandregulationsandasystemofenforcementthatfurtherempoweredthealreadypowerfulbanks.Inmovingmoneyfromthebottomtothetop,theyworsenedtheproblemsofinequalityinbothtailsoftheincomeandwealthdistribution.DEFACTOVS.DEJURERunningajudicialsystemiscostly,andtherulesofthegamedeterminehowlargethosecostsareandwhobearsthem.Ifonedesignsacostlysysteminwhichthepartiesthemselvesbearthecost,thenoneisdesigninganunfairsystem,evenifinprincipleitseemsotherwise.Ifonedesignsaslowjudicialsystem,thattoocanbeunfair.It’snotjustthat“justicedelayedisjusticedenied,”butthatthepoorcan’tbearthecostsofdelayaswellastherich.Corporationsknowthis.Intheirnegotiationswithlesswealthyopponentsastandardtacticistomakeasmallup-frontofferandthreatentoimposealongandcostlyprocess39withanuncertainoutcomeiftheofferisnotaccepted.Evenaccesstothelegalsystemisexpensive,andthatgivesanadvantagetolargecorporationsandthewealthy.Wetalkabouttheimportanceofintellectualproperty,butwehavedesignedanexpensiveandunfairintellectualpropertyregimethatworksmoretotheadvantageofpatentlawyersandlargecorporationsthanto40theadvancementofscienceandsmallinnovators.Largefirmscantrespassontheintellectualpropertyrightsofsmalleronesalmostwithimpunity,knowingthatintheensuinglegalfighttheycanoutgunthem.Roguepatenttrolls(lawfirms)canbuysleepingpatents(patentsthathavenotyetbeenusedtobringproductstothemarket)atalowprice,andthenwhenafirmissuccessfulinthesamefield,claimtrespass,andthreatentoshutitdownasaformofextortion.That’swhathappenedtoResearchinMotion,theproducerofthepopularBlackBerry,whichbecamethetargetofapatentsuitfrom“patent-holdingcompany”NTP,Inc.ThatcompanyiscurrentlyalsoinlitigationinvolvingApple,Google,Microsoft,41VerizonWireless,AT&T,Yahoo!andT-MobileUSA.Itwasn’tevenclearwhetherthepatentsthatweresupposedlyinfringedwerevalid.Butuntiltheirclaimsarereviewedanddeclaredinvalid—whichmaytakeyearsandyears,the“owners”ofthepatentcanshutdownanyfirmthatmighttrespass,unlessitpayswhateverfeeandacceptwhateverconditionsareimposeduponit,includingtheconditionthatthepatentnotbechallenged.Inthiscase,BlackBerrygaveintothedemandsandpaidmorethan$600million42toNTP.Morerecently,thecellphoneindustryhasengagedinatangleofpatentdisputes(involvingApple,Samsung,Ericsson,Google,158 Microsoft,Motorola,Nokia,RIM,LG,HP,andapatentholder,AcaciaResearchCorporation),inavarietyoflegalforumsindifferentcountries.Whiletheoutcomeisuncertain—ifcertainpartieswin,therangeofchoicesconsumersfacemaybedramaticallyreducedandpricesincreased—whatiscertainisthatthebigwinnersinthesebattleswillbethelawyers.Thelegalsystemitselfextractslargerents,aswenotedinchapter2.Thebiglegalbattlestoenforcethelawsthatexist—say,overwhetherMicrosoftviolatedthelawsdesignedtomaintainacompetitivemarketplaceorwhetherthebankscommittedfraud—entailbattalionsoflawyers.Therehasbeenanarmsrace;andit’sanarmsraceinwhichthebanksthatengageinfraudorthefirmsthatengageinanticompetitivepracticeshavethebigadvantage,especiallysinceprivatefirmsdowhattheycantocircumscribegovernment’sabilitytospend.TheconsequenceisillustratedbyhowtheSecuritiesandExchangeCommissionhaspursuedrepeatedoccurrencesoffraudbyAmerica’sbanks.TheSECandsecuritiesfraudIhavedescribedhowthebankstriedtotakeadvantageofordinaryhomeownersinthemortgagemarket.Thebankstriedtotakeadvantageofthemorefinanciallysophisticatedaswell.TheSEC(theU.S.SecuritiesandExchangeCommission,whichisinchargeofenforcingthefederalsecuritieslaws)hasrepeatedlybroughtcivilenforcementactionsagainstCitibankandothermajorbanksforviolationsofthefraudlaws.Whathappensafterthathasgenerallyfollowedthispath:Thebanksthreatenanever-endinglegalbattle.Compromisefollows:thebankspayalargefine,neitheradmittingnordenyingguilt.Theyalsopromisenevertodosuchathingagain.Butsoonaftertheirpromise,theyengageinsimilarbehavioragain.Thentheyincuranotherscoldingandafinetheycanafford.It’saconvenientsolution:thegovernmenthaslimitedresourcestoprosecutelegalcases,andtherearemanyinstancesoffraud.Havingreachedasettlementonone,thegovernmentcanthengoontoattackanother.Thesystemalsosuitsthebanks:thecostislowrelativetotheprofitstheyreapfromtheirfraudulentbehavior,and,hadtheyadmittedguilt,theevidencecouldhavebeenusedagainsttheminprivatelitigationbroughtbythosethefraudinjuredintheirattempttorecovertheirlosses.Thebanksknowthatmostoftheirvictimsdon’thavethelegalresourcestochallengethemwithoutthegovernment’shelp.Noonecanclaimthatjusticeisreallybeingdoneinthissystem.Aneconomicsysteminwhichthereisapatternofsuchabusescan’tworkwell:frauddistortstheeconomyandunderminestrust.AcourthastoapprovetheSECsettlements,andthecourtstypicallyapprovethemproforma.Butforonejudgetheleveloffraudfinallyprovedtoomuch.InlateNovember2011,JudgeRakoffoftheU.S.DistrictCourtinManhattanrejectedaproposed$285millionsettlementfromCitigouponafraudcharge.Henotedthatthebankhadbeenarepeatedoffender,a“recidivist.”ItwasclearthattheSECenforcementactionswerehavinglittleeffectonitsbehavior,partlybecausetheSECdidn’tbringcontemptchargesagainstrepeatedoffenderslikeCitibankforviolatingtheirpromises.Inthiscase,Citibank(likemanyoftheotherbanks,includingGoldmanSachs)hadconstructedsecuritiesconsistingofmortgages159 thatitbelievedwouldfail,partlysothatit(or,inthecaseofsomeotherbanks,favoredcustomers)couldbetagainstthesecurities.Whenthevaluesdeclined,thebank(oritsfavoredcustomers)madehugeproftsattheexpenseofthebank’sclientswhopurchasedthesecurities.Manyofthebanksdidn’tdisclosewhattheyweredoing.Onevariantoftheirdefensewascaveatemptor:“Nooneshouldtrustus,andanyonewhodoesisafool.”ButinthecasewhosesettlementJudgeRakoffrejected,Citibankandsomeoftheotherbankshadgonebeyondkeepingsilentontherisks:theyhadfalselytoldinvestorsthatanindependentpartywaschoosingtheportfolio’sinvestments.Whileinvestorslost$700millioninthedeal,Citibankmade$160million.Ifthiswereanisolatedinstance,itcouldbeblamedonafewindividuals.ButtheNewYorkTimes,inananalysisofSECfraudsettlements,“found51instances,involving19companies,inwhichtheagencyclaimedthatacompanyhadbrokenfraudlawsthat43theypreviouslyhadagreednevertobreach.”Itwouldseemwehaveaneconomicandlegalsystemthatprovidesincentivesforbadbehavior:theexecutives’paygoesupwhenprofitsgoup,eveniftheprofitsarebasedonfraud;butthecompany’sshareholderspaythefines.Inmanycasestheexecutiveswhowereresponsibleforthefraudulentbehaviorhavebeenlonggone.Thereissomethingtobesaidhereforcriminalprosecutionsagainstexecutives.Iftheshareholderspaythefines,andmanagementpaysitselfcompensationbasedonshort-termperformanceandhidingrisksinthetailsofthereturndistribution(theeventsthatoccurwithsmalllikelihood,likegettingcaught,prosecuted,andfined),weshouldn’tbesurprisedatthesepersistentpatternsoffraud.Insuchcircumstances,wehavetogobeyondfiningthecompany:itispeoplewhomakedecisionsandtakeactions,andtheyshouldbearresponsibilityfortheiractions.Thosewhocommitthesecrimescan’tjustshifttheiraccountabilitytoanabstractentitycalledthe“corporation.”CONCLUDINGCOMMENTSTheneedforastrongruleoflawiswidelyaccepted,butitalsomatterswhatkindofrulesthereareandhowtheyareadministered.Indesigningthesystemoflawsandregulationsthatgovernaneconomyandasociety,therearetrade-offs:somelawsandregulationsfavoronegroup,othersanother.Wehaveexaminedseveralexampleswherewhathashappenedwasperhapspredictable:thelawsandregulations,andhowtheyareimplementedandenforced,reflecttheinterestsofthetoplayerofsocietymorethanthoseofthepeopleinthemiddleandatthebottom.Growinginequality,combinedwithaflawedsystemofcampaignfinance,risksturningAmerica’slegalsystemintoatravestyofjustice.Somemaystillcallitthe“ruleoflaw,”butintoday’sAmericatheproudclaimof“justiceforall”isbeingreplacedbythemoremodestclaimof“justiceforthosewhocanaffordit.”Andthenumberofpeoplewhocanafforditisrapidlydiminishing.160 CHAPTEREIGHTTHEBATTLEOFTHEBUDGETWITHTHEONSETOFTHEGREATRECESSION,GOVERNmentrevenuesplummeted,andthenation’sdeficitanddebtsoared.AcrysoonwentoutintheUnitedStatesandEuropethatdeficitshadtobebroughtundercontrolassoonaspossible,typicallybydrasticcutsinexpenditures—inprogramsreferredtoasausterity.PresidentObamasetupabipartisandeficitreductioncommission,headedbytheformerWyomingsenatorAlanK.SimpsonandPresidentBillClinton’sformerchiefofstaffErskine1Bowles.AWashingtonthinktank,theBipartisanPolicyCenter,2cameoutwithitsownproposal.TheheadoftheBudgetCommitteeintheHouseofRepresentatives,PaulRyanofWisconsin,offered3another.Bythesummerof2011debateoverthebudgethadturnedrancorous,andHouseRepublicanseffectivelyheldthecountryforransom,refusingtoallowanincreaseinthedebtceiling,unlessitwasaccompaniedbyacommitmenttosubstantialdeficit4reduction—eithercuttingexpendituresorraisingtaxes.Thisbudgetbrinkmanshipobscuredtherealeconomicchallengesfacingthecountry:theimmediateproblemposedbythehighlevelofunemploymentandthegapbetweentheeconomy’spotentialoutputanditsactualoutput,andthelong-termproblemofgrowinginequality.Thebrickmanshipshiftedattentionawayfromtheseproblemstotheissuesofdeficitanddebtreduction.Astherecommendationsofthevariouscommissionscamein,someactuallyproposedloweringtaxesatthetopandincreasingtaxesinthemiddle.Theyignoredhowthedeficit—thegapbetweenthegovernmentsexpendituresandrevenues—hadcomeaboutinthefirstplace.Iftheyhadfocusedonthetrueoriginsofthedeficit,theywouldhaverealizedthatthereweremorestraightforwardwaysofgettingitundercontrol.Inthischapter,Iseektorecastthedebate.Iwillshowhowbudget,tax,andexpenditurepoliciescanactuallybeusedtoreduceourcountry’sinequalityatthesametimethattheypromoteeconomicgrowthandbringthedeficitundercontrol.THEHISTORYOFTHEDEFICITSItmaybehardtoremembernow,butjustadecadebeforeseeminglyout-of-controldeficitsrosetothetopofthenation’spolicyagenda,thecountryhadlargesurpluses,some2percentofGDP.SolargewerethesurplusesthatFedchairmanAlanGreenspanfrettedthattheentirenationaldebtwouldsoonberepaid,andthatwouldmaketheconductofmonetarypolicydifficult.(ThewaytheFederalReserveincreasesordecreasesinterestratesistosellorbuygovernmentTreasurybills,butiftherewasnogovernment161 debt,therewouldbenoTreasurybillstobuyandsell.)Therewas(accordingtohim)ananswertothispotentialcrisis:Bush’sproposedtaxcut,mostofthebenefitsofwhichwenttotherich.5Greenspan’ssupportforthe2001taxcutwaspivotal.Theargumentshouldhavebeenviewedwithskepticism:hadtheforecastsbeenaccurate,withthenationaldebtatsomefuturedateindangerofbeingpaidoff,heandthepresidentcouldhaveappealedtoCongresstoincreasespendingorcuttaxes.Itisinconceivablethattheywouldnothavecompliedquicklyenoughtoavoidtheallegedloomingdisasteroftheeliminationofthenationaldebt.Forthecriticsofthesetaxcuts,itseemedthatGreenspan’sagendahadlesstodowithmonetarypolicyandmoretodowithdownsizinggovernment.Andforthoseconcernedaboutthecountry’sincreasinginequality,thecombinationoftaxcutstargetedatthetopandweakenedsocialprotectionprogramsforlower-andmiddle-incomeAmericansthatwouldinevitablyfollowasfiscalconstraintstightenedwasparticularlytroubling.Itwasn’tlongbeforethesurplusesturnedtodeficitsundertheinfluenceoffourmajorforces.Thefirstwasthetaxcutsthemselves.Theinterveningyearshaveshownthemagnitudebywhichtheyexceededwhatthecountrycouldafford:by2010theCongressionalBudgetOffice(CBO)waspredictingthatifthetaxcutswereextendedforthenextdecade,thebudgetarycostsfor62011–20wouldbe$3.3trillion.Ofthe2012budgetdeficit,7aroundafifthisattributedtotheBushtaxcuts.Thesecondcontributortothedramaticchangeinthecountry’sfiscalpositionwastheexpensesincurredinthewarsinIraqandAfghanistan,withbudgetarycosts(overthelongrun)estimatedtoexceed$2to$3trilliondollars.Thebudgetarycostswill,infact,goonfordecades:almost50percentofreturningtroopsareeligibletoreceivesomelevelofdisabilitypayment,andsuchpaymentsandhealthcarecostsfortheseveteransarelikelyto8approachorexceedatrilliondollars.EvenastheIraqwarwasbeingbroughttoanendin2011,warspendingstillaccountedfor9atleast15percentofthe2012budgetdeficit.Insteadofraisingtaxestopayfortheseventures,weputthemonthecreditcard,withcompoundingconsequencesforthedebt,especiallyintheyearsbeforetheGreatRecession.Ata5percentinterestrate,a$2trillionnationaldebtrequires$100billiontoserviceit(evenifnoattemptweremadetorepay),yearafteryear.Rightnow,thatinterestbillislow,becauseinterestratesaresolow;butitisabillthatwillgrowmuchlargerwhentheeconomyrecoversandinterestratesreturntonormal.WhiletheUnitedStateswasfightingthosewars,itincreased10itsothermilitaryspendingbyhundredsofbillionsofdollars—includingspendingforwhatcriticssaidwereweaponsthatdidn’twork,againstenemiesthatdidn’texist.YoumightnothavesuspectedthattheColdWarwasoverbylookingattheDefenseDepartmentandCIAspending.Americawasspendingasifitwasstillongoing:itsmilitaryexpenditurestotaledthatofthe11entirerestoftheworldputtogether.WhilethetensofthousandsofIraqisandAfghanis,andthethousandsofyoungAmericanswhobecamedisabledordiedfightinginthesewarshavepaidahighprice,everypublicexpenditure,everyventure,haswinnersaswellaslosers,andthisisthecaseheretoo:defensecontractorswalkedawaywithexcessprofits,someofwhichgot“recycled”intheformofcampaign162 contributions.Someofthisspendingtooktheformof“rents”(aswecalledtheminchapter2),withgovernmentpayingpricesgreaterthancompetitivemarketrates.The$7billionHalliburtonno-bidcontractatthestartoftheIraqwarwasaclassicexample.Wedescribedinchapter6thehighcostsassociatedwithcontracting,inwhichthegovernmentpaysmorethanitwouldifgovernmentemployeesprovidedtheservices.Thecostofweaponssystemshassoaredevenasthegovernmenthastriedtoreinitin:the$382billionLockheedMartinF-35JointStrikerFighterby12itselfcostshalfoftheentireObamastimulusprogram.(Onecanunderstandwhysomanypeopleareupsetwithcurrentbudgetpriorities:thereismoneyforafighterjetthatcriticssaydoesn’thelpinthetypesofconflictstheUnitedStatesfindsitselfin,andlikelywillinthefuture,butthere’snomoremoneytohelphomeownersstayintheirhomes.)ThethirdlargesourceoftheincreaseinthedeficitwasthenewMedicaredrugbenefit,andwhilethebenefititselfmadesense,partofthecostwasanotherhuge“rent”—thistimenottothemilitarycontractorsbuttothepharmaceuticalindustry.Wenotedearlierthatasmalldetail—aprovisioninthebillprovidingthedrugbenefittoMedicarerecipientswhichsaidthatthegovernment,thelargestbuyerofdrugsintheworld,couldn’tnegotiatepriceswiththedrugcompanies—wasagiftworth,by13someestimates,ahalftrilliondollarsovertenyears.Thebiggestdifferencebetweentheworldof2001,whenweexpectedalargefederalbudgetsurplus,andtheworldof2011,whenwefacedyawningdeficitsasfarastheeyecouldsee,though,wastheGreatRecession.Anyrecessioncausesadecreaseinrevenuesandanincreaseinexpenditures(forunemploymentinsuranceandsocialprograms),andarecessionofthemagnitudeoftheGreatRecessionof2008causesamajorreversalinthefiscalpositionofacountry.SpainandIrelandalsohadbudgetsurplusesbeforethecrisisandnowareonthevergeoffiscalcollapse.EvenastheAmericaneconomywassupposedlyenteringintorecovery,in2012thedownturnaccountedforalmosttwo-thirdsofthedeficit—16percentofthedeficitwasformeasurestostimulatetheeconomy(thestimuluspackagethatincludedtaxcuts,aidtostates,andpublicinvestment);butalmosthalf(48percent)oftheentiredeficitwasaresultoftheunderperformanceoftheeconomy,whichledtolowertaxrevenuesandhigherexpendituresonunemploymentinsurance,foodstamps,andothersocialprotectionprograms.TheseshortfallsreflectthefactthattheU.S.GDPin2012ispredictedtobenearly$90014billionshortofitspotential.Thecriticalpointtobearinmindinthinkingaboutdeficitreductionisthattherecessioncausedthedeficits,nottheotherwayaround.Moreausteritywillonlyworsenthedownturn,andthehoped-forimprovementinthefiscalpositionwillnotemerge.KILLINGTHREEBIRDSWITHONESTONEThecausesofthereversalintheU.S.fiscalpositionprovideaclearprescriptionforhowtoputitonafirmfoundation:reversetheBusherataxcutsformillionaires,endthewarsandscalebackdefensespending,allowthegovernmenttonegotiatedrug163 prices,and,mostimportantly,putthecountrybacktowork.Restoringthecountrytofullemploymentwoulddomorethananythingelsetoimprovethecountry’sfiscalposition.Whilealloftheseactionswouldhelptoaddresscurrentbudgetwoes,improvethedistributionofincome,andmakemoneyavailableforinvestmentsthatcouldimprovefuturegrowth,thereareafew15otherreformsthatwouldgostillfurther.Makingthetaxsystemfairisonesuchreform.Rightnow,aswenotedinchapter3,speculatorsaretaxedatafractionoftherateofthosewhoworkfortheirliving.It’saprimeexampleofhowthoseinthe1percenthaveconvincedtherestofsocietythatwhatisintheirinterestsisintheinterestsofall.Thelowertaxratesoncapitalgainsdidn’tleadtohighersustainablegrowth,butratherfedtwospeculativebooms:it’snotanaccidentthat,inquicksuccession,afterthecapitalgainstaxcutsof1997andtheearly2000s,Americaexperiencedbothatech16bubbleandahousingbubble.Sotoo,Busharguedsuccessfullyin2003fora(temporary)cutonthetaxondividends,toamaximumof15percent,lessthanhalftheratepaidbysomeonewhoreceivesacomparableincomeintheformofwagesandsalaries.Theclaimwasthatitwouldleadtomoreinvestmentbyfirmsinplantandequipment,butitdidn’t.Arguably,itmayhavehadtheoppositeeffect.Asweobservedinchapter4,firmswere,ineffect,encouragedtopayoutdividendswhilethetaxrateswerelow,leavingfewerfundsinsidethecorporationforagoodinvestmentproject,shouldone17haveturnedup.Beyondthis,makingthetaxsystemnotonlymorefairbutmoreprogressivewouldinvolveclosingloopholesandenactingincreasesinthetaxratesatthetopandreductionsintaxratesatthebottom.Theexemptionofinterestonmunicipalbondsisanexampleofaninefficient“loophole”offarmorebenefittotherichthantothemunicipalities,theallegedbeneficiaries.Thetaxdeductibilityallowscitiestoborrowatalowerrate—butonlyslightlylower.If,forsimplicityofarithmetic,theinterestratehadbeen10percent,thetaxexemptionmightlowertheratethatacitycouldborrowto9percent.Ona$100millionbond,thecitythensaves$1millionayear.Thebondholders,manyoftheminthetoptaxbracket,get$9millionininterestpaymentsandowenotaxesontheirinterestincome.Butsupposetheyhadfacedacombinedfederalandstatetaxof40percent.Theywouldhavehadtopay$4millionintaxesandreapedafter-taxreturnsof$6million.Inourcurrentsystemtheytakehome$9million.Whileit’struethecitysaves$1million,todeliverthat$1millionofassistance,thestateandfederalgovernmenthavetogiveup$4millionintaxrevenues.Wealthybondholdersgetthreetimesthebenefitthatisreceivedbycities.Itwouldhavebeenfarmoreefficienttogivethecitiesadirectsubsidyfromthefederal18government.Abasicprincipleofeconomicsholdsthatitishighlyefficienttotaxrentsbecausesuchtaxesdon’tcauseanydistortion.Ataxonlandrentsdoesn’tmakethelandgoaway.Indeed,thegreatnineteenth-centuryprogressiveHenryGeorge19arguedthatgovernmentshouldrelysolelyonsuchatax.Today,ofcourse,werealizethatrentscantakemanyforms—theycanbecollectednotjustonland,butonthevalueofnaturalresources20likeoil,gas,minerals,andcoal.Thereareothersourcesof164 rents,suchasthosederivedfromtheexerciseofmonopolypower.Astifftaxonallsuchrentswouldnotonlyreduceinequalitybutalsoreduceincentivestoengageinthekindofrent-seekingactivitiesthatdistortoureconomyandourdemocracy.TheRightsuggeststhatalltaxesaredistortionary,butthat’ssimplynottrue:therenttaxeswouldactuallyimproveeconomicefficiency.Buttherearesomenewtaxesthatmightdosoevenmore.Abasicprincipleineconomicsisthatitisbettertotaxbadthingsthangoodthings.Comparedwithtaxingwork(aproductivething),itisbettertotaxpollution(abadthing,whetherit’soilthatpollutesouroceansfromspillsofoilcompanies,toxicwastesproducedbychemicalfirms,ortoxicassetscreatedbyfinancialfirms).Thosewhopollutedonotbearthecoststheyimposeontherestofsociety.Thefactthatthosewhogeneratewaterorairpollution(includinggreenhousegasemissions)donotpaythesocialcostsoftheiractionsisamajordistortionintheeconomy;ataxwouldhelpcorrectthisdistortion,discouragingactivitiesthatcreatenegativeexternalities,shiftingresourcesintoareaswheresocialcontributionsarehigher.Firmsthatarenotpayingthefullcoststheyimposeonothersare,ineffect,beingsubsidized.Atthesametime,suchataxcouldraiseliterallytrillionsofdollarsoveraten-yearperiod.Oil,gas,coal,chemical,paper,andmanyothercompanieshavepollutedourenvironment.Butthefinancialcompaniespollutedtheglobaleconomywithtoxicmortgages.Thefinancialsectorhasimposedenormousexternalitiesontherestofsociety—aswenoted,thetotalcostsofthefinancialcrisisforwhichtheybearsignificantresponsibilityisinthetrillionsofdollars.Inearlierchapterswesawhowflashtradingandotherspeculationmaycreatevolatility,butnotreallycreatevalue:theoverallefficiencyofthemarketeconomymayevenbereduced.Thepolluterpayprinciplesaysthatpollutersshouldpaythecoststhattheyimposeonothers.Throughourbailoutsandamyriadofhiddensubsidies,wehaveinfactbeeneffectivelysubsidizingthefinancialsector.Thereisagrowingdemandfortheimpositionofavarietyoftaxesonthefinancialsector,includingafinancialtransactionstax,ataxonallfinancialtransactionsataverylowrate,oratleastonaselectedsetofsuchtransactions,likeforeignexchangetransactions.Franceisalreadyintheprocessofadoptingone.TheUKhasamorelimitedvariant.TheheadsofSpainandGermanyandtheEuropeanCommissionhaveadvocatedsuchatax.Evenatverylowrates,itwouldraisesubstantialrevenues.Thereareotherwaysofraisingrevenues—simplystopgivingawayresourcesatbelow-marketpricestooil,gas,andminingcompanies.Doingsocanbethoughtofasasubsidytothesecompanies.Thegovernmentneedstomakesurethatit’snotgivingawaywilly-nillybillionsofdollars,asitdoeswhenitallowsTVstationstousespectrumwithoutcharge,whenitallowsminingcompaniestopayaminimalroyalty,ratherthanauctioningofftherightstoexploitthesenaturalresources,whenitconductsafiresaleonoilandgasleases,ratherthanawell-designedauctionto21maximizetherevenuetothepublic.Therearestillotherwaysofraisingmorerevenue:closingthehiddensubsidiestocorporationsburiedinourtaxcode(whatwereferredtoinchapter6ascorporatewelfare),oreliminatingtheloopholesandotherspecialprovisionsthathaveenabledsomany165 Americancorporationstoescapesomuchofthetaxesthattheyshouldbepaying.Inchapter6wepresentedevidenceontheimportancethatmostAmericansgivetofairness.Earlierchaptersshowedthat,withthoseattheverytoppayingasmallerpercentageoftheirincomeintaxesthanthosewhoarenotsowell-off,ourtaxsystemisnotfair—andiswidelyperceivednottobefair.Ourtaxsystemrelies,tosomeextentatleast,onvoluntarycompliance;butifthetaxsystemisviewednottobefair,suchcompliancewillnotbeforthcoming.Wewillbecomelikesomanyothercountrieswherecomplianceiseitherweakorattainedonlythroughintrusiveandforcefulmeasures.Butcreatingafairertaxsystemcanalsoraisesubstantialadditionalrevenues.Levyingadditionaltaxesinvolvesasimpleprinciple:gowherethemoneyis.Sincemoneyhasbeenincreasinglygoingtothetop,that’swhereadditionaltaxrevenueshavetocomefrom.It’sreallythatsimple.Thegoodnewsisthatthewealthytakesomuchofthenation’sincomepiethatarelativelysmallincreaseintheirtaxrateswouldyieldlargerevenues.Itusedtobesaidthatthetopdidn’thaveenoughmoneytofilltheholeinthedeficit;butthat’sbecominglessandlesstrue.Withthoseinthetop1percentgettingmorethan20percentofthenation’sincome,anincremental10percenttaxontheirincome(withoutloopholes)wouldgeneraterevenuesequaltosome2percentofthenation’sGDP.Inshort,ifwewereseriousaboutdeficitreduction,wecouldeasilyraisetrillionsofdollarsoverthenexttenyearssimplyby(a)raisingtaxesonpeopleinthetop—becausetheygetsomuchofthenation’seconomicpie,evensmallincreasesintaxratesraisessubstantialrevenues;(b)eliminatingloopholesandspecialtreatmentofthekindofincomeearneddisproportionatelybythetop—fromlowertaxratesforspeculatorsanddividendstoexemptionofmunicipalinterest;(c)eliminatingtheloopholesandspecialprovisionsoftheindividualandcorporatetaxsystemthatsubsidizecorporations;(d)taxingrentsathigherrates;(e)taxingpollution;(f)taxingthefinancialsector,atleasttoreflectinpartthecostsithasrepeatedlyimposedontherestoftheeconomy;and(g)makingthosewhogettouseorexploitournation’sresources—resourcesthatrightfullybelongtoallAmericans—payfullvalue.Theserevenueraiserswouldnotonlymakeforamoreefficienteconomyandsubstantiallyreducethedeficitbutalsoreduceinequality.That’spreciselywhythesesimpleideashavenotbeenfrontandcenterinthebudgetdebate.Becausesomanyinthe1percentderivetoomuchoftheirincomefromthesectorsthatgetthesegifts—fromoil,gas,andotherformsofenvironmentallypollutingactivities,fromthesubsidieshiddeninthetaxcode,fromtheabilitytoobtainournation’sresourcesonthecheap,frommyriadspecialbenefitsgiventothefinancialsector—theseproposalshavenotbeenfocalpointsofthestandarddeficitreductionagenda.Justaswecandesignataxsystemthatraisesmoremoneyandenhancesefficiencyandequality,sotooforexpenditures.Inchapter2wesawtheroleofrentsinenhancingincomesatthetopandnotedthatsomerentsarejustgiftsfromthegovernment.InearlierchaptersIdescribedtheimportantfunctionsthegovernmentneedstoperform.Oneoftheseissocialprotection—helpingthepoorandprovidinginsurancetoallAmericanswhentheprivatesectorfailstodosoadequatelyoronreasonableterms.Butwhilesomewelfareprogramsforthepoorhavebeencurtailed166 inrecentyears,whatwedescribedinchapter6ascorporatewelfare,subsidiestocorporations,increased.Ofcourse,wheneverproposalstoreduceoreliminatesubsidies(hiddenoropen)arebroached,therecipientsofthosesubsidiestrytodefendthemasbeinginthepublicinterest.Thereishereacertainirony,inthatmanyofthesecorporationsandrecipientsofgovernmentlargessesimultaneouslyargueagainstgovernmentspending—forasmallgovernment.Itishumannaturethatself-interestshapesjudgmentsoffairness.Theinfluencecan,infact,besubconscious.Butaswehaverepeatedlyobserved,thesesubsidiesandtheeffortstogetthemdistortoureconomyandourpoliticalsystem.Inthenextsection,we’llexplainhow,bycuttingthesesubsidies,andspendingthemoneyelsewhere,wecanactually22increaseemployment.SQUARINGTHECIRCLE:STIMULATINGTHEECONOMYINANERAOFBUDGETDEFICITSANDINADEQUATEDEMANDIftheeconomywereatfullemployment,wewouldfocusonthe“supplyside”effectsofreformstothetaxcodeandexpenditureprograms,reformsliketheeliminationofcorporatewelfarereducedistortions,therebyincreasingproductivityandGDP,evenastheyraisemorerevenue.Today,however,theRightadvocatesacuriouscombinationofsupply-anddemand-sidemeasures:deficitreduction,itissomehowargued,willrestoreconfidenceinthecountryanditseconomy,andthusbepositive;andtaxreductionswillimprovetheefficiencyoftheeconomyandputmoneyinthehandsofthosewhocanspenditwell.Ofcourse,ifdeficitsaretobereducedatthesametimethattaxesarebeingreduced,itmeansexpenditureshavetobereducedbyalot.Andthat’sthetrueagenda—downsizinggovernment.Indeed,sincemostontheRightwanttoprotectmilitaryexpenditures,thenecessaryreductionsineducation,research,infrastructure—allthenondefenseexpenditures—wouldevisceratetheseprograms.Butthisagendawouldnotonlyjeopardizethecountry’sfuturegrowth;itwoulddeepenthecurrenteconomicdownturn.InthissectionIexplainhowthegovernmentcanstimulatetheeconomyevenwhileitkeepsitsfocusondebt,andhowtheagendaoftheRightalmostsurelywillbedisastrous.Thegovernmentcouldborrowtodaytoinvestinitsfuture—forexample,ensuringqualityeducationforpoorandmiddle-classAmericansanddevelopingtechnologiesthatincreasethedemandforAmerica’sskilledlaborforce,andsimultaneouslyprotecttheenvironment.Thesehigh-returninvestmentswouldimprovethecountry’sbalancesheet(whichlookssimultaneouslyatassetsandliabilities)andyieldareturnmorethanadequatetorepaytheverylowinterestatwhichthecountrycanborrow.Allgoodbusinessesborrowtofinanceexpansion.Andiftheyhavehigh-returninvestments,andfacelowcostsofcapital—astheUnitedStatesdoestoday—theyborrowliberally.TheUnitedStatesisinanespeciallygoodpositiontopursuethisstrategy,bothbecausereturnstopublicinvestmentsaresohigh,asaresultofunderinvestmentforaquartercentury,andbecauseitcanborrowsocheaplylongterm.Unfortunately,especiallyamongtheRight(buteven,alas,amongmanyinthe167 center)deficitfetishismhasgainedground.Theratingagencies—stilltrustedinspiteoftheirincrediblybadperformanceinrecentdecades—havejoinedthefray,downgradingU.S.debt.Butthetestofthequalityofdebtistheriskpremiumthatinvestorsdemand.Asthisbookgoestopress,thereisademandforU.S.T-billsatinterestratesnearzero(andinrealterms,negative).Althoughdeficitfetishismcan’tbejustifiedonthebasisofeconomicprinciples,itmaybebecomingpartofthereality.Thestrategyofinvestinginthecountry’sfuturewouldinthemediumtolongrunreducethenationaldebt;butintheshortrun,thegovernmentwouldhavetoborrow,andthoseundertheinfluenceofdeficitfetishismarguethatdoingsoisreckless.Thereisanotherstrategythatcanstimulatetheeconomy,evenifthereisaninsistencethatthedeficitnownotincrease;itisbasedonalong-standingprinciplecalledthebalanced-budgetmultiplier.Ifthegovernmentsimultaneouslyincreasestaxesandincreasesexpenditure—sothatthecurrentdeficitremainsunchanged—theeconomyisstimulated.Ofcourse,thetaxesbythemselvesdampentheeconomy,buttheexpendituresstimulateit.Theanalysisshowsunambiguouslythatthestimulativeeffectisconsiderablygreaterthanthecontractionaryeffect.Ifthetaxandexpenditureincreasesarechosencarefully,theincreasein23GDPcanbetwotothreetimestheincreaseinspending.Andwhilethedeficitisneitherincreasednordecreasedimmediately—byassumption—thenationaldebtisdecreasedovertheintermediateterm,becauseoftheincreasedtaxrevenuesfromtheincreasedgrowththatisbroughtabout.Thereisfinalwayofsquaringthecircle—stimulatingtheeconomywithintheconfinesofthedebtanddeficit—thatworksevenifgovernmentcan’tincreaseitsoverallsize.Andthat’swherethereformswediscussedintheprecedingsectionbecomeparticularlyrelevant.Wecantakeadvantageoftheextenttowhichdifferenttaxesandexpendituresstimulatetheeconomy,spendingmoreonprogramsthathavelargemultipliers(whereeachdollarofspendinggeneratesmoreoverallGDP)andlessonprogramsthathavesmallmultipliers;raisingtaxesfromsourceswithlowmultiplierswhilecuttingtaxesonthosewithhighmultipliers.MoneyspentpayingforforeigncontractorsinAfghanistandoesn’tstimulatetheAmericaneconomy;moneyspentpayingunemploymentbenefitstothelong-termunemployeddoes,simplybecausetheseindividualsaresostrappedthattheytendtospendeverydollargiventothem.Raisingtaxesontheveryrichreducesspendingbyatmostaround80centsonthedollar;loweringtaxesatthebottomincreasesspendingatalmost100centsonthedollar.Hencemakingthetaxsystemmoreprogressivenotonlyreducesinequalitybutstimulatestheeconomyaswell.Trickle-upeconomicscanwork,evenwhentrickle-downeconomicsdoesn’t.EventherichcanbenefitfromtheincreasedGDP,insomecasesevenenoughtooffsettheincreasedtaxestheywouldhavetopay.Becausegovernmentprogramsthatincreaserents(whetherpayingtoomuchingovernmentprocurement,subsidiesforrichfarmers,orcorporatewelfare)godisproportionatelytothoseatthetop,cutbacksinthese—withthemoneygoingforincreasedinvestmentsandimprovedsocialprotection—increaseequity,efficiency,andgrowth;andinthecurrentsituationtheoveralleconomyisalsostimulated.168 TheGreekfactorTheunfoldingdebtcrisisinGreeceandotherproblemselsewhereinEuropehaveinstilledafearofdebtinmanyquarters.ManypeoplewholookatEurope’scrisisseeitconfirmingtheirprejudices:it’swhathappenswhenonehashightaxesanddebtandanexcessivelygenerouswelfaresystem.ButthisinterpretationofwhathasbeenhappeninginEuropeissimplywrong,andtherearemarkeddifferencesbetweenGreece’ssituation(andthesituationofotherEuropeancountries)andthatoftheUnitedStates—differencesarisingfromthemonetarysystem.Greececanbeconvictedofoverspending—though,again,thereissomeculpabilityofthefinancialsector;oneofAmerica’sbankshelpedanearliergovernmenthideitsfiscalpositionsbothfromitscitizensandtheEUbyusingderivatives.Butothercrisiscountriescannotbeaccusedoffiscalprofligacy:IrelandandSpainhadfiscalsurplusesbeforethecrisis.OneofthebigdifferencesbetweentheUnitedStatesandGreece(andthoseothercountries)isthatwhilethoseothercountriesowemoneyineuros,overwhichtheyhavenodirectcontrol,U.S.debtisdenominatedindollars—andtheUnitedStatescontrolstheprintingpresses.That’swhythenotionthattheUnitedStateswoulddefault(suggestedbyoneoftheratingagencies)bordersontheabsurd.Ofcourse,thereissomechancethat,topayoffwhat’sowed,somanydollarswouldhavetobeprintedthattheywouldn’tbeworthmuch.Butthentheissueisinflation,andatpresentthemarketsjustdon’tthinkthatinflationisasignificantrisk.Onecaninferthatbothfromtheverylowinterestratethatthegovernmenthastopayonitslong-termdebtandevenmorefromwhatithastopayforinflation-protectedbonds(ormoreaccurately,thedifferencebetweenthereturnsonordinarybondsandinflation-protectedbonds).Now,themarketcouldbewrong,butthentheratingagenciesgivingadowngradetotheUnitedStatesshouldhaveexplainedwhythemarketwaswrong,andwhytheybelievedthatthereisamuchhigherriskofinflationthanthemarketbelieved.Theanswershavenotbeenforthcoming.Beforetheeuro,Greeceowedmoneyindrachmas.Nowitowesmoneyineuros.NotonlydoesGreeceowemoneyineuros,butcontrolofthecentralbankisvestedinEurope.TheUnitedStatesknowsthattheFedwillbuyU.S.governmentbonds.Greececan’tevenbesurethattheEuropeanCentralBank(ECB)willbuyGreekbondsownedbyitsownbanks.Infact,theECBcontinuallythreatensnottobuythesovereignbondsofthecountriesoftheeurozone,unlesstheydoasitsays.TheRight’salternativeEurope’scrisisisnotanaccident,butit’snotcausedbyexcessivelong-termdebtsanddeficitsorbythe“welfare”state.It’scausedbyexcessiveausterity—cutbacksingovernmentexpendituresthatpredictablyledtotherecessionof2012—andaflawedmonetaryarrangement,theeuro.Whentheeurowasintroduced,mostdisinterestedeconomistswereskeptical.Changesinexchangeratesandinterestratesarecriticalforhelpingeconomiesadjust.IfalloftheEuropeancountrieswerebuffetedbythesameshocks,thenasingleadjustmentoftheexchangerateandinterestratewoulddoforall.ButdifferentEuropean169 economiesarebuffetedbymarkedlydifferentshocks.Theeurohadtakenawaytwoadjustmentmechanisms,andputnothinginitsplace.Itwasapoliticalproject;politiciansthoughtthatsharingacurrencywouldmovethecountriesclosertogether,buttherewasn’tenoughcohesionwithinEuropetodowhatneededtobedonetomaketheeurowork.Alltheyagreeduponwasnottohavetoolargedeficitsanddebts.ButasSpainandIrelandsoaptlyshowed,thatwasn’tenough.Therewashopethatovertheyears,thepoliticalprojectwouldbefinished.Butwhenthingsweregoingwell,therewasnomomentumtodoanythingfurther;andafterthecrisis,whichaffecteddifferentcountriessodifferently,therewasnowill.Thecountriescouldagreeonlyonfurtherbelttightening,whichforcedEuropeintoadouble-diprecession.LookingacrossEurope,amongthecountriesthataredoingbestareSwedenandNorway,withtheirstrongwelfarestatesandlargegovernments,buttheychosenottojointheeuro.Britainisnotincrisis,thoughitseconomyisinaslump:ittoochosenottojointheeuro,butittoodecidedtofollowtheausterityprogram.Unfortunately,manymembersofCongresswanttheUnitedStatestojointhatsame“austerityandsmallgovernment”bandwagon—tocutbacktaxesandexpenditures.Wesawthatbalancedincreasesintaxesandexpendituresstimulatetheeconomy.Bythesametoken,balancedcutbacksinexpendituresandtaxeswillleadtoacontractionintheeconomy.Andifwegoonestepfarther,astheRightwantstodo,tocutbackexpendituresevenmore,inavaliantifpossiblyfruitlessattempttoreducethedeficit,thecontractionwillbeevengreater.UNMASKINGTHEDEFICITAGENDA:PRESERVINGANDEXTENDINGINEQUALITIESItmightseemstrange,inacountrywheretaxratesatthetoparealreadylowerthantheyareinmostoftheotheradvancedindustrialcountries,tohaveadeficitreductionprogramemphasizethereductionoftoptaxratesandtaxratesoncorporations,butthat’sexactlywhattheBowles-SimpsonDeficit24ReductionCommissiondid.Itproposedlimitingthetopmarginaltaxratetobetween23percentand29percent,partofitsbroaderagendaoflimitingthesizeofgovernment,cappingoveralltaxrevenuesat21percentofGDP.Indeed,aboutthree-fourthsofthedeficitreductionisachievedbycutbacksingovernmentspending.Reagansupply-sideeconomics,whichheldthatloweringtaxrateswouldincreaseeconomicactivity,somuchsothattaxrevenueswouldactuallyincrease,has(aswenotedinchapter3)beendisprovedbywhathappenedafterboththeBushandtheReagantaxcuts.Todayindividualtaxratesaremuchlowerthantheywerein1980,suggestingthatfurtherreductionsintaxrateswouldlowertaxrevenuesevenmore.Theargumentthatthecorporatetaxrateshouldbelowered(to25between23percentand29percent,fromthecurrent35percent)wasevenlessconvincing,thoughtheBowles-Simpsoncommission’sproposalstoclosethemyriadloopholes,ifactuallyimplemented,wouldmeanthatmanycorporationswouldpaymoretaxeseventhoughtheofficialratewaslowered.Wenotedinchapter3thattheeffectivetaxrate—thefractionoftheirincomethatcorporations170 actuallypayintaxes—ismuchlessthan35percent,withsomeofthecountry’spremiercorporations,likeGE,payingnotaxes.Butwhilethereisacompellingcaseforclosingtheloopholes,evenfocusingsimplyoninvestmentandjobcreation,therewaslittlecaseforanacross-the-boardloweringofthecorporatetaxrate.Afterall,withthetaxdeductibilityofinterest,thetaxlowersthecostofborrowingandthereturnproportionately.Thereisnoadverseeffectoninvestmentforanyinvestmentfinancedthroughborrowing,andonceonetakesintoaccountthefavorableratesatwhichcapitalcouldbedepreciated(businessesareallowedtodeductfromtheirincomeanamounttoreflectthefactthattheirmachinesarewearingout),thetaxcodeactuallyencourages26investment.Ifthecommissionwasconcernedaboutthetax’seffectoninvestment,thereweremoreprecisewaystotweakthetaxcodethananacross-the-boardcut:itcouldhavesuggestedloweringthetaxonfirmsthatcreatedjobsandinvestedinAmericaandraisingtaxesonthosethatdidn’t.SuchapolicywouldraiserevenuesandprovideincentivesformoreinvestmentandjobcreationintheUnitedStates.Eachofthedeficitreductiongroupssoughttoaddressdistortionaryaspectsofthetaxcode—provisions,manyofthemdeliberatelyplacedbyspecialinterests,thatencouragespecificsectorsintheeconomy.Nogroup,however,suggestedafrontalattackoncorporatewelfareandthehiddensubsidies(includingtothefinancialsector)thatwe’vestressedinthisbook,partlybecause,aswesawinchapter6,theRighthassucceededinconvincingmanyAmericansthatanattackoncorporatewelfareis“classwarfare.”DeductionsManyoftheadvocatesofdeficitreductionhavegivenparticularattentiontoasetofdeductionsthathavebeenofspecialbenefittothemiddleclass—theinterestdeductionformortgagesandthe27deductionforhealthcarebenefits.Buteliminatingthesedeductionswouldbeaneffectiveincreaseintaxationonthemiddleclass,whoseincomehasbeenstagnatingordecliningforyears.Anyoneconcernedwiththeplightofthemiddleclassshouldhaveseenthatifdeductionswereeliminated,they—notthoseatthetop—shouldhavebeencompensatedwithlowertaxrates.Mosteconomistswouldhavesupportedtheeliminationofthehomemortgagededuction,whichleadstotoomuchspendingonhousing.Additionally,themortgagedeductioncanbefaultedforencouragingexcessiveindebtedness.Thegovernmentwas,ineffect,subsidizingdebt—anotherhiddensubsidytothebankerswhowereamongthetruebeneficiaries.Andbecausericherindividualsfacehighertaxrates,theybenefitmorefromthemortgagedeductionthandolower-incomeindividuals.Thetaxdeduction,ascurrentlydesigned,isbothdistortionaryandinequitable.Anditmaynotevenbeeffectiveinincreasinghomeownershipinurbanareas,wheresomanylower-incomeindividualslive.Inthoselocalities,wherethesupplyofhousingislimited,themortgagesubsidiesmay28raiseprices,makinghomeownershiplessaffordable.Butthetimingoftheeliminationisaconcern:eliminatingthedeductionwouldhavemadehousingmoreexpensive,depressinghousingprices.BecauseaquarterofallAmericanswithmortgagesowemoreontheirmortgagesthanthevalueoftheirhouses—someelevenmillionfamilies—thecrisisinthehousingsectorwould171 havebecomeonlyworse.Therewouldhavebeenmoreforeclosures,moredepressedcommunities,andthiskeysectoroftheeconomywouldhaveremainedinthedoldrumsforyearstocome.Thelongerthehousingmarketstaysdepressed,thelongertheeconomyremainsinitscurrentstateofnear-recession.Thereisawayaroundthequandary.In2009afirst-timehomebuyertaxcreditof$10,000helpedtopropupthehousingmarketbyprovidingfirst-timebuyerswithequity.Renewingandextendingthisprogramtoalllow-incomefamilieswouldsimultaneouslyhelpstimulatethehousingmarket,helprestoretheeconomytohealth,andmakeitpossibleforlower-incomefamiliestoaffordhomes.Moregenerally,avarietyoftaxprovisions(likespecialtreatmentofretirementaccounts)aredesignedtoencourageindividualstosavemore;whethertheyactuallyleadtomoresavingsisquestionable,butbecausetheyareofmuchgreaterbenefittoupper-incomeindividuals,theydohelpenrichtherichwhodosave.Butthereisnothingcomparableforlow-incomeindividuals.Ifthegovernmentprovidedacashabletaxcreditforinvestmentsbylow-incomehouseholds(thatis,supplementedtheirsavings,eveniftheydidn’tpayanytaxes),itwouldprovidethemwithincreasedincentivestosaveandmightevenreducesomeofthedisparitybetweenthebottomandthetop.AnequitableapproachtodeficitreductionInshort,whiledeficitreductionisnotthemajorimmediateproblemfacingtheeconomytoday,thetaskofreducingthedeficitisnotthatdifficult.Simplyreversethemeasuresthatledtothereversalofthegovernment’sfiscalpositionfrom2000totoday;raisetaxesatthetop;cutoutcorporatewelfareandthehiddensubsidies;increasetaxesoncorporationsthatdon’tinvestandcreatejobsintheUnitedStatesrelativetothosethatdo;imposetaxesandchargesonpolluters;stopthegiveawaysofourcountry’sresources;cutbackonmilitarywaste;anddon’toverpayforprocurement,whetherfromthedrugcompaniesordefensecontractors.There’smorethanenoughmoneyinthisagendatomeetthemostambitiousdeficitreductiontargetsetbyanyofthedeficitreductioncommissions.Contrastingthisagendawiththereformsproposedbythevariouscommissions,onecomestooneoftwoconclusions:eithersomeofthemweredeliberatelyseekingtocontinuethepathofrestructuringoureconomyinwaysthatbenefitthetopattheexpenseoftherest;ortheyweretakeninbysomeofthemythsthathavedistortedrationaleconomicpolicymaking.MYTHSThedebateoverthebudgethasbeencloudedbyasetofmyths,someofwhichwehavealreadydiscussed.Thesupply-sidemytharguesthattaxingtherichwillreduceworkandsavingsandthateveryone—notjusttherich—willbehurt.Everyindustryhasitsownversionofthismyth:cuttingbackonmilitaryexpenditureswillcostjobs.Cuttingbackontaxbenefitstothecoaloroilindustrywillcostjobs.Industriesthatcontributetoairorwaterpollutionorthatcreatetoxicwastesclaimthatforcing172 polluterstopayforthecoststheyimposeonotherswillcostjobs.Aswe’veexplained,historyandtheoryarguestronglyagainstsupply-sideeconomics,buttodaythat’salmostbesidethepoint.Todayourproblemisnotsupplybutdemand:largefirmsatleasthavethecashonhandtomakeanyinvestmentthattheywant;butwithoutdemandfortheirproducts,suchinvestmentswon’tbeforthcoming.Tostimulateinvestment,wemustfocusonhowbesttostimulatedemand.Gettingmoremoneyintothepocketsofthoseinthemiddleandatthebottomwoulddothat.That’swhydeficitreductionproposalsthatwould,ineffect,imposemuchoftheburdenoftaxincreasesonthemiddlewouldsimplymakethings29worse.Itistheresponsibilityofmacropolicy—monetaryandfiscalpolicy—tomaintaintheeconomyatfullemployment.Whenthingsaregoingwell,andtheeconomyisoperatingnearfullemployment,excessivemilitaryspendingandlavishcorporatewelfaredon’tcreatejobs.Theyjustdistorttheeconomybymovinglaborfrommore-productiveusestoless-productiveuses.Itistruethatifwecorrectthesedistortions,someworkerswithsector-specificskillswillsuffer,astheirskillswillnolongerbeindemand.Butthatisnotanargumentforkeepingtheminplace.Itisanargumentforrobustadjustmentassistancefortheaffectedworkers—assistancethattheRighthastypicallyresisted.Perhapsthemyththat’sbeenmosteffectiveistheclaimthatraisingtaxesonmillionairesorcorporationswillhurtsmallbusinessesandthereforecostjobs.Inrealityveryfewsmallbusinesseswouldevenbeaffectedbysuchtaxes—under1percent.Butit’sonlytheirprofitsthatwouldbeslightlyreduced.Ifitwereprofitabletohireaworkerorbuyanewmachinebeforethetax,itwouldstillbeprofitabletodosoafterthetax.Sayhiringaworkeryieldedthefirmareturnof$100,000,andthefirmhadtopay(inclusiveofalltaxes)$50,000,thefirm(smallorlarge)makesaneatprofitof$50,000.Iftheownernowhadtopayanextrataxonthatprofitof5percent,itwouldlowerwhathenettedby$2,500,butitwouldstillbeveryprofitableforhimtohiretheworker.Whatissostrikingaboutclaimstothecontraryisthattheyflyinthefaceofelementaryeconomics:noinvestment,nojobthatwasprofitablebeforethetaxincrease,willbeunprofitableafterward.Theremaybeaslightconcernthatinthiseraoflimitedcreditavailabilityforsmallfirms,ahighertaxonmillionairesmightreducetheirabilitytomakedesirableinvestments(simplybecausetheywouldhavelessmoneyaftertaxtospend).Ironically,thebanksthatweresoamplysupportedintheGreatRecessionclaimthatitisnotthecase—goodsmallbusinesseswithgoodprojectscan,theysay,getthemoneytheyneed.Accordingtothebankers,thelackoflendingtosmallbusinessesisnotduetothebanks’failuretofulfilltheirsideofthebargain(whenmoneywasgivensofreelytothebanks,theunderstandingwasthatitwassothattheycouldandwouldcontinuetolend);itisduetotherecession’seliminationofgoodlendingopportunities.Butevenifthereisaproblemwiththeabilitytoinvest,therearebetterwaysofhandlingitthangivingablankchecktothecorporationsandhopingthatsomehow30someofthatmoneywilltrickledownandeventuallycreatejobs.173 CutbackstosocialinsuranceWhentheRightisnotviciouslydefendingagainstevenmodestincreasesintaxesforthewealthy,thoseinthe1percentandtheiralliesadvocatecutstosocialinsurance—bothhealthcareandSocialSecurity(pensions)fortheaged,oftendisparaginglycalledmiddle-classentitlements.TheRightfoughtagainsttheadoptionofbothoftheseprograms.Nowit’sblamingtheseprogramsforthecountry’sfiscaldifficulties.Initsmosthopefulscenarios,theRightwouldprivatizebothservices.Privatization,ofcourse,isbasedonyetanothermyth:thatgovernment-runprogramsmustbeinefficient,andprivatizationaccordinglymustbebetter.Infact,aswenotedinchapter6,thetransactioncostsofSocialSecurityandMedicarearemuch,muchlowerthanthoseofprivate-sectorfirmsprovidingcomparableservices.Thisshouldnotcomeasasurprise.Theobjectiveoftheprivatesectoristomakeprofits—forprivatecompanies,transactionscostsareagoodthing;thedifferencebetweenwhattheytakeinandwhattheypayoutiswhattheywant31tomaximize.Thegapbetweenrevenuesandexpendituresforpublicprogramsdoescreateproblemsoverthelongrun.InthecaseofSocialSecurity,thegapisprobablyrelativelysmall,withahighdegreeofuncertainty.SocialSecurity’sfiscalpositiondependsheavilyonforecastsofwages,population,andlongevity.Economicforecastersdidn’tdoaverygoodjobofpredictingtheGreatRecessionevenayearbeforeitoccurred,sonooneshouldputmuchcredenceineconomicforecastsfortyyearsout.Itisevenpossiblethattheprogramwillbeinsurplus,especiallyifthelevelofimmigrationcontinuesatitsprerecessionpace,relativetothesizeofthepopulation.Ofcourse,wehavetobeattunedtothepossibilitythattherewillbealargelong-termdeficitintheSocialSecurityprogramandthattherewillhavetobechangestoeithercontributionsorbenefits.Afewadjustmentsnowdomakesense:increasingthemaximumincomeforwhichcontributionsaremade(in2011contributionswereonlymadeupto$106,800ofincome,withtheresultthatlessthan86percentofwagesweresubjecttothepayrolltax);continuingtheadjustmentoftheageofretirementaslongevityincreases(butthismustbeaccompaniedbyincreasedsupportforthosewhohavetoretireearlyasaresultofpartialdisability);andincreasingtheprogressivityofthesystemtobetterreflecttheincreasinginequalityinoursociety.Thoseatthetopcurrentlygetslightlylessthantheycontribute;thoseatthebottomslightlymore.Tiltingthebalancealittlemorewould,withtheextensionofthecontributionstoupper-incomeindividuals,bothhelpthoseatthebottomandputSocialSecurityonfirmerfinancialfooting.Inthelongerrun,theremayhavetobesomeadditionaladjustments,say,aslightincreaseintaxes,aslightdecreaseinbenefits;buteveninthestandardscenarios32thegapismoderate.SocialSecurityhasbeenanimpressivelysuccessfulprogram,33whichhasnotonlyalmosteliminatedpovertyamongtheelderlybutalsoprovidedakindofsecuritythatnoprivateinsuranceprogramcanmatch,protectingagainstvolatilityinthestockmarketaswellasagainstinflation.ManyAmericanswhohavereliedonprivatepensionsknowwhatI’mtalkingabout:evenasgovernmentprogramsattempttomakesurethatprivatepensionsare174 adequatelycapitalized,firmshavegamedtheiremployees.Beforethecompaniesgobankrupt,theirCEOswalkoffwithlargepay;butthepensionfundsareputatrisk.PresidentBush’sagendaforprivatizationofSocialSecuritywasnotaboutprovidingmoremoneytoAmerica’sretireesormoresecurityoraboutincreasingefficiency.Itwasaboutonethingonly:providingmoremoneytothe1percentattheexpenseofthe99percent—moremoneytoWallStreet.Themagnitudesinvolvedarepotentiallyenormous.Thinkofthe$2.6trillionintheSocialSecurityfund.IfWallStreetcouldgetjust1percentperyearformanagingthatmoney,thatwouldbeanextrabonanzaforthemanagersof$26billionayear.MedicareTheissuesinvolvedwiththeMedicareprogramaremorecomplicated,butonlyslightlyso.Americahasaninefficienthealthcaresystemthatdeliversfirst-ratehealthcaretothosewhoareluckyenoughtohavegoodhealthinsuranceorwealthyenoughtoafforditwithoutinsurance.Asystemriddledwithdistortionsandrents,healthcare’shightransactionscostsfeedtheprofitsoftheinsurancecompanies,anditshighdrugpricesfeedtheprofitsofthepharmaceuticalindustry.Thereisonewaytosolvethelong-termdeficitassociatedwithMedicareandMedicaid:makethehealthcaresectormoreefficient.IfthecostofdeliveringhealthcareintheUnitedStateswerecomparabletothatofotheradvancedindustrialcountriesthatachievebetteroutcomes,asevidenced,forinstance,bylongevityorinfantormaternalmortality,America’sbudgetaryproblemswouldbe34solved.Instead,thedeficitreductioncommissionsandproposalsonofferin2011eitherwavedtheirhands—sayingthatthegrowthinMedicarespendingwouldhavetobecapped,withoutsayinghowthatwouldbeachieved—or,asintheRyanplan,suggestedconvertingMedicaretoavoucherprogram,inwhichindividualswouldbegivenachitthattheycouldusetopayforhealthinsuranceinthe35privatemarket.Thosewhocouldn’tsupplementthevoucherwiththeirownmoneywouldhavetomakedowiththebestpolicythattheycouldgetwiththevoucher.Theimplicationwasclear:ifcostsofmedicalcareingeneralincreasedbutspendingontheagedwascapped,thosewhocouldaffordtopaymoreoutoftheirownpocketwouldhaveto;andthosethatcouldnotwouldhavedowithout—forthem,therewouldbe,ineffect,rationing.MostofthereformsinSocialSecurityandMedicarehavetobephasedingraduallyovertime,whichiswhythesecutbackswillnothaveanimmediatebigeffectoncurrentdeficit.Ontheonehand,that’sthebigadvantage:onecantalkaboutfiscal36responsibilitybutnotcrimptheeconomynow.Ontheotherhand,forthetruedeficithawks,that’sthebigdisadvantage.Talkischeap.TheRightwantsrealcutsinspendingnow,andapromiseoffuturecutsinsocialprograms.Butenactingrealcutsnowwillexacerbatetheeconomicdownturnandworsentheplightofthoseinthemiddleandatthebottom.BlamethevictimStillanothermythisthatthepoorhaveonlythemselvestoblame.175 Theunemployedarejoblessbecausetheyarelazy.Theyhaven’t37searchedhardenough.Whenfacedwithaproposaltoextendunemploymentbenefits,advocatesoftheseideasworryaboutmoralhazard.Providinginsurancetotheunemployed,theythink,reducestheirincentivetolookforajob,whichinturnleadstohigherunemployment.Whethersuchclaimsarevalidwhentheeconomyisoperatingnearfullemploymentisnotmyconcernhere.Withfourapplicantsforeveryjob,however,itshouldbeobviousthattheproblemtodayisnotthelackofapplicantsforjobs,butthelack38ofjobs.Ifmorepeoplesearched,therewouldjustbethatmanymorepeopleapplyingforthefewjobsthatwereavailable.There39wouldessentiallybenochangeinthelevelofemployment.Standardfareamongcentralbankers(andothersontheright)maintainsthatitisnotthattheyhavefailedtomanagetotaldemandtokeeptheeconomyfullyfunctioning.Instead,theyshiftblameelsewhere,particularlytoworkers,fordemandingexcessivejobsecurityandtoohighwages,underminingthefunctioningofthelabormarket.Thecrisisdemonstratedhowwrongtheirviewsaboutthelabormarketwere:theUnitedStates,withallegedlythemostflexiblelabormarket,performedfarworsethancountries40withstrongerlaborprotections(likeSwedenandGermany).Andthereasonisobvious:cutsinwagesreducetotaldemandanddeepenthedownturn.AUSTERITYTheworstmythsarethatausteritywillbringrecoveryandthatmoregovernmentspendingwillnot.Theargumentisthatbusinessmen,seeingthatthegovernment’sbooksareinbettershape,willbemoreconfident;moreconfidencewillleadtomoreinvestment.Interestingly,onthebasisofthisargument,theadvocatesshouldsupportourfirststrategyforeconomicrecovery:higherpublicinvestment.Sincetherearepublicinvestmentopportunitiesthatarewidelybelievedtohaveveryhighexpectedreturns—muchhigherthantheinterestrategovernmenthastopaytoborrow,morepublicinvestmentwouldleadtoalowerlong-runnationaldebt;andthebeliefthatthatwassoshouldinstillconfidence,bringingonanevenstrongerburstofeconomicactivity.Buttheadvocatesofausteritydonotsupporthigher41publicinvestment.Anotherwaytoconsiderthemeritsofausterityistolookathistory.Historyshowsthatausterityhasalmostneverworked,andtheoryexplainswhyweshouldn’tbesurprisedbythis.Recessionsarecausedbylackofdemand—totaldemandislessthanwhattheeconomyiscapableofproducing.Whenthegovernmentcutsbackonspending,demandisloweredevenmore,andunemploymentincreases.Underlyingthemyththatausteritywillbringconfidenceisoftenanothermyth—themyththatthenationalgovernment’sbudgetislikeahousehold’sbudget.Everyhousehold,soonerorlater,hastolivewithinitsmeans.Whenaneconomyhashighunemployment,thesimpleruledoesnotapplytothenationalbudget.Thisisbecauseanexpansionofspendingcanactuallyexpandproductionbycreatingjobsthatwillbefilledbypeoplewhowouldotherwisebeunemployed.Asinglehousehold,byspendingmorethanitsrevenues,cannotchangethemacroeconomy.Anationalgovernmentcan.AndtheincreaseinGDPcanbeamultipleofthe176 amountspentbythegovernment.Thoseinfinancestresstheimportanceofconfidence,butconfidencecan’tberestoredbypoliciesthatleadtomoreunemploymentandloweroutput.Confidencecanberestoredonlythroughpoliciesthatleadtogrowth—andausteritydoesjusttheopposite.Austerity’sadvocatespresentevidenceofcountriesinadownturnthathaveimposedausterityandrecovered.Butacarefullookshowsthatthosecountrieswereallsmallandhadtrading42partnersthatwereexperiencingaboom.Thus,increasedexportscouldeasilyreplacereducedgovernmentexpenditures.ThatisnotthecasetodayfortheUnitedStatesandEurope,whosetrading43partnersarethemselvesinaslump.Onemighthavethoughtthatthosewhoadvocateausteritywouldhavelearnedfromtheplethoraofearlierexperienceswhereausterityhaddisastrousconsequences:HerbertHoover’sausterityconvertedthe1929stockmarketcrashintotheGreatDepression,IMFausterityconvertedthedownturnsinEastAsiaandLatinAmericaintorecessionsanddepressions;theself-imposedandforcedausterityinseveralEuropeancountries(theUK,Latvia,Greece,Portugal)isnowhavingexactlythesameeffect.Butausterity’sadvocateshaven’tseemedtocometotermswiththisoverwhelmingevidence.LikethedoctorsoftheMiddleAgeswhobelievedinbloodletting,butwhenthepatientdidn’tgetbetterarguedthatwhattheyreallyneededwasanotherround,thebloodlettersoftwenty-first-centuryeconomicswillnotwaver.Theywilldemandevermoreausterity,andtheywillfindmyriadexcusesforwhythefirstdosagedidn’tworkaspredicted.Meanwhile,unemploymentwillincrease,wageswilldecrease,andgovernmentprogramsuponwhichthoseinthemiddleandatthebottomrelywillwitheraway.Bycontrast,governmentspendinghassucceeded.ItwasultimatelygovernmentspendinginanticipationofWorldWarIIthatpulledthecountryoutoftheGreatDepression.AlthoughtheNewDealprovidedsomestimulus,andhelpedtheeconomyrecoverbetween1933and1936,thestimuluswasnotlargeenoughtoovercomethecombinedeffectofthecontractionofspendingatthestateandlocallevelsandtheweaknessesinagriculture(incomesofthoseinthatsector,constitutingaquarterofthepopulation,felldramaticallyinthisperiod—by50percentbetween1929and441932alone).Then,attheendofRoosevelt’sfirstterm,in1936,worriesaboutthedeficitandpressuresfromfiscalconservativesinducedhimtocutbackfederalspending.The45economy’srecoverywashalted,andgrowthturnednegative.ThemythofthefailedstimulusTheadvocatesofausteritycounterthosewhoargueformoregovernmentspendingbysayingthatsuchspendingwillnotstimulatetheeconomy.Theybegintheircritiquebyobservingthatthealmost$800billionstimuluspackageenactedinFebruary2009didn’tsavetheeconomyfromadeeprecession—andneitherwouldmoregovernmentspending.Butthestimulusdidwork:ifithadn’tbeenforthestimulus,theunemploymentratewouldhavepeakedinexcessof12percent,morethan2percentagepointshigherthanthelevelseventuallyreached.Theadministrationdidmakeseveralmistakes.First,it177 underestimatedthedepthanddurationofthedownturn.Itthoughtthatwithoutthestimulusunemploymentwouldpeakataround10percent.Administrationeconomists,someofwhomhadbeenconnectedwiththecreationofthebubble,underestimateditssize.Theysimplycouldn’tbelievethatrealestatepriceswerethatoverinflated;sotheybelievedthatthefallinpriceswouldbeonlytemporary,andwiththerecoveryofhousingpricesconsumptionwouldberestored.Asbusinessessawaquickrecovery,theywouldbereluctanttolettheirgoodemployeesgo.Therealitywasotherwise:therehadbeenanenormousbubble,andwithpricesstill30percentbelowprecrisislevelsgoingonfiveyearsafterthebubblebroke—insomeplacesmorethan50percentbelowprecrisislevels—ithasbecomeincreasinglyclearthattherealestatesectorwillbedepressedforyearstocome,evenifthe46financialsectorwereperfectlybacktohealth.That’saproblem,becausebeforethecrisissome40percentofallinvestmentwasinrealestate.Asecondmistakewasthattheadministrationbelievedthattheprimaryproblemwasthefinancialcrisis—notrecognizingtheunderlyingneedforstructuraltransformation.Theenormousincreasesinproductivityinmanufacturing,outpacingtheincreaseindemand,inevitablymeantthatlaborwouldhavetomoveoutofthatsector—justastheenormousincreasesinagriculturalproductivityintheyearsbeforetheGreatDepressionmeantthatlaborhadtomoveoutofagricultureintomanufacturing.Moreover,withglobalizationanincreasinglylargefractionofthejobsinmanufacturingwouldresideindevelopingcountriesandemergingmarkets,compoundingtheneedforstructuraltransformation.Theadministrationfailed,too,tograspanotherfundamentalproblem,thegrowinginequalityanditsimpactonwhathadhappenedbeforethecrisis,andwhatwaslikelytohappensubsequently.Beforethecrisis,theaveragehouseholdsavingsratewasnearzero,andthatmeantthatmanyAmericansweredissaving—hadnegativesavings.Withtheupper20percentofthepopulationholdingapproximately40percentofthenationalincomeandsavingapproximately15percentofthatincome(foratotalofapproximately6percentofnationalincomebeingsaved),itmeantthatthebottom80percent,withtheremaining60percentofthenationalincome,hadtobedissavingatarateof10percentoftheirincome.Again,evenifthebankswereperfectlyrestoredtohealthandevenifthedeleveragingofthehouseholdsector(thatis,payingdowntheirexcessiveindebtedness)wascomplete,thesehouseholdsshouldn’treturntotheirwaywardwaysofconsumingpersistentlybeyondtheirincome,andbanksshouldn’tlendtothem.That’swhyit’sunrealistictothinkthattheconsumptionexcessesoftheprecrisislevelwillresume.And,ofcourse,thedecliningshareofwages—theincreasinginequality—willmaketherecoveryallthemoredifficult,withoutgovernmentassistance.Thesemistakesineconomicanalysishadconsequences.Thebeliefthattheeconomywouldrecoverquicklyonitsown—oncethebankshadbeenbroughtbacktohealthwithgovernmentassistance—ledtoastimuluspackagethatwastoosmallandtooshort-lived.Becausetheadministrationthoughtthedownturnwouldbeshort,itthoughtfirmswouldholdontotheirworkers;butbusinessesknewotherwise,andhencethelayoffofworkerswasgreaterthantheadministrationanticipated.Moreover,thestimuluswasnotaswelldesignedasitcouldhavebeen;therecouldhavebeenmore178 stimulusperdollarofspending.Butthebeliefthatonlyashort-termpalliativewasneeded,whilethefinancialsectorrecovered,mayhavemadetheadministrationmorerelaxedaboutthese47weaknesses.Theadministration’smisjudgmentsinthisareawerecompoundedbyonemore:thethoughtthatifitsspokesmencouldtalkuptheeconomyand“restoreconfidence,”thealmightyAmericanconsumerwouldsomehowreturn.InMarchof2009theystartedtalkingaboutgreenshoots;butbysummertheseshootshadturnedbrown.Intheyearsthatfollowed,glimmersofhopewouldoccasionallyappear,buttheseattemptstorepeatedlyexudeconfidencemayactuallyhaveunderminedconfidence(andespeciallyinboththeadministrationandtheFed):clearly,thecountry’sleaders48hadn’tgraspedwhatwasgoingon.WhygovernmentspendingcanbeveryeffectiveThelogicofwhygovernmentspendingcanbe—andhasbeen—effectiveinstimulatingtheeconomyiscompelling.Ifgovernment,say,increasesspending,GDPincreasesbyamultipleofthatamount.TherelationshipbetweentheincreaseinGDPandtheincreaseingovernmentspendingiscalledthemultiplier.Notsurprisingly,thoseontherightsaythatthemultiplierissmall—andmaybeevennearzero.Ofcourse,whentheeconomyisatfullemployment,moregovernmentspendingwon’tincreaseGDP.Ithastocrowdoutotherspending.IftheFedincreasesinterestratesorreducescreditavailability,asitworkstoensurethattheincreasedgovernmentspendingisnotinflationary,investmentwillbecrowdedout.Buttheseexperiencesareirrelevantforthequestionofassessingtheimpactofgovernmentspendingwhenunemploymentishigh(andit’slikelytobehighforyearstocome)andwhentheFedhascommitteditselftonotincreasinginterestratesinresponse.Inthesecircumstances—theconditionsoftheGreatRecession—multipliersarelikelytobelarge,farin49excessofone.Thegovernmentspendingcan,ofcourse,beevenmoreeffectiveifitgoestohighproductivityinvestments,includingthosethatfacilitatetherestructuringoftheeconomy.Beyondthehighdirectreturnstosuchinvestments,thereareotherbenefits—returnstoprivateinvestmentsareincreased,sothatprivateinvestmentsare“crowdedin”;thedeficitisreducedinthemediumterm,andnotonlyshouldthatinstillconfidencebutconsumers,realizingthattheirfuturetaxburdenswillbelower50thantheymightotherwisebe,mayconsumemoretoday.Evenprivateconsumptionis“crowdedin.”Governmentmoneyspentonstructuralreform—helpingmoveresourcesfromold,lesscompetitivesectorstonewsectors—stimulatestheeconomy,andthehigherincomesgiveindividualsandfirmstheresourcestoadapttothechangedeconomy.InmanyoftheEuropeancountriesfacingausterity,thereissimultaneouslyademandforfasterstructuralreforms.Thestructuralreformsthattheyoftenfocusupondonotentailgovernmentassistanceinmovingtheeconomyintonewsectors.Rather,whatisreferredtoisamixtureofcounterproductivemeasures(loweringminimumwages)andrent-reducingmeasures(likemoreeffectiveenforcementofcompetitionlawsandreducing179 licensingrestrictions),withmeasuresofambiguouseffect—rushedprivatizationsthathave,inmanycountries,actuallyincreasedrentsandimpairedefficiency.Thesereformsaretoppedoffwithaspirationalmessages—tobemorecompetitive.Evenwerethesereformstooccurathistoricallyunprecedentedpaces,itwouldbeyearsbeforethefullbenefitswererealized.Butthesereformsatbest(whentheyarewelldesigned,andmanyarenot)improvethesupplysideoftheeconomy;aswehaverepeatedlynoted,however,theweaknessesintheeconomytodaystemfromthedemandside,andacutbackinworkers’income,eitherasaresultoffiringworkersorlowerwages,simplylowerstotaldemand,loweringGDPandweakeningthecapacitiesofthosewhohavetomakethestructuraltransformationstodoso.Adjustmentislikelytobeimpaired.Infact,unlesssomethingisdoneaboutdemandandgrowthnow(andmostoftheEuropeanprogramsseemtobedoinglittleornothing),structuralreformsthatincreaseefficiencyimplythatfewerworkerswillberequiredtoproducewhateveroutputtheeconomygenerates.Desirableasthestructuralreformsareforthelongrun,theyruntheriskofincreasingunemploymentandloweringoutputintheshortrun.CONCLUDINGCOMMENTSTheviewsofthebankersandothersofthe1percentonhowtorespondtothecrisis—cutwagesandcutbudgets—won’trestoreoureconomiestoprosperity.It’snotevenclearthatthepoliciestheyadvocatewillbeverysuccessfulinreducingthedeficitinthecurrentconditionsofeconomicweakness:lowerGDPandhigherunemploymentwillmeanlowertaxrevenuesandhigherexpenditures.Norisitevenclearthatthey’reintheinterestsofthe1percent,thoughit’seasytoseewhytheymightthinkthat.Loweringwages(“morelabormarketflexibility”)wouldincreaseprofits,ifonlysalesheldup.Thebankers,moreover,arealwaysfocusedongettingpaidback.Theythinkofahouseholdthatowesthemmoney.Ifthehouseholdcutsbackonspendingonitself,ithasmoremoneytogivethebank.Buttheanalogybetweenthehouseholdandtheeconomyisfalse:cuttingbackongovernmentspendingdestroysdemandanddestroysjobs.Thehouseholdwon’thavethemoneytorepaythebankerifitsincomefallsconcomitantlywithcutbacksinexpenditure.Andrepaymentwillbeevenmoredifficultifincomefallsbyamultipleofthecutbackinexpenditures—whichispreciselywhateconomicshasshowntobethecase.What’sstrikingishowmanypeople—punditsandordinarycitizensalike,thoseingovernmentandthoseoutside—havebeenseducedbythemythofausterityandthemyththatthegovernmentbudgetislikeahousehold’sbudget.Manypeoplehavebeencapturedbyasubtle,parallelargumentthattheRightmakesaboutmacroeconomics:Therewasastimulus.Theeconomydidn’tgetbetter.Itevengotworse.Ergo,thestimulusdidn’twork.Butthestimulusdidwork;itpreventedtheunemploymentratefrombeingevenhigher.The1percenthascapturedanddistortedthebudgetdebate—usinganunderstandableconcernaboutoverspendingtoprovidecoverforaprogramaimedatdownsizingthegovernment,anactionthatwouldweakentheeconomytoday,lowergrowthinthefuture,and,mostimportantlyforthefocusofthisbook,increase180 inequality.Ithasevenusedtheoccasionofthebudgetbattletoargueforreducedprogressivityinourtaxsystemandacutbackinthecountry’salreadylimitedprogramsofsocialprotection.Giventheweaknessesintheeconomy(boththelackofdemandtodayandthelackofinvestmentinourfuture),deficitfetishismfocusesonthewrongproblem,atleastfornow.Butevenifonegaveintodeficitfetishism,we’veshownthattherearealternativetaxandexpenditurepoliciesthatcansimultaneouslyincreaseeconomicefficiency,increasethenation’soutputandloweritsunemploymentrate,andaddressoneofthecountry’smosttroublesomeproblems,itsgrowinginequality.Amajorsourceofinequality,atthebottom,isunemployment.Thosewithoutjobssuffer,andsodothosewithjobs,ashighunemploymentputsstrongdownwardpressureonwages.SinceAmerica’spoliticalgridlockisconstrainingtheuseoffiscalpolicy(taxesandexpenditures)torestoretheeconomytofullemployment,hopehasshiftedtomonetarypolicy.Asthischapterhaspointedout,mattersmaygetevenworse:deficitfetishismcouldleadtoausterity,whichwillweakentheeconomyfurtherandputanevengreaterburdenonmonetarypolicy.Butismonetarypolicyuptothetask?Thenextchapterexplainswhymonetarypolicyhasn’treallyservedournationaswellasitshould:totoolargeanextent,it’sbeendesignedtoservethefinancialsectorandotherinterestsofthoseatthetop.181 CHAPTERNINEAMACROECONOMICPOLICYANDACENTRALBANKBYANDFORTHE1PERCENTSOMEREADERSMIGHTBESURPRISEDTOSEEACHAPTERonmacroeconomics—thebranchofeconomicsthatdealswiththeoveralllevelofeconomicactivity,withoutput(GDP)andemployment,withinterestratesandinflation—inabookoninequality.Nothingaffectsthewell-beingofmostcitizensmorethanthestateofthemacroeconomy—whetherthereisfullemploymentandgrowth.Andwhenmacroeconomicpoliciesfail,andunemploymentsoars,thoseatthebottomareamongthosethatsufferthemost.Morebroadly,macroeconomicpolicygreatlyaffectsthedistributionofincome.Policymakersshouldbeawareofthis,buttheyoftenactasiftheyaren’t.Indeed,thedistributionofincomeisseldommentionedinmacroeconomics,andthat’sexactlythepoint.Themostimportantresponsibilityofpolicymakersistomaintaintheoverallstabilityoftheeconomy.TheGreatRecessionoffersevidenceofacolossalfailure.AndthisfailurehasimposedanenormousburdenonordinaryAmericans—asworkers,ashomeowners,astaxpayers,aswedescribedinChapter1.Weexplainedhowthefailureofmacroeconomicsfinallybroughttotheforetheproblemswithoureconomicsystem.Whenthingsweregoingwell,mostpeoplewereprosperingandcouldpersuadethemselvesthatthosewhoweren’thadonlythemselvestoblame.Butwiththerecessionof2008,thestorystoppedmakingsense.Toomanypeoplewho“playedbytherules,studiedhard,workedhard”werejustgettingby,ornotevengettingby.Thesystemwasn’tworking.Thisbookhasarguedthat,inmanyways,oureconomicsystemhasbenefitedthoseatthetop,attheexpenseoftherest,andthatthissystemisfarremovedfromwhathasbeencalled“theachievementmodelofincomedetermination,”inwhichincomesreflectcontributionstosociety.Inthischapterwefocusonthecontributionofourmacroeconomicpolicytothisoutcome—before,during,andafterthecrisis.Policyentailschoices.Therearedistributiveconsequencesofallpolicies.Acentralthemeofthisbookisthatsomeofthepolicychoiceshavesimultaneouslyincreasedinequality—benefitingthoseatthetop—andhurttheeconomy.Butmanychoicesaremorecomplicatedandinvolvetrade-offs.Ifthereisatrade-offbetweeninflationandunemployment,pursuinglowerinflationmeanshigherunemploymentandworkerssuffer;lowerunemploymentmeanshigherinflation,andbondholders182 seethevalueoftheirassetserode.Afocusoninflationputsthebondholders’interestsatcenterstage.Imaginehowdifferentmonetarypolicymighthavebeenifthefocushadbeenonkeepingunemploymentbelow5percent,ratherthanonkeepingtheinflationratebelow2percent.Differentpoliciesalsoimposedifferentrisksondifferentsegmentsofsociety.Ifthingsgowrong,whowillbeartheconsequences?Ifthingsgoright,whoreapsthebenefits?TheFedgambled,intrustingthatbanksontheirowncouldmanagerisk—agamblethatpaidoffhandsomelyforthebanks,andespeciallyforthebankers,butinwhichtherestpaidtheprice.TheFedcouldhavecurbedtherecklessandpredatorylending,theabusivecreditcardpractices,butchosenottodoso.Again,thebankswerethewinners;therestthelosers.MonetaryandmacroeconomicpolicyandFedactionthuscontributedtothecountry’sgrowingproblemofinequalityinseveralways.Atthebottomandinthemiddle,higherunemploymentthanwasnecessaryattimes(implyinglowerwages)meantlowerincomesforworkers.Lessprotectionfromtheabusivepracticesofthebankshurttheirstandardsofliving.We’llevenseehowcurrentmacroeconomicpoliciesmayevenbecontributingtocreatingajoblessrecovery—whentherecoveryactuallygetsreallyunderway.Hiddensubsidiestobanksandsupportforderegulationthatcontributedsomuchtothefinancializationoftheeconomycontributedtotheincreasinginequalityatthetop,andaggressivepoliciesfightinginflationmeantthatrichbondholdersdidn’thavetoworrythatinflationwoulderodetheirvalue.Thesefailuresarenotanaccident.Theinstitutionalarrangementsbywhichmonetarypolicyissetaredesignedtogivedisproportionatevoicetothebankersandtheirallies.Thiswasevenreflectedinthemodelsthatbecamepartofthestandardtoolkitofcentralbanks.Whiletheyfocusedoninflation(somethingbondholderscaredagreatdealabout),theyignoreddistribution(somethingbankerswouldn’twantcentralbankerstothinktoomuchabout)—eventhough,aswehaveargued,growinginequalitywascriticalincreatingtheeconomy’sinstability.JustastheGreatRecessiondrewattentiontoAmerica’sgrowinginequality—destroyingthemyththatallwerebenefitingfromthegrowththathadoccurredintheprecedingquartercentury—itdestroyedtwoothermyths:thatafocusoninflationwasthecornerstonetoeconomicprosperity,andthatthebestwayofensuringeconomicstabilitywastohaveanindependentcentralbank.Thischapterwillexplainhowthemonetarypoliciesthatwerepursuedsimultaneouslyweakenedoveralleconomicperformanceandincreasedinequality.Thereisanalternativesetofpoliciesandinstitutionalarrangementsthatholdsoutthepromiseofnotonlybetterandmorestablegrowthbutalsoofamoreequitablesharingofthebenefitsofthatgrowth.HOWMODERNMACROECONOMICSANDMONETARYPOLITICESHAVEHURTTHE99PERCENTThecentralfocusofmuchofmodernmacroeconomicsandmonetarypolicyisoninflation—keepinginflationlowandstableallegedlyprovidesthemacroeconomicconditionsunderwhichamarketeconomy183 canflourish.Inflation—especiallyveryhighanderraticlevelsofinflation—canbeaproblem,buttheUnitedStatesandWesternEuropehavenotfacedaseriousproblemofinflationinmorethan1athirdofacentury.Focusingonyesterday’sproblemscandistractonefromthemorepressingissuesoftoday.IntheyearsbeforetheGreatRecession,offarmoreconcernthanapossibleslightlossofefficiencyfromaslightincreaseininflationshouldhavebeentheverybiglossfromthecollapseofthe2financialsystem.IntheyearsaftertheonsetoftheGreatRecession,offarmoreconcernthanapossibleslightlossofefficiencyfromaslightincreaseininflationshouldhavebeentheverybiglossesfromthewasteofresourcesasaresultoftheeconomy’snotlivinguptoitspotential.Aswenotedinchapter4,thosewhosufferthemostincrisesareworkersandsmallbusinesses,andthat’sbeenespeciallytrueinthiscrisis,wherecorporateprofitsremainhighinmany3sectorsandbanksandbankersaredoingwell.Highunemploymenthurtsthosewhodependonworkingfortheirliving;mostofthosewithjobsfaceshorterhoursandlowerincomes.Butitparticularlyhurtsthoseatthebottom.Themoreskilledworkersdisplacethelessskilled,andthelessskilleddisplacetheunskilled.Whileeachofthesegroupssufferswithlowerincomes,4thosethataredisplacedfromtheirjobsarehurtthemost.Ahighlevelofjoblessnessdoesn’tjustaffectthosewholosetheirjobsorhavetheirworkinghourscut:ithurtsthebottom99percentbyforcingdownwagesasworkerscompeteforjobs.Andthewaymostcentralbanksconductmonetarypolicycreatesaratcheteffectthathasbeenworkingruthlesslyforthepastseveraldecades.Assoonaswagesstarttorecover,thecentralbankers,withtheirsingle-mindedfocusoninflation,raisethespecterofpriceincreases.Theyraiseinterestratesandtightencredit,tomaintainunemploymentatanunnecessarilyhighlevel.Toooftentheysucceedinchokingoffwageincreases—withtheresultthat5productivityhasbeengrowingsixtimesfasterthanwages.(Atthetimeofthe2008crisis,workershadnotyetrecoveredwhat6theyhadlostinthelastrecession.)Centralbankershaveahardtimelimitingtheiropinionstomonetaryandbankregulatorypolicy.(Iftheyhadstucktotheirknitting,andgottenmonetaryandregulatorypolicyright,theeconomywouldbeinfarbettershape.)Acentralthemeofthesebankersisthatthereshouldbemore“labormarketflexibility,”whichtypicallymeansloweringwages,andespeciallyminimumwagesandjobprotections.Buttheweakeningofsystemsofsocialprotectionhasamplifiedtheadverseeffectsonthe99percentofmistakenmacropolicies.Minimumwageshavenotkeptupwithinflation(sothattherealfederalminimumwageintheUnitedStatesin2011is15percentlowerthanitwasalmostathirdofacenturyago,in1980);andthishasobviouslymadeloweringwages7easier,especiallyatthebottom.Unemploymentinsurancealsohasnotkeptupwiththetimes,sothosewholosetheirjobsandareluckyenoughtohaveunemploymentinsurancereceiveafractionof8theirpreviouspay.And,aswesawinchapter1,thenumberofunemployedwhoarenotreceivingbenefitshasrisentostaggeringlevels.Buttheweakeningofthesystemofsocialprotectionandthepushformoreflexiblelabormarketsmayitselfhaveamplifiedthe184 macroeconomicconsequencesofflawedmonetarypolicies.ThecentraleconomicproblemintheGreatRecession,aswehavenoted,islackoftotal(oraggregate)demand.Withgoodsystemsofsocialprotection,workers’incomeandconsumptionaresustained,eveninthefaceofadownward“shock”totheeconomy.Economistsrefertotheseshockabsorbersasautomaticstabilizers.Ontheotherhand,wagedeclinesinresponsetoanadverseshocktotheeconomyamplifyitseffects.Thecentralbankerswhoweresimultaneouslycallingformore“wageflexibility,”focusingoninflation,andignoringtherisksoffinancialfragilityweresimultaneouslypursuingapolicythatexposedtheeconomytoariskofamajorshockandadvocatingpoliciesthatwouldensurethattheshock,whenitoccurred,wouldhavedeepandseriousconsequences.OblivioustothedistributionalconsequencesofmonetarypolicyAsInoted,thestandardmacroeconomicmodelsdon’tevenrecognizethatthedistributionofincomematters,andsoit’snotsurprisingthattheFedinitspolicieshasoftenseemedoblivioustothedistributionalimplicationsofitsdecisions.Evenwhenitdoesfocusonemployment,itsfailuretotakeintoaccountthedistributionalconsequencesofitsactionsleadittoadoptpoliciesthatmaybecounterproductive.Forinstance,theFedfocusesoninterestratesinthemistakenbeliefthatchangesintheinterestratesareasimple“lever”bywhichitcancontroltheeconomy—lowertheinterestrateandtheeconomyexpands;raisetheinterestrateanditslowsdown.Andthoughtherearetimesandcircumstancesinwhichtheinterestratemayhavethoseeffects,atothertimesthelinksareatbestweakandotherinstrumentsmighthavebeenmoreeffective.Forinstance,inresponsetotherealestatebubble,itwouldhavemademoresensetoraisethedownpaymentrequirementsformortgagesthantoraiseinterestrates;onedidn’twanttoslowdownproductiveinvestments,justtodampenthebubble.SuchregulationswereanathematotheFed,withitsreligiousdevotiontothepricesystemandthewondersofthemarket.Whentheeconomywentintoatailspin,theloweringofinterestratesmayhavesavedthebanks,butitclearlydidn’treignitetheeconomy.Evenifthelowerratesthatbankspaidforfundshadbeenpassedontoborrowers,inmostsectorstherewouldn’thavebeenmuchincreasedinvestment,giventhelowlevelofcapacityutilization—theeconomyalreadyhadmorethanenoughcapacitytoproducewhateverwasdemanded.So,besidescheapmoneyforthebanks—ahiddensubsidy—therereallywasn’tmuchbenefittoloweringtheinterestrate.WhentheFedloweredinterestratesinresponsetothecollapseofthetechbubble,itdidn’tleadtomuchbusinessinvestment,butitdidleadtotherealestatebubble.Butwithrealestatepricesdownasmuchastheywere,itwasalmostinconceivablethatlowerinterestrateswouldhavemucheffectthere.Therewasacost,however:allthoseretiredindividualswhohadinvestedprudentlyingovernmentbondssuddenlysawtheirincomesdisappear.Inthisway,therewasalargetransferofwealthfromtheelderlytothegovernment,andfromthegovernmenttothebankers.Butlittlementionoftheharmtotheelderlywas9made,andlittlewasdonetooffsetit.185 Thelowerinterestratesmighthavedampenedspendinginotherways.Personsnearingretirement,seeingthattheywouldhavetoputawaythatmuchmoreinsafegovernmentbondstogettheretirementincometheydesired,wouldhavetosavemore.Aswouldparentssavingtoputtheirkidsthroughschool.Evencursoryattentiontothedistributionalconsequencesofsuchpolicieswouldhaveraiseddoubtabouttheeffectivenessofthelow10interestratepolicy.TheFed,withitsfocuseveronthe1percent,didhoweversuggestthatlowerinterestrateswouldincreasestockmarketprices—helpingthoseatthetop,who,aswehaveseen,ownadisproportionateshareofthestockmarket—andhigherstockmarketpriceswouldleadtomoreconsumption,becausepeoplewouldfeelwealthier.Butinterestrateswouldnotremainatsuchalowlevelforever,whichmeantthegaininstockpriceswasnotlikelytobepermanent.Itwasunlikelythatanytemporaryincreasesinstockpricescausedbyatemporaryloweringofinterestrates,ofbenefitparticularlytotherich,wouldtranslateintosubstantial11increasesinconsumption.AlthoughtheFed’slowinterestratepolicyhadn’tledtotheresurgenceofinvestmentasithadhoped,itdidencouragethosewhowereplanninginvestmentstosubstitutecheapcapitalforlabor.Capitalwas,ineffect,atatemporaryartificiallylowprice,andonemightaswelltakeadvantageofthisunusualsituation.Thisreinforceddistortedpatternsofinnovationthatfocusedonsavinglaboratatimewhenitwasincreasinglyinabundance.Itiscuriousthatatatimewhenunemploymentamongtheunskilledissohigh,groceryanddrugstoresarereplacingcheckoutclerkswithautomaticmachines.TheFedwasmakingitmoreandmorelikelythat,whenarecoverysetin,itwouldbeajoblessone.Indeed,thisturnedouttobethehallmarkoftherecoveryfromthe2001recession,duringwhichtheFedhadagain12putinterestratesatlowlevels.HelpingthetopWe’vealreadynotedanumberofwaysthattheFedhelpedthebanksandthebankers,especiallyinthecrisis.TheFederalReservelendstothebanksatverylowinterestrates,ratesthat,especiallyintimesofcrisis,arefarbelowthemarketrate.Ifabankcanborrowatclosetozero,andbuyalong-termgovernmentbondyielding,say,3percent,itmakesanifty3percentprofit13fordoingnothing.Lendthebankingsystematrilliondollarsayear,andthat’sa$30billiongift.Butbankscanoftendobetter—theycanlendtotripleA–ratedfirms,primecustomers,atmuchhigherinterestrates.Iftheycanlendatjust10percent,thenthegovernment’swillingnesstolendthematrilliondollarsatclosetozerointerestrateisa$100billion14ayeargift.BankscanalsodepositmoneyintotheFederalReserve,andtheynow,forthefirsttime,receiveinterestonthosedeposits—15anotherhiddentransferfromtaxpayerstothebanks.Curiously,thislatestgiftmayhavediscouragedlending.Payingbanksnottolendmeantthattheincrementalreturnsbanksgotfromlending16werelowered.Morebroadly,thebailoutstrategyputtheinterestsofthe186 banks(andespeciallythelargebanks)andbankersaheadofthe17restofoureconomy.Moneywasgiventothebanksallegedlysothattheflowofcreditwouldnotbeinterrupted,butnoconditionswereimposedonthefinancialinstitutionsreceivingfunds.Noconditionstomaintaintheflowoflending,noconditionsnottousethemoneytopaybonuses.Muchofthemoneygiventothebankswenttobonuses,nottobankrecapitalization.Moneywentdisproportionatelytothelargebanks,whichweremoreinterestedinspeculationandtradingthaninlending.Totheextentthattheylentmoneyatall,itwasdisproportionatelytolargeinternationalfirms.Thegovernment’smoney,forthemostpart,didn’tgotothesmallerregionalandcommunitybanksthat18focusonlendingtosmallandmedium-sizeenterprises.Not19surprisingly,hundredsofthesesmallerbankswentbankrupt,andhundredsmorewereinsuchaprecariouspositionthattheyhadto20curtaillending.Forastrategyaimedatmaintainingtheflowofcredit,theFed’sdecisions(togetherwithTreasury)weredeeplyflawed.Deregulation:keytotheincreasingfinancializationoftheeconomyThisdeferencetothebanksliesatthecenteroftheFed’s,andothercentralbanks’,greatestcontributiontoinequality:theirfailuretoimposeadequateregulationandtoadequatelyenforceregulationsthatexisted—theculminationoftwodecadesoffinancialderegulationthathadbegununderPresidentReagan.TheFedanditschairmanAlanGreenspanwereinstrumentalinstrippingawaytheregulationsthathadbeensoimportantinensuringthatthefinancialsystemservedthecountrywellinthedecadesaftertheGreatDepression.Theywerealsoinstrumentalinpreventingnewregulationstoreflectchangesinthefinancialsector,suchasthedevelopmentofderivatives,thatposedthreatstothe21stabilityofthefinancialandeconomicsystem.Thisderegulationhadtworelatedconsequences,bothofwhichwenotedearlier.First,itledtotheincreasingfinancializationoftheeconomy—withalltheassociateddistortionsandinequities.Second,itallowedthebankstoexploittherestofsociety—throughpredatorylending,abusivecreditcardfees,andotherpractices.Thebanksshiftedrisktowardthepoorandtowardthetaxpayer:whenthingsdidn’tgoasthelendershadpredicted,othershadtobeartheconsequences.TheFednotonlydidn’t22discouragethis;itencouragedit.Itisclearthat,fromasocietalperspective,thebanksdidnothelppeoplemanagerisk;theycreatedit.Butwhenitcametomanagingtheirownrisk,thebankersweremoresuccessful.Theydidn’tbearthedownsideoftheiractions.Intheaftermathofthecrisis,theFed’spositionintheregulatorydebateshowedwheretheirallegiancewas.Regulationsshouldhavebeendesignedtoencouragebankstogobacktotheboringbusinessoflending.Recognizingthatthetoo-big-to-failbankshadperverseincentives,theyshouldhavefocusedonhowtolimitthesizeandinterconnectednessofthebanks.Moreover,too-big-to-failbankshaveacompetitiveadvantageoverotherbanks—thosewhoprovidethemfinanceknowthattheycancount,ineffect,onagovernmentguarantee,andthustheyarewillingtoprovidethemfundsatlowerinterestrates.Thebigbankscanthus187 prospernotbecausetheyaremoreefficientorprovidebetterservicebutbecausetheyareineffectsubsidizedbytaxpayers.Ourfailuretoimposeataxtooffsetthisadvantageisjust23givingthetoo-big-to-failbanksanotherlargegift.Therecognitionthatoutsizebonusesgavefinancialprofessionalsincentivestoengageinexcessrisktakingandshortsightedbehaviorshouldalsohaveledtotightregulationsonthedesignofbonuses.Andinacknowledgmentoftheriskofundercapitalizedbanks—wheresmallchangesinthevalueofassetscanbeenoughtocausebankruptcy—thereshouldhavebeentightregulationonthesizeofbonusesanddividendsuntilthebankingsystemwasfullyrecovered.Recognizingtherolethatlackoftransparencyandderivativeshadplayedinthebankingcrisis,theFedshouldhaveinsistedthatsomethingbedoneaboutboth.Littleoftheabovewasdone,andwhatwasdonewasoftenachievedovertheoppositionoftheFederalReserve.Thenewregulatorybill(Dodd-Frank)signedintolawinJuly2010gavemuchoftheresponsibilityforimplementingregulationstotheFed,andatleastinsomeareasitagainshowedwhereitsloyaltieswere.Tocitebutafewexamples:inthediscussionprecedingthepassageoftheDodd-Frankbill,theSenatecommitteewithresponsibilityforoversightofderivativeshadrecommendedthatgovernment-insuredbanksnotbeallowedtowritederivatives.Whileitwasn’tclearwhetherderivativeswereinsuranceproductsorgamblinginstruments,itwasclearthattheyweren’tloans.Iftheywereinsuranceproducts,theyshouldberegulatedbystateinsuranceauthorities;iftheyweregamblingproducts,theyshouldberegulatedbystategamblingauthorities;butinnocircumstancesshouldtheybeunderwrittenbytheU.S.government,throughtheFederalDepositInsuranceCorporation,thegovernmentagencythatinsuresbankdepositors.ButBenBernanke,theFedchief,arguedotherwise(overtheoppositionoftworegionalFedpresidents,whoseemedtoharborthequaintnotionthatbanksshouldfocusonbanking).Bernankeandthebigbanksthatmadebillionsayearfromthecreditdefaultswaps,orCDSes,won.Meanwhile,thereemergedabroadconsensusamongeconomistsandpolicymakers(includingatleastoneFederalReserveregionalgovernorandthegovernoroftheBankofEngland,MervynKing)thatsomethingoughttobedoneaboutthetoo-big-to-failbanks.Kingpointedoutthatiftheyweretoobigtofail,theyweretoobigtoexist.Evenearlier,PaulVolcker,formerchairmanoftheFederalReserve,hadobservedthatthesebankswerealsotoobigtobemanaged.ButtheFederalReserveBoard’scurrentandpastchairmen(GreenspanandBernanke,responsibleforbringingonthecrisis)haveneverseemedeventorecognizetheproblem,atleastnotenoughtosuggestthatsomethingbedone.Andtherewasmuchthatcouldbedone:fromregulatorysolutionslimitingbanksizeandwhattheycoulddo,totaxestooffsettheadvantagesdescribedearlier.TheFed,ofcourse,neversetouttoincreaseinequality—eitherbythebenefitsitprofferedtothoseatthetoporbywhatitdidtothoseinthemiddleandatthebottom.Indeed,asweshallexplainlater,mostofitsboardmembersprobablytrulybelievedthatitspolicies—laxregulation,fightinginflation,helpingbanksthataresoessentialtothefunctioningofoureconomy—wouldpromotegrowthfromwhichallwouldbenefit.Butthat’sjusttestimonytotheextenttowhichtheFedwas“captured”bytheperspectivesandworldviewofthebankers.188 TOWARDAMOREDEMOCRATICCENTRALBANK24Acentralthesisofcurrentconventionalwisdomisthatcentralbanksshouldbeindependent.Iftheyaresubjecttopoliticalforces,sothethinkinggoes,politicianswillmanipulatemonetarypolicyfortheirshort-runadvantageatalong-runcost;theywillstimulatetheeconomyexcessivelybeforeanelection,withtheprice—higherinflation—tobepaidaftertheelection.Moreover,withanindependentcentralbankcommittedtolowinflation,marketswillnotbuildinflationaryexpectationsintotheirbehavior,soinflationwillbecontained,andtherewillbebetteroveralleconomicperformance.ThefailureofindependentcentralbanksTheindependentcentralbanksoftheUnitedStatesandEuropedidn’tperformparticularlywellinthelastcrisis.TheycertainlyperformedfarmorepoorlythanlessindependentcentralbankslikethoseofIndia,China,andBrazil.Thereasonwasobvious:America’sandEurope’scentralbankshad,ineffect,beencapturedbythefinancialsector.Theymightnothavebeendemocraticallyaccountable,buttheydidrespondtotheinterestsandperspectivesofthebankers.Thebankerswantedlowinflation,aderegulatedfinancialsector,withlaxsupervision,andthat’swhattheygot—eventhoughtheeconomiclossesfrominflationwereminusculecomparedwiththelossesthatarosefromtheexcessivelyderegulatedfinancialmarket.Thelossestoordinaryconsumersfrompredatorylendingweregivenshortshrift—indeed,theadditionalprofitsincreasedthefinancialstrengthofthebanks.Thesoundnessofthebankingsystemwas,afterall,thecentralbanks’firstcharge.CaptureWesawinchapter2thataregulatoryagencyiscapturedbythosethatitissupposedtoregulatewhenthepoliciesitpursuesandregulationsthatitadoptsreflectmoretheinterestsandperspectivesofthosethatitissupposedtoregulateratherthanthepublicinterest.Captureoccurspartiallyasaresultofrevolvingdoors,wheretheregulatorscomefromregulatedsectorand,aftertheirbriefstintingovernment,returntoit.“Capture”ispartlywhatiscalledcognitivecapture—inwhichtheregulatorcomestoadoptthemindsetoftheregulated.IntheUnitedStatescapturealsooccurredmoredirectly,aswhenWallStreetweighedinstronglyonpotentialappointeestothecentralbank.IsawthatduringtheClintonadministration,wheretwoexcellentappointmentswereineffectvetoedbythefinancialmarkets,onebecauseshehaddemonstratedaconcernaboutdiscriminationinlending,theotherbecauseheseemedtooconcernedaboutencouragingeconomicgrowthandfullemployment.ThemostcuriouscasewastheonethatoccurredduringtheObamaadministration,whichnominatedabrilliantNobelPrizewinnerwhohaddonepathbreakingworkextendingourunderstandingofunemploymentanditsdeterminants—somethingthatshouldhavebeenofcentralconcerntotheFed.Perhapssomeinthefinancialmarketsrealizedthathavingacriticalthinker,whomightcast189 doubtoncertainconventionalcentralbankdoctrinesthatwerenotgroundedineconomictheoryorevidence,wouldbeinconvenient.HisnominationneverevengotthroughtheSenateBanking25Committee.Inspiteofsuchpressures,therehasbeenconsiderablediversityofperspectivesamongtheFedgovernors.Therewaseven26oneFedgovernorwhowarnedaboutthebadlendingtothehousingsector,buthewaseffectivelyignoredbytheothers.Inthisrecession,severaloftheFedgovernorshavebeenadamantthatunemploymentisthekeyissue,andthereisarecognitionthattheunderlyingproblemisalackofdemand.Somehaveevenmadetheheretical(forcentralbankers)suggestionthatuntiltheeconomy’sunemploymentrateissubstantiallylower,unemployment,notinflation,oughttobethe“target”ofmonetarypolicy.AlackoffaithindemocracyThelackoffaithindemocraticaccountabilityonthepartofthosewhoargueforindependentcentralbanksshouldbedeeplytroubling.Wheredoesonedrawthelineinturningoverthecentralresponsibilitiesofgovernmenttoindependentauthorities?Thesameargumentsaboutpoliticizationcouldbeappliedtotaxandbudgetarypolicies.Isuspectsomeinthefinancialmarketwouldbecontenttoturnthoseresponsibilitiesoverto“technicalexperts.”Buthere’sthehiddenagenda:thefinancialmarketswouldnotbecontentwithjustanysetoftechnicalexperts.Theyprefer,aswehaveseen,“experts”whosharedtheirviews—viewsthatsupporttheirinterestsandideology.TheFederalReserveanditschairmenliketopretendthattheyareabovepolitics.Itisconvenientnottobeaccountable,tobeindependent.Theyseethemselvesassimplywisemenandwomen,publicservants,helpingtosteerthecomplexshipoftheeconomy.ButiftherewasanydoubtofthepoliticalnatureoftheFedanditschairmen,itshouldhavebeenresolvedbyobservingtheseeminglyshiftingpositionsofthecentralbankoverthepasttwentyyears.In1993,whentheUnitedStateshadalargefiscaldeficitandhighunemployment,thechairmanoftheFed,AlanGreenspan,urgedthegovernmenttotakestrongactionstoreducethedeficit,withtheunderstandingthatinterestrateswouldthenbereducedtorestoretheeconomytofullemployment.Buttheeconomywasfacingunemployment;itwasnotoverheated.Therewasnoreasontomaketheloweringofinterestratesconditionalonareductionofthedeficit;indeed,loweringinterestratesandincreasingtheavailabilityofcreditcouldhaveworkedhandinhandtohelpgettheeconomygrowing,andthatwouldhavedonewondersforthedeficit.Butinterestrateswereloweredonlytoalittlebelow3percent—presumablyiftheyhadbeenloweredfurther,theeconomywouldhavehadamorerobustrecovery.Then,in2001,GreenspanurgedCongresstocuttaxes,creatingamassivedeficit,andrespondedtotherecessionbyloweringinterestratestoamuchlowerlevel—eventuallytounder1percent.Oneinterpretationoftheseseeminglyinconsistentpositionswasthattherealobjectivewastodownsizegovernmentandreducetax27progressivity.Inanydemocracyapublicinstitution—andpretendasitmight,acentralbankisapublicinstitution—musthavesomedegreeofaccountability.Theremustbeoversighttomakesurethatthereis190 nomalfeasance,andthatthecentralbankfunctionsinaccordancewithitsmandate,andthatthemandateinquestionisinaccordwiththepublicinterest.Inamoderndemocraticsociety,governanceisacentralconcern.Howarethoseresponsibleformakingcriticaldecisionschosen?Howarethedecisionsmade?Istheresufficienttransparencythattherecanbemeaningfulpublicscrutiny?Fewmattersareofgreaterconcerntocitizensthantheperformanceoftheeconomy,andmonetarypolicyisacentraldeterminantofthatperformance.Indeed,standardmodelsinpoliticalscienceshowthatespeciallythelevelofunemploymentanditsrateofchangeisthemostimportantdeterminantofpresidentialandcongressionalelectoraloutcomes.Andyet,itseemsthatundercurrentarrangementspublicofficialsarebeingheldaccountableforsomethingoverwhichtheydonotcontroloneofthemainlevers.IntheUnitedStatesoursystemofgovernanceandaccountabilityforourcentralbankshouldinfactbeanembarrassment.Monetarypolicyissetbyacommittee(calledtheOpenMarketCommittee)ofthesevenmembersoftheFederalReserveBoard,plusthetwelveregionalFederalReserveBankpresidents,ofwhomonlytheheadoftheNewYorkFedandfourothershavetherighttovote.ButtheregionalFederalReserveBankpresidentsarechoseninanontransparentprocessthatgivesthepubliclittlesay,andinwhichthebanks(whichtheyaresupposedtobe28regulating)havetoomuchinfluence.WhilethecurrentFedchairman,BenBernanke,haswritten29forcefullyaboutthevirtueoftransparency,heseemstohavechangedhismindoncethetaskofprovidinghiddenassistancetothebanksmovedmoretothecenteroftheFed’sagenda.Whenthemediarequestedinformation,ofthekindthatothergovernmentagenciesarerequiredtodiscloseundertheFreedomofInformationAct,theFedclaimedthattheFedwasnotsubjecttotheact.TheFederalDistrictCourtdisagreed,buttheFedwasunrepentant—itrefusedtodisclosewhatthepresswantedtoknow.TheFedappealedthedecision,andtheappellatecourtreaffirmedthattheFedwasaccountable.Reportedly,theFedwouldhaveappealedtotheSupremeCourt,hadtheWhiteHousenottoldtheFedthatitwasinfactpartofthegovernmentandhadtoobeythelawsthatappliedtoothergovernmentagencies.Congress,independently,demandedanauditofwhattheFedwasdoing—includingwhowasgettingitsmoney.Eventually,theFedsuccumbedtothepressurefromcourtsandCongress,andwhentheinformationwasdisclosed,theAmericanpeopleunderstoodbetterwhytheFederalReservehadnotwantedtodisclosetheinformation.Therealreasonforsecrecy,itturnedout,wastohidepoliciesthatwouldnotmeetwithpopularsupport—andtoconcealinconsistenciesbetweenwhattheFedwassaying30andwhatwasgoingon.InthegreatbailoutthatmarkedthebeginningoftheGreatRecession,theheadoftheNewYorkFedwasoneofthetriumvirate(alongwiththeheadoftheFederalReserveandthesecretaryofTreasury)thatshapedthebailout,determinedwhogotsavedandwhogotexecuted,andwhogothowmuchandonwhatterms.Andhe,inturn,hadbeennominatedbyacommitteethatconsistedofbankersandCEOsfromsomeofthesamefirmsthatwerebailedout31onmostfavorableterms.Thereistheappearance,ifnotthe191 reality,ofaconflictofinterest.AmericansneverfullyunderstoodwhyAIGgotabailoutofthemagnitudethatitdidorwhy,whenitsderivativeswereboughtback,theywerepaidoffat100centsonthedollar—farhigherthanwasnecessary.ButwhentheultimatebeneficiariesoftheAIGbailoutwererevealed,allbecameclearer:thebiggestbeneficiarywasGoldmanSachs,andotherrecipientswerelargeforeignbanks,someofwhichweresuspectedofhavingcomplexfinancialdealingswithGoldmanSachs.ItseemedespeciallystrangethattheUnitedStateswasbailingoutforeignbanks.Ifforeignbankswereintrouble,itshouldhavebeentheresponsibilityoftheforeigngovernmentstobailouttheirownbanks.Asmoreinformationwasgivenout,itbecameclearthattheFedhadbeenlendingmassivelytoforeignbankslongbeforethe32September2008crisis.Evidently,theU.S.FedwasthelenderoflastresortnotonlyforU.S.banksbutforforeignbanksas33well.HadAmericanbanksundertakensuchcomplexandlarge-riskexposureswiththeseotherbanksthatiftheysank,Americanbankswouldbeatrisk?Ifso,itwasevidentthattheFedhadfailedinitssupervisoryjobaswellasinitsregulatoryresponsibilities.ItalsogrewclearthatinspiteofstatementsfromtheFedclaimingthattheproblemsofthesubprimemortgageandthe34breakingofthebubblewerewellcontained,globalfinancialmarketshadbeengoingthroughtraumaformonths.ThedatathattheFedwasforcedtorevealalsoshowedthatinthemonthsafterLehmanBrotherscollapsed,largebanks,likeGoldmanSachs,wereborrowinglargeamountsfromtheFed,whilesimultaneouslyclaimingpubliclythattheywereinexcellenthealth.Noneofthisshouldbesurprising:anindependentcentralbank,capturedbythefinancialsector,isgoingtomakedecisionsthatrepresentthebeliefsandinterestsofthefinancialsector.Evenifitweredesirabletohaveacentralbankthatwasindependentfromthedemocraticpoliticalprocess,theboardshouldatleastberepresentativeandnotdominatedbymembersofthefinancialsector.Severalcountriesdonotallowthosefromthefinancialsectortoserveontheircentralbankboard—theyseeitasanobviousconflictofinterest.Thereexistsawealthofexpertiseoutsidethefinancialsector.Indeed,thoseinthefinancialsectorareattunedtomakingdealsandarenotexpertsinthecomplexitiesofmacroeconomicinterdependencies.Today,fortunately,therearerealexpertsinavarietyofinstitutionsotherthanthefinancialsector—includingacademia,NGOs,andunions.Thosewhofavoranindependentcentralbankoftenassumethatnotrade-offsareinvolvedinthedecisionsthebanktakes.Technicalexpertscanfigureoutthebestwayofmanagingtheeconomyjustastheycandecideonthebestdesignofabridge.Buttrade-offsaretheessenceofeconomicpolicymaking.Thereare,aswehaveargued,choicestobemade;somewillbenefitfromthesechoiceswhileotherslose.ItisevidentnowthattheFedfailedtomaintaineconomicstability—andafterthecrisis,itfailedtorestoretheeconomytohealth;itisevident,too,thattheeconomicdoctrinesonwhichitspolicieswerebasedwerebadlyflawed.Nopolicyiswithoutrisk.ButthepolicieschosenbytheFedforcedthebruntoftherisktobebornebyhomeowners,workers,andtaxpayers,whiletheupsidewascapturedbythebanks.Therewereotherpolicies,withotherrisks,inwhichthe192 restofoursocietywouldhavefaredfarbetter,andthebanksworse.Weneedtorecognizethatacentralbank’sdecisionsareessentiallypolitical;theyshouldnotbedelegatedtotechnocrats,andtheycertainlycan’tbelefttothosewho35disproportionatelyrepresentoneofthevestedinterests.Theeurocrisis—anexampleTheinstitutionalflawsinthedesignofthecentralbankingsystemforregulatingbanksanddetermininginterestratesintheUnitedStatesalsoariseincountriesaroundtheworld.BeforethecrisisAmericawasheldupasamodelofgoodinstitutionaldesign,andcountrieselsewhereimitatedit.Intheaftermathofthecrisis,theflawsinthesystemhavebecomeapparent,andtheUnitedStates,andothersthathaveadoptedsimilarinstitutionalarrangements,shouldbethinkingofaredesign.CriticalasIamoftheFed,IfindmattersevenworseinEurope.America’scentralbankofficiallyissupposedtolookatinflation,growth,andemployment.TheEuropeanCentralBank(ECB),Europe’sequivalentoftheFederalReservethatrulesovertheseventeen-countryeurozone,issupposedtofocusonlyoninflation.ItalsoreflectsthemindsetofthebanksandfinancialcommunityevenmorethantheFeddoes.TheECBresponsetothegreatdebtcrisisthatbeganwithGreeceinJanuary2010offersanexample.FirstGreece,thenIrelandandPortugal,laterfollowedbySpainandItaly,facedinterestratesontheirdebtthatwereunsustainable.ThespecterofaGreekdefaultshiftedfromaremotepossibilityinJanuary2010toaninevitabilitybyJuly2011,thoughsomewhatgentlerwordslike“adebtrestructuring”wereused.Greeceowedmorethanitcouldpossiblypaywithoutinflictingpoliticallyunacceptablepainonthecitizensofthecountry.WhentheonlyproblemseemedtobethatofGreece,asimplepatchontheEuropeansystemcouldhavedonethetrick.ButwhenlargecountrieslikeSpainandItalyfaceddifficultiesfinancingtheirdebtatreasonableinterestrates,itwasclearthattheproblemwouldrequiremoreresoluteaction.36TheECBplayed,atbest,anambiguousrole.Forinstance,inthecaseofGreece,itinsistedthatanyrestructuringofthedebt(askingcreditorstotakeadebtwrite-downandpostponerepayment)bevoluntary.Theysaidwhateveragreementwasreachedcouldn’tbeallowedtosetoffa“creditevent,”meaninganeventthatwouldtriggerapaymentoncreditdefaultswaps,theriskysecuritiesthatwouldpayoffifGreecedefaulted.Insayingthat,theECBseemedtobeplacingtheinterestsofthebankswellabovethatoftheGreekpeople.Greeceneededadeeprestructuring(anotherwayofsayingalargereductioninitsdebtburden),wellbeyondthatwhichmightemergefromavoluntaryrestructuring,butonlyavoluntarywrite-downwouldnotbeconsideredacreditevent.TherewassomethingevenmorecuriousabouttheECBposition.Creditdefaultswapsaresupposedtoprovideinsurance.Ifyouhaveaninsurancepolicy,youwanttheinsurancecompanytobegenerousanddeclarethatan“insurableevent”hasoccurred:itistheonlywaythatyoucancollectonyourpolicy.Infact,sometimespeopledosomethingtocreatesuchanevent(that’showtheterm“moralhazard”arose).IntheGreekcasetheECBsaidthatitdidn’twanttheseinsurancepoliciestobetriggered.Ifthederivativeshadbeenpurchasedasinsuranceproducts,thenthe193 bankswouldhavewantedtocollectontheinsurance,andtheECB,asprotectorofthebanks,wouldhavewantedthataswell.OneexplanationwasthattheECBhadfailedinitsregulatoryrole,andsomebanks,ratherthanbuyinginsurance,wereengagedingamblingandstoodtoloseiftheCDSeshadtopayoff.TheECBseemedtobeputtingtheinterestsofthesebanksaheadnotonlyofthecitizensofGreecebutalsoofthosebanksthathadbeen37moreprudentandpurchasedinsurance.Ofcourse,theresponsibilityoftheECBandtheEuropeanfinancialauthoritieswastomakesurethatthebankswereadequatelycapitalizedandwerenotexcessivelyexposedtorisk.Thattheyhadfailedmiserablywasevident:weeksafterEuropeanfinancialinstitutionsweregivenacleanbillofhealth(fromthepassageofastresstest,supposedlydesignedtoensurethatthebankscouldsurviveamajoreconomicstress),theIrishbankscollapsed.Afewweeksaftertheyweregivenasecondsealofapproval,havingsupposedlytightenedtheirstandards,another38majorEuropeanbank(Dexia)failed.MONETARYPOLICYANDTHEBATTLEOFIDEASAcentralthemeofthisbookisthattherehasbeenabattleofideas—overwhatkindsofsociety,whatkindsofpolicies,arebestformostcitizens—andthatthisbattlehasseenanattempttopersuadeeveryonethatwhat’sgoodforthe1percent,whatthetopcaresaboutandwants,isgoodforeveryone:lowertaxratesatthetop,reducethedeficit,downsizethegovernment.Itisnotacoincidencethatcurrentlyfashionablemonetary/macroeconomicsfindsitsoriginsintheworkoftheinfluentialChicagoschooleconomistMiltonFriedman,thestrongadvocateofso-calledfree-marketeconomics,whichdownplayedtheimportanceofexternalitiesandignoredinformationimperfections39andother“agency”issues.WhilehispioneeringworkonthedeterminantsofconsumptionrightlyearnedhimaNobelPrize,hisfree-marketbeliefswerebasedmoreonideologicalconvictionthanoneconomicanalysis.Irememberlongdiscussionswithhimontheconsequencesofimperfectinformationorincompleteriskmarkets;myownworkandthatofnumerouscolleagueshadshownthatintheseconditions,marketstypicallydidn’tworkwell.Friedmansimplycouldn’torwouldn’tgrasptheseresults.Hecouldn’trefutethem.Hesimplyknewthattheyhadtobewrong.He,andotherfree-marketeconomists,hadtwootherreplies:evenifthetheoreticalresultsweretrue,theywere“curiosities,”exceptionsthatprovedtherule;andeveniftheproblemswerepervasive,onecouldn’trelyongovernmenttofixthem.Friedman’smonetarytheoryandpolicyreflectedhiscommitmenttomakingsurethatgovernmentwassmallanditsdiscretionlimited.Thedoctrinethathepushed,calledmonetarism,heldthatgovernmentshouldsimplyincreasethemoneysupplyatafixedrate(therateofgrowthofoutput,equaltotherateofgrowthofthelaborforceplustherateofgrowthofproductivity).Thatmonetarypolicycouldnotbeusedtostabilizetherealeconomy—thatis,toensurefullemployment—wasnotofmuchconcern.Friedmanbelievedthatonitsowntheeconomywouldremainatornearfullemployment.Anydeviationwouldbequicklycorrectedas194 longasthegovernmentdidn’tmuckthingsup.InFriedman’seyes,theGreatDepressionwasnotamarketfailure,butagovernmentfailure:theFedhadfailedtodowhatitshouldhavedone.Itletthemonetarysupplydecrease.Ineconomicswedon’thavetheopportunitytodoexperiments.Wecan’trelivetheGreatDepressionagain,changingmonetarypolicytoseetheconsequences.Butinsomeways,theGreatRecessionhasprovidedawonderful,ifcostly,opportunitytotestsomeoftheideas.BenBernanke,astudentoftheGreatDepression,knewthecriticismsoftheFederalReserve,andhedidn’twanttobeaccusedofignoringlessonslearned.Hefloodedtheeconomywithliquidity.AstandardmeasureofmonetarypolicyactionisthesizeoftheFed’sbalancesheet—howmuchithaslentouttothebankingsystemandboughtingovernmentandotherbonds.Thebalancesheetnearlytripled,from$870billion(June28,2007)beforethecrisisto$2.93trillionasthisbookgoestopress40(February29,2012).Thisliquidityincrease—togetherwiththemassiveTreasurybailout—mayhavesavedthebanks,butitfailedtopreventtherecession.TheFedmayhavecausedthecrisisthroughitsloosemonetarypolicyandlaxregulations,buttherewaslittleitcoulddotopreventorreversethedownturn.41Finally,itschairmanadmittedasmuch.Friedmanalsohadviewsaboutbankingregulations—likemostotherregulations,hethought,theyinterferedwitheconomicefficiency.Headvocated“freebanking,”theideathatbanksshouldbeeffectivelyunrestrained,anideathathadbeentried,andfailed,inthenineteenthcentury.HefoundawillingstudentintheChileandictatorAugustoPinochet.Freebankingdidleadtoaburstofeconomicactivityasnewbankswereopenedandcreditflowedfreely.Butjustasitdidn’ttakelongforAmerica’sderegulatedbankingindustrytobringtheAmericaneconomytoitsknees,Chile,too,experienceditsdeepestdownturnin1982.ItwouldtakeChilemorethanaquartercenturytopaybackthedebtsthatthegovernmentincurredinfixingtheproblem.Inspiteoftheseexperiences,theviewthatfinancialmarketsworkwellontheirown—thatgovernmentshouldnotinterfere—becameadominantthemeduringthepastquartercentury,pushed,aswehaveseenbyFedchairmanAlanGreenspanandasuccessionofTreasurysecretaries.And,againaswehavenoted,itservedtheinterestsofthefinancialsectorandothersatthetopwell,evenasitdistortedtheeconomy.Moreover,eventhoughthecollapseofthefinancialsystemseemedtohittheFedbysurprise,itshouldn’thave.BubbleshavebeenpartofWesterncapitalismsincethebeginning—fromthetulipbulbmaniaof1637inthe42Netherlandstothehousingbubbleof2003–07.Andoneoftheresponsibilitiesofmonetaryauthorities,inensuringeconomic43stability,istodiscouragetheformationofsuchbubbles.Monetarismwasbasedontheassumptionthatthevelocityofcirculation—thenumberoftimesadollarbillturnsoverinayear—wasconstant.Andwhileinsomecountriesandinsomeplacesthathadbeentrue,intherapidlychangingglobaleconomyoftheendofthetwentiethcentury,itwasnot.Thetheorybecamedeeplydiscreditedjustyearsafteritwastherageamongallthecentralbankers.Astheyquicklyabandonedmonetarism,theylookedforanewreligionconsistentwiththeirfaithinminimalinterventioninthemarkets.Theyfounditininflationtargeting.Underthisschemecentralbanksshouldpickaninflationrate(2percentwasafashionablenumber),andwheneverinflationexceededthatrate,195 theyshouldraiseinterestrates.Thehigherinterestrateswould44dampengrowth,andtherebydampeninflation.TheobsessionwithinflationInflationtargetingwasbasedonthreequestionablehypotheses.Thefirstisthatinflationisthesupremeevil;thesecondisthatmaintaininglowandstableinflationwasnecessaryandalmostsufficientformaintainingahighandstablerealgrowthrate;the45thirdisthatallwouldbenefitfromlowinflation.Highinflation—suchasthehyperinflationthatplaguedGermany’sWeimarRepublicintheearly1920s—isarealproblem;butitisnottheonlyeconomicproblem,anditisoftennotthe46mostimportantone.Inflation,aswehavenoted,hasnotbeenamajorproblemintheUnitedStatesandEuropeforathirdofacentury.AtleastintheUnitedStates,theFedhadabalancedmandate—inflation,employment,andgrowth—butinpracticethefocuswasoninflation,anduntilrecentlyanycentralbankerwhosuggestedotherwiseriskedbecomingapariah.EvenastheUnitedStatesfacedunemploymentof9percent—andhiddenunemploymentthatmeantthatthetrueunemploymentwasmuchhigher—three“inflationhawks”ontheFedboardvotedtoraiseinterestratesbecauseoftheirsingle-mindedconcernwithinflation.In2008,shortlybeforetheglobaleconomycollapsed,inflationtargetingwasputtothetest.Mostdevelopingcountriesfacedhigherratesofinflationnotbecauseofpoormacromanagementbutbecauseoilandfoodpricesweresoaring,andtheseitemsrepresentamuchlargershareoftheaveragehouseholdbudgetindevelopingcountriesthaninrichones.InChina,forexample,inflationapproached8percentormore.InVietnamitreached2347percent.Inflationtargetingmeantthatthesedevelopingcountriesshouldhaveraisedtheirinterestrates,butinflationinthesecountrieswas,forthemostpart,imported.Raisinginterestrateswouldn’thavemuchimpactontheinternational48priceofgrainsorfuel.Aslongascountriesremainintegratedintotheglobaleconomy—anddonottakemeasurestorestraintheimpactofinternationalpricesondomesticprices—domesticpricesoffoodandenergyare49boundtorisemarkedlywheninternationalpricesdo.Raisinginterestratescanreduceaggregatedemand,whichcanslowtheeconomyandtameincreasesinpricesofsomegoodsandservices,especiallynontradedgoodsandservices.Butunlesstheyaretakentoanintolerablelevel,thesemeasuresbythemselvescannotbringinflationdowntothetargetedlevels.Ifglobalfoodandenergypricesaregoingupat20percentayear,fortheoverallinflationratetobe2percentwouldrequirewagesandpriceselsewheretobefalling.Thatwouldalmostsurelyentailamarkedeconomicslowdownandhighunemployment.Thecurewouldbeworse50thanthedisease.Forinflationhawkstheeconomyisalwaysattheedgeofaprecipice:onceinflationstarts,itwillbedifficulttocontrol.Andsincethecostofreversinginflation—disinflation,asit’scalled—issolarge,itisbesttoaddressitimmediately.Buttheseviewsarenotbasedonacarefulassessmentoftheevidence.Thereisnoprecipice,andmildupticksininflation,iftheylookasiftheymightbecomepersistent,caneasilybereversedby196 51tighteningcreditavailability.Inshort,itwassimplywrongthatthebestwaytomaintainhighemploymentandstronggrowthwastofocusoninflation.Thefocusoninflationdistractedattentionfromthingsthatwerefarmoreimportant:thelossesfromevenmoderateinflationwerenegligibleincomparisontothelossesfromthefinancialcollapse.DoingsomeoneelseafavorAswe’veseen,thereisarationaleinstandardeconomicmodelsforkeepinginflationlow,butthosemodelsaremisleading.Onthebasisofthosemodels,advocatesforkeepinginflationlowargueforlowinflationbecauseitwouldbegoodfortheeconomyasawhole.Theydon’tsingleoutthebondholdersasthebigrecipientsofthebenefitsoflowinflation.Inflation,asitisput,isthecruelesttax.Itaffectseverybodyindiscriminatelyandespeciallythepoor,whoareleastabletobearit.Butasksomeonewhohasbeenoutofajobforfouryearswhathewouldprefer—anotheryearofunemploymentoraslightincreaseininflationfrom,say,1percentto2percent.Theanswerisunambiguous.Thetollunemploymenttakesonworkersishighandhardtomanage.Bettersomejobwhosepayhasdeclinedinrealtermsbyafewpercentthannojob.WallStreetpunditsusedtoarguethatinflationhurtpoorretirees,butthatargumentwasalsoincorrect,sinceSocial52Securitygoesupwithinflationandrecipientsarethereforeprotected.Inperiodsinwhichmarketsworkwell,workersarealsoprotected.Higherpricesincreasethe(marginal)returnto53workers,andsoshouldincreasetheirpaycommensurately.Itismainlybecauseinperiodsinwhichinflationhashistoricallybeenhigh,therewerealsolargeshockstotherealeconomy,thatinflationaryepisodeswereoftenaccompaniedbydecreasesinrealincomeforworkers.Bondholdersaren’tdoinganyoneelseafavorwhentheymaintainvigilanceoverinflation,andespeciallynotwhentheypersuadethemonetaryauthoritiestoincreaseinterestrates.Theyaremerelyhelpingthemselves.Andit’saone-sidedbet:ifthecentralbankersareoverlyvigilant,andinflationislowerthantheyexpected,orpricesareactuallyinducedtodecline,bondholderswinbothbecauseofthehigherinterestpaymentstheyreceiveandbecauseofthehighervalueofthemoneythattheygetbackwhenthebondcomestomaturity.Notrade-offsPrecrisiseconomicanalysisarguednotonlythatgovernmentinterventionwasnotneeded—becausemarketsbyandlargewereefficientandstable—butalsothatitwasineffective.Bubbles,sothelogicwent,didn’texist.Buteveniftherewereabubble,governmentcouldn’tbesurewhethertherewasoneuntilafteritbroke;andevenifitcouldtell,theonlyinstrumentatitsdisposalwasthebluntinstrumentofinterestrates.Itwasbetterjusttoletthebubblerunitscourse,sincecleaningupthemessafterwardwouldbecheaperthandistortingtheeconomytopreventabubblefromsurfacing.IftheleadersoftheFedhadn’tbeensoweddedtothenotionthattherewerenobubbles,itwouldhavebeenobvioustothem(as197 itwastoeconomistslikeRobertShiller,ofYale,oneofthe54country’sleadingexpertsonhousing),thattheunprecedentedriseinhousingpricesrelativetoincomesalmostsurelyrepresentedabubble.Inaddition,theFeddidn’thavetorelyoninterestratechangestodampenthebubble—itcouldhaveincreaseddownpaymentrequirementsortightenedlendingstandards.CongresshadgiventheFedauthoritytodosoin1994.TheFedinitsallegiancetomarketfundamentalismhadtieditsownhands.Economistshave,similarly,providedtheFedwithreasonsnottoattempttoaddressunemployment.Peopleinadynamiceconomyhavetomovefromjobtojob,andthattakestime,whichcreatesanaturalrateofunemployment.Topushtheeconomybeyondthatnaturalratepushestheeconomytoever-acceleratinginflation(inthisview).Astheunemploymentratefallsevenbrieflybelowthenaturalrate,inflationincreases;butthenmarketparticipantscometoexpectthatrateofinflation,andsotheybuildthatintotheirwageandpriceincreases.Eventually—and,intheeyesoftheseeconomists,soon—thecentralbankwillhavetogivein,allowingunemploymenttoreturntothenaturalrate.Butthen,accordingtothisview,afurtherpricewillhavetobepaidtobringdowntheinflationrate.Todothat,unemploymentwillhavetobehigherthanthenaturalrate.Otherwiseinflationwillsimplypersist.Theircontentionisthatthebenefitsofthetemporarylowunemploymentarefarsmallerthanthecosts—inhigherinflationandsubsequenthighunemployment.Theseideasprovidedintellectualcomforttocentralbankerswhodidn’twanttodoanythingaboutunemployment.Buttherewerestronggroundsforskepticismabouttheseideas:somecountries,likeGhanaandIsrael,havemanagedtobringdowntheirinflationratesveryquicklyatlittlecost.Theunderlyinghypothesisthatthereisastablerelationshipbetweentheunemploymentlevelandtherateofaccelerationofinflationhasnotwithstoodthetestoftime,andtheevenstrongerhypothesisunderlyingtheclaimthatthecostsofdisinflationaregreaterthanthebenefitsofallowingslightlyhigherinflationhasreallyneverbeenwell55established.Theuseoftheterm“natural”unemploymentratesuggeststhatitis“natural”andnaturalthingsaregood,oratleastunavoidable.Yetthereisnothingnaturalaboutthehighlevelofunemploymentweseetoday.Andtheseideasarebeingusedbythosethatdon’twantgovernmenttotakestepstodoanythingaboutit.Thereis,Ibelieve,considerablescopeforloweringtheunemploymentrate.TherearemillionsofAmericanswhohavejobsbutareworkingpart-timeorshorthourssimplybecausethereisnotenoughtotaldemandintheeconomy.Whateverone’sguessaboutthelevelofthe“natural”unemploymentratetoday—andwhetheronebelievesthattheconceptofnaturalunemploymentisatallrelevant—itisclearthatincreasesinaggregatedemand56wouldbebeneficial.Ofcourse,governmentneedstodomorethanjustincreasetotaldemand;ithastohelpindividualschangesectors,fromwheretheywereneededyesterdaytowheretheywillbeneededtomorrow.These“activelabormarketpolicies”haveproveneffectiveinseveralcountries,especiallyinScandinavia.Cutbacksingovernmentspendingforsuchprogramswillnotonlylowertotalincomebyloweringdemandbutalsoleadtoahigherlevelofnaturalunemployment,ifsuchathingexists.Statefundingcutsinhigher198 education—whichhavebeenespeciallylargeinscience,engineering,andhealthcarefieldsbecausethesefieldsareespeciallyexpensivetoteach—meanthatsomejobsinthesefieldsaregoingunfilled,andthecutsdisproportionatelyreducethe57abilityforthepoortoreceivemoretrainingandgetgoodjobs.CONCLUDINGCOMMENTSFormostpeople,wagesarethemostimportantsourceofincome.Macroeconomicandmonetarypoliciesthatresultinhigherunemployment—andlowerwagesforordinarycitizens—areamajorsourceofinequalityinoursocietytoday.Overthepastquartercenturymacroeconomicandmonetarypoliciesandinstitutionshavefailedtoproducestability;theyfailedtoproducesustainablegrowth;and,mostimportantly,theyfailedtoproducegrowththatbenefitedmostcitizensinoursociety.Inlightofthesedramaticfailures,onemighthaveanticipatedaquestforanalternativemacroeconomicandmonetaryframework.Butjustasthebanks—whicharguethatnosystemisaccidentproof,thattheyhavebeenthevictimsofaonce-in-a-centuryflood,andthatourcurrentrecessionisnoreasontochangeasystemthatworks—havebeenremarkablysuccessfulinresistingreregulation,manyofthosewhoheldtheerroneousbeliefsaboutmacroeconomicsthatledtotheflawedmonetarypolicieshavebeenunrepentant.Theyhavebeenreluctanttochangethosebeliefs.Thetheorywascorrect,theyclaim;therewereonlyafewflawsin58implementation.Intruththemacroeconomicmodelsplacedtoolittleattentiononinequalityandtheconsequencesofpoliciesfordistribution.Policieshavebeenbasedontheseflawedmodelsbothhelpedcreatethecrisisandhaveprovenineffectiveindealingwithit.Theymayevenbecontributingtoensuringthatwhentherecoveryoccurs,itwillbejobless.Mostimportantly,forthepurposesofthisbook,macroeconomicpolicieshavecontributedtothehighlevelofinequalityinAmericaandelsewhere.Whiletheadvocatesofthesepoliciesmayclaimthattheyarethebestpoliciesforall,thisisnotthecase.Thereisnosingle,bestpolicy.AsIhavestressedinthisbook,policieshavedistributiveeffects,sotherearetrade-offsbetweentheinterestsofbondholdersanddebtors,youngandold,financialsectorsandothersectors,andsoon.Ihavealsostressed,however,thattherearealternativepoliciesthatwouldhaveledtobetteroveralleconomicperformance—especiallysoifwejudgeeconomicperformancebywhatishappeningtothewell-beingofmostcitizens.Butifthesealternativesaretobeimplemented,theinstitutionalarrangementsthroughwhichthedecisionsaremadewillhavetochange.Wecannothaveamonetarysystemthatisrunbypeoplewhosethinkingiscapturedbythebankersandthatiseffectivelyrunforthebenefitofthethoseatthetop.199 CHAPTERTENTHEWAYFORWARD:ANOTHERWORLDISPOSSIBLETHERE’SNOUSEINPRETENDING.INSPITEOFTHEenduringbeliefthatAmericansenjoygreatersocialmobilitythattheirEuropeancounterparts,Americaisnolongerthelandofopportunity.Nothingillustrateswhathashappenedmorevividlythantheplightoftoday’stwenty-year-olds.Insteadofstartinganewlife,freshwithenthusiasmandhope,manyofthemconfrontaworldofanxietyandfear.Burdenedwithstudentloansthattheyknowtheywillstruggletorepayandthatwouldnotbereducedeveniftheywerebankrupt,theysearchforgoodjobsinadismalmarket.Iftheyareluckyenoughtogetajob,thewageswillbeadisappointment,oftensolowthattheywillhavetokeepliving1withtheirparents.Whilefifty-somethingparentsworryabouttheirchildren,theyalsoworryabouttheirownfuture.Willtheylosetheirhome?Willtheybeforcedtoretireearly?Willtheirsavings,greatlydiminishedbytheGreatRecession,carrythemthrough?Theyknowthatiftheyfacehardship,theymaynotbeabletoturntotheirchildrenforhelp.FromWashingtoncomesevenworsenews:cutbacksinMedicarethatwillmakeaccessbysomegroupstohealthcareunaffordablearewidelydiscussed.SocialSecurity,too,seemstobeonthecuttingtable.AsolderAmericansfacetheirsunsetyears,thedreamsofacomfortableretirementseemamirage.Thedreamsofaprosperous,betterlifefortheirchildrenmaybeasantiquatedassomethingoutofa1950smovie.What’sbeenhappeninginAmericahasalsobeenhappeninginmanycountriesaroundtheworld.Butitisnotinevitable.Itisnottheinexorableworkingsofthemarketeconomy.Therearesocietiesthathavemanagedthingsfarbetter,eveninaworldwheremarketforcesandthedominantpolicyparadigmleadtosubstantialinequalitybecauseofdifferencesinability,effort,andluck.ThosesocietiesproduceastandardoflivinghigherthanthatoftheUnitedStatesformostoftheircitizens,measurednotjustintermsofincomebutintermsofhealth,education,security,andmanyotheraspectsthatarekeytodeterminingthequalityoflife.AndsomesocietieswhereinequalitywasfarworsethanintheUnitedStateshavelookedovertheprecipice,seenwhatmightlieahead,andretreated:theyhavemanagedtoreducethedegreeofinequality,tohelpthepoorandtoextendeducation.Anotherworldispossible.Wecanachieveasocietymoreinaccordwithourfundamentalvalues,withmoreopportunity,ahighertotalnationalincome,astrongerdemocracy,andhigherlivingstandardsformostindividuals.Itwon’tbeeasy.Therearesomemarketforcespullingustheotherway.Thosemarket200 forcesareshapedbypolitics,bytherulesandregulationsthatweasasocietyadopt,bythewayourinstitutions(liketheFederalReserve,ourcentralbank,andotherregulatoryagencies)behave.Wehavecreatedaneconomyandasocietyinwhichgreatwealthisamassedthroughrentseeking,sometimesthroughdirecttransfersfromthepublictothewealthy,moreoftenthroughrulesthatallowthewealthytocollect“rents”fromtherestofsocietythroughmonopolypowerandotherformsofexploitation.Thisbookisnotaboutthepoliticsofenvy:thebottom99percentbyandlargearenotjealousofthesocialcontributionsthatsomeofthoseamongthe1percenthavemade,oftheirwell-deservedincomes.Thisbookisinsteadaboutthepoliticsofefficiencyandfairness.Thecentralargumentisthatthemodelthatbestdescribesincomedeterminationatthetopisnotonebasedonindividuals’contributionstosociety(the“marginalproductivitytheory”introducedearlier),eventhough,ofcourse,someatthetophavemadeenormouscontributions.Muchoftheincomeatthetopisinsteadwhatwehavecalledrents.Theserentshavemoveddollarsfromthebottomandmiddletothetop,anddistortedthemarkettotheadvantageofsomeandtothedisadvantageofothers.Amoreefficienteconomyandfairersocietywillalsocomefrommakingmarketsworklikemarkets—morecompetitive,lessexploitive—andtemperingtheirexcesses.Therulesofthegamematternotjustfortheefficiencyoftheeconomicsystembutalsofordistribution.Thewrongrulesleadtoalessefficienteconomyandamoredividedsociety.Investingmoreinoursociety—ineducation,technology,andinfrastructure—andprovidingmoresecuritytoordinarycitizenswillleadtoamoreefficientanddynamiceconomy,onemoreconsistentwithwhatweclaimtobeandofferingmoreopportunitytoawidersegmentofthesociety.Eventhe1percent(thosewhoaretherenow)maybenefitwhenthecapabilitiesofsomanyatthebottomarenotsquandered.Andmanymorepeoplewillhaveashotatonedaybeinginthe1percent.Finally,makingthesocietymoreequalislikelytoaffecttheprevailingideologythatinfluencesourmicroeconomicandmacroeconomicpolicies.Wehaveidentifiedseveralmythsonwhichthisideologydepends.Wecanbreakoutofthevisciouscyclewherethepoliticaldominationofthetopleadstobeliefsandpoliciesthatenhanceeconomicinequalityandreinforcetheirpoliticaldomination.ForathirdofacenturyAmericanworkershaveseentheirstandardoflivingfirststagnateandthenerode.Tothosewho,inthedepthsoftheGreatDepression,saidthatmarketforceswouldeventuallyprevailandrestoretheeconomytofullemployment,Keynesretortedtotheeffectthat,yes,inthelongrunmarketsmaywork,butinthelongrunwe’realldead.ButI’mnotsurethatevenhehadinmindalongrunaslongastheperiodthatAmericanworkershaveseentheirstandardoflivingbeinggrounddown.Inthischapter,Iwillreviewwhathastobedonetocreatethisotherworld—thereformsweneedinoureconomicsandourpolitics.Unfortunately,weareheadedinthewrongway;thereisariskthatpoliticalandeconomicchangeswillmakethingsworse.Iendonanoteoutliningwhathastohappenifwearetochangecourse—acautiousnoteofoptimism.Aswethinkabouthowtostrengthenoureconomy,itisimperativethatwenotsuccumbtoGDPfetishism.We’veseen(in201 chapters1and4)thatGDPisnotagoodmeasureofeconomicperformance;itdoesn’treflectaccuratelychangesinthestandardofliving,broadlydefined,ofmostcitizens,anditdoesn’ttelluswhetherthegrowthweexperienceissustainable.THEECONOMICREFORMAGENDAArealeconomicreformagendawouldsimultaneouslyincreaseeconomicefficiency,fairness,andopportunity.MostAmericanswouldgain;theonlylosersmightbesomeofthe1percent—thosewhoseincome,forinstance,dependsonrentseekingandthosewhoareexcessivelylinkedtothem.Thereformsfollowcloselyfromourdiagnosis:wehaveaproblematthetop,themiddle,andthebottom.Simplesolutionswon’tsuffice.Weidentifiedmultiplefactorscontributingtothecountry’scurrenthighlevelofinequalityandlowlevelofopportunity.Whileeconomistsoftenargueabouttherelativeimportanceofeachofthefactors,weexplainedwhyresolvingthequestionisanalmostimpossibletask.Besides,inequalityofopportunityinAmericahasgrowntothepointwherewehavetodoeverythingwecan.Someofthecausesofinequalitymaybelargelybeyondourcontrol,otherswecanaffectonlygradually,inthelongrun,buttherearestillothersthatwecanaddressimmediately.Weneedacomprehensiveattack,someofthekeyelementsofwhichIlayoutbelow.CURBINGTHEEXCESSESATTHETOPChapter2showedhowsomuchofthewealthatthetopisderived,inonewayoranother,fromrentseekingandrulesofthegamethataretiltedtoadvantagethoseatthetop.Thedistortionsandperversionsofoureconomicsystemarepervasive,butthefollowingsevenreformswouldmakeabigdifference.ReducingrentseekingandlevelingtheplayingfieldCurbingthefinancialsector.Sincesomuchoftheincreaseininequalityisassociatedwiththeexcessesofthefinancialsector,itisanaturalplacetobeginareformprogram.Dodd-Frankisastart,butonlyastart.Herearesixfurtherreformsthatareurgent:(a)Curbexcessiverisktakingandthetoo-big-to-failandtoo-interconnected-to-failfinancialinstitutions;they’realethalcombinationthathasledtotherepeatedbailoutsthathavemarkedthelastthirtyyears.Restrictionsonleverageandliquidityarekey,forthebankssomehowbelievethattheycancreateresourcesoutofthinairbythemagicofleverage.Itcan’tbedone.Whattheycreate2isriskandvolatility.(b)Makebanksmoretransparent,especiallyintheirtreatmentofover-the-counterderivatives,whichshouldbemuchmoretightlyrestrictedandshouldnotbeunderwrittenbygovernment-insuredfinancialinstitutions.Taxpayersshould202 notbeinvolvedinbackinguptheseriskyproducts,nomatterwhetherwethinkofthemasinsurance,gamblinginstruments,or,asWarrenBuffettputit,financialweapons3ofmassdestruction.(c)Makethebanksandcreditcardcompaniesmorecompetitiveandensurethattheyactcompetitively.Wehavethetechnologytocreateanefficientelectronicspaymentmechanismforthetwenty-firstcentury,butwehaveabankingsystemthatisdeterminedtomaintainacreditanddebitcardsystemthatnotonlyexploitsconsumersbutimposeslargefeesonmerchantsforeverytransaction.(d)Makeitmoredifficultforbankstoengageinpredatorylendingandabusivecreditcardpractices,includingbyputtingstricterlimitsonusury(excessivelyhighinterestrates).(e)Curbthebonusesthatencourageexcessiverisktakingandshortsightedbehavior.(f)Closedowntheoffshorebankingcenters(andtheironshorecounterparts)thathavebeensosuccessfulbothatcircumventingregulationsandatpromotingtaxevasionandavoidance.ThereisnogoodreasonthatsomuchfinancegoesonintheCaymanIslands;thereisnothingaboutitoritsclimatethatmakesitsoconducivetobanking.Itexistsforonereasononly:circumvention.Manyofthesereformsareinterrelated:amorecompetitivebankingsystemislesslikelytoengageinabusivepractices,lesslikelytobesuccessfulinrentseeking.Curbingthefinancialsectorwillbehard,becausethebanksaresocleveratcircumvention.Evenifbanksarelimitedinsize—ahardenoughtask—theywillmakecontractswitheachother(suchasderivatives)thatwillensurethattheyaretoointertwinedtofail.Strongerandmoreeffectivelyenforcedcompetitionlaws.Whileeveryaspectofourlegalandregulatorycodeisimportantforbothefficiencyandequity,thelawsgoverningcompetition,corporategovernance,andbankruptcyareespeciallyrelevant.Monopoliesandimperfectlycompetitivemarketsareamajorsourceofrents.Bankingisnottheonlysectorinwhichcompetitionisweakerthanitshouldbe.Aswelookacrossthesectorsoftheeconomy,itisstrikinghowmanyaredominatedbyatmosttwo,three,orfourfirms.Atonetime,itwasthoughtthatthatwasOK—thatinthedynamiccompetitionassociatedwithtechnologicalchange,onedominantfirmwouldreplaceanother.Therewascompetitionforthemarketratherthancompetitioninthemarket.Butwenowknowthatthiswon’tsuffice.Dominantfirmshavetoolswithwhichtosuppresscompetition,andoftentheycanevensuppressinnovation.Thehigherpricesthattheychargenotonlydistorttheeconomybutalsoactlikeatax,therevenuefromwhichdoesn’t,however,gotopublicpurposes,butratherenrichesthecoffersofthemonopolists.Improvingcorporategovernance—especiallytolimitthepoweroftheCEOstodivertsomuchofcorporateresourcesfortheirownbenefit.Toomuchpower,toomuchdeferencetotheirsupposedwisdom,isgiventocorporateexecutives.Wehaveseenhowtheyusethatpowertodiverttoomuchofthecorporation’sresources203 totheirownbenefit.Lawsthatgiveshareholdersasayonpaywouldmakeadifference.Sowouldaccountingrulesthatletshareholdersknowclearlyhowmuchthey’regivingawaytotheirexecutives.Comprehensivereformofbankruptcylaws—fromthetreatmentofderivativestounderwaterhomesandtostudentloans.Bankruptcylawoffersanotherexampleofhowthebasicrulesofthegamethatdeterminehowmarketsworkhavestrongdistributionalconsequences,aswellaseffectsonefficiency.Asinmanyotherareas,theruleshaveincreasinglyfavoredthoseatthetop.Everyloanisacontractbetweenawillingborrowerandawillinglender,butonesideissupposedtounderstandthemarketfarbetterthantheother;thereisamassiveasymmetryininformationandbargainingpower.Accordingly,thelendershouldbearthebruntoftheconsequencesofamistake,nottheborrower.Makingbankruptcylawmoredebtor-friendlywouldgivebanksanincentivetobemorecarefulinlending.WewouldhavefewercreditbubblesandfewerAmericansdeeplyindebt.Oneofthemostegregiousexamplesofbadlending,aswe’venoted,isthestudentloanprograms;andbadlendingtherehasbeenencouragedbythenondischargeabilityofthedebt.Inshort,anunbalancedbankruptcylawhascontributedtoabloatedfinancialsector,toeconomicstability,toexploitationofthepoorandlessfinanciallysophisticated,andtoeconomicinequality.Endgovernmentgiveaways—whetherinthedispositionofpublicassetsorinprocurement.Theprecedingfourreformsfocusonrestrictingtheabilityofthoseatthetop,includingthoseinthefinancialsector,fromexploitingconsumers,borrowers,shareholders,andothersinprivatetransactions.Butmuchoftherentseekingtakestheformofexploitingtaxpayers.Thisexploitationassumesmanydifferentguises,somethatarebestdescribedsimplyasgiveawaysandothersthatfallundertherubicofcorporatewelfare.Aswesawinchapter2,theamountsofgovernmentgiveawaystocorporationsarehuge,rangingfromtheno-bargainingprovisionindrugs,tothecost-plusHalliburtoncontractsindefense,tothepoorlydesignedauctionsforoil,tothegivingawayofspectrumtoTVandradio,tothebelow-marketroyaltyratesforminerals.Thesegiveawaysareapuretransfer,fromtherestofthepopulationtocorporationsandthewealthy;butinaworldofbudgetconstraints,theyaremorethanthat,fortheyresultinlessspendingonhigh-returnpublicinvestments.Endcorporatewelfare—includinghiddensubsidies.Weexplainedinearlierchaptershowthegovernmenttoooften,ratherthanhelpingpeoplewhoneedassistance,spendsitsvaluablemoneyhelpingcorporations,throughcorporatewelfare.Manyofthesubsidiesareburiedinthetaxcode.Whilealltheloopholes,exceptions,exemptions,andpreferencesreducetheprogressivityofthetaxsystemanddistortincentives,thisisespeciallytrueofcorporatewelfare.Corporationsthatcan’tmakeitontheirownshouldcometoanend.Theirworkersmayneedassistancemovingtoanotheroccupation,butthat’samatterfardifferentfromcorporatewelfare.Muchofcorporatewelfareisfarfromtransparent—perhaps204 becauseifcitizensreallyknewhowmuchtheyweregivingaway,theywouldnotallowit.Beyondthecorporatewelfareembeddedinthetaxcodeisthatembeddedincheapcreditandgovernmentloanguarantees.Amongthemostdangerousformsofcorporatewelfareareonesthatlimitliabilityforthedamagetheindustriescancause—whetherit’slimitedliabilityfornuclearpowerplantsorfortheenvironmentaldamageoftheoilindustry.Notbearingthefullcostofone’sactionisanimplicitsubsidy,soallthoseindustriesthatimpose,forinstance,environmentalcostsonothersare,ineffect,beingsubsidized.Likesomanyoftheotherreformsdiscussedinthissection,thesewouldhaveatriplebenefit:amoreefficienteconomy,feweroftheexcessesatthetop,improvedwell-beingfortherestoftheeconomy.Legalreform—democratizingaccesstojustice,anddiminishingthearmsrace.Thelegalsystemgeneratesenormousrentsattheexpenseoftherestofsociety.Wedon’thaveasysteminwhichthereisjusticeforall.Wehaveasysteminwhichthere’sanarmsrace,andthosewiththedeepestpocketsareinthebestpositiontofightandtowin.Thedetailsofthereformofourlegalsystemwouldtakemebeyondtheconfinesofthisbook—orevenamuchlongertome.Sufficeittosaythattherequiredreformisfarmoreextensivethan,andverydifferentfrom,thelitigationreformadvocatedbytheRight.Embracingtheconservativereformagenda,astriallawyerscorrectlypointout,4wouldleaveordinaryAmericansunprotected.Butothercountrieshave,forinstance,developedsystemsofaccountabilityandprotection—wheredoctorsthatengageinmalpracticeareheldaccountable,andwherethosewhosufferinjury,whetherasaresultofmalpracticeorsimplybadluck,arecompensatedappropriately.TaxreformEachofthesevenreformsthatwehavedescribedyieldadoubledividend:enhancedeconomicefficiencyandincreasedequality.Butevenafterwedothat,largeinequalitieswillremain,andtoproviderevenuesforpublicinvestmentandotherpublicneeds,tohelpthepoorandthemiddleclass,toensuretheexistenceofopportunityforallsegmentsofthepopulation,we’llhavetoimposeprogressivetaxesand,mostimportantly,doabetterjobinclosingloopholes.Aswe’veseen,inrecentdecades,we’vebeencreatingalessprogressivetaxsystem.Createamoreprogressiveincomeandcorporatetaxsystem—withfewerloopholes.Ourtaxsystem,whilenominallyprogressive,ismuchlessprogressivethanitseems.Itisriddled,aswehavenoted,withloopholes,exemptions,exceptions,andpreferences.Afairtaxsystemwouldtaxspeculatorsatatleastthesamerateasthosewhoworkfortheirincome.Itwouldensurethatthoseatthetoppayatleastaslargeapercentageoftheirincomeintaxesas5thosewithlowerincomes.Thecorporatetaxsystemshouldbereformed,bothtoeliminateloopholesandtoencouragemorejobcreationandinvestment.Inchapter4,Iexplainedthat,contrarytotheassertionoftheRight,wecouldhaveamoreefficienttaxsystemthatis,infact,moreprogressive.EarlierIcitedstudiesthatshowed,on205 thebasisoftheresponseofsavingsandlaborsupply,thatthetoptaxrateshouldbewellinexcessof50percent,andplausibly6inexcessof70percent.Andthesestudieshavenotfullytakenintoaccounttheextenttowhichveryhighincomesarisefrom7rents.Createamoreeffective,andeffectivelyenforcedestatetaxsystem,topreventthecreationofanewoligarchy.TherestorationofameaningfulestatetaxwouldhelpinthepreventionofanewAmericanoligarchyorplutocracy,andsowouldtheeliminationofthepreferentialtreatmentofcapitalgains.Theadverseeffectsarelikelytobeminimal:mostofthosewhoaccumulatetheselargeestatesdosoasaresultofluckortheexerciseofmonopolypower,oraremotivatedbynonpecuniary8incentives.HelpingtheRestWecanjudgeoursystembyitsresults,andifwedoso,wehavetogiveitafailinggrade:alittlewhileagothoseatthebottomandinthemiddlegotaglimpseoftheAmericandream,buttoday’srealityisthatforalargesegmentofthepopulationthatdreamhasnowvanished.Someofthereformsdescribedearlierwouldnotonlycurbthetopbuthelptherest.Forinstance,endingsomeoftheabusiveandmonopolisticpracticeswill,byitself,increasetheirrealwell-being.Ordinarypeoplewillpaylessforcreditcards,telephones,computers,healthinsurance,andahostofotherproducts.Severaladditionalactionswould,Ithink,makeabigdifferenceintheplightofthe99percent.Someofthemrequireresources,andthereformsdescribedabove,andamplifiedinchapter8,wouldgeneratetherequiredrevenue.Improvingaccesstoeducation.Opportunityisshaped,morethananythingelse,byaccesstoeducation,andthedirectionwehavebeengoing(income-segregatedresidentialcommunities,sharplydecreasedpublicsupportforhighereducation—andtheresultingsharpincreasesintuitioninpubliccollegesandrestrictionsonplacesavailableinengineeringandotherhigh-demandbuthigh-costfields)canbereversedaswell,butitwilltakeaconcertednationaleffort.Whatcanbedonetoimproveaccesstoeducation,and,inparticular,toimprovethequalityofpubliceducation,9woulditselftakeatome.Butthereisonethingthatcanbedonequickly:thefor-profitschools,whetherfinancedbygovernmentloans,government-guaranteedloans,orprivateloans,withthenooseofnondischargeability,havefailedtoincreaseopportunity,andhaveinfactbeenamajorforcedraggingdownpooraspiringAmericans.Afewmayemergewithbetterjobs,butthevastmajoritysimplyemergeencumberedwithgreaterdebt.Itisunconscionablethatweallowthispredatoryactivitytocontinue,andevenmoreunconscionablethatitis,ineffect,supportedbypublicmoney.Publicmoneyshouldbeusedtoexpandsupportforstateandnonprofithighereducationalsystemsandtoprovidescholarshipstoensurethatthepoorhaveaccess.206 HelpingordinaryAmericanssave.Wealthdynamicsareaffected,bothatthetopandthebottom,bygovernmentpolicies.Wedescribedhowthetaxsystemhelpstherichaccumulateandbequeathmoneytotheirheirsthoughavarietyofincentives.Thepoorgetnosuchassistancefromthetaxsystem.Governmentincentivesforthepoortosave(say,amatchinggrantor10expansionoffirst-timehomeownerprograms)would,overtime,helpcreateafairersociety,withmoresecurityandopportunity,withalargerfractionofthenation’swealthatthebottomandinthemiddle.Healthcareforall.Thetwomostimportantimpedimentstoindividuals’achievingtheireconomicaspirationsarethelossofajobandanillness.Thetwotogetherformalethalcombination,oneoftenassociatedwithbankruptcy.HealthcareinAmericahastraditionallybeenprovidedbyemployers.ThisinefficientandantiquatedsystemhascontributedgreatlytotherealitythattheUnitedStateshasthemostinefficientandpoorest-performing,overall,healthcaresystemamongtheadvancedindustrialcountries.Theproblemwithourhealthcaresystemisnotthatwespendtoomuch;it’sthatwedon’tgetvalueforourmoneyandthattoomanypeopledon’thaveaccesstohealthcare.Obama’shealthcarereformpartiallyaddressedthelatterproblem,thoughcourtchallengescombinedwithcutbacksinpublicsupportmayunderminetheeffectivenessofthereforms.Butitdidlittle(at11leastintheshortrun)toimproveefficiency.Ourhighcostsaredueinparttorentseekingbyinsurancecompaniesandthepharmaceuticalindustry.Othercountrieshavecurbedtheserents.Wehavenot.Othercountriesnotaswell-offastheUnitedStateshavemanagedtoprovideuniversalaccesstohealthcare.Mostcountriestreataccesstomedicineasabasichumanright.Butevenifonedoesn’tapproachtheissuefromthisprincipledperspective,ourfailuretoprovideaccesstohealthcareincreasestheinefficiencyofourhealthcaresystem.Intheend,withmuchdelay,wedoprovidesomehealthcaretothosewhoareindesparateneed.Butithappensinemergencyrooms,andcostsareoftenmuchincreasedasaresultofthedelayintreatment.Lackofaccesstohealthcarecontributessignificantlytoinequality,andthisinequalityinturnunderminestheperformanceofoureconomy.Strengtheningothersocialprotectionprograms.Thecrisishasshownhowwoefullyinadequateourunemploymentinsurancesystemis.Weshouldn’thavetohaveamajorpoliticalbattle,inwhichtheunemployedareheldhostage,everyfewmonthsasfinancialsupportforextendedunemploymentinsurancecomestoanend.Thenewrealityisthat,giventhemagnitudeoftherecessionof2008andgiventhemagnitudeofthestructuraltransformationoureconomyisgoingthrough,therewillbelargenumbersoflong-termunemployedfortheforeseeablefuture.Governmentprograms(liketheearned-incometaxcredit,Medicaid,foodstamps,andSocialSecurity)haveprovenveryeffectiveinreducingpoverty.Morespendingontheseprogramscouldreducepovertyevenmore.Temperingglobalization:creatinga207 morelevelplayingfieldandendingtheracetothebottomGlobalizationandtechnologybothcontributetothepolarizationofourlabormarket,buttheyarenotabstractmarketforcesthatjustarrivefromonhigh;rather,theyareshapedbyourpolicies.Wehaveexplainedhowglobalization—especiallyourasymmetricglobalization—istiltedtowardputtinglaborinadisadvantageousbargainingpositionvis-à-viscapital.Whileglobalizationmaybenefitsocietyasawhole,ithasleftmanybehind—notasurprisegiventhat,toalargeextent,globalizationhasbeenmanagedbycorporateandotherspecialinterestsfortheirbenefit.Toooften,theresponsetothethreatofglobalizationistomakeworkersevenmoreworse-off,notjustbycuttingtheirwagesbutalsobyloweringsocialprotections.Thegrowthoftheantiglobalizationmovementis,underthesecircumstances,totallyunderstandable.Therearemyriadwaysinwhichglobalizationcouldbebrought12backintoabetterbalance.Inmanycountriestheonslaughtofhotmoneymovinginandoutofthecountryhasbeendevastating;ithascausedhavocintheformofeconomicandfinancialcrises.Thereisaneedforregulationsoncross-bordercapitalflows,especiallyoftheshort-term,speculativekind.Formostcountriessomerestrictionsintheunbridledflowofcapitalwouldcreatenotonlyamorestableeconomybutalsooneinwhichcapitalmarketswouldexertalessheavyhandovertherestofoursociety.ThismaynotbeapolicythatiseasilyavailabletotheUnitedStates.Butbecauseofthedominantroleweplayintheglobaleconomy,wedohaveopportunitiestohelpshapeglobalization—opportunitiesnotavailabletoothers.Inreshapingglobalization,wehavetorealizethattherehasoccurredaracetothebottomfromwhichwehaveallsuffered.TheUnitedStatesisinthebestpositiontostopthis(ifitspoliticswouldallowit);itcanfightforbetterworkerrightsandconditions,betterfinancialregulations,betterenvironmentalconditions.Butothercountries,workingtogether,canalsofightagainsttheracetothebottom.Eventheadvocatesofglobalizationshouldunderstandthattemperingglobalizationisintheirinterests.Forifglobalizationisnotmanagedbetterthanithasbeen,thereisarealriskofaretreat,intoprotectionismorformsofbeggar-thy-neighborpolicies.TherearespecificpoliciesthattheUnitedStatescanundertaketorebalanceglobalizationinwaysthatareconsistentwithincreasingglobalequityandefficiency.Forinstance,currentU.S.taxlaw,whereU.S.corporationsaretaxedonlyonprofitsthattheybringbackhome,encouragesoutsourcingofjobs.Oursystemofglobalcompetitionencouragesfirmstolocateonthebasisnotofglobalefficiencybutoftaxcompetition;whileit’sunderstandablewhycorporationslikethis,sincetaxcompetitionincreasestheirafter-taxprofits,itdistortstheglobaleconomyandunderminestheabilitytoimposefairtaxationoncapital.TheUnitedStatesisinaposition,forinstance,totaxcorporationsthatoperateintheUnitedStatesonthefullbasisoftheprofitstheyderivefromtheirsalesintheUnitedStates,regardlessof13wheretheirproductionoccurs.208 RestoringandmaintainingfullemploymentAfiscalpolicytomaintainfullemployment—withequality.Themostimportantgovernmentpolicyinfluencingwell-being,withthemostimportantconsequencesfordistribution,ismaintainingfullemployment.UnlesstheUnitedStatesiscareful,itcouldmoveintoasituationsimilartothatofsomeEuropeancountries,withpermanentlyhigherunemployment—avastwasteofresources,whichwouldsimultaneouslyleadtomoreinequalityandweakenbothoureconomicandourfiscalsituation.Forseventy-fiveyearswe’veknownthebasicprinciplesofhowtomaintaintheeconomyatornearfullemployment.Chapter8explainedhowwell-designedmacropoliciescanactuallyachieveallthreeobjectivessimultaneously—lowerdebtsanddeficits,fastergrowthandemployment,andanimproveddistributionofincome.Amonetarypolicy—andmonetaryinstitutions—tomaintainfullemployment.Historically,however,therehasbeengreaterrelianceonmonetarypolicythanonfiscalpolicyforshort-termstabilization,simplybecauseitcanadjusttochangingcircumstancesmorerapidly.Butdeficienciesingovernance,andintheprevailingeconomicmodels,haveledtoamassivefailureofmonetarypolicy.Chapter9explainedthereformsintheory,ingovernance,andinpolicythatareneeded:amoreaccountableandamorerepresentativecentralbank,andashiftawayfromtheexcessivefocusoninflationtoamorebalancedfocusonemployment,growth,andfinancialstability.Correctingtradeimbalances.OneofthereasonsthattotaldemandissoweakisthattheUnitedStatesimportssomuch—morethan14halfatrilliondollarsmorethanweexport.Ifexportscreatejobs,thenimportsdestroyjobs;andwe’vebeendestroyingmorejobsthanwe’vebeencreating.Forawhile,alongwhile,governmentspending(deficits)madeupthedifference,allowingtheUnitedStatestomaintainfullemploymentinspiteofthegap.Buthowlongcanwecontinuetoborrowatsuchaclip?AsIarguedinchapter8,thebenefitsofborrowing,especiallyforhigh-returninvestment,stillwellexceedthecosts;butsometimeinthefuture,perhapsthenot-too-distantfuture,thismaynotbetrue.Inanycase,politicsintheUnitedStatesismakingthesustainingofdeficits,evenforfinancinginvestment,difficult.Ifthatcontinues,andourtradedeficitcontinues,maintaining15fullemploymentwillprovevirtuallyimpossible.Moreover,andperhapsmoreimportantly,withanagingpopulation,Americashouldbesavingforthefuture,notlivingbeyonditsmeans.Fromaglobalperspective,thereisanotherreasontotrytocorrecttradeimbalances:globalimbalances—thelargediscrepanciesbetweenimportsandexports(deficitsinthecaseoftheUnitedStates,surplusesinthecaseofChina,Germany,andSaudiArabia)havelongbeenaworry.They(ormoreaccurately,a“disorderlyunwinding”oftheseunbalances,asmarketscometobelievethattheyareunsustainableandexchangeratesadjustabruptly)maynothavebeenthecauseofthelastGreatRecession,buttheycouldbeofthenext.Restoringtradebalancehasprovenextraordinarilydifficult.TheUnitedStateshastriedcompetitivedevaluation—loweringinterestratesbelowthatofitscompetitors,whichnormally209 lowersexchangerates.ButI’velikenedexchangeratestonegativebeautycontests:badasAmericanpoliticsandeconomicmanagementare,Europeseemstohavesurpassedus;andthetrade16imbalanceshavepersisted.Exchangeratesaredeterminedlargelybycapitalflows,andfinancepayslittleattentiontoitsconsequences:ascapitalseeksasafeharborintheUnitedStates,theexchangerateisdrivenup,exportsarehurt,importsencouraged,thetradeimbalanceincreases,andjobsaredestroyed.Butevenifworkers’livelihoodsareputatrisk,thefinancier’smoneyfeelssafer.Thisis,ofcourse,justtheconsequenceofmarketforcesworkingthemselvesout—butmarketforcesshapedbyrulesandregulationsthatallowthefreeflowofmoneywithoutrestraint.Thisisjustanotherexampleofhowthewell-beingoffinanceisputovertheinterestsofordinaryworkingpeople.Therearesomeinterestingproposalsthatwouldrestoretradebalanceandhelprestoretheeconomytofullemployment.Oneoftheproblems,though,isthattherulesofglobalization—designedlargelybytradelawyersfocusingonimpedimentsfacingparticularindustriesratherthanonbig-pictureissuesassociatedwithsystemicperformance—aresuchthatsomeofthereformsmay17contraveneexistingrules.Activelabormarketpoliciesandimprovedsocialprotection.Our18economyisgoingthroughalargestructuraltransformation.Thechangesbroughtaboutbyglobalizationandtechnologyrequirelargemovementsacrosssectorsandjobsbyworkers,andmarketsbythemselvesdon’thandlethesechangeswell.Tomakesurethattherearemorewinnersfromthisprocessandfewerlosers,governmentwillhavetoplayanactiverole.Workerswillrequireactiveassistancetohelpthemmovefromjobsthatarebeinglosttonewjobsthatarebeingcreated,withheavyinvestmentsineducationandtechnologytoensurethatthenewjobsareatleastasgoodasthelostones.Activelabormarketpoliciescanwork,butonly,ofcourse,iftherearejobsforpeopletomoveinto.Ifwecan’tsucceedinreformingourfinancialsystemtomakeitreturntoitscorefunctionofprovidingfinanceforthenewbusinessesofthefuture,thenthegovernmentmayevenneedtotakeamoreactiveroleinfinancingthenewenterprises.AnewsocialcompactSupportingworkers’andcitizens’collectiveaction.Therulesofthegameaffectthebargainingstrengthofdifferentparticipants.Wehavecreatedrulesofthegamethatweakenthebargainingstrengthofworkersvis-à-viscapital,andworkershavesufferedasaresult.Thedearthofjobsandtheasymmetriesinglobalizationhavecreatedcompetitionforjobsinwhichworkershavelostandtheownersofcapitalhavewon.Whetherthatistheresultofanaccidentalevolutionorofadeliberatestrategy,itisnowtimetorecognizewhathashappenedandtoreversecourse.Maintainingthekindofsocietyandthekindofgovernmentthatserveallthepeople—consistentwithprinciplesofjustice,fairplay,andopportunity—doesn’thappenbyitself.Somebodyhastolookafterit.Otherwiseourgovernmentandourinstitutionsgetcapturedbyspecialinterests.Attheveryleast,weneedcountervailingpowers.Butoursocietyandourpolityhavegrownoffkilter.Allhumaninstitutionsarefallible;allhavetheir210 weaknesses.Nooneproposesabolishinglargecorporationsbecausesomanyexploittheirworkersordamagetheenvironmentorengageinanticompetitivepractices.Rather,werecognizethedangers,weimposeregulations,weattempttoalterbehavior,knowingthatwewillneverfullysucceed,butthatthesereformscanimprovebehavior.Andyet,ourattitudetowardunionshasbeentheopposite.Theyarevilified,andinmanystatesthereareexplicitattemptstounderminethem,butthereisnorecognitionoftheimportantrolethattheycanplayincountervailingotherspecialinterestsandindefendingthebasicsocialprotectionsthatarenecessaryifworkersaretoacceptchangeandtoadjusttothechanging19economicenvironment.Affirmativeaction,toeliminatethelegacyofdiscrimination.Oneofthemostinvidious—andhardesttoeradicate—sourcesofinequalityisdiscrimination,bothongoingdiscriminationtodayandthelegacyofpastdiscrimination.Indifferentcountriesittakesondifferentforms,butalmosteverywherethereisracialandgenderdiscrimination.Marketforcesontheirownwon’teradicateit.We’vedescribedhow,togetherwithsocialforces,theycanenableittopersist.Butsuchdiscriminationcorrodesourbasicvalues,ourbasicsenseofidentity,thenotionofnationhood.Stronglawsprohibitingdiscriminationareessential;buttheeffectsofpastdiscriminationcontinue,andsoevenifweweresuccessfulineliminatingdiscriminationtoday,itsconsequenceswouldstillbewithus.Fortunately,we’velearnedhowtoimprovemattersthroughaffirmativeactionprograms—softerthanhardquotas,butwhenimplementedwithgoodintentions,theycanhelpoursocietyevolveinwaysthatareconsistentwithourbasicprinciples.Becauseeducationisthekeytoopportunity,suchprogramsareperhapsevenmoreimportanttherethanelsewhere.RestoringsustainableandequitablegrowthAgrowthagenda,basedonpublicinvestment.Weexplainedwhytrickle-downeconomicsdoesn’twork:growthdoesn’tautomaticallybenefitall.Butgrowthdoesprovidetheresourceswithwhichtotacklesomeofsociety’smostintractableproblems,includingthoseposedbypoverty.RightnowthemainproblemconfrontingtheU.S.andEuropeaneconomiesislackofdemand.Buteventually,whentotaldemandisenoughtofullyuseourresources—puttingAmericabacktowork—thesupplysidewillmatter.Supply,notdemand,willthenbetheconstraint.Butit’snotthesupply-sideeconomicsemphasizedbytheRight.Onecanraisetaxesoncorporationsthatdon’tinvestandlowertaxesonthosethatdo,andonthosethatcreatejobs.Doingthatismorelikelytoleadtogrowththanthekindsofacross-the-boardtaxreductionsthatsomebusinessesdemand.Whilethesupply-sideeconomicsoftheRighthasexaggeratedtheimportanceoftaxincentives,especiallywhenitcomestothecorporateincometax,ithasunderestimatedtheimportanceofotherpolicies.Governmentinvestments—ininfrastructure,education,andtechnology—underpinnedgrowthinthelastcentury,andtheycanformthebasisofgrowthinthiscentury.Theseinvestmentswillexpandtheeconomyandmakeprivateinvestmentevenmoreattractive.Asthe211 20economichistorianAlexFieldshaspointedout,thedecadesof1930s,’40s,’50s,and’60swereperiodsofhighproductivityincreases—higherthanthedecadesbeforeandafter—andmuchofthissuccesshadtodowithpublicinvestments.Redirectinginvestmentandinnovation—topreservejobsandtheenvironment.Weneedtoredirectinvestmentandinnovationfromsavinglabor(aeuphemismundercurrentcircumstancesforcreatingunemployment)tosavingresources.Thiswon’tbeeasy;therewillhavetobebothapushandapull.Forinstance,ininnovation,wecandothisbothbythekindofbasicandappliedresearchthatthegovernmentfundsandbyforcingfirmstopayfortheirfullenvironmentaldamage.Thatwillprovidethemwithincentivestosaveonresources,divertingtheirattentionawayfromreplacingworkers.Ratherthanacross-the-boardlowinterestrates(asnow),whichencouragethereplacementevenoflow-skilledworkersbymachines,wecoulduseinvestmenttaxcreditstoencourageinvestment;butthecreditswouldbegivenonlyforinvestmentsthatsaveresourcesandpreservejobs,notforinvestmentsthatdestroyresourcesandjobs.Throughoutthisbook,I’veemphasizedthatwhatmattersisnotjustgrowth,butwhatkindofgrowth(or,asit’ssometimesput,thequalityofgrowth).Growthinwhichmostindividualsareworse-off,wherethequalityofourenvironmentsuffers,wherepeopleendureanxietyandalienation,isnotthekindofgrowththatweshouldbeseeking.Thegoodnewsisthatsometimeswecanbothshapemarketforcesforthebetterandderiverevenuesthatcanbeusedtopromotegrowthandenhancesocietalwell-being.THEIMMEDIATEISSUESIhavelaidoutalong-termeconomicreformagenda,butrightnowthelargestcausesofsufferingamongthe99percentareinthelabormarketandhousing.Inhousing,wesawhowaccountingstandardswereamajorimpedimenttorestructuring,andthatgovernmentprogramsforrestructuringweredesignednottoforce,ornoteventoencourage,principalwrite-downs.Therulesofthegamefavoredthebanksoverthehomeowners,andthoserulesmustbechanged.Wesawthatinourdiscussionofforeclosuresinchapter7.Thebanksneedtobegivenincentives,andperhapsberequired,torestructuremortgages.Requiringthemtorecognizethelossesoftheirmortgages—whichiscalled“markingtomarket”—wouldeliminateamajorobstacletorestructuring.Taxincentives—allowingfavorabletreatmentoflossesifincurredaspartofarestructuringnow,andlessfavorabletreatmentoflossesthatresultfromforeclosure—mightprovideacarrot.Andifthatdoesn’twork,forcingarestructuringmaybenecessary.Wehaveaprovisioninourbankruptcycode,Chapter11,thatgivescorporationsthathavebecomeoverindebted(evenasaresultoffoolishnessontheirpart)afreshstart;werecognizethevalueofkeepingenterprisesgoing,thevalueofthejobsthatareretained.But,aswearguedinchapter6,ifit’sdesirabletogivecorporationsafreshstart,it’sequallyvaluabletogivefamiliesafreshstart.Currentpolicyisdevastatingfamiliesandcommunities.Weneedahomeowners’Chapter11thatwouldwritedownwhatthefamilyowes,inreturnforashareofthecapital212 gainwhenthehouseissold.TheObamaadministration,throughFannieMaeandFreddieMac,21thetwoprivatemortgagecompaniesthatthegovernmenttookoverastheycollapsedatthebeginningofthecrisis,nowownsasubstantialfractionofallmortgages.Itisunconscionablethat22theyhavenotrestructuredthemortgagesthattheyhold.Taxpayers,homeowners,andoureconomywouldallbebetter-off.Fixingthemortgageproblemisnecessarytogetoureconomygoing,butit’snotsufficient.Thelabormarket,too,isinshambles,withclosetooneinsixworkerswhowouldlikeafull-timejobunabletogetone.Moreaggressivestimulationoftheeconomy,throughfiscalpolicy,asdescribedinchapter8,couldsubstantiallylowertheunemploymentrate,andmoreactivelabormarketpoliciescouldtrainworkersforthenewjobsthattheeconomywillcreateasitrecovers—whichmaybedifferentfromtheoldjobsinmanufacturingandrealestatethathavebeendestroyed.THEPOLITICALREFORMAGENDATheeconomicsisclear:thequestionis,Whataboutthepolitics?Willourpoliticalprocessesallowtheadoptionofeventhebarestelementsofthisagenda?Ifthatistooccur,majorpoliticalreformsmustprecedeit.Weallbenefitfromhavingawell-functioningdemocracyand23society.Butbecauseweallbenefit,anyonecanbeafreerider.Asaresult,therewillbeunderinvestmentinthesmoothfunctioningofourdemocracy,perhapsthemostimportantpublicgoodofall.Ineffect,we’veprivatizedtoalargeextentthesupportandmaintenanceofthepublicgood,withdisastrousconsequences.We’veletprivatecorporationsandrichindividualsspendmoneyto“inform”usofthemeritsofalternativepoliciesandcandidates.Andtheyhaveeveryincentivetodistorttheinformationtheyprovide.Alternativeinstitutionalarrangementsarepossible,but,again,wemaybemovinginthewrongdirection.Campaignfinancereformwouldlimitthescopeforcorporatefundingofcampaigns,buttheSupremeCourtinitsCitizensUnitedcaseremoved24stricturesonbigfirms’contributions.Wecouldmakecorporationsmoreaccountabletotheirshareholders,forcingthemtogototheirshareholdersforavoteoncampaigncontributions,butwithcorporationscontrollingCongress,it’sbeenimpossibletogetthisandsimilarlegislationcurbingthepoliticalpowerofcorporationsadopted,orevenseriouslydiscussed.Wecoulddiminishtheneedforcampaigncontributions,byhavingmorepublicfundingorbyrequiringbroadcasterstoprovidefreeairtime.Butneitherthebroadcasters(whomakelargeamountsofmoneyfromcampaignadvertising)northecorporations(wholikethingsthewaytheyare,forobviousreasons)supportsuchreforms,andtheiroppositionmakescongressionalpassageofsuchreformsallbutimpossible.Wecouldtrytoensuregreateraccesstolessbiasedinformation,asseveraloftheScandinaviancountriesdo.Ratherthanjusthavingmediacontrolledbymoguls—drawndisproportionatelyfromthe1percent,andmostlyreflectingtheirviews—they’vetried,withsomesuccess,tocreateamore213 democraticmedia.Wecould,asmanyoftheEuropeancountriesdo,providepublicsupportforavarietyofindependentthinktanks,toensureamorebalanceddebateaboutthewisdomofalternativepolicies.Wecouldmakemoneylessimportantinthepoliticalprocessbyrequiringvoting(withfinancialpenaltiesfornotcomplying),asAustralia,Belgium,andLuxembourgdo.Thisalsoshiftsthefocusofthepoliticalpartiesfromturningoutvoterstoinformingvoters.Notsurprisingly,voterparticipation(surpassing9025percentinAustralia)farexceedsthatintheUnitedStates.Andtherearepoliticalreformsthatwouldmakevoterregistrationandvotingeasier,andmakevotingmoremeaningful—andthusincreasevoterturnout,byensuringthatthepoliticalprocessismoreresponsivetotheconcernsofthe99percent.Somereformswould26representfundamentalchangesinourpoliticalsystem,butothers,suchasreducingthescopeforgerrymanderingorthescopeforfilibuster,couldbeaccomplishedwithinourcurrentpoliticalstructure.Noneofthesearefoolproofrecipes;allofthemarelikelytodiminishonlyslightlythepoliticalpowerofthe1percent.Andyet,takentogetherwiththeeconomicreformagendaoftheprevioussection,theyoffertheprospectofanewera—foroureconomy,ourpolitics,andoursociety.Andthatleadsustoafinalquestion.ISTHEREHOPE?Thepoliticalandeconomicreformagendainthischapterassumesthatwhilemarketforcesplaysomeroleinthecreationofourcurrentlevelofinequality,marketforcesareultimatelyshapedbypolitics.Wecanreshapethesemarketforcesinwaysthatpromotemoreequality.Wecanmakemarketswork,oratleastworkbetter.Similarly,wewillnevercreateasystemwithfullequalityofopportunity;butwecanatleastcreatemoreequalityofopportunity.TheGreatRecessiondidnotcreatethecountry’sinequality,butitmadeitmuchworse,somuchsothatitmadeithardtoignore,anditfurtherlimitedalargesegmentofthepopulation’saccesstoopportunity.Withtherightpolicies,alongthelinesoftheagendalaidoutearlierinthischapter,wecanmakethingsbetter.It’snotamatterofeliminatinginequalityorcreatingfullequalityofopportunity.It’sjustamatterofreducingthelevelofinequalityandincreasingtheextentofequalityofopportunity.Thequestionis,canwegetthere?Ourdemocracy,tiltedasitmaybe,providestworoutesbywhichreformmighthappen.Thoseinthe99percentcouldcometorealizethattheyhavebeendupedbythe1percent:thatwhatisintheinterestofthe1percentisnotintheirinterests.The1percenthasworkedhardtoconvincetherestthatanalternativeworldisnotpossible;thatdoinganythingthatthe1percentdoesn’twantwillinevitablyharmthe99percent.Muchofthisbookhasbeendevotedtodestroyingthismythandtoarguingthatwecouldactuallyhaveamoredynamicandmoreefficienteconomyandafairersociety.In2011wewatchedpeopletaketothestreetsbythemillionstoprotestpolitical,economic,andsocialconditionsintheoppressivesocietiestheyinhabit.GovernmentstoppledinEgypt,214 Tunisia,andLibya.ProtestseruptedinYemen,Bahrain,andSyria.Therulingfamilieselsewhereintheregionlookedonnervouslyfromtheirair-conditionedpenthouses.Willtheybenext?Theyarerighttoworry.Thesearesocietieswhereaminusculefractionofthepopulation—lessthan1percent—controlsthelion’sshareofthewealth;wherewealthisamaindeterminantofpower,bothpoliticalandeconomic;whereentrenchedcorruptionofonesortoranotherisawayoflife;andwherethewealthiestoftenstandactivelyinthewayofpoliciesthatwouldimprovethelivesofpeopleingeneral.Aswegazeoutatthepopularfervorinthestreets,wemightaskourselvessomequestions.WhenwillitcometoAmerica?WhenwillitcometoothercountriesoftheWest?Inimportantways,ourowncountryhasbecomelikeoneofthesedisturbedplaces,servingtheinterestsofatinyelite.Wehaveabigadvantage—weliveinademocracy—butit’sademocracythathasincreasinglynotreflectedtheinterestsoflargefractionsofthepopulation.Thepeoplesensethis—it’sreflectedinthelowsupporttheyexpressforCongressandintheabysmallylowvoterturnout.Andthat’sthesecondwaythatreformcouldhappen:the1percentcouldrealizethatwhat’sbeenhappeningintheUnitedStatesisnotonlyinconsistentwithourvaluesbutnoteveninthe1percent’sowninterest.AlexisdeTocquevilleoncedescribedwhathesawasachiefelementofthepeculiargeniusofAmericansociety,somethinghecalled“self-interestproperlyunderstood.”Thelasttwowordswerekey.Everyonepossessesself-interestinanarrowsense:Iwantwhat’sgoodformerightnow!Self-interest“properlyunderstood”isdifferent.Itmeansappreciatingthatpayingattentiontoeveryoneelse’sself-interest—inotherwords,tothecommonwelfare—isinfacta27preconditionforone’sownultimatewell-being.Tocquevillewasnotsuggestingthattherewasanythingnobleoridealisticaboutthisoutlook.Rather,hewassuggestingtheopposite:itwasamarkofAmericanpragmatism.ThosecannyAmericansunderstoodabasicfact:lookingoutfortheotherguyisn’tjustgoodforthesoul;it’sgoodforbusiness.Thetop1percenthavethebesthouses,thebesteducations,thebestdoctors,andthebestlifestyles,butthereisonethingthatmoneydoesn’tseemtohavebought:anunderstandingthattheirfateisboundupwithhowtheother99percentlive.Throughouthistory,thishasbeensomethingthatthetop1percenteventuallydolearn.Often,however,theylearnittoolate.Wehaveseenthatpoliticsandeconomicsareinseparable,andthatifwearetopreserveasystemofonepersononevote—ratherthanonedollaronevote—reformsinourpoliticalsystemwillberequired;butweareunlikelytoachieveafairandresponsivepoliticalsystemwithinaneconomicsystemthatischaracterizedbythedegreeofinequalitythatmarksours.Wehaveseenmostrecentlythatourpoliticalsystemcan’tworkifthereisn’tadeepersenseofcommunity;buthowcanwehavesuchasenseofcommunityifourcountryissodivided?Andseeingtheincreasingdivideinoureconomy,wecanonlyask,Whatwillitportendforthefutureofourpolitics?TherearetwovisionsforAmericaahalfcenturyfromnow.Oneisofasocietymoredividedbetweenthehavesandthehave-nots,acountryinwhichtherichliveingatedcommunities,sendtheirchildrentoexpensiveschools,andhaveaccesstofirst-ratemedicalcare.Meanwhile,therestliveinaworldmarkedby215 insecurity,atbestmediocreeducation,andineffectrationedhealthcare—theyhopeandpraytheydon’tgetseriouslysick.Atthebottomaremillionsofyoungpeoplealienatedandwithouthope.Ihaveseenthatpictureinmanydevelopingcountries;economistshaveevengivenitaname,adualeconomy,twosocietieslivingsidebyside,buthardlyknowingeachother,hardlyimaginingwhatlifeislikefortheother.Whetherwewillfalltothedepthsofsomecountries,wherethegatesgrowhigherandthesocietiessplitfartherandfartherapart,Idonotknow.Itis,however,thenightmaretowardwhichweareslowlymarching.Theothervisionisofasocietywherethegapbetweenthehavesandthehave-notshasbeennarrowed,wherethereisasenseofshareddestiny,acommoncommitmenttoopportunityandfairness,wherethewords“libertyandjusticeforall”actuallymeanwhattheyseemtomean,wherewetakeseriouslytheUniversalDeclarationofHumanRights,whichemphasizestheimportancenotjustofcivilrightsbutofeconomicrights,andnotjusttherightsofpropertybuttheeconomicrightsofordinarycitizens.Inthisvision,wehaveanincreasinglyvibrantpoliticalsystemfardifferentfromtheoneinwhich80percentoftheyoungaresoalienatedthattheydon’tevenbothertovote.Ibelievethatthissecondvisionistheonlyonethatisconsistentwithourheritageandourvalues.Initthewell-beingofourcitizens—andevenoureconomicgrowth,especiallyifproperlymeasured—willbemuchhigherthanwhatwecanachieveifoursocietyremainsdeeplydivided.Ibelieveitisstillnottoolateforthiscountrytochangecourse,andtorecoverthefundamentalprinciplesoffairnessandopportunityonwhichitwasfounded.Time,however,mayberunningout.FouryearsagotherewasamomentwheremostAmericanshadtheaudacitytohope.Trendsmorethanaquarterofthecenturyinthemakingmighthavebeenreversed.Instead,theyhaveworsened.Todaythathopeisflickering.216 NOTESPreface1.May2011,availableathttp://www.vanityfair.com/society/features/2011/05/top-one-percent-201105(accessedFebruary28,2012).2.Seechapter1foradescriptionofhowunequaltheUnitedStateshasbecome,andforcitations.3.Thenatureofthemarketfailuresdiffered,ofcourse,acrosscountries.InEgypt,forinstance,neoliberalmarketreformshadbroughtsomegrowth,butthebenefitsofthatgrowthhadnottrickleddowntomostindividuals.4.Notallofthemshowupinthe“official”unemploymentstatistic,whichstoodat8.3percent.Somewereactivelylookingforafull-timejobandcouldn’tgetanyjob,somehadacceptedapart-timejobbecauseafull-timejobwasnotavailable,someweresodiscouragedbythelackofjobsthattheyhaddroppedoutofthelaborforce.ThenumbersinEuropearesimilar.5.Widelyreportedinthemedia;see,e.g.,http://www.dailymail.co.uk/news/article-2048754/Occupy-Wall-Street-Bloomberg-backs-dawn-eviction.html(accessedDecember3,2011).6.USAToday,availableathttp://www.usatoday.com/news/nation/story/2011-10-17/poll-wall-street-protests/50804978/1.7.Non-AmericansmaybesurprisedtofindoutthattheU.S.unemploymentinsurancenormallyextendsforonlysixmonths.Chapter1describesboththebattlestogetitextendedduringtherecessionandthelargenumbersofpeoplenotcovered.8.SuchdivisionssmackedofMarxiananalysis,whichwasanathemaduringtheColdWar,andinsomeplacesevenafterit.9.Asweshowinchapter1.Sociologistsemphasizethatthereismoretoclassthanjustincome.10.We’llprovideevidenceonthisinlaterchapters.11.Oneresponsewouldbetostoptalkingaboutvalues.Rhetoricaboutequality,fairness,dueprocess,andthelikedon’thaveanythingtodowithhowtheworldworks.Inpoliticswewouldcallthisemphasisonrealityrealpolitik.Advocatesof“realism”ineconomicsoftensupportakindofeconomicDarwinism;letthesystemevolveandletthefittestsurvive.Systemsthatareflawed,likecommunism,won’tsurvive.Fornow,American-stylecapitalismisthebestsystem.Inthenineteenthcenturytheseideaswerereferredtoas“socialDarwinism.”AvariantofthisconceptwaspopularizedamongtheRight.Suchanargument(oftenunexpressed)sometimesseemstohaveinfluencedadvocatesofAmerican-stylecapitalism.Thereare,however,anumberofproblemswiththisperspective.Atatheoreticallevel,thisteleologicaltakeonevolution—thatitleadstothebest-possiblesystem—hasnojustification.Norisitcertainthatasystemthatworksnowwillhavetheresiliencetomeetfuturechallenges.Itispreciselythisinabilitytoassessresiliencethatisoneoftheflawsofthemodernmarketeconomy.SeealsoJ.E.Stiglitz,WhitherSocialism?(Cambridge:MITPress,1994).12.AsofAugust2011,for16-to24-year-olds.SeeBureauofLaborStatisticswebsite,http://www.bls.gov/news.release/youth.nr0.htm(accessedDecember3,2011).13.Thatourjudicialsystemhasbeenunderminedbythegrowinginequalityhasbeenthesubjectofrecentdiscussions.See,e.g.,GlennGreenwald,WithLibertyandJusticeforSome:HowtheLawIsUsedtoDestroyEqualityandProtectthePowerful(NewYork:MetropolitanBooks/HenryHolt,2011).Othershavealsocalledattentiontohowthefailureofourpolitics—theundueinfluenceofspecialinterests—isunderminingoureconomy,anddidsoevenbeforethefinancialcrisismadeitself-evident.SeeRobertKuttner,TheSquanderingofAmerica:HowtheFailureofOurPoliticsUnderminesOurProsperity(NewYork:Knopf,2007).14.ThisistheperspectivethatIarguedforinmyearlierbooksGlobalizationandItsDiscontents(NewYork:W.W.Norton,2002),MakingGlobalizationWork(NewYork:W.W.Norton,2006),TheRoaringNineties(NewYork:W.W.Norton,2003),andFreefall(NewYork:W.W.Norton,2010).OtherswhohavesoundedsimilarthemesincludetheexcellentbooksbyRobertKuttner,EverythingforSale:TheVirtuesandLimitsofMarkets(NewYork:Knopf,1997);JohnCassidy,HowMarketsFail:TheLogicofEconomicCalamities(NewYork:Farrar,StrausandGiroux,2009);MichaelHirsh,CapitalOffense:HowWashington’sWiseMenTurnedAmerica’sFutureOvertoWallStreet(NewYork:Wiley,2010);andJeffMadrick,TheAgeofGreed:TheTriumphofFinanceandtheDeclineofAmerica,1970tothePresent(NewYork:Knopf,2011).15.NewYork:SimonandSchuster,2010.16.NewYork:Twelve,2011.17.NewYork:RussellSage,2008.217 18.NewYork:MITPress,2008.Thesebooksfollowinalongtradition,includingGregPalast,TheBestDemocracyMoneyCanBuy,rev.ed.(NewYork:Plume,2004).19.Analternativeinterpretation,whichIdiscussbrieflyinchapter5,isthatofThomasFrank,inhisWhat’stheMatterwithKansas?HowConservativesWontheHeartofAmerica(NewYork:MetropolitanBooks,2004).20.Thischapterofmythesiswaspublishedas“TheDistributionofIncomeandWealthAmongIndividuals,”Econometrica37,no.3(July1969):382–97.OtherpapersgrowingoutofthisearlyworkincludetwowithGeorgeAkerlof,withwhomIsharedthe2001NobelPrize,“Investment,Income,andWages”(abstract),Econometrica34,no.5,suppl.issue(1966):118,and“Capital,WagesandStructuralUnemployment,”EconomicJournal79,no.314(June1969):269–81;onewithmythesissupervisor,RobertSolow,“Output,EmploymentandWagesintheShortRun,”QuarterlyJournalofEconomics82(November1968):537–60;andanotherchapterfrommythesis,“ATwo-Sector,TwoClassModelofEconomicGrowth,”ReviewofEconomicStudies34(April1967):227–38.21.Idescribesomeoftheinfluencescontributingtotheevolutionofmythinking,especiallyabouttheroleofinformationimperfections,inmyNobellecture,“InformationandtheChangeintheParadigminEconomics,”inLesPrixNobel;TheNobelPrizes2001,ed.ToreFrängsmyr(Stockholm:NobelFoundation,2002),pp.472–540.Alsoavailableathttp://www.nobelprize.org/nobel_prizes/economics/laureates/2001/stiglitz-lecture.pdf(accessedFebruary28,2012)andinabbreviatedformas“InformationandtheChangeintheParadigminEconomics,”AmericanEconomicReview92,no.3(June2002):460–501.SeealsothebriefautobiographywrittenfortheNobelFoundation,“NobelMemoirs,”inLesPrixNobel;TheNobelPrizes2001,pp.447–71,and“ReflectionsonEconomicsandonBeingandBecominganEconomist,”inTheMakersofModernEconomics,vol.2,ed.ArnoldHeertje(NewYork:HarvesterWheatsheaf,1994),pp.140–83.ChapterOneAMERICA’S1PERCENTPROBLEM1.FromJanuary2007toDecember2011thereweremorethan8.2millionforeclosurestartsand4millioncompletedforeclosures.SeeRealtytrac,2012,“2012ForeclosureMarketOutlook,”February13,availableathttp://www.realtytrac.com/content/news-and-opinion/slideshow-2012-foreclosure-market-outlook-7021(accessedMarch28,2012).Therearestillmanyforeclosuresinthepipeline—some5.9millionpropertiesare30ormoredaysdelinquentorinforeclosure;seeMortgageMonitorReport,LenderProcessingServices(March2012),availableathttp://www.lpsvcs.com/LPSCorporateInformation/NewsRoom/Pages/20120321.aspx(accessedMarch28,2012).Additionally,11.1million,or22.8percent,ofallresidentialpropertieswithamortgageintheUnitedStateswereunderwater(hadnegativeequityattheendofthefourthquarterof2011);see“NegativeEquityReport,”Corelogic(Q4,2011),availableathttp://www.corelogic.com/about-us/researchtrends/asset_upload_file360_14435.pdf(accessedMarch28,2012).2.Theexactamountvariesfromyeartoyear.Fordataonincomeinequality,IrelyheavilyontheworkofEmmanuelSaezandThomasPiketty.TheimportantinitialworkisT.PikettyandE.Saez,“IncomeInequalityintheUnitedStates,1913–1998,”QuarterlyJournalofEconomics118,no.1(2003):1–39.AlongerandupdatedversionispublishedinA.B.AtkinsonandT.Piketty,eds.,TopIncomesovertheTwentiethCentury:AContrastbetweenContinentalEuropeanandEnglish-SpeakingCountries(NewYork:OxfordUniversityPress,2007).Tablesandfiguresupdatedto2010inExcelformatareavailableatSaez’swebsite,http://www.econ.berkeley.edu/~saez/.Saezhasanaccessiblesummaryofthisworkonhiswebsite,“StrikingItRicher:TheEvolutionofTopIncomesintheUnitedStates.”NotethattheSaezdataarebasedonincometaxreturns,andthusarehighquality,butalsothereforecoveronlyreportedincome.Totheextentthatupper-incometaxpayersarebetterabletoavoidreportingincome,e.g.,throughkeepingincomeabroadincorporationstheycontrol,thedatamayunderestimatetheextentofinequality.IalsodrawonarecentCBOreport,“TrendsintheDistributionofHouseholdIncomebetween1979and2007,”October2011,availableathttp://www.cbo.gov/sites/default/files/cbofiles/attachments/10-25-HouseholdIncome.pdf;andonrecentworkbyJ.Bakija,A.Cole,andB.T.Heinin“JobsandIncomeGrowthofTopEarnersandtheCausesofChangingIncomeInequality:EvidencefromU.S.TaxReturnData,”workingpaper,January2012,availableathttp://web.williams.edu/Economics/wp/BakijaColeHeimJobsIncomeGrowthTopEarners.pdf.TheCensusHistoricalTablesprovidedataonmedianhouseholdincomesovertime,availableatttp://www.census.gov/hhes/www/income/data/historical/household/index.html.Basicsourcesofdataforacross-countrycomparisonsareOECD,“DividedWeStand:WhyInequalityKeepsRising,”December5,2011;WorldBank,WorldBankDevelopmentIndicators,availableathttp://data.worldbank.org/indicator;andtheLuxembourgIncomeStudy.TheEconomicPolicyInstituteprovidesexcellentinterpretationsandupdatesofthedataatitswebsite,http://www.epi.org/.3.LaurenceMishelandJoshBivens,“OccupyWallStreetersAreRightaboutSkewedEconomicRewardsintheUnitedStates,”EPIBriefingPaper331,October26,2011,availableathttps://docs.google.com/viewer?url=http://www.epi.org/files/2011/BriefingPaper331.pdf&hl=en_US&chrome=true(accessedFebruary28,2012).Anothermanifestationofthegrowinginequalitythat218 in1979theratiooftheaverageincomeinthetop0.1percent,includingcapitalgains,was“only”around50timesgreaterthanthatoftheaverageinthebottom90percent.By2010theratiowas164timesthatoftheaveragebottom90percentofincomeearners.Meanwhile,theratiooftheaveragehouseholdincomeofthetop1percenttothatofthebottom90percenthastripled,from14:1to42:1.BasedondatafromPikettyandSaez,“IncomeInequalityintheUnitedStates,1913–1998,”andtheupdatesonSaez’swebsite,citedinn.2,above.4.Moreprecisely,thetop1percentcontrolabout35percentofthewealth.Ifthevalueofthehomeisexcluded,i.e.,“nonhomewealth,”thenumberisconsiderablylarger:thetop1percentownstwo-fifthsofthenation’swealth.EdwardN.Wolffcomparesbothfiguresin“RecentTrendsinHouseholdWealthintheUnitedStates:RisingDebtandtheMiddle-ClassSqueeze—anUpdateto2007,”LevyInstituteWorkingPaperno.589,March2010,availableathttp://www.levyinstitute.org/pubs/wp_589.pdf(accessedFebruary28,2012).TheFederalReserveistheoriginalsourceforthenet-worthfigures,includinghomewealth;seeArthurB.Kennickell,“What’stheDifference?EvidenceontheDistributionofWealth,Health,LifeExpectancyandHealthInsuranceCoverage,”paperpreparedforthe11thBiennialCDC/ATSDRSymposium,September23,2007,availableathttp://www.federalreserve.gov/pubs/oss/oss2/papers/CDC.final.pdf(accessedFebruary28,2012).Notethatthetop1percentincomemaynotperfectlyoverlapthetop1percentwealthholders—thesearetwodifferentcategories.Thetop1percentofincomeearnersown“only”about25percentofthenation’swealth.SeeArthurB.Kennickell,“PondsandStreams:WealthandIncomeintheU.S.,1989to2007,”staffworkingpaperintheFinanceandEconomicsDiscussionSeries,FederalReserveBoard,Washington,DC,January7,2009,p.36,availableathttp://www.federalreserve.gov/pubs/feds/2009/200913/200913pap.pdf(accessedFebruary29,2012).5.BasedondatafromPikettyandSaez’s,“IncomeInequalityintheUnitedStates,1913–1998,”andtheupdatesonSaez’swebsite,citedinn.2,above.6.Thetop1percentofincomeearnersreceivedsome60percentofthegainsduringthecountry’seconomicexpansionbetween1979and2007.Whiletherealafter-taxhouseholdincomeofthe1percentgrewby275percentinthatperiod,thebottomfifth’saveragerealafter-taxhouseholdincomeroseonly18percent.Indeed,thebottom90percentofearnersgotjustafourthofwhatthetop0.1percentgained.Basedondatafrom,PikettyandSaez,“IncomeInequalityintheUnitedStates,1913–1998,”andtheupdatesonSaez’swebsite,citedinn.2,above.SeeEPIBriefingPaper,October26,2011,citedinn.3,above;andJoshBiven,“Three-FifthsofAllIncomeGrowthfrom1979–2007WenttotheTop1%,”EconomicPolicyInstitue,October27,2011,availableathttp://www.epi.org/publication/fifths-income-growth-1979-2007-top-1/(accessedFebruary28,2012).TheCBO2011study,citedinn.1,above,presentsasimilarpicture.7.Weusetheterm“typical”torefertothemedianincome,i.e.,theincomesuchthathalfofallworkershaveanincomehigherthanthatnumber,halfbelow.Medianhouseholdincomewasactuallylowerin2010($49,445)thanitwasin1997,adjustedforinflation($50,123in2010dollars).Overthelongerperiod,1980–2010,medianfamilyincomeessentiallystagnated,growingatanannualrateofonly0.36percent.BasedontableH-9ofCensushistoricaltables,availableathttp://www.census.gov/hhes/www/income/data/historical/household/index.html.8.Adjustedforinflation,malemedianincomein2010was$32,137;in1968itwas$32,844.SeetableT-5oftheU.S.CensusBureau’sincomereport,availableathttp://www.census.gov/hhes/www/income/data/historical/people/index.html(accessedFebruary13,2012).(Ofcourse,themedianworkertodayisadifferentpersonfromthemedianpersonin1968,andthesenumberscanbeaffectedbyimmigrationofunskilledworkers.)9.ByApril2010,stockmarketprices(S&P500),whichhadfallen56percentbetweenthepeak,inOctober2007,andthetrough,inMarch2009,wereup78percentfromthetrough(thoughatthetimeofwriting,theyarestill13percentbelowthepeak).10.Seethe2012updatetothedataforPikettyandSaez,“IncomeInequalityintheUnitedStates,1913–1998.”11.Housepricesare,atthetimeofwriting(February2012),stilldown33percent,andforthoselivinginsomepartsofthecountry(e.g.,Miami,Florida),thedeclineisstillmorethan50percent(usingS&P/Case-ShillerHomePriceIndices).See“AllThreeHomePriceCompositesEnd2011atNewLowsAccordingtotheS&P/Case-ShillerHomePriceIndices,”pressreleaseofS&P/Case-ShillerHomePriceIndices,February28,2012,availableathttp://www.standardandpoors.com/servlet/BlobServer?blobheadername3=MDT-Type&blobcol=urldocumentfile&blobtable=SPComSecureDocument&blobheadervalue2=inline%3B+filename%3Disposition&blobheadervalue1=application%2Fpdf&blobkey=id&blobheadername1=content-type&blobwhere=1245329497678&blobheadervalue3=abinary%3B+charset%3DUTF-8&blobnocache=true(accessedMarch2,2012).12.AccordingtoLawrenceMishelandJoshBivens,“OccupyWallStreetersAreRightaboutSkewedEconomicRewardsintheUnitedStates,”EconomicPolicyInstituteBriefingPaperno.331,availableathttp://www.epi.org/files/2011/BriefingPaper331.pdf(accessedFebruary10,2012).Someotherstudiesgiveslightlydifferentnumbers—all,though,showcorrespondinglyhighratiosofCEOpaytothatofthemedianworker.13.Figuresarefrom1983.SeePikettyandSaez,citedinn.2,above.Therearesomeproblemsinestimatingchangesinincomeshareoverlongperiodsoftime.Priorto1986,thankstotherelativelylowcorporateincometaxrate,itpaidsomehigh-incomeindividualstosheltertheirincomeinsideacorporation,because219 itallowedthedeferralofpayingthehighindividualincometaxratessolongasmoneyremainedwithinthecorporation.Thischangedin1986,leadingtohigherincomesreportedonindividuals’owntaxreturns.Whilethisexplainsasubstantialportionoftheincreaseinreportedincomesaround1986,lookingbeyondthisperiod—1988onward—itisclearthattherehavebeenhugeincreasesintheshareofincomegoingtothetop.SeeJonBakijaetal.,“JobsandIncomeGrowthofTopEarnersandtheCausesofChangingIncomeInequality:EvidencefromU.S.TaxReturnData;”RogerGordonandJoelSlemrod,“Are‘Real’ResponsestoTaxesSimplyIncomeShiftingbetweenCorporateandPersonalTaxBases?,”inDoesAtlasShrug?TheEconomicConsequencesofTaxingtheRich,ed.JoelSlemrod(Cambridge:HarvardUniversityPress,2000);andJoelSlemrod,“HighIncomeFamiliesandtheTaxChangesofthe1980s:TheAnatomyofBehavioralResponse,”inEmpiricalFoundationsofHouseholdTaxation,ed.MartinFeldsteinandJamesPoterba(Chicago:UniversityofChicagoPress,1996).Itisimportanttonotethatthecompositionofthe1percent(orthe0.1percent)ischangingovertheyears.It’snotthattheincomeofthosewhowereinthe1percentin2002were65percentricheronaveragein2007.Thereissomemobility—but,aswediscusslaterinthischapter,muchlessthaniswidelyassumed.Thestatisticsaysonlythatthosewhowereinthetopinmorerecentyearsseizedamuchlargerfractionofthenation’seconomicpiethanthosewhowereinthetoppositionstenyearsago,ortwenty-fiveyearsago.14.Whilethoseatthebottomandmiddlehaveseentheirincomefallinthiscentury,thedividebetweentherichandthepoorhasbeengrowingforathirdofacentury.Between1979and2007,theafter-taxincomeforthetop1percentincomeearnersincreased275percent.Forthe21stthrough80thpercentiles,theincreasewasjustbelow40percent.Forthebottom20percent,theincreasewasonly18percent.Thenetresultofthisisthatthe“theshareofhouseholdincomeaftertransfersandfederaltaxesgoingtothehighestincomequintilegrewfrom43percentin1979to53percentin2007”(forthe1percenttheincreasewasfrom8percentto17percent),whereastheshareofafter-taxandtransferincomeforallotherquintilesfell(allbybetween2and3percentagepoints).SeeCBO,“TrendsintheDistributionofHouseholdIncome.”Thethresholdforbelongingtothetop1percentofincomeearnersin2010whencapitalgainsareincluded,accordingtoPikettyandSaez,“IncomeInequalityintheUnitedStates,1913–1998,”andtherelateddataupdatedonSaez’swebsite,is$352,055.Forthetop0.1percent,thethresholdwas$1,492,175.(Thedatahavenotbeenupdatedpast2010.)Incontrast,themedianhouseholdincomein2010was$49,455(in2010dollars),accordingtocensusdata,tableH-9,citedinn.7,above.Differentstudieshaveusedslightlydifferentcalculationstoassessthecutoffpointforthetop1percent,butthepictureisessentiallythesame.15.Assuminga2,000-hourworkyear,the$1.3millionperyearconvertsintoapproximately$650perhour,orsome80timesgreaterthantheminimumwage.ThefigurescomefromCBO,AverageFederalTaxRatesin2007,June,availableathttp://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/115xx/doc11554/averagefederaltaxrates2007.pdf(accessedFebruary29,2012).Seetable1.Again,differentdatasourcesprovideslightlydifferentnumbers—butthepictureisessentiallythesame.AccordingtoPikettyandSaez,“IncomeInequalityintheUnitedStates,1913–1998,”the“top1percent”(thosewithincomesabove$352,055in2010)hadanaverageincome,includingrealizedcapitalgains,of$1.4millionin2007(droppingto$1.0millionin2010).16.SeeCBO,AverageFederalTaxRatesin2007.Table1reportstheaverageafter-taxincomeofthehighestquintileas$198,300,whereasthesumoftheafter-taxincomeaveragesoftheotherquintilesis$77,700+$55,300+$38,000+$17,700=$188,700.17.Povertywasreducedby40percent.Usingthenationalpovertystandard,thepercentageinpovertyfellfromalmost36percentin2003to21percentin2009.Alsoreducedwastheincomeshareofthetop10percent,from46.7percentto42.5percentbetween2001and2009.Seehttp://www.unicef.org/infobycountry/brazil_statistics.html#0;http://web.worldbank.org/wbsite/external/countries/lacext/brazilextn/0,menuPK:322367~pagePK:1411WorldBankDevelopmentIndicators:http://data.worldbank.org/indicator.18.From2004to2010,theBrazilianeconomyexpandedatanaveragerateof4.4percentperyear;iftheglobalrecessionyearof2009isexcluded,theaverageisnearly5.3percent,muchhigherthanitwas,say,from1985to1994.SeeWorldBankIndicators,availableathttp://data.worldbank.org/indicator/ny.gdp.mktp.kd.zg?page=2(accessedMarch5,2012).19.Growthinthepastthirtyyears(1981–2011)wasnotasstrongasintheprecedingthirtyyears(anaverageannualgrowthof2.8percentversus3.6percent).FederalReserveBankofStLouis,RealGrossDomesticProductgrowthrate,availableathttp://research.stlouisfed.org/fred2/series/GDPC1/downloaddata?cid=106.20.From1992to2000,thelowestquintilegrewat2.6percent,fasterthananyoftheotherquintilesexceptthetopfifth,whichgrewat3.5percent.U.S.CensusBureau,citedbyAlanB.Krueger,“TheRiseandConsequencesofInequalityintheUnitedStates,”addressdeliveredattheCenterforAmericanProgress,January12,2012.21.There’sbeenredistributionawayfromthebottomandmiddle,andalmostallofwhat’sbeenredistributedhasgonetotheverytop,thetop1percent.Thisisadirectcorollaryofthefactthatincomesatthebottomandinthemiddlehavebeenfalling,whilethoseattheverytophavebeenrising.CBO,“TrendsintheDistributionofHouseholdIncome.”220 22.SeealsoKrueger,“TheRiseandConsequencesofInequality.”23.SeeNationalCenterforEducationStatistics,“FastFacts,”onthequestion“Whatistheaverageincomeforyoungadults?,”availableathttp://nces.ed.gov/fastfacts/display.asp?id=77.24.Basedonmedianincomeforhouseholdswithahouseholderwhoisatleast25andhasabachelor’sdegreeormore.SeeCensusHouseholdIncomeHistoricalTableH-13,“TableH-13.EducationalAttainmentofHouseholder—HouseholdswithHouseholder25YearsOldandOverbyMedianandMeanIncome:1991to2010,”availableathttp://www.census.gov/hhes/www/income/data/historical/household/(accessedMarch1,2012).Medianincomesforcollege-educatedwomenoverthesametimeperiodhavebeenflatandaretodayattwo-thirdsthelevelofmaleearnings.SeeU.S.CensusBureau,HistoricalIncomeTableP-16,availableathttp://www.census.gov/hhes/www/income/data/historical/people/.25.AsPaulKrugmanhaspointedout,“almosttwo-thirdsoftherisingshareofthetoppercentileinincomeactuallywenttothetop0.1percent…whosawtheirrealincomesrisemorethan400percent”from1979to2005.“Oligarchy,AmericanStyle,”NewYorkTimes,November4,2011,availableathttp://www.nytimes.com/2011/11/04/opinion/oligarchy-american-style.html(accessedMarch1,2012).AccordingtodatafromPikettyandSaez,“IncomeInequalityintheUnitedStates,1913–1998,”andSaez’swebsite,citedinn.2,above,theincomeofthetop0.1percentin1979accountedforjust3.44percentofthetotalincome,butby2005itssharehadmorethantripled,to10.98percent.Bakijaetal.,“JobsandIncomeGrowthofTopEarners,”reportthattheincreaseofthetop0.1percentinpretaxincomesharewasfrom2.2percentto8percentfrom1981to2006.Otherdataseriesgiveslightlydifferentnumbers,butcorroboratetheenormousincreaseintheshareofthetop0.1percent.26.Thatis,householdincomeconsistsofwagesandsalariesandreturnsoncapital.Thereisathirddeterminant,whichwewilldiscusslaterinthechapter—governmentcanaugmentincomes(throughtransferprograms)ordiminishthem(throughtaxes).Aswenotebelow,governmentprogramshavebecomelessprogressive,thatis,takenlessfromthetopandgivenlesstothebottom.27.Moreprecisely,overtheperiod1979–2006,thetop1percentsawwagesgrowby144percent;thetop0.1percent,by324percent.Eventhetop1percentgetsmorethan20timesthatofthebottom90percent.LawrenceMishel,JaredBernstein,andHeidiShierholz,TheStateofWorkingAmerica2008/2009(Ithaca,NY:ILRPress,animprintofCornellUniversityPress,2009),table3.10,citedinMishelandBiven,“OccupyWallStreetersAreRight.”28.Whenthenumberswerealreadylarge—125to1and131to1,respectively.FromMishelandBivens,“OccupyWallStreetersAreRight,”basedonanalysisofEdwardWolff,unpublishedanalysisoftheU.S.FederalReserveBoard,SurveyofConsumerFinancesandFederalReserveFlowofFunds,preparedfortheEconomicPolicyInstitute,inSylviaAllegretto,TheStateofWorkingAmerica’sWealth,2011:ThroughVolatilityandTurmoiltheGapWidens,EconomicPolicyInstituteBriefPaper292(Washington,D.C.:EPI,2010).29.MishelandBiven,“OccupyWallStreetersAreRight,”basedondatafromCBO,p.8.Thisiswhythedataonincomeinequalityshowsomuchmoreinequalitythanthedatafocusingjustonwageandearningsinequality.30.From1979to2007.MishelandBiven,“OccupyWallStreetersAreRight,”p.9,EPIanalysisofdatafromtheCBOcollectionofdataoneffectivefederaltaxes.31.“SixWal-MartHeirsAreWealthierThanU.S.EntireBottom30%,”LosAngelesTimes,December9,2011,citinganalysisdonebytheUC-BerkeleyeconomistSylviaAllegretto,availableathttp://latimesblogs.latimes.com/money_co/2011/12/six-walmart-heirs-wealthier-than-bottom-30-percent.html(accessedJanuary25,2011).32.LarryKatzofHarvardhaspopularizedtheterminanumberofpaperswrittenwithcoauthors(andcitedinthenextchapter).SeeDavidH.Autor,LawrenceF.Katz,andMelissaS.Kearney,“ThePolarizationoftheLaborMarket,”AmericanEconomicReview96,no.2(May2006):189–94;andClaudiaGoldinandLawrenceF.Katz,“Long-RunChangesintheWageStructure:Narrowing,Widening,Polarizing,”BrookingsPapersonEconoicActivity2(2007):135–64,andthereferencescitedthere.Autor,Katz,andKearneyciteMaartenGoosandAlanManning,“LousyandLovelyJobs:TheRisingPolarizationofWorkinBritain,”LondonSchoolofEconomics,CenterforEconomicPerformanceDiscussionPapers:No.DP0604,2003,asthefirstsourceoftheterm“polarization.”33.Onewayofsayingthisnumericallyisthefollowing:theratiooftheincomeofthoseatthetop(say,atthe95thpercentile,i.e.,only5percentofthepopulationhasahigherincome)tothoseinthemiddlehasincreased,whiletheratiooftheincomeofthoseinthemiddletothoseatthebottom(say,atthe20thpercentile)hasnotchanged.DatafromPikettyandSaez,“IncomeInequalityintheUnitedStates,1913–1998,”toU.S.CensusHistoricalTables(H-9andH-1),showsthattheratioofthe95thpercentilehouseholdstothemedianin1980was2.6;theratioofthemedianincomehouseholdstothe20thpercentilewas2.4.In2010,theratioofthe95thpercentileincometothemedianincomewas3.0;theratioofthemedianincometothe20thpercentileincomewasstill2.4.34.Anotherwayofseeingtheeviscerationofthemiddleclassisthatthefractionofthosewithincomesthatareclosetothemiddle—withinarangethatgoesfrom50percentgreaterthanthemedianto50percentlessthanthemedian—hasfallensince1970fromjustover50percenttojustover42percent.Krueger,“TheRiseandConsequencesofInequality,”citingCouncilofEconomicAdvisercalculationsbasedontheCurrentPopulationSurvey.35.BureauofLaborStatistics,EmploymentSituationSummary,November2011,availableathttp://www.bls.gov/news.release/empsit.nr0.htm.221 36.Foranexcellenttellingofsomeofthesestories,seePeterGoodman,PastDue:TheEndofEasyMoneyandtheRenewaloftheAmericanEconomy(NewYork:TimesBooks,2009).SeealsoLisaA.Goodman,LeonardSaxe,andMaryHarvey,“HomelessnessasPsychologicalTrauma:BroadeningPerspectives,”AmericanPsychologist46,no.11(November1991):1219–25.37.SeeU.S.CensusBureau,“Income,Poverty,andHealthInsuranceCoverageintheUnitedStates:2010,”issuedSeptember2011,P60-239.38.Himmelsteinetal.“conservatively”estimatethat“62.1%ofallbankruptciesin2007weremedical,”thatis,hadimportantmedicalfactorsasacontributor.Furthermore,“mostmedicaldebtorswerewelleducated,ownedhomes,andhadmiddle-classoccupations.Threequartershadhealthinsurance.Usingidenticaldefinitions,between2001and2007,theshareofbankruptciesattributabletomedicalproblemsroseby49.6%.”D.Himmelstein,D.Thorne,E.Warren,andS.Woolhandler,“MedicalBankruptcyintheUnitedStates,2007:ResultsofaNationalStudy,”AmericanJournalofMedicine122,no.8(2009):741–46.Intermsofgettingatamorecausalmeasure,i.e.,estimatingthedirecteffectofahealthshockonthedecisionofwhetherornottodeclarebankruptcy,GrossandNotowidigdofind“thatout-of-pocketmedicalcostsarepivotalinroughly26percentofpersonalbankruptciesamonglow-incomehouseholds.”TalGrossandMatthewJ.Notowidigdo,“HealthInsuranceandtheConsumerBankruptcyDecision:EvidencefromExpansionsofMedicaid,”JournalofPublicEconomics95,nos.7–8(2011):767–78.39.WashingtonStateChildCareResourceandReferralNetwork,2010datareports.Averagestatewidecostforonepreschoolerandonetoddler.Assumeschildrenareinfull-time,full-yearcentercare.Availableathttp://www.childcarenet.org/partners/data(accessedFebruary2,2012).40.BureauofLaborStatistics,EmploymentSituation,availableathttp://www.bls.gov/news.release/empsit.toc.htm(accessedFebruary2,2012).41.See,e.g.,StephanePallage,LyleScruggs,andChristianZimmermann,“UnemploymentInsuranceGenerosity:ATrans-AtlanticComparison,”IZADiscussionPapers3869,InstitutefortheStudyofLabor(IZA),2008.42.Mostrecently,beforethisbookwenttopress,inFebruary2012.43.ACongressionalResearchServicereportnotesthat2millionofthe14.4millionunemployedinJune2011wereunemployedformorethan99weeks.G.Mayer,“TheTrendinLong-TermUnemploymentandCharacteristicsofWorkersUnemployedforMoreThan99Weeks,”September12,2011,availableathttp://big.assets.huffingtonpost.com/crsreport.pdf.TheBLSreportsthat9percentofthe2010unemployedhadreachedadurationof99weeksofunemployment.SeeR.Ilg,“HowLongbeforetheUnemployedFindJobsorQuitLooking?,”BureauofLaborStatistics,May2011,availableathttp://www.bls.gov/opub/ils/summary_11_01/unemployed_jobs_quit.htm.44.AsofOctober2011.InDecember2007,thatratiowas1.8;atthepeakoftheGreatRecession,itreached6.1.BureauofLaborStatistics,“JobOpeningsandLaborTurnoverSurvey—October2011,”December13,2011,availableathttp://www.bls.gov/web/jolts/jlt_labstatgraphs.pdf.45.Somepoliticians,andafeweconomists,worriedthatunemploymentinsurancewoulddiscouragesearch.Butmoresearchwouldhavejustmeantlongerlines,notmoreemployment.46.MichaelCooperandAllisonKopicki,“JoblessGoWithout,ButStayHopeful,PollFinds,”NewYorkTimes,October27,2011,pp.A1,A16.47.Forthose45to54,theaveragedurationofunemploymentinJanuary2012was43weeks,forthose55to64,theaveragealreadyexceedsayear,atalmost57weeks.SeeHouseholdDataTableA-6fromtheBureauofLaborStatistics,“UnemployedPersonsbyAge,Sex,Race,HispanicorLatinoEthnicity,MaritalStatus,andDurationofUnemployment,”January2012,availableathttp://www.bls.gov/web/empsit/cpseea36.pdf(accessedMarch6,2012).48.See,e.g.,StevenJ.DavisandTillvonWachter,“RecessionsandtheCostsofJobLoss,”November2011,preparedfortheBrookingsPapersonEconomicActivity,availableathttp://www.columbia.edu/~vw2112/papers//Recessions_and_the_Costs_of_Job_Loss_23_November_2011.pd(accessedMarch5,2012).SeealsoP.Oreopoulos,T.vonWachter,andA.Heisz,“TheShort-andLong-TermCareerEffectsofGraduatinginaRecession:HysteresisandHeterogeneityintheMarketforCollegeGraduates,”NBERWorkingPaper,no.12159(2006);orL.Kahn,“TheLong-TermLaborMarketConsequencesofGraduatingfromCollegeinaBadEconomy,”LabourEconomics12,no.2(April2010):303–16.49.ApointexplainedinDomenicoDelliGatti,MauroGallegati,BruceC.Green-wald,AlbertoRusso,andJosephE.Stiglitz,“SectoralImbalancesandLongRunCrises,”proceedingsoftheBeijing2012WorldCongressoftheInternationalEconomicAssociation.50.Oneinfourmortgageowners,some14millionAmericans,areunderwater,foranetnegativeequitytotalof$700billion.M.Zandi,“ToShoreUptheRecovery,HelpHousing,”SpecialReport,Moody’sAnalytics,May25,2011.51.Thosereceivingmortgagesbetween2004and2008wereparticularlyhardhit;ofthosereceivingloansinthisperiod,2.7millionhouseholdshavealreadybeenforeclosedupon,andanother3.6millionareatseriousrisk.D.GruensteinBocian,W.Li,andC.Reid,“LostGround,2011:DisparitiesinMortgageLendingandForeclosures,”CenterforResponsibleLending,November2011,availableathttp://www.responsiblelending.org/mortgage-lending/research-analysis/Lost-Ground-2011.pdf.52.Zandi,“ToShoreUptheRecovery.”53.PewResearchCenter,“WealthGapsRisetoRecordHighsbetweenWhites,Blacks,HispanicsTwenty-to-One”(2011),availableat222 http://www.pewsocialtrends.org/2011/07/26/wealth-gaps-rise-to-record-highs-between-whites-blacks-hispanics/.54.WorldBank,LifeExpectancyatBirth(years),availableathttp://data.worldbank.org/indicator/SP.DYN.LE00.IN?order=wbapi_data_value_2009+wbapi_data_value+wbapi_data_value-last&sort=desc.55.AccordingtotheWorldBank,theUnitedStates’mortalityrateforunder-5’sin2010was8per1000.Thisplacesit45thintheworldonthismetric,worse,e.g.,thanCuba(6),Belarus(6),Lithuania(7),andtheUnitedArabEmirates(7).InIcelandtherateisfourtimesbetter(at2).Dataavailableathttp://data.worldbank.org/indicator/SH.DYN.MORT?order=wbapi_data_value_2010+wbapi_data_value+wbapi_data_value-last&sort=asc.ThepicturesformaternalmortalityratiodatafromtheWorldBankaresimilar,where,e.g.,theperformanceofGermanyisthreetimesbetterthanthatoftheUnitedStates.56.In2002thebottomdecile’slifeexpectancywas73.2,asopposedto79.8forthetop.Thegapbetweenthetopandthebottomhasactuallybeengrowing.In1982thehighestdecilehadanexpectedlifeof76.3comparedwith71.0forthelowestdecile.(Somemeasuresofinequalityinhealth,however,suchastheGinicoefficient,doshowanimprovement.)S.Peltzman,“MortalityInequality,”JournalofEconomicPerspectives23,no.4(Fall2009):175–90.Inequalitiesinhealtharelong-standingandwidespread.AsreportedinDavidCutler,AngusDeaton,andAdrianaLleras-Muney,“TheDeterminantsofMortality,”JournalofEconomicPerspectives20,no.3(Summer2006):97–20,“Americansinthebottom5percentoftheincomedistributionin1980hadalife-expectancyatallagesthatwasabout25percentlowerthanthecorrespondinglife-expectanciesofthoseinthetop5percentoftheincomedistribution(Rogot,Sorlie,JohnsonandSchmitt,1992)”(p.98).Theycontinue(p.99),“Americanblackshadalifeexpectancyin2002thatwas5.4yearslessthanthatofAmericanwhites.InEnglandandWalesin1997–2001,malemanualworkerscouldexpecttolive8.4yearslessthanprofessionals,agapthathasincreasedsincetheearly1970s.”57.Some5.9millionaged25to34werelivingathome,up14percentfromaprerecessionfigureof4.7million.See“America’sFamiliesandLivingArrangements:2011,”aseriesoftablesfromthe2011CurrentPopulationSurvey.K.Newman,TheAccordionFamily(Boston:BeaconPress,2012),reportsthatthereisahigherproportionofU.S.parentslivingwithchildrenthanatanyothertimesincethe1950s.58.CarolMorello,“MarriedCouplesataRecordLow,”WashingtonPost,December14,2011,citingdataprovidedbyRoseKreider,aCensusBureaudemographer.Thetrend,ofcourse,waspresentbeforetherecession,butthemagnitudeofthechangewasdramatic,andhadmuchtodowiththerecession.Thetotalnumberofcoupleslivingtogetherwithoutbeingmarriedwas7.5millionin2010.Inmanypoorercountries,lackofeconomicresourcesisabarriertomarriageorleadstomarriagelaterinlife;insomeways,Americanmoresarefollowingthesamepattern.59.Partoftheproblemisthatindividualswithoutahistoryofviolentcrimecanbegivenlongprisontermsforpossessionofdrugs.Butpartoftheproblemreflectshighlevelsofviolence.Butthepatternofincarcerationsuggeststhatothersocialforces(includingdiscrimination)areatplay.SeeRobertPerkinson,TexasTough(NewYork:MetropolitanBooks,2010)andMichelleAlexander,TheNewJimCrow(NewYork:NewPress,2010).60.FBI,“CrimeintheUS,1991–2010,”UniformCrimeReports,availableathttp://www.fbi.gov/about-us/cjis/ucr/crime-in-the-u.s/2010/crime-in-the-u.s.-2010/tables/10tbl01.xls.Homicidesrosesharplyinthe1970s,topeakat10.2per100,000in1980,fallingslightlyinthemid-1980sbeforerisingagainto9.8per100,000in1991andfallingoffsince.In2010theratewas4.8per100,000.U.S.DepartmentofJustice,HomicideTrendsintheUnitedStates,1980–2008,November2011.Theviolent-crimeratereacheditshighestlevelof758per100,000peoplein1991(thedatacover1960–2010).By2009thatratewasdownto429.FBI,UniformCrimeReportsaspreparedbytheNationalArchiveofCriminalJusticeData,availableatUCRdatatool,http://www.ucrdatatool.gov/index.cfm(accessedJanuary1,2012).61.TheratesofincarcerationandsupervisionarefromL.Glaze,CorrectionalPopulationsintheUnitedStates,2010,UnitedStatesBureauofJusticeStatistics,NCJ231681,2011.Accordingtothesamereport,thetotalnumberundercorrectionalsupervisionasof2010isevenlarger—morethansevenmillion.InternationalcomparisonsarefromtheInternationalCentreforPrisonStudies,availableathttp://www.prisonstudies.org/info/worldbrief/wpb_stats.php?area=all&category=wb_poprate,accordingtowhichtheworld’snexthighestincarcerationratesareRwanda,atabout595,andRussia,witharateof542.Formorewithin-U.S.cross-statecomparisons,seealsoPewCenterontheStates,2008,Onein100:BehindBarsinAmerica2008,availableathttp://www.pewcenteronthestates.org/uploadedFiles/One%20in%20100.pdf.62.Between1987and2007theratioof(generalfund)spendingoncorrectionstothatonhighereducationincreasedacrossallstatesexcepttwo.InNewYorkthatratioincreasedby0.61.Oregonspendsa$1.06oncorrectionsforeverydollarofspendingonhighereducation;Michigan,$1.19.PewCenterontheStates,Onein100:BehindBarsinAmerica2008,availableathttp://www.pewcenteronthestates.org/uploadedFiles/8015PCTS_Prison08_FINAL_2-1-1_FORWEB.pdf.63.ThatGDPgivesamisleadingimpressionoftheeconomy’shealthisthemainmessageoftheCommissionontheMeasurementofEconomicPerformanceandSocialProgress.Jean-PaulFitoussi,AmartyaSen,andJosephE.Stiglitz,withJ.223 FitoussiandA.Sen,MismeasuringOurLives:WhyGDPDoesn’tAddUp(NewYork:NewPress,2010),alsoavailableathttp://www.stiglitz-sen-fitoussi.fr/en/index.htm(accessedMarch1,2012).64.America’sprisonpopulationisabout2.27million,accordingtotheDepartmentofJustice.See“CorrectionalPopulationintheUnitedStates,2010,”U.S.DepartmentofJustice,BureauofJusticeStatistics,December2011,NCJ236319,availableathttp://bjs.ojp.usdoj.gov/content/pub/pdf/cpus10.pdf(accessedMarch1,2012).Ifthatpopulation,whichisnotemployed,wasaddedtotheJanuary2012civilianlaborforceof154.40millionandtothose12.76millioncurrentlycountedasunemployed,itwouldincreasetheunemploymentratefrom8.3percentto9.5percent.UnemploymentfiguresarefromtheBureauofLaborStatistics’“UnemploymentSituationReport—January2012,availableathttp://www.bls.gov/news.release/pdf/empsit.pdf(accessedMarch1,2012).Onestudy,writtenin1999,whentheprisonpopulationwassomewhatlower,showedthattheunemploymentratemightbeasmuchas2percenthigherifprisonpopulationswereincludedinthecount.See,e.g.,BruceWesternandKatherineBeckett,“HowUnregulatedIstheU.S.LaborMarket?ThePenalSystemasaLaborMarketInstitution,”AmericanJournalofSociology104,no.4(January1999):1030–60.Incarcerationitself,however,maycontributetohigherunemploymentratesamongthenonimprisonedpopulation,because,aswenoteinchapter3,thosewhohavebeenincarceratedhavemuchpoorerjobprospects,andthisisespeciallytrueforAfricanAmericans.65.Federalpovertythresholdsweredevelopedinthemid-1960sbyMollieOrshanskyattheSocialSecurityAdministration.Onthebasisofsurveyworkthatindicatedthathouseholdsatthetimespentroughlyathirdoftheirincomeonfood,thepovertylinewascalculatedasthreetimesthecostoftheUSDA’seconomyfoodplan.ThethresholdsareusedbytheCensusBureauandareannuallyupdatedforinflation.Thefederalpovertyguidelinesareanadministrativetool(issuedbytheDepartmentofHealthandHumanServices)andhavebeeninstitutionalizedinavarietyofimportantwelfareprograms.Themeasuresobviouslyhaveproblems(asOrshanskyherselfhasnoted),notablythatthecostoffoodrelativeto,e.g.,housingandhealthcarehaschangeddramatically.In2011thepovertylevelforafamilyoffourwas$22,350.TheU.S.DepartmentofHealthandHumanServicesPovertyGuidelines,availableathttp://aspe.hhs.gov/poverty/11poverty.shtml.66.H.LukeShaeferandKathrynEdin,“ExtremePovertyintheUnitedStates,1996to2011,”NationalPovertyCenterPolicyBriefno.28,February2012,availableathttp://npc.umich.edu/publications/policy_briefs/brief28/policybrief28.pdf(accessedMarch1,2012).Thenumbersincreasedfrom636,000to1.46million.Familiesspentatleastonemonthintheyearinextremepoverty.Thestudyincludesonlycashincome,andthusdoesnotincludein-kindbenefits.Still,onlyoneinfivereceivedrentvouchersorlivedinpublichousing.Evenifthehouseholdspentnothingonfoodormedicalcare,justobtaininghousingforafamilyofthreeat$180amonth—andhavingnothingleftoverforanythingelse—isanear-impossibility.67.SeeOECDFactbook2011–2012:Economic,EnvironmentalandSocialStatistics,availableonlineathttp://www.oecd-ilibrary.org/(accessedMarch5,2012).68.Some46.3millionareonfoodstampsasoffall2011,yet14.5percentofAmericansstillfacefoodinsecurity.See“SupplementalNutritionAssistanceProgram:NumberofPersonsParticipating,”dataprovidedbytheU.S.DepartmentofAgriculture,availableathttp://www.fns.usda.gov/pd/29snapcurrpp.htm(accessedMarch1,2012),and“FoodSecurityintheUnitedStates:KeyStatisticsandGraphics,”U.S.DepartmentofAgriculture,availableathttp://www.ers.usda.gov/briefing/foodsecurity/stats_graphs.htm(accessedMarch1,2012).Foodinsecurityismeasuredasfollows:“Attimesduringtheyear,thesehouseholdswereuncertainofhaving,orunabletoacquire,enoughfoodtomeettheneedsofalltheirmembersbecausetheyhadinsufficientmoneyorotherresourcesforfood.”69.Underthenewmeasure,thenumbersinpovertyincreasedfromfrom43.6millionin2009to46.2millionin2010,andthenumbersinpovertyunderthenewmeasurewereactuallyhigherthanundertheold.Thepovertythresholdlevelin2010was$17,568forasinglemotherwithtwochildren.Asthediscussionearlierinthechaptershouldhavemadeclear,livinginmostofourcities,providingchildcare,food,shelter,andclothingforthatamount—leavingalittlefortheamenitiesofamodernlife—ishardtoimagine.Foodstampseasetheburden,givingthefamilyamaximumof$526amonth,or$6perdayperperson.SeeU.S.Census,“TheResearchSupplementalPovertyMeasure:2010,”November2011.Thisdiscussionhasnotemphasizedenoughthemanydimensionsofpoverty.WhenIwaschiefeconomistoftheWorldBank,weconductedasurveyof10,000people,toassesswhataspectsoftheirlifemostweighedthemdown.Thelackofincomewasobvious.Butrepeatedly,theyemphasizedinsecurityandthelackofvoice,theirinabilitytoshapethedecisionsthataffectedtheirlives.DeepaNarayanetal.,CanAnyoneHearUs?VoicesofthePoor(NewYork:PublishedbyOxfordUniversityPressfortheWorldBank,2000);andWorldBank,WorldDevelopmentReport2000–2001:AttackingPoverty(NewYork:OxfordUniversityPress,2000–01).70.Ofthe46.2millionpeoplelivingbelowthepovertyline,only3.5millionareaged65andover,some7.6percentofthoseinpoverty.Inthegeneralpopulation,peopleaged65andovercomposesome13percent.Thereductioninold-agepovertyisduemainlytoSocialSecurity.AccordingtotheCensusBureau,“In2010,thenumberofpeopleaged65andolderinpovertywouldbehigherbyalmost14millionifsocialsecuritypaymentswereexcludedfrommoneyincome,quintuplingthenumberofelderlypeopleinpoverty”(p.22).U.S.CensusBureau,“Income,Poverty,andHealthInsuranceCoverageintheUnitedStates:2010,”issuedin224 September,andU.S.Census,“TheResearchSupplementalPovertyMeasure:2010,”November2011.71.SeeU.S.Census2011,“ChildPovertyintheUnitedStates2009and2010:SelectedRaceGroupsandHispanicOrigin,”availableathttp://www.census.gov/prod/2011pubs/acsbr10-05.pdf(accessedMarch6,2012).Forsomegroupstherateismuchhigher:nearly40percentofAfricanAmericanchildrenlivedinpovertyin2010.72.KatharineBradbury(p.26)concludes,onthebasisofthedatafromthePanelStudyofIncomeDynamics,thata“varietyofmeasuresindicatethatU.S.familyincomemobilityhasdecreasedoverthe1969–2006timespan,andespeciallysincethe1980s.”K.Bradbury,“TrendsinU.S.FamilyIncomeMobility,1969–2006,”FederalReserveBankofBoston,WorkingPapers,no.11-10,2011,availableathttp://www.bos.frb.org/economic/wp/wp2011/wp1110.pdf.73.“DoesAmericaPromoteMobilityAsWellAsOtherNations?,”EconomicMobilityProjectofthePewCharitableTrusts(November2011),p.2,availableathttp://www.economicmobility.org/assets/pdfs/CRITA_FINAL.pdf(accessedMarch26,2012).74.E.g.,MarkHuggett,GustavoVentura,andAmirYaron,“SourcesofLifetimeInequality,”AmericanEconomicReview101,no.7(December2011):2923–54,showthat“differencesininitialconditionsaccountformoreofthevariationinlifetimeearnings,lifetimewealth,andlifetimeutilitythandodifferencesinshocksreceivedovertheworkinglifetime.”Therelationshipbetweenparents’incomeandthatoftheirchildrenis,infact,verysimilartothatbetweenparents’heightandthatoftheirchildren.AlanKrueger,chairmanofPresidentObama’sCouncilofEconomicAdvisersandadistinguishedPrince-tonUniversityprofessor,haspointedout,“Thechanceofapersonwhowasborntoafamilyinthebottom10percentoftheincomedistributionrisingtothetop10percentasanadultisaboutthesameasthechancethatadadwhois5’6”tallhavingasonwhogrowsuptobeover6’1”tall.Ithappens,butnotoften.”Krueger,“TheRiseandConsequencesofInequality.”Thecorrelationbetweenachild’sheightorincomeandthatofhisparentsisaround.5.75.Krueger,“TheRiseandConsequencesofInequality,”referstothissystematicrelationshipbetweeninequalityandastandardmeasureofmobility(theintergenerationalincomeelasticity)astheGreatGatsbyCurve.76.JasonDeParle,“HarderforAmericanstoRisefromLowerRungs,”NewYorkTimes,January4,2012,citingworkbyMarkusJäntti.Inparticular,seeM.Jäntti,B.Bratsberg,K.Røed,O.Raaum,R.Naylor,E.Österbacka,A.Björklund,andTorEriksson,“AmericanExceptionalisminaNewLight:AComparisonofIntergenerationalEarningsMobilityintheNordicCountries,theUnitedKingdomandtheUnitedStates,”IZADiscussionPaperno.1938,2006,availableathttp://users.abo.fi/mjantti/dp1938.pdf.77.Withfullequalityofopportunity,only40percentofthoseinthebottomrungwouldremaininthebottom40percent.NumbersfromDeParle,“HarderforAmericanstoRisefromLowerRungs,”citingworkbyMarkusJänttietal.,“AmericanExceptionalisminaNewLight.”78.Some62percentofthechildrenofthoseinthetopquintilewindupinthetop40percent.DeParle,“HarderforAmericanstoRisefromLowerRungs,”citingJ.B.Isaacs,I.V.Sawhill,andR.Haskins,“GettingAheadorLosingGround:EconomicMobilityinAmerica,”Brookings/PewEconomicMobilityProject,February2008,availableathttp://www.economicmobility.org/assets/pdfs/PEW_EMP_GETTING_AHEAD_FULL.pdf.79.JonathanChait,“NoSuchThingasEqualOpportunity,”NewYork,November7,2011,pp.14–16.80.Some29percentoflow-incomestudentswithhigheighth-gradetestscorescompletecollege,comparedwith30percentofhigh-incomestudentswithloweighth-gradetestscoreswhoearnadegree.81.Some19percentofchildrenborninthelowestincomefifthwhoearnacollegedegreemakeitintothehighestfifth,whereas23percentofchildrenborninhighestgroupwhodon’tgraduateremaininhighestbracket.82.Basedonstandardizedtests.OECDProgrammeforInternationalStudentAssessment(PISA)2009results,especiallytherankingsavailableathttp://www.pisa.oecd.org/dataoecd/54/12/46643496.pdf(accessedMarch2,2012).83.Usingdifferentdefinitionsofwhatmakesa“topschool,”variousstudieshaveprovidedtellingnumbersaboutthelackofeconomicdiversityineliteuniversities.ResearchbyAnthonyP.CarnevaleandStephenJ.Rose,citedbyLawrenceMishel,JaredBernstein,andHeidiShierholzinTheStateofWorkingAmerica2008/2009(Ithaca,NY:ILRPress),showedearlierinthelastdecadethatsome74percentoftop-schoolfreshmanhailedfromfirst-quartilefamilies,whileonly6percentand3percentwerefromthebottomthirdandfourthquartiles,respectively.(Itisalsostrikingthatthereissolittledifferencebetweenthebottomquarterandthenext.Thisispartlybecausethecollegeshavefocusedtheireffortsatrecruitingtheverypoorandminorities.)Otherstudiessupportthistrend;seeforinstanceAlexanderAstinandLeticiaOsequera,“TheDeclining‘Equity’ofHigherEducation,”ReviewofHigherEducation27,no.3(2004):321–41.84.JanetCurrieprovidescompellingevidencethat“childrenborntolesseducatedandminoritymothersaremorelikelytobeexposedtopollutioninutero.”Shestudiedadatasetcontaining11millionbirthsacrossfivestatesbetween1989and2003,combinedwithinformationaboutthelocationofSuperfundsitesandinformationfromEPAToxicReleaseInventory(TRI)facilities.Whereas61percentofblackmotherslivewithin2,000metersofsuchasite,only41percentofwhitemothersdo.Heranalysisleadshertoconclude(p.12),“These225 estimatesstronglysupporttheclaimsoftheenvironmentaljusticeliteraturethatminoritiesandpeopleoflowersocioeconomicstatusaremorelikelytobeexposedtopotentiallyharmfulpollutantsforreasonsthatcannotbeexplainedbytheirbroadgeographicaldistribution,education,orotherobservablecharacteristics.”SeeCurrie,“InequalityatBirth:SomeCausesandConsequences,”AmericanEconomicReview:PapersandProceedings101,no.3(2011):1–22.Earlier,weprovideddatashowingthelargefractionofAmericansthatfaceinsecurityandthelargefractionofchildreninpoverty.Itiswellestablishedthathungerandlackofadequatenutritionimpedelearning.85.See,e.g.,SamuelBowles,StevenN.Durlauf,andKarlaHoff,eds.,PovertyTraps(NewYork:RussellSageFoundation;Princeton:PrincetonUniversityPress,2006).86.PewEconomicMobilityProject,“EconomicMobilityandtheAmericanDream:WhereDoWeStandintheWakeoftheGreatRecession?”Washington,DC:PewCharitableTrusts,2011,availableathttp://www.economicmoility.org/poll2011.87.“CompanieslistedonJapan’sstockexchangespaidtheirchiefexecutivesanaverageof$580,000insalaryandothercompensationlastfiscalyear,PWCestimates,about16timesmorethanthetypicalJapaneseworker.AverageCEOpayatthe3,000largestU.S.companiesis$3.5million,includingstockoptionsandbonuses,accordingtotheCorporateLibrary,aresearchgroup.”J.Clenfield,“InJapan,Underpaid—andLovingIt,”BloombergBusinessweek,2010,availableathttp://www.businessweek.com/magazine/content/10_28/b4186014341924.htm.88.Aswenoted,differentsourcesgiveslightlydifferentnumbers,butallpresentthesamepicture.One(athttp://www.ips-dc.org/reports/executive_excess_2010)reportsCEOpayofmajorU.S.corporationsassome263timesthatoftheincomeoftheaverageworker.Theyreportthat,ininflation-adjustedterms,CEOpayin2009wasnearly8timeshigherthaninthe1970s.Earlier,wepresenteddatafromMishel,Bernstein,andShierholz,TheStateofWorkingAmerica.ThisshowedCEOcompensationtothatofthetypicalworkerforlargefirms,uptenfoldfrom24to1in1965to243toonein2010.WhereasCEOcompensationgrewbyonly0.8precentayearfrom1950to1975,sincethenithasgrownmorethan10percentperyear.SeeC.FrydmanandD.Jenter,“CEOCompensation,”AnnualReviewofFinancialEconomics2,no.1(December2010):75–102.FrydmanandSaksreport“RatioofAverageTop3CompensationtoAverageWorkers”between1970and1979as33.Thatratio(whichshouldbeslightlylowerthanthatoftheCEOcompensationtothatoftheaverageworkers)grewatarateof4.7percentinthe1980s,8.9percentinthe1990s,and6percentbetween2000and2003,risingtoalevelof219(seetable6,p.45).C.FrydmanandR.Saks,“HistoricalTrendsinExecutiveCompensation1936–2003,”workingpaper,November2005,availableathttp://faculty.chicagobooth.edu/workshops/AppliedEcon/archive/pdf/FrydmanSecondPaper.pdf(accessedJanuary27,2012).89.SeeJosephE.Stiglitz,TheRoaringNineties(NewYork:Norton,2003).90.See“ChequeswithBalances:WhyTacklingHighPayIsintheNationalInterest,”finalreportoftheUKHighPayCommission,p.24,availableathttp://highpaycommission.co.uk/wp-content/uploads/2011/11/HPC_final_report_WEB.pdf(accessedMarch1,2012).91.Ibid.,p.21.EventheInstituteofDirectors(theU.K.organizationofCorporateDirectors)suggeststhatsomethingisoutofline.SeeInstituteofDirectorspressrelease,“TheAnswertoHighExecutivePayLieswithShareholdersandBoards,SaysIoD,”October28,2011,availableathttp://press.iod.com/2011/10/28/the-answer-to-high-executive-pay-lies-with-shareholders-says-iod/(accessedMarch6,2012).92.OECD,“DividedWeStand.”AmongOECDcountries,TurkeyandMexicobothhavesubstantiallygreaterinequalityasmeasuredbytheGinicoefficient.Seethediscussionofthismeasurebelow.93.ThesecomparisonsarebasedonGinicoefficientdataprovidedbytheUnitedNationsInternationalHumanDevelopmentIndicators,butarealsosupportedbyotherdatabases.TheGinicoefficientisanimperfectmeasureofinequality,butisusefulforgeneralinternationalcomparisonssuchasthisone.IdiscusssomeofthedifficultiesofcomparingGinidatainsubsequentfootnotesinthischapter.94.SeeUnitedNationsHumanDevelopmentReportstatistics,availableonlineathttp://hdr.undp.org/en/statistics/(accessedMarch6,2012).TheonlycountrywhereinequalityhadalargernegativeeffectonrankingwasColombia.95.SeeWorldBankIndicators,availableathttp://data.worldbank.org/indicator.96.UnitedNationsHumanDevelopmentIndicatorsdatabase,availableathttp://hdrstats.undp.org/en/tables/(accessedMarch6,2012).97.Somecautionmustbeusedinmakingcomparisonsacrosscountries.DatanecessaryforcalculatingtheGinicoefficientaredifficulttocollect,especiallyinpoorcountries.Moreover,inequalityinincomemaynotadequatelycaptureinequalityin“well-being,”especiallyincomparinggovernmentsthatprovidestrongsafetynetsandsystemsofsocialprotection.Moreover,someoftheinequalityinlargercountries(likeChina)mayberelatedtogeography.TherearevarioussourcesfordatacomparingGinicoefficientsacrosscountries,includingtheWorldBank,theUnitedNations,theCIA,andtheGlobalPeaceIndex.Seerespectivelyhttp://data.worldbank.org/indicator/SI.POV.GINI?page=2&order=wbapi_data_value_2009%20wbapi_data_value%20wbapi_data_value-last&sort=asc,http://hdrstats.undp.org/en/indicators/67106.html,https://www.cia.gov/library/publications/the-world-factbook/rankorder/2172rank.html,andhttp://www.visionofhumanity.org/.98.Calculatedbetween1999and2009onthebasisofdatafromtheU.S.Census226 Bureau.SeeHistoricalTableH-4,GiniRatiosforHouseholds,byRaceandHispanicOriginofHouseholder,availableathttp://www.census.gov/hhes/www/income/data/historical/household/index.html.99.SeeUNHumanDevelopmentIndicatorsdatabase.Itshouldbenotedthatdataarequiteincompleteforrecentyears,andthattheUN’scalculationoftheGinicoefficientintheUnitedStatesin2000(40.8)isdifferentfromtheU.S.censuscalculationforthatyear(46.2).Iattempttomakecomparisonsonlywithinonedatasetatatime.100.SeeEurostatdataonEuropeanGinicoefficients,availableathttp://appsso.eurostat.ec.europa.eu/nui/show.do?dataset=ilc_di12&lang=en(accessedMarch5,2012).101.BasedoncomparisonofWorldBankdata,availableathttp://data.worldbank.org/indicator/NY.GDP.PCAP.KD?page=6(accessedFebruary14,2012).TheU.S.GDPpercapitain2010inconstant2000dollarswas$35,527,andin1980itwas$20,004.102.Thereisastandardtheoryineconomicsthatconsumptionshouldreflectdifferencesinlifetime(orpermanent)income.SeeMiltonFriedman,ATheoryoftheConsumptionFunction(Princeton:PrincetonUniversityPress,1957).Thelargeinequalitiesinconsumptionthussuggestlargeinequalitiesinlifetimeincomes.Notethatyear-to-yearvariationsinincomecanstillhavewelfareconsequences,ifcapitalmarketsareimperfect(astheyare)sothatindividualscan’tsmoothconsumption.UsingannualearningsdatafromtheSocialSecurityAdministration,WojciechKopczuk,EmmanuelSaez,andJaeSongfindthat“mostoftheincreaseinthevarianceof(log)annualearningsisduetoincreasesinthevarianceof(log)permanentearningswithmodestincreasesinthevarianceoftransitory(log)earnings.”Thus,infact,theincreaseinearningsinequalityisinpermanentincome.Furthermore,theyfindthatitremainsdifficultforsomeonetomoveuptheearningsdistribution(thoughtheydofindupwardmobilityforwomenintheirlifetime).Seetheir“EarningsInequalityandMobilityintheUnitedStates:EvidencefromSocialSecurityDatasince1937,”QuarterlyJournalofEconomics125,no.1(2010):91–128.Totheextentthatconsumptioninequalitymayhavebeenlessthanincomeinequalitybeforethecrisis,andthatitgrewmoreslowlythandidincomeinequality,itwaspartlybecauseofunbridledborrowing.Withthecollapseofthehousingmarket,theabilitytoconsumebeyondone’sincomehasbeenreduced.Thisprovidesanimportantcritiqueofearlieranalysesofconsumptioninequality,e.g.,DirkKruegerandFabrizioPerri,“DoesIncomeInequalityLeadtoConsumptionInequality?EvidenceandTheory,”ReviewofEconomicStudies73(January2006):163–92.103.In1995,CongressrequestedthatapanelofexpertsfromtheNationalAcademyofSciencesissueareportinvestigatingrevisionstothepovertythreshold.NationalResearchCouncil.MeasuringPoverty:ANewApproach(Washington,DC:TheNationalAcademiesPress,1995).104.TheHeritageFoundationhasrecentlycomplained,“In2005,thetypicalhouseholddefinedaspoorbythegovernmenthadacarandairconditioning.Forentertainment,thehouseholdhadtwocolortelevisions,cableorsatelliteTV,aDVDplayer,andaVCR.Iftherewerechildren,especiallyboys,inthehome,thefamilyhadagamesystem,suchasanXboxorPlayStation.Inthekitchen,thehouseholdhadarefrigerator,anovenandstove,andamicrowave.Otherhouseholdconveniencesincludedaclotheswasher,aclothesdryer,ceilingfans,acordlessphone,andacoffeemaker.”R.RectorandR.Sheffield,2011,“AirConditioning,CableTV,andanXbox:WhatIsPovertyintheUnitedStatesToday?,”July19,2011,availableathttp://www.heritage.org/research/reports/2011/07/what-is-poverty.Ofcourse,sellingtheTV(oroneoftheseotherappliances)wouldnotgofartoprovidefood,medicalcare,housing,oraccesstogoodschools.Thereisanotherimportantarea,exploringtherelationshipbetweenconsumptionandhappiness,goingbackatleasttoVeblen’s(1899)TheoryoftheLeisureClass,whichintroducedtheconceptof“conspicuousconsumption.”Morerecently,RichardWilkinsonandKatePickett,inTheSpiritLevel:WhyGreaterEqualityMakesSocietiesStronger(NewYork:BloomsburyPress,2009),arguethatmoreequalitycanimprovehappinessthroughreducing“socialevaluationanxieties”andassociatedstresses.105.SeeU.S.Census,“TheResearchSupplementalPovertyMeasure:2010,”November2011.106.Aswe’llexplaininchapter3,therearetwosidesofthisargument(bothwrong).Thefirstisthattaxingthetopathigherrateswillreducetheirincentivestoworkandsave,somuchthattaxrevenuesmayevenfall;thesecondisthathelpingthepoorwilljustbreedmorepoverty—inducingthoseatthebottomnottowork.107.MittRomneyontheTodayShow,January11,2012,“Ithinkit’sfinetotalkaboutthosethingsinquietrooms….It’saveryenvy-oriented…approachandIthinkit’llfail.”Availableathttp://blogs.chicagotribune.com/news_columnists_ezorn/2012/01/shhhhh.html(accessedJanuary25,2012).ChapterTwoRENTSEEKINGANDTHEMAKINGOFANUNEQUALSOCIETY1.That’soneofthereasonsthatgoodstockmarketperformanceisnolongeragoodindicatorofahealthyeconomy.StockscandowellbecausewagesarelowandtheFed,worriedabouttheeconomy,keepsinterestratesatnearzero.227 2.Thucydides,ThePeloponnesianWar,trans.RichardCrawley(NewYork:ModernLibrary,1951),p.331(book5.89).3.That’swhythecaseswherethoseinpowervoluntarilygivesomeofituparesointeresting.Insomeofthem,it’sbecausethoseinpowerhaveanunderstandingoftheirownlong-terminterests—andthelong-terminterestsofthosetheyaresupposedtoserve.Thatwasthecase,e.g.,whenthekingofBhutan,in2007,insistedonconvertinghiscountryintoaconstitutionalmonarchy.Hehadtopersuadehiscitizensthatthatwastherightcourseforthem.Theelitesofnineteenth-centurycountriesthatextendededucationmusthaveknownthattherewasariskthatthiswouldoverthelongrunweakentheirdominanceofthepoliticalfranchise;yettheshort-termeconomicadvantagesofhavingamoreeducatedworkplaceseemtohavedominatedthelong-termpoliticalconsequences.SeeFrançoisBourguignonandSébastienDessus,“EquityandDevelopment:PoliticalEconomyConsiderations,”pt.1ofNoGrowthwithoutEquity?,”ed.SantiagoLevyandMichaelWalton(NewYork:PalgraveMacmillan,2009).DaronAcemogluandJamesRobinsontheorizethatdemocratizationisawayforrulingelitestocommittofutureredistribution,andthusavoidtheextremeofrevolutionwhenfacedwithsocialunrest.Ifthereisnotsufficientstrengthintherebellion,repressionortemporaryreform(ortransfers)mightsuffice.AcemogluandRobinson,EconomicOriginsofDictatorshipandDemocracy(Cambridge:CambridgeUniversityPress,2006).4.SeeKarlPolyani,TheGreatTransformation(NewYork:Rinehart,1944).OneofthetheoriesdevelopedinresponsetoMarxwasthatofNassauSenior,thefirstholderoftheDrummondChairatOxfordUniversity,whoarguedthatthereturncapitalistsearnedwascompensationfortheir“abstinence”(i.e.,saving,ornotconsuming).5.Theformalizationofthisideaiscalledthe“firstwelfaretheoremofeconomics.”Itassertsthatundercertainconditions—whenmarketsworkwell—noonecanbemadebetter-offwithoutmakingsomeoneelseworse-off.But,asweshallexplainshortly,therearemanyinstancesinwhichmarketsdonotworkwell.ArecentpopularanalysisisKaushikBasu,BeyondtheInvisibleHand:GroundworkforaNewEconomics(Princeton:PrincetonUniversityPress,2011).Basuusesthemetaphorofamagicshowtodescribethewaythediscussionofeconomicsonthepoliticalrightdrawsattentiontotheconclusionofthistheorem—thatmarketsareefficient—andawayfromtheveryspecialandunrealisticconditionsunderwhichtheconclusionholds—perfectmarkets.Likeagoodmagician,afree-marketeconomistsucceedsbydrawingspectators’attentiontowhathewantsthemtosee—therabbitjumpingoutofthehat—whiledistractingtheirattentionfromotherthings—howtherabbitgotintothehatinthefirstplace.6.AdamSmith,TheWealthofNations(1776;NewYork:P.F.Collier,1902),p.207.7.SeeCarmenReinhartandKennethRogoff,ThisTimeIsDifferent:EightCenturiesofFinancialFolly(Princeton:PrincetonUniversityPress,2009).8.Aderivativeisjustafinancialinstrumentthereturntowhichisderivedonthebasisofsomethingelse,e.g.,theperformanceofastockorthepriceofoilorthevalueofabond.Afewbankshaveprofitedenormouslybykeepingthismarketnontransparent,garneringforthemselvesanamountwidelyestimatedatmorethan$20billionayear.9.OnOctober31,2011,MFGlobalHoldings,abrokeragefirmrunbyJonCorzine,filedforbankruptcyprotectioninNewYork.Itwastheeighth-largestcorporatebankruptcyinU.S.historyandthebiggestfailurebyasecuritiesfirmsinceLehmanBrothersHoldingsInc.filedforChapter11inSeptember2008.10.Whiletheremaybesomedebateaboutwhentakingadvantageofinformationasymmetriesisunethical(reflectedinthemaxim“caveatemptor,”puttingtheobligationonthebuyertobewareofthepossibilityofinformationasymmetries),thereisnodoubtthatthebankssteppedovertheline.Seethediscussioninlaterchaptersoverthelargefinespaidbythebanksforpracticesthatwerefraudulentanddeceptive.11.Thispredatorybehaviortookanumberofforms.Onewaywastochargeveryhighinterestrates,sometimesobfuscatedbyfees.Theabolitionofusurylaws(whichlimittheinterestrateslenderscancharge)providedlendersgreaterscopeforchargingexorbitantinterestrates;andlendersfoundwaysofcircumventingwhateverregulationstherewere.Rent-a-Centerclaimedtoberentingfurniture;itwasreallysellingfurnitureandsimultaneouslylendingmoney—atextraordinarilyhighinterestrates.Manystatestriedtocircumscribeitsactivities,butituseditspoliticalinfluence(ithadseniorex-politicians,includingaformerleaderoftheRepublicansintheHouseofRepresentatives,onitsboard)totrytogetfederalpreemption(wherebyweakerfederalrulespreempttherightsofstatestoregulate).In2006Rent-a-Center(withnationwiderevenuesinexcessof$2billion)wassuccessfullysuedbythestateofCaliforniafordeceptivebusinesspractices.Seehttp://oag.ca.gov/news/press_release?id=1391.Creditcardsandpaydayloansprovidedothervenuesforpredatorypractices.Amongmanydiscussions,see,e.g.,RobertFaris,“PaydayLending:ABusinessModelThatEncouragesChronicBorrowing,”EconomicDevelopmentQuarterly17,no.1(February2003):8–32;JamesH.CarrandLopaKolluri,PredatoryLending:AnOverview(Washington,DC:FannieMaeFoundation,2001).12.Awell-performingfinancialsectorisabsolutelyessentialforawell-performingeconomy.Itallocatescapital,managesrisk,andrunsthepaymentsmechanism.AsIexplaininFreefall(NewYork:Norton,2010),intherun-uptothe2008–09crisis,itdidnotperformthesefunctionswell.Partofthereasonisthatitwasfocusedmoreoncircumventingregulationsandexploitiveactivities,likepredatorylending.Thenegative-sumnatureisreflectedintheimmenselosses228 intherealestatesector.Thefinancialsectorlikestoclaimthatithasbeenhighlyinnovative,andthattheseinnovationsareattherootoftheeconomy’soverallsuccess.ButasPaulVolcker,formerchairmanoftheFederalReserve,pointedout,thereislittleevidenceofanysignificanteffectoftheseinnovationsoneconomicgrowthorsocietalwell-being(withtheexceptionoftheATMmachine).Butevenifthefinancialsectorhadcontributedslightlytothecountry’sgrowthintheyearsbeforethecrisis,thelossesassociatedwiththecrisismorethanoffsetanyofthesegains.13.Arecentstudyhasshownthatpeopleofhigherstatus/incomehavefewerqualmsaboutbreakingtherules,aremorelikelytobedrivenbyself-interest,morelikelytocheat,andmorelikelytobehaveinotherwaysthatwouldgenerallybeviewedasunethical.PaulK.Piff,DanielM.Stancato,StephaneCote,RodolfoMenoza-Denton,andDacherKeltner,“HigherSocialClassPredictsIncreasedUnethicalBehavior,”ProceedingsoftheNationalAcademyofSciences,February27,2012.Whilewhatis“unfair”or“unethical”dependson“norms,”andtheremaybedisagreementsaboutwhatisorisnotfair,theexperimentfocusedonsituationswheretherewouldbebroadconsensusonwhatwasfairorethical.Similarly,muchofthefinancialsectorbehaviorthatIcriticizebelowviolatesvirtuallyanysenseof“fairness”or“ethics.”14.Thisproblemhascometobecalledthe“naturalresourcecurse.”Thereareotherreasonsthatsuchcountrieshavenotdonewell:managingnaturalresourcescanbedifficult(pricesfluctuateandexchangeratescanbecomeovervalued).ForarecentreviewofsomeoftheproblemsandhowtheycanbeaddressedseeEscapingtheResourceCurse,ed.M.Humphreys,J.Sachs,andJ.E.Stiglitz(NewYork:ColumbiaUniversityPress,2007).Seealso,e.g.,MichaelRoss,TheOilCurse:HowPetroleumWealthShapestheDevelopmentofNations(Princeton:PrincetonUniversityPress,2012);andidem,TimberBoomsandInstitutionalBreakdowninSoutheastAsia(NewYork:CambridgeUniversityPress,2001).15.AccordingtoWorldBankIndicators,availableathttp://data.worldbank.org/indicator,50percentofthepopulationwaslivingunderthenationalpovertylinein1998beforeChaveztookofficein1999.16.Hesharedthe1964NobelPrizeinPhysicswiththeSovietscientistisNikolayBasovandAleksandrProkhorovfor“fundamentalworkinthefieldofquantumelectronics,whichhasledtotheconstructionofoscilatorsandamplifiersbasedonthemaser-laserprinciple.”17.Theyreceivedthe1956NobelPrizeinPhysics“fortheirresearchesonsemiconductorsandtheirdiscoveryofthetransistoreffect.”18.TheWorldWideWebConsortiumhefoundeddecidedthatitsstandardsshouldbebasedonroyalty-freetechnology,sothattheycouldeasilybeadoptedbyanyone.LikeJobs,BillGatesisoftenheraldedasaninnovator,buteventhoughtheadoptionofhisproductsisnearlyuniversalnow,thatisduemoretohisbusinessacumen—andnear-monopolyofthemarket—thantotheuniquenessofthetechnologyhesells.19.Bakijaetal.found(p.3)that“executives,managers,supervisors,andfinancialprofessionalsaccountforabout60percentofthetop0.1percentofincomeearnersinrecentyears,andcanaccountfor70percentoftheincreaseintheshareofnationalincomegoingtothetop0.1percentoftheincomedistributionbetween1979and2005.”Thecompositionofthetop1percentin2005was31percent“Executives,managers,supervisors(non-finance)”;15.7percent“Medical,”13.9percent“Financialprofessionals,includingmanagement,”and8.4percent“Lawyers.”Theshareoffinancealmostdoubledovertheperiod,risingfrom7.7percentin1979to13.9percentin2005.(Nonfinanceexecutivesandmedicalfellslightly;lawyersincreasedmarginally.)Thesestatisticsarebasedonanincomemeasurethatexcludescapitalgains.Thisisveryimportantbecauseabouthalfofallcapitalgainsaccruetothetop0.1percent.Forthetop400incomeearners,60percentoftheirincomeisintheformofcapitalgains.J.Bakija,A.Cole,andB.T.Hein,“JobsandIncomeGrowthofTopEarnersandtheCausesofChangingIncomeInequality:EvidencefromU.S.TaxReturnData.”SeealsocommentsbyC.Rampell,“TheTop1%:Executives,DoctorsandBankers”NewYorkTimes,October17,2011,availableathttp://economix.blogs.nytimes.com/2011/10/17/the-top-1-executives-doctors-and-bankers/;andLauraD’AndreaTyson,“TacklingIncomeInequality,”NewYorkTimes,November18,2011,availableathttp://economix.blogs.nytimes.com/2011/11/18/tackling-income-inequality/.20.SeeForbesWorld’sBillionaireslistathttp://www.forbes.com/wealth/billionaires/;rankingisfrom2011.21.Slim’sGrupoCarso,FranceTelecom,andSouthwesternBellpaid$1.7billioninDecember1990toacquire“acontrolling20.4percentstakeinTelmex,whichincludes51percentofthevotesinthecompany.”SeeKeithBradsher,“RegulatoryPitfallinTelmexSale,”NewYorkTimes,December7,1990,availableathttp://www.nytimes.com/1990/12/27/business/talking-deals-regulatory-pitfall-in-telmex-sale.html?scp=1&sq=telmex%20southwestern%20bell%201990&st=cse(accessedMarch3,2012).22.Inthemidnineties,Russiaborrowedlargeamountsofmoneyfromtheprivatesector,puttingupsharesinitsoilandnaturalresourcecompaniesascollateral.Butitwasallarusetoturnoverstateassetstotheoligarchs.Thiswascalled“loansforshares.”SeeChrystiaFreeland,SaleoftheCentury:Russia’sWildRidefromCommunismtoCapitalism(NewYork:CrownBusiness,2000).Avarietyofspeciousargumentsareoftenputforwardfortheseprivatizations.Mostrecently,Greecehasbeenpushedtoprivatize,asaconditionforgettingassistancefromEuropeandtheIMF.Foradiscussionofprivatizationandtheargumentsusedforit,seechapters6and8,below,andJ.E.Stiglitz,GlobalizationandIts229 Discontents(NewYork:Norton,2002).Noteverycountryandnoteveryprivatizationhassufferedfromtransferringstateassetstoprivatepartiesatbelowfairmarketprices.ManybelievethattheprivatizationsintheUKunderMargaretThatcher,withsharespubliclyfloatedandwiththenumberofsharesanyonepersonorcompanycouldbuystrictlylimited,wereconducteddeliberatelyinamannertoavoidsuchoutcomes.23.SeeForbesAmerica’sHighestPaidChiefExecutives2011,availableathttp://www.forbes.com/lists/2011/12/ceo-compensation-11_rank.html.24.Thisisobviouslyacontroversialclaim:theCEOsmightarguethatinfacttheyreceivebutasmallfractionofwhattheycontributetoshareholdervalue.But,aswearguebelow,theso-calledincentivestructuresarepoorlydesigned,providinglittlelinkbetweenthatpartoftheincreaseinmarketvaluethatisattributabletotheeffortsoftheCEOandthatwhichistheresultofbroadermarketforces—lowercostsofinputsorhigherstockmarketpricesingeneral.Somestudieshavesuggested,moreover,thatoncetotalcompensationistakenintoaccount(includingadjustmentsofbonuseswhenthestockmarketdoesn’tdowell),thereislittlerelationshipbetweenfirmperformanceandcompensation.Forabroaderdiscussionofthisissue,seeJ.E.Stiglitz,RoaringNineties(NewYork:W.W.Norton,2003);andespeciallyLucianBebchukandJesseFried,PaywithoutPerformance:TheUnfulfilledPromiseofExecutiveCompensation(Cambridge:HarvardUniversityPress,2004).25.Stillonemoregroupisrealestatemoguls,whobenefitfromspecialprovisionsofthetaxcodeandoftengetrentsasaresultoflocalgovernmentvariancesinzoninglaws.26.Thesearesometimescallednaturalmonopolies.Theyincludetheexamplesgivenearlierwherenetworkexternalitiesareverylarge.27.Theadvocatesofstrongerintellectualpropertyrights,ofcourse,claimotherwise.Interestingly,intheUnitedStatesmanyofthemostinnovativefirms,thoseinSiliconValley,havebeenamongthoseopposingcertainproposalsbythoseinthedrugandentertainmentindustriestostrengthenintellectualpropertyrights.Recentrevisionsofpatentlawarguablygavelargecorporationsanadvantageovernewfirms,illustratingthefact,repeatedinthenextchapter,thattherearestrongdistributiveconsequencesofanylegalframework.Foradiscussionofhowourcurrentintellectualpropertyframeworkmayactuallyinhibitinnovation,seeJ.E.Stiglitz,MakingGlobalizationWork(NewYork:Norton,2006),andClaudeHenryandJ.E.Stiglitz,“IntellecutalProperty,DisseminationofInnovation,andSustainableDevelopment,”GlobalPolicy1,no.1(October2010):237–51.28.See,e.g.,A.Dixit,“TheRoleofInvestmentinEntry-Deterrence,”EconomicJournal90,no.357(March1980):95–106;andJ.TiroleandD.Fudenberg,“TheFatCatEffect,thePuppyDogPloyandtheLeanandHungryLook,”AmericanEconomicReview74(1984):361–68.ThepracticesMicrosoftusedtoriditselfofitsrivals(describedbelow)alsohelpedprevententryofnewcompetitors.29.It’sclearthatonewantsstandards;onedoesn’twanttobeoperatedonbyanunqualifieddoctor.But,forinstance,thesupplyofqualifieddoctorscouldhavebeenincreasedsimplybyincreasingthenumberofplacesinmedicalschool.30.In1890CongresspassedtheShermanAnti-TrustAct,anditsenforcementspeededupinthetwentiethcentury.In1911theSupremeCourtorderedthedissolutionoftheStandardOilCompanyandtheAmericanTobaccoCompany,whichbroughtdownthetwopowerfulindustrialtrusts.In1984theCourtbrokeupAT&T’smonopolyfollowingUnitedStatesv.AT&T.SeeCharlesR.Geisst,MonopoliesinAmerica:EmpireBuildersandTheirEnemiesfromJayGouldtoBillGates(NewYork:OxfordUniversityPress,2000).31.Theterm“Chicagoschool”isoftenappliedtothisgroupofeconomists,partiallybecausethehighpriestofthisreligion,MiltonFriedman(andmanyofhisacolytes),taughtattheUniversityofChicago.Butitshouldbeunderstoodthatmanyatthatgreatuniversityarenotdevoteesofthisschoolofthought,andthattherearemanydevoteesinotheruniversitiesaroundtheworld.Thetermhas,however,becomeacommonlyusedshorthand.32.Onegroupevenwentsofarastoarguethatmarketswillbehavecompetitivelyevenifthereisonlyonefirm,solongasthereispotentialcompetition.Thisargumentplayedanimportantroleinairlinederegulation,whereitwascontendedthateveniftherewasonlyoneairlineonagivenroute,itwouldbedisciplinedfromchargingmonopolypricesbythethreatofentry.Boththeoryandexperiencehaveshownthatthisargumentiswrong,solongastherearesunkcosts(coststhatwon’tberecoveredifafirmentersandsubsequentlyleaves),nomatterhowsmallthosecosts.SeeJosephFarrell,“HowEffectiveIsPotentialCompetition?,”EconomicsLetters20,no.1(1986):67–70;J.E.Stiglitz,“TechnologicalChange,SunkCosts,andCompetition,”BrookingsPapersonEconomicActivity3(1987),pp.883–947;andP.DasguptaandJ.E.Stiglitz,“PotentialCompetition,ActualCompetition,andEconomicWelfare,”EuropeanEconomicReview32,nos.2–3(March1988):569–77.33.Fordiscussionandexamplesofconservativefoundations’contributiontotheChicagoschoollawandeconomicsprograms,seeAllianceforJustice,JusticeforSale:ShortchangingthePublicInterestforPrivateGain(Washington,DC:AllianceforJustice,1993).34.TheDepartmentofJusticebroughtacaseagainstAmericanAirlinesintheearlyyearsofthiscentury.IthoughttheevidencethatAmericanAirlineshadengagedinpredatorybehaviorwasespeciallycompelling,butthejudgedidn’tneedtolookattheevidence:theSupremeCourthadruledthattherewasjusttoostrongapresumptionagainsttheexistenceofpredatorypricingtomakeprosecutionpossible.230 35.OneofNetscape’sfounders,MarcAndreessen,waspartoftheteamattheUniversityofIllinoisatUrbana-ChampaignthatdevelopedMosaic,thefirstwidelyusedwebbrowser,whichwasaprojectoftheuniversity’sNationalCenterforSupercomputingApplications(oneoftheoriginalsitesoftheNationalScienceFoundation’sSupercomputerCentersProgram).SeethewebsiteoftheNCSA,http://www.ncsa.illinois.edu/Projects/mosaic.html(accessedMarch3,2012);andJohnMarkoff,“NewVentureinCyberspacebySiliconGraphicsFounder,”NewYorkTimes,May7,1994,availableathttp://www.nytimes.com/1994/05/07/business/new-venture-in-cyberspace-by-silicon-graphics-founder.html?ref=marcandreessen(accessedMarch3,2012).36.ForanoverviewoftheMicrosoftcase,seeGeisst,MonopoliesinAmerica.37.SeeStevenC.SalopandR.CraigRomaine,“PreservingMonopoly:EconomicAnalysis,LegalStandards,andMicrosoft,”GeorgeMasonLawReview4,no.7(1999):617–1055.38.SeeMicrosoft’sannualreport.39.AsthelateOxfordprofessorandNobelPrizewinnerJohnHickssaid,“Thebestofallmonopolyprofitsisaquietlife.”J.R.Hicks,“AnnualSurveyofEconomicTheory:TheTheoryofMonopoly,”Econometrica1,no.8(1935).KennethArrowpointedoutthatbecausemonopolistsrestrictproduction,thesavingtheygetfromreducingcostsisdiminished.SeeArrow,“EconomicWelfareandtheAllocationofResourcesforInvention,”inTheRateandDirectionofInventiveActivity:EconomicandSocialFactors(Princeton:PrincetonUniversityPress,1962),pp.609–26.Monopolies,ofcourse,don’tlastforever:newtechnologiesandtheopen-sourcemovementarealreadybeginningtochallengeMicrosoft’sdominance.40.Calculatedbytotalassetsofcommercialbanks,asofSeptember3,2011.SeeFDICStatisticsonBanking,availableathttp://www2.fdic.gov/SDI/SOB/index.asp;andFederalReserveStatisticalReleaseLargeCommercialBanks,availableathttp://www.federalreserve.gov/releases/lbr/current/default.htm.41.Moreover,banksdon’tcompeteonpricefortheservicestheyoffer.Ifyouwanttodoamergeroracquisition,everymajorbankchargesthesamepercentagefee.Whentakeoverswerehundredsofmillionsofdollars,theresultingchargeswerelarge;whentheybecamebillions,chargesbecameastronomical,foressentiallythesameamountofworkbythesamenumberofpeople.42.From2010Q4to2011Q3(themostrecentlyavailableyear),FDIC-insuredinstitutionsmadeanaggregateprofitof$115billion.SeeFDICQuarterly,availableathttp://www.fdic.gov/bank/analytical/quarterly/index.html.Butthesenumbersdon’treallycapturethemagnitudeofbankprofits,sincetheyaretheprofitsafterpayingoutthemega-bonusestotheexecutives,whichcanpushcompensationatsomefirmsabove50percentofrevenuesafterothercostshavebeentakenout,i.e.,the“true”profitsmaybeasmuchasdoubletheabovenumber.Theprofitsandbonusesofthebankingsectorexceed1percentofthecountry’sentirenationaloutput.Suchnumbersleadmanytoconcludethatthefinancialsector,whichissupposedtobetheservantoftherestoftheeconomy,hasbecomeitsmaster.43.Microsofttriedtoexertpoliticalinfluencethroughavarietyofchannels.Ithasmadecampaigncontributionsof$13,516,304from1999topresent.Seecampaignmoney.com,compiledfromcampaignfinancereportsanddatadisclosedbyFederalElectionCommission,listsofcontributionavailableathttp://www.campaignmoney.com/Microsoft.asp?pg=88(accessedMarch6,2012).TheremediesputforwardbyPresidentBush’sJusticeDepartmentinresponsetoMicrosoftsconvictiononanticompetitivebehaviorweremildanddidnoteffectivelycurtailitsmarketpower.See,e.g.,AndrewChin’saccountoftheoutcomeofUnitedStatesv.MicrosoftCorp.:“DecodingMicrosoft:AFirstPrinciplesApproach,”WakeForestLawReview40,no.1(2005):1–157.Inthecaseofantitrustlaws,there’sapartialremedyfortheabsenceofeffectivepublicenforcement:privateantitrustaction(whichwasintroducedbecauseofworriesaboutthewillingnessofpublicauthoritiestotakeenforcementaction).44.ThelateNobelPrize–winningeconomistGeorgeStiglerwroteextensivelyaboutthis.See,e.g.,Stigler,“TheEconomicTheoryofRegulation,”BellJournalofEconomics11(1971):3–21.45.DatafromtheOpenSectrets.org,awebsiteoftheCenterforResponsivePolitics,countinglobbyistsforcommercialbanks,finance,andcreditcompanies.Whenalllobbyistsarecountedinthefinance,insurance,andrealestateindustries,thenumberballoonstonearlyfivepercongressman.Seehttp://www.opensecrets.org/lobby/indus.php?id=F&year=a(accessedMarch24,2012).46.ThelatestinstancewasthevetobytheSenateBankingCommitteechairmanofthenominationofNobelPrize–winningeconomistPeterDiamond.Diamondwouldhaveprovidedacriticalvoiceonsomeofthedoctrinesthatprevailamongsomeofthegovernors.(DiamondwasfirstnominatedtotheFedbyPresidentObamainApril2010;hewasrenominatedinSeptemberandagaininJanuary2011,afterSenateRepublicansblockedafloorvoteonhisconfirmation.OnJune5,2011,Diamondwithdrewhisnomination,endingafourteen-monthnominationeffortresistedbySenatorRichardShelbyofAlabama,who,withpartycolleaguesrepeatedlycriticizedDiamondforsupportingthecentralbank’smonetarystimulus.Diamondrespondedthathisopponentsfailedtoappreciatethatunderstandingthedeterminantsofunemploymentisessentialtoeffectivemonetarypolicy.)47.TheMedicarePrescriptionDrug,Improvement,andModernizationActof2003.48.TheeconomistDeanBaker’sresearchshowsthat$332billioncouldbesavedbetween2006and2013(around$50billionayear)inthemostconservativehigh-costscenario,ifMedicarewereallowedtonegotiateprices;inthemiddle-costscenario,$563billioncouldbesavedforthesamebudgetwindow.SeeBaker,The231 SavingsfromanEfficientMedicarePrescriptionDrugPlan(Washington,DC:CenterforEconomicandPolicyResearch,January2006).49.ItisestimatedthatfourbanksintheUnitedStatestakehomeawindfallofsome$20billionayearinderivatives.50.Themarketforethanolwasdistortedinotherways—suchasethanolrequirementsandsubsidiesforgasolinerefinerswhoblendedgasolinewithethanol—mostofwhichcamefromAmerica’scornproducers.Seethe2010CBOstudy“UsingBiofuelTaxCreditstoAchieveEnergyandEnvironmentalPolicyGoals,”availableathttp://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/114xx/doc11477/07-14-biofuels.pdf(accessedMarch2,2012);and“TheGlobalDynamicsofBiofuel,”BrazilInstituteSpecialReport,April2007,issueno.3,availableathttp://www.wilsoncenter.org/sites/default/files/Brazil_SR_e3.pdf(accessedMarch2,2012).51.Congressfinallyallowedthesubsidytoexpireattheendof2011.52.Famously,ADMwasfinedathenrecord$100millionforlysinepricefixingin1997,aresultofalengthyfederalinvestigationthatalsoledtoconvictionsandprisontimeforthreeexecutives.(ThisbecameabookbyKurtEichenwaldandthena2009moviestarringMattDamon,TheInformant.)53.Intheearlydaysofcorn-basedethanol,thiswasflatlywrong:thedemandforcornbyethanolproducerswassolowthatthecornfarmersreceivedalmostnobenefitfromthesubsidy.Becauseusageofcornforethanolproductionwassuchasmallfractionofglobalsupply,ithadaneglibleeffectoncornprices.ADMandotherethanolproducerswerethetruebeneficiaries.54.TheU.S.governmentpaidatotalof$261.9billionforagriculturesubsidiesfrom1995to2010.AccordingtoUSDA,63percentoffarmsdonotreceiveanypayments.Amongthosepayments,alargechunk(62percentin2009)goestolarge-scalecommercialfarms(withgrossannualsalesof$250,000ormore).Between1995and2010,thetop10percentoffarmsreceived$30,751averageperyear,whilethebottom80percentoffarmsreceived$587averageperyear.SeeUSDAEconomicResearchService,“FarmIncomeandCost:FarmsReceivingGovernmentPayments,”availableathttp://farm=.ewg.org/region.php?fips=00000®name=UnitedStatesFarmSubsidySummary.55.Andindeed,manybookshavebeenwrittenonthesubject.See,e.g.,GlennParker,CongressandtheRent-SeekingSociety(AnnArbor:UniversityofMichiganPress,1996).ChapterThreeMARKETSANDINEQUALITY1.Moreprecisely,ifthedemandcurveshiftsmorethanthesupplycurve.2.Employmentinmanufacturingdroppedfrom18millionin1988tolessthan12millionnow.SeeDepartmentofLabor,BureauofLaborStatistics.3.Foranexcellentdiscussionoftheseissues,seeDavidH.Autor,LawrenceF.Katz,andMelissaS.Kearney,“MeasuringandInterpretingTrendsinInequality,”AmericanEconomicReview96(May2006):189–94;andClaudiaGoldinandLawrenceF.Katz,“Long-RunChangesintheWageStructure:Narrowing,Widening,Polarizing,”BrookingsPapersonEconoicActivity2(2007):135–64,andthereferencescitedthere.4.DavidH.Autor,LawrenceF.Katz,andAlanB.Krueger,“ComputingInequality:HaveComputersChangedtheLaborMarket?,”QuarterlyJournalofEconomics113(November1998):1169–213;andL.F.Katz,“TechnologicalChange,Computerization,andtheWageStructure,”inUnderstandingtheDigitalEconomy,ed.E.BrynjolfssonandB.Kahin(Cambridge:MITPress,2000),217–44.5.GoldinandKatz,“Long-RunChangesintheWageStructure,”153.Theyattributemostofthedifferencetothedeclineineducationalattainmentofnative-bornAmericans.6.SeeOECD,EducationataGlance:OECDIndicators,2011,p.54,availableathttp://www.oecd.org/dataoecd/61/2/48631582.pdf(accessedMarch2,2012).7.Ibid.,p.68.8.Fordata,seetheOECDProgrammeforInternationalStudentAssessment(PISA)2009results.9.Evenby1998,collegegraduatewageshadrisento1.75timesthatofhighschoolgraduatewages(upfrom1.59in1970).10.See,e.g.,DavidH.Autor,FrankLevy,andRichardJ.Murnane,“TheSkillContentofRecentTechnologicalChange:AnEmpiricalExploration,”QuarterlyJournalofEconomics118(2003):1279–333.11.AccordingtoAutoretal.,“MeasuringandInterpretingTrendsinInequality,”since1988themostrapidriseinwageshasoccurredatthetop,andtheslowestgrowthinthemiddletwoquartiles.12.SeeDomenicoDelliGatti,MauroGallegati,BruceC.Greenwald,AlbertoRusso,andJosephE.Stiglitz,“SectoralImbalancesandLongRunCrises”(forthcoming2012);andJ.E.Stigltiz,“TheBookofJobs,”VanityFair,January2012,availableathttp://www.vanityfair.com/politics/2012/01/stiglitz-depression-201201(accessedFebruary15,2012).13.SeeBillVlasic,“DetroitSetsItsFutureonaFoundationofTwo-TierWages,”NewYorkTimes,September12,2011,availableathttp://www.nytimes.com/2011/09/13/business/in-detroit-two-wage-levels-are-the-new-way-of-work.html?pagewanted=all(accessedMarch6,2012).The2007GMannualreportconfirmssomeofthedetailsonwages,availableathttp://bigthreeauto.procon.org/sourcefiles/GM_AR_2007.pdf(accessedMarch6,232 2012),seepp.62–63.Foralongerdiscussionofwages,seeBruceC.GreenwaldandJuddKahn,Globalization:TheIrrationalFearThatSomeoneinChinaWillTakeYourJob(Hoboken,NJ:JohnWiley,2009).14.Someontherightcomparewagesinpublic-sectorjobstothoseinprivate-sectorjobsunadjustedforeducation—thatis,nottakingaccountofdifferencesinthelevelofeducationbetweenthepublicandprivatesectors—andcomplainthatpublic-sectorwagesaretoohigh.Buteducation-adjustedpublicsectorpay(thatis,takingintoaccountdifferencesineducationbetweenthetwosectors)islowerthanprivate.Somecontendthatmoregenerous(andlessrisky)pensionsandotherbenefitsinthepublicsectorcompensateforthisdifferential.Munnelletal.findinsteadthatprivatesectorworkersenjoya“modest”4percentpremiumevennetofbenefits.A.Munnell,J.-P.Aubry,J.Hurwitz,andL.Quimby,“ComparingCompensation:State-LocalversusPrivateSectorWorkers,”CenterforRetirementResearchatBostonCollege,no.20,September2011.15.Traditionallymanyeconomistshavebeenuncomfortableindealingwiththesedistributivechanges,becauseofthedifficultiesofmakinginterpersonalcomparisons.Economistsoftenfocuson“Paretoefficient”equilibria—wherenoonecanbemadebetter-offwithoutmakingsomeoneelseworse-off;oron“Paretoimprovements,”wheresomeoneismadebetter-off,butnooneisharmed.Butfewpolicychangesareofthatsort.Generally,somegainandsomelose.AParetoefficientequilibrium,asislearnedinelementaryeconomicscourses(andthenperhapsforgotten),mightbeveryundesirablebecauseitleftmanypeopleatbaresubsistence.16.Severalhundredyearsago,inEnglandandScotland,thelargelandownersenclosedthecommonland.Someeconomistshavearguedthatthiswasdesirable,becauseitavoidedtheproblemofovergrazing,aproblemthatwascalledthe“tragedyofthecommons.”Butfarlargerthantheefficiencyeffectwerethedistributiveeffects:largenumberslosttheirlivelihoodandbecameimpoverished.AstheNobelPrize–winningeconomist/politicalscientistElinorOstromhaspointedout,thereareotherwaystoavoidthetragedyofthecommonsandtoensurethattheresourcesarewellmanaged—suchassimplyregulatingthenumberofsheepthatcangraze.Thesecandojustaswellinattainingefficiency,butwithfarbettersocialconsequences.Thetruetragedyofthecommonswasthatwiththeprivatizationofthecommonsbythelords,thousandsbecamedestituteandhadtomigrateeithertothecitiesofBritainorabroad.Asystemofuserights—allowingeachfamilytograze,say,tensheep—wouldhavepreventedtheproblemofovergrazingaswellasthefurtherimmiserationofthepeasants.Virtuallyeverysocietyinwhichwaterisveryscarce(suchastheindigenouspeopleoftheAtacamaDesert)orwhichreliesonirrigationhasdevelopedcomplexregulatoryschemesforallocatingwater,balancingoutequityandefficiency—andwithonlylimiteduseofprices.Foramoreextensivediscussionofsomeoftheseissues,seeStigltiz,MakingGlobalizationWork,chap.4.17.Thatwasanotheriniquitousaspectofthe2005bankruptcyact:itmadeevenloansfromfor-profitbanksforfor-profitschoolsnondischargeable.18.We’lldiscusspredatoryeducationloansinalaterchapter.Anotherbankruptcy“reform”(discussedinchapter2),givingderivativesseniorityinbankruptcy,notonlydistortedtheeconomybyencouragingthesegamblinginstrumentsbutdidsoattheexpenseofothers—includingworkersandpensioners,whoseclaimsagainstthebankruptfirmwerecorrespondinglyweakened.19.TheUniversalDeclarationofHumanRights,adoptedbytheUnitedNationsonDecember10,1948,recognizedbotheconomicrightsandpoliticalrights;buttheeconomicrightsthatwereidentifiedpertainedtotheordinarycitizen.“(1)Everyonehastherighttoastandardoflivingadequateforthehealthandwell-beingofhimselfandofhisfamily,includingfood,clothing,housingandmedicalcareandnecessarysocialservices,andtherighttosecurityintheeventofunemployment,sickness,disability,widowhood,oldageorotherlackoflivelihoodincircumstancesbeyondhiscontrol.”TheUniversalDeclarationofHumanRights,availableathttp://www.un.org/en/documents/udhr/index.shtml#a25.Implicitly,itwasrealizedthatindividualswhosesurvivalwasatriskcouldandwouldnoteffectivelyexercisetheirpoliticalrights.IntheyearsoftheColdWar,thoseontheleftemphasizedtheimportanceoftheseeconomicrights,whiletheU.S.governmentcentereditsattentiononpoliticalrights.Ironically,wheneconomicrightswerefinallydiscussed,itwastherightsnotofworkersandcitizensbutofcapital;itwaspropertyrights,intellectualpropertyrights,therightsofcapitaltomovefreelyacrossborders.Inothercountries,however,therehasbeenincreasingrecognitionoftheeconomicrightsofordinarycitizens,e.g.,intheconstitutionofSouthAfrica,whereeventherighttohousingisaccepted.SeeChapter2,BillofRights,Section26:“26(1)Everyonehastherighttohaveaccesstoadequatehousing.(2)Thestatemusttakereasonablelegislativeandothermeasures,withinavailableresourcestoachievetheprogressiverealisationofthisright.(3)No-onemaybeevictedfromtheirhome,orhavetheirhomedemolished,withoutanorderofthecourtmadeafterconsideringalltherelevantcircumstances,”availableathttp://www.info.gov.za/documents/constitution/1996/96cons2.htm#26.TheIndiansupremecourthasrecognizedrightstoeducation;in2002,throughthe86thAmendmentAct,Article21(A)wasincorporatedintheconstitutiontomakeeducationafundamentalrightforchildren,andrightstopollution-free-air(underArticle21).Italsorecognizesfundamentalrights,particularlytheRighttoLifeguaranteedinArticle21.Aroundtheworld,therights-basedapproachhasreceivedincreasingattention.See,e.g.,theworkdonebytheformerheadoftheUNHumanRightsCommission(andformerpresidentofIreland)MaryRobinson’sorganization,RealizingRights,availableathttp://www.realizingrights.org/.233 20.Thisignores,however,themanysocialandotherconsequencesoflabormigration,bothtothecountrythatthemigrantleavesandthecountrytowhichhecomes.21.Ofcourse,some,perhapsmany,ofthoseadvocatingtheliberalizationoffinancialmarketslookonlyatthedirectincreaseintheirprofitabilityfromtheirabilitytoinvestinplaceswherereturnsarehigher.Theydon’tthinkaboutthesystemiceffectsofasymmetricliberalizationonwages.22.Financialmarketintegrationentailsnotjustthefreemovementofcapitalacrossbordersbutalsothefreemovementoffinancialinstitutionsacrossborders.Seechapter6forafullerdiscussionoftheseissues.23.Asimilarproblemarisesinthedesignofelectricnetworks.Moreintegratednetworksaresubjecttosystemicbreakdowns—aprobleminonelittleplace,likeasubstationinOhio,canbringdownthewholeEastCoast.Theresponseisthedesignofeffectivecircuitbreakers,toisolate—orquarantine—theproblem.24.Banksspendalotofmoneylobbyingbothagainstregulationsandforbailoutsthatservetheirinterests.Lobbyingexpendituresin2009jumped12percentfrom2008,to$29.8million,amongtheeightbanksandprivateequityfirmsthatspentthemosttoinfluencelegislation,andmuchoftheincreasehappenedinthelastthreemonthswhenCongressvotedonfinancereformbills.See“BanksStepUpSpendingonLobbyingtoFightProposedStifferRegulations,”LosAngelesTimes,February16,2010.Asanexampleoftheimpactofbanklobbyists,theFederalReserveseta24-centmaximumonthefeebankscanchargeretailmerchantsfordebitcardtransactionsinJune2011,anamountthatwasamultipleofreasonableestimatesofthecostofthetransaction,androughlydoublethe12centstentativelyproposedbytheFedinDecember2010.See“FedHalvesDebitCardBankFee,”NewYorkTimes,June29,2011,availableathttp://www.nytimes.com/2011/06/30/business/30debit.html.25.Developingcountriesalsohavemanycomplaintsagainstglobalization,whichI’vediscussedelsewhere.Forinstance,theyrightlycomplainthatthetradeagreementsarenotfair:thebargainingpowerisallonthesideofthedevelopedcountries.Considertheso-calledFreeTradeAgreements,whichtheUnitedStateshaswithmanyothercountriesaroundtheworld.Theseagreementsarenotreallyfree-tradeagreements.Iftheywere,theywouldbeafewpageslong,witheachsideagreeingtoeliminateitstariffs,itsnontariffbarriers,anditssubsidies.Buttheagreementsgotohundredsofpages,becausetheyareinfactmanaged-tradeagreements,andmanagedforthebenefitofspecialinterests.Theyareagreementsinwhichhostsofindustriesinsistononeformoffavorabletreatmentoranother.Companies’focusisnaturallyonrulesthatincreasetheirprofits.Whentradeliberalizationhelpstheirprofits,thenthey’reinfavorofit;butwhenitworkstheotherway,theyopposeit.Andforthemostpart,theU.S.traderepresentativeandtradeministersfromotheradvancedindustrialcountriesrepresenttheinterestsofthecountry’scompanies.Openinguptradeis,however,onlyonepartofthefocusoftradenegotiations.Todaymuchattentioniscenteredoninducingothercountriestoopenuptheirmarketstoforeigninvestmentandprotectingtheinvestmentsthataremadethere—thatis,providingconditionsthatenhancethemovementofjobsoverseas.Inshort,muchofthefocusisonenhancingcorporateprofits,ratherthanonincreasingjobsathome.Andthisisnotsurprising,givenwherethecampaigncontributionsandlobbyingiscomingfrom.(It’snotanaccidentthatsometimes,theU.S.traderepresentativehasbeenapresidentialcampaignmanager.)Everybodybelievesthatexportsaregood—butthatimportsarebad.(Suchaposition,ofcourse,isintellectuallyincoherent.)Ourfirmsclaimthatifsomeotherfirmundercutsthem,itmustbeplayingunfair.Itmustbesellinggoodsbelowcost,orbesubsidizedbyitsgovernment.U.S.firmsusetheseargumentstoadvocatefortheimpositionofdutiesto“leveltheplayingfield.”Wheninternationaltradeagreementspreventtheimpositionoftariffs,theUnitedStates(andothercountries)turnaggressivelytousingwhatarecallednontariffbarriers,andespeciallydumpingduties.ButthefactofthematteristhatmanyAmericanindustriesarenotthemostefficientintheworld.Manyhavenotinvestedwhattheyshouldeitherinpeopleorinmachines,andthat’swhytheircostsarehigher.ForadiscussionoftheimportanceofinnovationintheAmericanautomobilemanufacturing,andhowU.S.firmshavestackedupagainstforeigncompetitors,seeMcKinsey&Company,“IncreasingGlobalCompetitionandLaborProductivity:LessonsfromtheUSAutomotiveIndustry,”areportoftheMcKinseyGlobalInstitute,2005,availableathttp://www.mckinsey.com/Insights/MGI/Research/Productivity_Competitiveness_and_Growth/Increasing(accessedMarch6,2012).26.Initsearlyhistory,theUnitedStateshadsuchconditions,andindeedaverydifferentprocessplayedout.TerritoriesandthenewwesternstatesoftheUnioncompetedforsettlerswiththeolderstatesontheEasternSeaboard.Thisledacrossthenationtotheexpansionofvotingrights,intherighttorunforpoliticaloffice,andinpubliceducation,whichinturncontributedtothevastexpansionofliteracyintheUnitedStates(relativetowhatithadbeenbefore,andwhatitwasinEurope).SeeS.EngermanandK.Sokoloff,“FactorEndowments,Inequality,andPathsofDevelopmentamongNewWorldEconomies,”Economia3,no.1(2002):41–109;andS.EngermanandK.Sokoloff,“TheEvolutionofSuffrageInstitutionsintheNewWorld,”JournalofEconomicHistory65,no.4(December2005):891–921.27.Thisisespeciallytrueforsmallercountries.Mostoftheadverseshockstheyfacecomefromabroad.28.SeeD.NewberyandJ.E.Stiglitz,“ParetoInferiorTrade,”ReviewofEconomicStudies51(1984):1–12.29.Theseideashavebeenatthecenteroftradetheoryformorethansixtyyears.234 SeeP.A.Samuelson,“InternationalTradeandtheEqualisationofFactorPrices,”EconomicJournal58(June1948):163–84;andW.F.Stolper,W.F.andP.A.Samuelson,“ProtectionandRealWages,”ReviewofEconomicStudies9,no.1(1941):58–73.Foramoreextensivediscussionoftheseissues,seeStiglitz,MakingGlobalizationWork,chap.3.Astandardimplicationofthesetheoriesisthatthedifferentialbetweenunskilledandskilledworkers’wagesshouldnarrowindevelopingcountries,reducinginequality.Thishasnothappened.Oneofthereasonsisthatthemostunskilledworkersindevelopingcountries—thosewhoare,e.g.,subsistencefarmers—maybemadeevenworse-offasaresultoftradeagreementsthatopenuptheirmarketstohighlysubsidizedagriculturalgoods.Thereisnoagreementamongeconomistswhohaveattemptedtoquantifytherelativeimportanceoftradeglobalizationoninequality.Itusedtobepartoftheconventionalwisdomthatasmallpart(atmostafifth)oftheincreaseininequalitywasduetoglobalization.(Forinstance,FlorenceJaumotteandIrinaTytell,“HowHastheGlobalizationofLaborAffectedtheLaborShareinAdvancedCountries?,”IMFWorkingPaper,2007,arguesthattechnologicalchangewasmoreimportantthanglobalization,especiallyonthewagesoflowskilledworkers.)Butmorerecently,PaulKrugmanhasarguedthattheimpactofglobalizationmaybelargerthanwaspreviouslythought.“TradeandInequality,Revisited,”Vox,June15,2007;seealsohispaper“TradeandWages,Reconsidered,”BrookingsPanelonEconomicActivity,Spring2008.PartofthedifficultyisthatglobalizationisintertwinedwiththechangingproductivitywithintheUnitedStates,theweakeningofunions,andahostofothereconomicandsocietalchanges.Thereisnoobviouswaytospecifythecounterfactual:whatwouldthedegreeofinequalityhavebeen,ifwehadnothadglobalization,buteverythingelsehadbeenthesame?30.Therelativeimportanceofthesesocietalchangesandthemarketforcesdescribedearlier(especiallytheroleofskill-biasedtechnicalchange)hasbeenasubjectofsomecontentioninlaboreconomics.DavidCardandJohnDiNardo,”Skill-BiasedTechnologicalChangeandRisingWageInequality:SomeProblemsandPuzzles,”JournalofLaborEconomics20(2002):733–83,andThomasLemieux,“IncreasedResidualWageInequality:CompositionEffects,NoisyData,orRisingDemandforSkill?,”AmericanEconomicReview96,no.3(2006):461–98,focusonthetimingoftheincreaseininequality—inthe1980s—suggestingitiscausedbytheinstitutional/societalchanges,includingthosewefocusonhere.PikettyandSaez,“IncomeInequalityintheUnitedStates,1913–1998,”QuarterlyJournalofEconomics118,no.1(2003):1–39,“TheEvolutionofTopIncomes:AHistoricalandInternationalPerspective,”AmericanEconomicReview96(2006):200–206,andFrankLevyandPeterTemin,“InequalityandInstitutionsin20thCenturyAmerica,”workingpaper,MIT2007,focusingontheriseofinequalityattheverytop,advanceanexplanationbasedonsocialnormsandregulatoryandinstitutionalchanges,alongthelinespresentedinthissection.Othersocietalchangeshavecontributedtoinequalityamonghouseholds,e.g.,increasesinthenumberoffemale-headedhouseholds,andanincreaseinassociativemating(wherehigher-incomemalesaremorelikelytomarryhigher-incomefemales).SeeR.FernandezandR.Rogerson,“SortingandLong-RunInequality,”QuarterlyJournalofEconomics116(2001):1305–41.Differencesamonghouseholdsinhoursworked(partlyrelatedtodifferencesingenderparticipationsandchangesinpatternsofgenderdiscrimination)alsoplayedarole.Thesechanges,whileimportant,arelesssignificantthantheotherchangesonwhichwehavefocused.SeeOECD,“DividedWeStand:WhyInequalityKeepsRising,”December5,2011.31.Seehttp://www.bls.gov/news.release/union2.nr0.htm.32.SeedetailsinJosephA.McCartin,CollisionCourse:RonaldReagan,theAirTrafficControllers,andtheStrikeThatChangedAmerica(NewYork:OxfordUniversityPress,2011).33.Seechapter4foramoreextensivediscussion.Criticsask,Ifit’ssoprofitabletopayworkershighwages,whydon’tfirmsdoitontheirown?Acentralthesisofthisbookisthatmanagerialincentivesarenotwellalignedeitherwithrealeconomicreturnsorevenwiththeinterestsofshareholders.34.Partofthereasonforthedifferinginterpretationsisthatthereareinstanceswhereinefficientworkrulesdointerfereunnecessarilywithefficiency.Allhumaninstitutionsarefallible;itmakesnomoresensetocondemnallunionsforthefailingsofsomethantocondemnallcorporationsforthefailingsofsome.Foradiscussionofcircumstancesunderwhichunionizationincreasesproductivity,seeRichardB.FreemanandJamesL.Medoff,“TradeUnionsandProductivity:SomeNewEvidenceonanOldIssue,”AnnalsoftheAmericanAcademyofPoliticalandSocialScience473(1984):149–64.35.SeeSusanFleck,JohnGlaser,andShawnSprague,“TheCompensation-ProductivityGap:AVisualEssay,”MonthlyLaborReview,January2011,pp.57–69.Movementsintheshareoflabor(orlaborcompensation)innationalincomearealsoaffectedbychangesinsectorcompositionandgovernmentwagepolicies.36.Whichmeansthatifthefirmmakeslosses,themostthatashareholdercanloseistheamounthehasspentonhisshares.Bycontrast,withunlimitedliabilitypartnerships,apartnercanlosenotonlyhisoriginalinvestment,butmuchmore.37.Atakeoverbattleoccurswhensomeoutsidefirmtriestobuyenoughsharestogetcontrolofthefirmanddisplaceexistingmanagement.38.Thenotionthatmanagementmaynotpursuetheinterestsofshareholders—thatthereis,inmodernAmerica,aseparationofownershipandcontrol—wasadvancedbyA.A.BerleandG.C.Means,TheModernCorporationandPrivateProperty(NewYork:Macmillan,1932).Anexplanationforthisseparation,intermsofcostlyandimperfectinformation,wasprovidedbyJ.E.Stiglitz,“CreditMarketsandtheControlofCapital,”JournalofMoney,Banking,andCredit17,no.2(1985):235 133–52.Thereisalargesubsequentliteratureonthesetopics.See,e.g.,AaronS.EdlinandJosephE.Stiglitz,“DiscouragingRivals:ManagerialRent-SeekingandEconomicInefficiencies,”AmericanEconomicReview85,no.5(December1995):1301–12;andAndreiShleiferandRobertW.Vishny,“ASurveyofCorporateGovernance,”JournalofFinance52,no.2(June1997):737–83.39.JohnBogle,thefounderofVanguardGroup,aninvestmentmanagementcompanythatmanagesapproximately$1.6trillioninfunds,inhiscommentsonBebchukandFried,PaywithoutPerformance.TheBoglequotationisfromp.483ofareviewandsummaryofBebchukandFriedbyHenryTosiinAdministrativeScienceQuarterly50,no.3(September2005):483–87.40.Australiahassuchlegislation.Ourcorporateexecutivesfoughtevena“sayinpay”provisionthatwouldhavenotbeenbindingoncorporations.Shareholdersaresupposedto“own”thecompany,butourcorporateofficerssomehowthinkit’srightthattheownershaveabsolutelynosayinthepayofthosewhoaresupposedlyworkingforthem.41.Inmanufacturingthedeclineintheshareofwageswasfromapeakinexcessof65percentatthebeginningofthecenturyto58percentin2010;forbusinessincomeasawhole,from63percentin1990to61percentin2005;butitthenfellfurther,to58percentbymid-2011.Onehastotreatthedatawithsomecaution.Thedataatthetoparedistortedbythefactthatbankers’(andotherCEOs’)compensationistreatedlikeanyotherwage,wheninfactit’spartoftherentstheygarnerfromtheirpositions.Totheextentthatpayatthetopissodistorted,whatisgoingonisinfactnotwelldescribedbyaconventionaldemandandsupplymodel.42.In2010awoman’smedianwagewas80percentofaman’s,upfrom62percentin1979;themedianwageamongAfricanAmericansandHispanicsis80percentand70percent,respectively,ofthatamongwhitepeople.43.Thereisahugeliteratureonlabormarketdiscrimination;see,e.g.,JosephG.AltonjiandRebeccaM.Blank,“RaceandGenderintheLaborMarket,”inHandbookofLaborEconomics,ed.OrleyC.AshenfelterandDavidCard,vol.3,pt.C(NewYork:Elsevier,1999),pp.3143–259.(Ofcourse,thereisalsoafeedbackloopin“statistical”discrimination—differencesineducation,too,arearesultofdiscrimination.)Seenote47inthischapterforfurtherdiscussionofstatisticaldiscrimination.44.See,inparticular,theNobelPrize–winningeconomistGaryBecker’sTheEconomicsofDiscrimination(Chicago:UniversityofChicagoPress,1957).45.Ofcourse,foralongtime,JimCrowlawsreinforcedmarketprocessesofdiscrimination.Inadequatepubliceducationensuredthatthosefromcertaingroupsbeganlifewithahandicap–andthatproblemcontinuestoday.46.See,e.g.,DilipAbreu,“OntheTheoryofInfinitelyRepeatedGameswithDiscounting,”Econometrica56,no.2(March1988):383–96.SeealsoGeorgeA.Akerlof,“Discriminatory,Status-BasedWagesamongTradition-Oriented,StochasticallyTradingCoconutProducers,”JournalofPoliticalEconomy93,no.2(April1985):265–76.47.Thisisanotherexampleofthenotionofreflexivitydiscussedinchapter5.Psychologicalphenomena,whereindividuals’perceptionsareaffectedbytheirbeliefs,reinforcetheresult—aphenomenonalsodiscussedfurtherinchapter5.Foradiscussionofstatisticaldiscrimination,seeEdmundS.Phelps,“TheStatisticalTheoryofRacismandSexism,”AmericanEconomicReview62(1972):659–61.Foradiscussionofthekindsofdiscriminatoryequilibriumjustdescribed,seeJosephStiglitz,“ApproachestotheEconomicsofDiscrimination,”AmericanEconomicReview6,no.2(1973):287–95;Stiglitz,“TheoriesofDiscriminationandEconomicPolicy,”inPatternsofRacialDiscrimination,ed.G.vonFurstenbergetal.(Lexington,MA:LexingtonBooks,1974),pp.5–26;andK.J.Arrow,“TheTheoryofDiscrimination,”inDiscriminationinLaborMarkets,ed.O.AshenfelterandA.Rees(Princeton:PrincetonUniversityPress,1973).48.SeeM.Bertrand,D.Chugh,andS.Mullainathan,“ImplicitDiscrimination,”AmericanEconomicReview95,no.2(2005):94–98.49.Thesestudiesareoftencalled“audit”studies.SeeM.BertrandandS.Mullainathan,“AreEmilyandGregMoreEmployableThanLakishaandJamal?AFieldExperimentonLaborMarketDiscrimination,”AmericanEconomicReview94,no.4(September2004):991–1013;andJ.Braucher,D.Cohen,andR.M.Lawless,“Race,AttorneyInfluence,andBankruptcyChapterChoice,”JournalofEmpiricalLegalStudies(forthcoming).50.SeeD.Pager,“TheMarkofaCriminalRecord,”AmericanJournalofSociology108,no.5(2003):937–75;andDevahPager,Marked:Race,Crime,andFindingWorkinanEraofMassIncarceration(Chicago:UniversityofChicagoPress,20007).51.CenterforDiseasesandControl,“Deaths:PreliminaryDatafor2009,”NationalVitalStatisticsReports59,no.4(March2011):16.52.In2009atypicalHispanichadwealthofonly$6,325,while,aswenotedinchapter1,atypicalwhitehad$113,149.Fouryearsearlieratypicalwhitehouseholdhad“only”tentimesthatofblacks.AboutathirdofHispanics(31percent)andblacks(35percent)hadzeroornegativenetworthin2009,comparedwithhalfthatnumber(15percent)forwhites.(In2005thenumberswere29percentforblacks,23percentforHispanics,and11percentforwhites.)PewResearchCenter,“WealthGapsRisetoRecordHighsbetweenWhites,Blacks,andHispanics,”July26,201.53.Formorediscussionofdiscriminationseechapter4.54.SeeTaxPolicyCenter:UrbanInstituteandBrookingsInstitution,tableavailableathttp://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=213.MostofthebenefitsoftheBushtaxcutswenttothoseattheverytop—two-thirdstothetopquintile,one-thirdtothetop1percent.236 55.Theoretically,theeffectoflowertaxesonsavingsisambiguousbecausewhilehighertaxratesreducethereturntosavings,theyforcethosewhoareattemptingtosaveforaparticulartarget—likeretirementorfinancingthecollegeeducationoftheirchildren—tosavemore.(Moreformally,economistssaythatthereareincomeandsubstitutioneffectsthatpullindifferentdirections,withambiguousneteffects.)Fromtheperspectiveofnationalsavings,evenifthetaxcutincapitalgainsinducedmoreprivatesavings(whichisdubious),itincreasesthefederaldeficit.Itisparticularlyunlikelythatthegaininprivatesavingsissogreatastooffsetthelattereffect.56.AschairmanofClinton’sCouncilofEconomicAdvisers,Iwasactivelyinvolvedinthedebateoverloweringcapitalgains,activelyopposingit:itwasinequitable,thegapbetweenhowcapitalgainsandotherreturnstocapitalweretaxedwasdistortionary,andtheallegedbenefitswereillusionary.Particularlyobjectionablewasextendingthepreferentialtreatment(underbothBushandClinton)toinvestmentsthathadalreadybeenmade.Inthesecasesitwashardtoarguethattherewasany“incentive”benefittooffsettheadversedistributionalconsequences.57.D.Kocieniewski,“AFamily’sBillions,ArtfullySheltered,”NewYorkTimes,November26,2011,availableathttp://www.nytimes.com/2011/11/27/business/estee-lauder-heirs-tax-strategies-typify-advantages-for-wealthy.html?pagewanted=all.58.CBO,“TrendsintheDistributionofHouseholdIncomebetween1979and2007,”October2011.Dataisfor2007.Numbersvaryfromyeartoyear.59.Thesenumbersrefertocapitalgainsanddividendssubjecttotax.FromJoelFriedmanandKatherineRichards,“CapitalGainsandDividendTaxCuts:DataMakeClearThatHigh-IncomeHouseholdsBenefittheMost,”CenteronBudgetandPolicyPriorities,January30,2006.60.SeeJamesB.Steward,“WorkingAllDayfortheIRS,”NewYorkTimes,February17,2012,availableathttp://www.nytimes.com/2012/02/18/business/working-all-day-for-the-irs-common-sense.html?pagewanted=1&ref=jamesbstewart(accessedMarch3,2012).61.See“Richest400TookRecordShareofCapitalGainsduringMarketMeltdownYear,”Forbes,May11,2011.62.EthanPollackandRebeccaThiess(basedondatafromCBOandIRS):EconomicPolicyInstitute,“TaxesontheWealthyHaveGoneDownDramatically,”April14,2011.ThefamousinvestorWarrenBuffettevencalledforhighertaxpaymentinhisop-edintheNewYorkTimes,sayingthattheverywealthypeoplelikehimselfpaylowertaxratesthanthemiddleclass,thankstospecialtaxcategoriesforinvestmentincome.“StopCoddlingtheSuper-Rich,”NewYorkTimes,August14,2011,availableathttp://www.nytimes.com/2011/08/15/opinion/stop-coddling-the-super-rich.html(accessedMarch2012).63.Conservatives,withtheirobsessionwithincentives,shouldhaveworriedaboutthepeculiarincentivestowhichhavingazerotaxrateoninheritancesforoneyearmightgiverise.64.Andsome,likeGE,actuallygetmoneybackfromthegovernment.SeeDavidKocieniewski,“G.E.’sStrategiesLetItAvoidTaxesAltogether,”NewYorkTimes,March24,2011.Itssuccessisbasedbothoneffectivelobbyingfortaxprovisionsthatbenefititandoneffectiveexploitationoftaxprovisions(whichitcando,withataxdepartmentofalmostonethousand).MultinationalslikeGEoftenshiftincomearound,sothatitappearsthatmoreoftheirprofitsoriginateinlowtaxedcountries.(InthecaseofGE,e.g.,inrecentyears46percentofitsrevenuesoriginateintheUnitedStates,butitclaimsthatonly18percentofitsprofitsdo.)AU.S.GovernmentAccountabilityOffice(GAO)studyfoundthat55percentofU.S.companiespaidnofederalincometaxesduringatleastoneyearinaseven-yearperioditstudied.SeeGAO,“ComparisonoftheReportedTaxLiabilitiesofForeign-andU.S.-ControlledCorporations,1998–2005,”June2008,availableathttp://www.gao.gov/new.items/d08957.pdf.65.Corporateincometaxrevenueaccountedfor30percentoftotalgovernmentreceiptsin1954andhaddeclinedto9percentby2010.SeeTaxPolicyCenter:UrbanInstituteandBrookingsInstitution,tableavailableathttp://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=203.At$191billionin2010,corporationtaxwasequalto1.3percentofthenation’sGDP;internationallycorporateincometaxrevenuesinOECDcountriesaveraged2.8percentofGDPin2009,thelatestyearforwhichstatisticswerepublished.SeeOECD(2011),RevenueStatistics2011,OECDPublishing,availableathttp://dx.doi.org/10.1787/rev_stats-2011-en-fr(accessedMarch2,2012).66.See“MicrosoftOutlinesQuarterlyDividend,Four-YearStockBuybackPlan,andSpecialDividendtoShareholders,”Microsoftpressrelease,July20,2004,availableathttp://www.microsoft.com/presspass/press/2004/jul04/07-20boardpr.mspx(accessedMarch2,2012).67.AccordingtoanIRSstudyin2008,during2004–05,843corporationsbroughtintotheUnitedStatesalmost$362billionoftheiroverseasprofits,atthespecial5.25percenttaxrate,asavings(overthenormaltaxtheywouldhavehadtopay)ofmorethan$100billion.SeeMelissaRedmiles,“TheOne-timeReceivedDividendDeduction,”2008IRS,availableathttp://www.irs.gov/pub/irs-soi/08codivdeductbul.pdf.TheLevinreportreleasedonOctober2011studiedthetop15corporationsclaimingthelargestqualifyingoverseasdividendsunderthe2004AmericanJobsCreationAct;itfoundthatafterrepatriating$155billion,thesefirmsfirmsreducedtheiroverallU.S.workforcebynearly21,000jobs,andtheirR&Dspendingslightlydecreasedafterthetaxbreak.SeePermanentSubcommitteeonInvestigations,SenatorCarlLevin,“RepatriatingOffshoreFunds:2004TaxWindfallForSelectMultinationals,”availableathttp://levin.senate.gov/download/repatriating-offshore-funds.237 68.Itisunderstandablewhythereislessredistributionatthestatelevel.Stateshavetocompeteforpeopleandfirms.69.Housingsubsidiesloweritby.9percentagepoints,theSupplementalNutritionAssistanceProgramlowersitby1.7percentagepoints,andtheschoollunchprogramby.4percentagepoints.SeeU.S.CensusBureau,“TheResearchSupplementalPovertyMeasure,2010,”issuedNovember2011.70.TheCBO,“TrendsintheDistributionofHouseholdIncome,”concluded,“Theequalizingeffectoftransfersandtaxesonhouseholdincomewassmallerin2007thanithadbeenin1979.”Forinstance,whiletheshareofthemarket(beforetaxesandtransfers)incomeofthetop1percentdoubledbetween1979and2007,theafter-taxandtransfersharemorethandoubled,from8percentto17percent.Attheotherendofthespectrum,thebottom20percentofthepopulation’sshareofafter-taxandtransferincomefellfrom7percentto5percent.71.BureauofLaborstatistics,TableA-4,Employmentstatusofthecivilianpopulation25yearsandoverbyeducationalattainment,seasonallyadjusted,February2012,http://www.bls.gov/news.release/empsit.t04.htm(accessedMarch25,2012)andBureauofLaborStatistics,“CollegeEnrollmentandWorkActivityof2010HighSchoolGraduates,”http://www.bls.gov/news.release/hsgec.nr0.htm(accessedMarch25,2012).72.K.BischoffandS.F.Reardon,“GrowthintheResidentialSegregationofFamiliesbyIncome,1970–2009,”November2011,availableathttp://cepa.stanford.edu/sites/default/files/RussellSageIncomeSegregationreport.pdfandSeanF.ReardonandKendraBischoff,“IncomeInequalityandIncomeSegregation,”AmericanJournalofSociology116,no.4(January2011):1092–53.73.K.HoffandA.Sen,“Homeownership,CommunityInteractions,andSegregation,”AmericanEconomicReview95,no.4(2005):1167–89.74.AsRossPerlinhasdescribedinInternNation(London:Verso,2011).75.IntheNewWorldcolonieswithhigherinequalityattheoutsetofcolonization,institutionstendedtoevolveinwaysthatrestrictedtoanarroweliteaccesstopoliticalpowerandopportunitiesforeconomicadvancement.NewWorldcolonieswithlowerinitialinequalityfollowedaverydifferentpathofinstitutionaldevelopment.EngermanandSokoloffhavediscernedthispatterninawiderangeofpublicpoliciesovermanycenturies:intherighttovote,publicschooling,thedistributionoflandandotherpublicnaturalresources,bankinglaws,taxation,andpatentinstitutions.SeeKennethL.SokoloffandStanleyL.Engerman,“HistoryLessons:Institutions,FactorEndowments,andPathsofDevelopmentintheNewWorld,”JournalofEconomicPerspectives14,no.3(2000):217–32;andSokoloffandEngerman,“FactorEndowments,Inequality,andPathsofDevelopmentamongNewWorldEconomies,”Economia3,no.1(2002):41–109.AnoverviewoftheeffectsofinitialinequalityoninstitutionaldevelopmentisK.Hoff,“PathsofInstitutionalDevelopment:AViewfromEconomicHistory,”WorldBankResearchObserver18,no.22(2003):2205–26.76.KennethR.Feinberg,whomPresidentObamaappointedtooverseebankexecutivecompensationhasarguedthatnearly80percentofthe$2billionin2008bonuspaydoledoutbytroubledbankswasunmerited.By2010bonuspayhadfullyrecovered—atjustthetwenty-fivetoppublictradedbanksandsecurityfirms,ithadhit$135.5billion,oralmost1percentofGDP.LouiseStory,“ExecutivePay,”NewYorkTimes,December5,2011,availableathttp://topics.nytimes.com/top/reference/timestopics/subjects/e/executive_pay/index.htmlSeepressreleaseofthereportatU.S.Treasury’swebsite,“TheSpecialMasterforTarpExecutiveCompensationConcludestheReviewofPriorPayments,”July23,2010,availableathttp://www.treasury.gov/press-center/press-releases/Pages/tg786.aspx(accessedFebruary15,2012).77.WarrenBuffett,ChairmanandCEOofBerkshireHathaway,ina2002lettertohisshareholderswrotethat“derivativesarefinancialweaponsofdestruction,carryingdangersthat,whilenowlatent,arepotentiallylethal”onpage15ofthereport.Thatreportcanbeaccessedhere:http://www.berkshirehathaway.com/letters/2002pdf.pdf(accessedonMarch21,2012).AngeloMozilo,formerCountrywideCEO,oneoftheworstpurveyorsofthekindsofmortgagesthatbroughtonthecrisis,earnedaround$470millionbetween2001and2006.WallStreetJournal,November20,2008,availableathttp://online.wsj.com/public/resources/documents/st_ceos_20081111.html.Nowdeceased,RolandArnall,formerAmeriquestfounder(andambassadortotheNetherlandsunderPresidentGeorgeW.Bush),hadanestimatedwealthof$1.5billion.Theparentofthatcompanypaidasettlementin2006of$325millioninrelationtodeceptiveloanpractices—forwhichitadmittednowrongdoing.Whenthatcompanyfailed,thedivisionsoftheparentwerefoldedintoCitigroup.Seehttp://www.nytimes.com/2008/03/19/business/19arnall.html.78.UnjustDeserts:HowtheRichAreTakingOurCommonInheritanceandWhyWeShouldTakeItBack(NewYork:NewPress,2009),p.97.79.Theproblemswithexecutivecompensationhavebeenhighlighted—andexplained—byBebchukandFried,PaywithoutPerformance.Theypointoutthatmanagerialdiscretion—theabilityofexecutivestosettheirowncompensationschedules—hasresultedinpaystructuresthateffectivelydecouplepayfromperformanceandmisalignincentives.MichaelJensenandKevinMurphy,“PerformancePayandTop-ManagementIncentives,”JournalofPoliticalEconomy98,no.2,(1990):225–64,provideempiricalevidenceoftheverylooselinkbetweenpay(includingoptions,stockholdings,anddismissal)andperformance.HenryTosiJr.andLuisGomez-Mejiaprovideanexplanation,relatedtotheseparationofownershipandcontrol(agencytheory)discussedabove.IalsodiscusstheseissuesingreaterdetailinTheRoaringNineties.80.Sotoo,thebankshaveconnivedwiththeCEOs,tohelpthem“extract”more238 moneyoutoftheirfirms,inreturnensuringthatthebanksmakeexcessiveprofits.Thebank-CEOcollusionwasexposedbythescandalsthatmarkedthebeginningofthecentury(involvingbankanalysts,Woldcom,Enron,accountingfirms,etc.)andisdescribedmorefullyinStiglitz,TheRoaringNineties.81.JamesK.Galbraith,InequalityandInstability:AStudyoftheWorldEconomyJustbeforetheGreatCrisis(NewYork:OxfordUniversityPress,2012).ChapterFourWHYITMATTERS1.Afewcountriesintransitionfromcommunismtoamarketeconomy,aswellassomeresource-richcountries,aremakingstridestousurpitsunfortunateposition.2.ArjunJayadev,“DistributionandCrisis:ReviewingSomeoftheLinkages,”HandbookonthePoliticalEconomyofCrisis,ed.G.EpsteinandM.Wolfson(forthcoming),basedonT.PikettyandE.Saez,“IncomeInequalityintheUnitedStates,1913–1998,”QuarterlyJournalofEconomics118,no.1(2003):1–39.3.KarenE.Dynan,JonathanSkinner,andStephenP.Zeldes,“DotheRichSaveMore?,”JournalofPoliticalEconomy112,no.2(2004):397–444.4.FortheUnitedStatestheshort-runmultiplierisnormallyestimatedtobearound1.5;butwhatisrelevantinalong-termdownturnisthemultiperiod,long-termmultiplier,whichislarger,morelike2.(Notethatmanyconservativeeconomistsarguethatthemultiplierissmaller,butthisisbecausemuchofthedatauponwhichtheydrawentailsperiodsinwhichtheeconomyisatornearfullemployment,sothatasthegovernmentspendsmore,monetaryauthoritiesengageinoffsettingcontractionaryactions.Inthecurrentcontext,theFedhascommitteditselfnottoincreaseinterestrates.)Thereareanumberofothertechnicalreasonstoexpectthemultiplierinthecurrentcontexttobelarge:(a)muchofthemoneythatisnotspentintheUnitedStates(“recycled”here)goestobuyimports,andwithsomuchoftheworld’seconomyweak,thisspendingincreasesincomesabroad,leadinginturntomorepurchasesfromtheUnitedStates;(b)individualsandfirms,seeingincomesrise,maybecomemoreconfidentintheeconomy,leadingtomoreinvestmentandconsumption(thisissometimesreferredtoasthe“confidencemultiplier”);and(c)inparticular,households,anticipatinghighincomesinthefuture,aremorewillingtospendtoday.5.PeterOrzsag,“AsKaldor’sFactsFall,OccupyWallStreetRises,”Bloomberg,October18,2011.Thewagesharedeclinedby5percentagepointsfrom1990to2011,but3percentagepointsfrom2005to2011alone.NicholasKaldor,anotedCambridgeUniversityeconomistofthemidtwentiethcentury,hadclaimedthat,byandlarge,theshareoflaborwasconstant.Whiletechnologicalchangemayincreasethedemandforsometypesoflaboranddecreaseitforothers,thereisnogeneraltheoryaboutwhatshouldhappentotheshareoflabor.Iftechnologicalchangeincreasesthe“effective”supplyoflabor,andlaborandcapitalarenotverysubstitutable,thentechnologicalchangedrivesdowntheshareoflabor.Butthepatternofincreaseofwages—withwagesattheverytop(e.g.,ofbankers)increasingsomuchrelativetothatofothers—isconsistentwiththeviewthatsomethingelsebesidestechnologicalchangeiscausingthedeclineinthewageshare.6.Foramorecompletetellingofthisstory,seeJ.E.Stiglitz,TheRoaringNineties(NewYork:Norton,2003).7.Foracloserlookathowthesetaxcutsbenefitedtherich,seeJoelFriedmanandIsaacShapiro,“TaxReturns:AComprehensiveAssessmentoftheBushAdministration’sRecordonCuttingTaxes,”CenteronBudgetandPolicyPriorities,April23,2004.FriedmanandShapiroestimatethatin2004themiddle20percentincomeearnersreapedabout8.9percentofthetaxcutwindfall,whilethetop1percentgot24.2percent.Thoseearningoveramilliondollarsalonegained15.3percentofthebenefit.Seealso“ExtendingtheBushTaxCutsIstheWrongWaytoStimulatetheEconomy,”reportbytheJointEconomicCommitteeMajorityStaff,ChairmanCharlesE.Schumer;ViceChairRep.CarolynB.Maloney,April2008.8.In2004privatenon–realestateinvestmentwas11.59percentofGDP,ascomparedwith13.97percentin2000.See“FlowofFundsAccountsoftheUnitedStates,1995–2004,”BoardofGovernorsoftheFederalReserve,tableF.6,p.4,availableathttp://www.federalreserve.gov/releases/z1/Current/annuals/a1995-2004.pdf(accessedMarch3,2012).9.Thetheory(andsomeoftheevidence)explainingwhythedividendtaxcutmayhavebeenbadforinvestmentissetoutinAntonKorinekandJosephE.Stiglitz,“DividendTaxationandIntertemporalTaxArbitrage,”JournalofPublicEconomics93,nos.1–2(February2009):142–59.Seealsothereferencescitedthere.10.See,e.g.,“TheEstateTaxandCharitableGiving,”CongressionalBudgetOffice,July2004,availableathttp://www.cbo.gov/doc.cfm?index=5650(accessedFebruary15,2012).11.SeeJ.E.Stiglitz,Freefall(NewYork:Norton,2010),foramorecompletetellingofthehousingbubbleanditsimmediateaftermath.12.Whilemanyofthebiginstancesofderegulationarewellknown,deregulationhashadpervasiveeffects.Eventhoughthegovernmenthad,ineffect,givenagiftworthbillionsofdollarstotheTVcompanies,itbecamereluctanttoimposerestrictions.In1985,guidelinesforminimalamountsofnonentertainmentprogrammingonTVwereabolished.FCCguidelinesonhowmuchadvertisingcanbecarriedperhourwereeliminated.Seehttp://www.pbs.org/now/politics/mediatimeline.html.239 13.Thedistinctionbetweentheshorttermandthelongtermisimportant,fortworeasons.Whenrestraintsareremoved,otherstooengageinsimilarpractices,andifmarketsarecompetitive,theseemingprofitsquicklydisappear.Inthelongrun,atleastinthefinancialsector,thebanksmayactuallyhavelostsubstantialamounts(orwouldhave,hadthegovernmentnotgiventhemsomuchmoney),becauseoftheinstabilitytowhichtheirexcessesgaverise.14.Thelinkbetweeninequality,thecreditbubble,andtheeconomiccrisiswaslaidoutinStiglitz,Freefall,and“ReportoftheCommissionofExpertsofthePresidentoftheUnitedNationsGeneralAssemblyonReformsoftheInternationalMonetaryandFinancialSystem,”September21,2009,availableasTheStiglitzReport(NewYork:NewPress,2010).Sincethen,alargeliteratureonthesubjecthasdeveloped.See,e.g.,M.KumhofandR.Ranciere,“Inequality,LeverageandCrises,”IMFworkingpaper,2010;andRaghuramG.Rajan,FaultLines:HowHiddenFracturesStillThreatentheWorldEconomy(Princeton:PrincetonUniversityPress,2010).Forasurveyandreferences,seeJ.E.Stiglitz,“MacroeconomicFluctuations,Inequality,andHumanDevelopment,”JournalofHumanDevelopmentandCapabilities(2012).I’vearguedthatinequality,evenhighinequality,maynotnecessarilyleadtocrises;thereareotherwaysofrespondingtothedeficiencyinaggregatedemandthatmayresult,andotherfortuitouscircumstancesthatcanfillthegap.ThatisnotinconsistentwiththeempiricalfindingsinMichaelD.BordoandChristopherM.Meissner,“DoesInequalityLeadtoaFinancialCrisis?,”NBERWorkingPaperNo.17896,March2012.15.Atleastintheshorttomediumterm.Moderngrowththeory—seeRobertM.Solow,“AContributiontotheTheoryofEconomicGrowth,”QuarterlyJournalofEconomics70,no.1(February1956):65–94—hasemphasizedthatinthelongrunthegrowthrateisdeterminedbythepaceofinnovation(productivityincrease)andpopulationgrowth.Higherinstabilitymayleadtolessinvestmentinresearchanddevelopment,andthusaslowerpaceofincreaseinproductivity.16.Somepartsofthemarket,inparticularthelargebanks,actinarisk-lovingwayandhavebeenamajorsourceofthevolatilityintheeconomy.Therearefourpossibleexplanationsforthisbehavior:(a)Organizationalincentives:thelargebanksactuallypushoffmuchoftherisktogovernment,becausetheyaretoobigtofail.(b)Individualincentives(agencyproblems):thoseinsidethebankhaveincentivesthatencouragerisktaking.(c)Self-selection:inanysocietytherearethosewhoareriskloving,andtheyareespeciallyattractedtothefinancialsector.(d)Pervasiveirrationality:thoseinthefinancialsectorsystematicallyunderestimaterisk;andtheirinvestorsdonotunderstandtherisksofleverageandunderestimateitsconsequences.17.See,e.g.,thefindingsthereportoftheUNcommissionchargedwithanalyzingthecausesofthecrisisandcomingupwithremedies.ReportoftheCommissionofExpertsofthePresidentoftheUnitedNationsGeneralAssemblyonReformsoftheInternationalMonetaryandFinancialSystem,September21,2009,availableasTheStiglitzReport(NewYork:NewPress,2010).18.AndrewG.BergandJonathanD.Ostry,“InequalityandUnsustainableGrowth:TwoSidesoftheSameCoin?,”IMFStaffDiscussionNote,April8,2011,p.3,availableathttp://www.imf.org/external/pubs/ft/sdn/2011/sdn1108.pdf(accessedMarch25,2012).19.DominiqueStrauss-Kahn,“TheGlobalJobsCrisis—SustainingtheRecoverythroughEmploymentandEquitableGrowth,”April13,2011,availableathttp://www.imf.org/external/np/speeches/2011/041311.htm.20.Thereare,ofcourse,manywaysofproducingthesegoods.Basicresearchcould,forinstance,befinancedbythegovernmentandproducedeitherinprivatelaboratories,universities,orgovernment-runlaboratories.TheUnitedStateshastraditionallyemployedallofthese.21.AreportoftheCouncilofEconomicAdvisersdocumentedthehighreturnstogovernmentsupportforresearchanddevelopment.CouncilofEconomicAdvisers,“SupportingResearchandDevelopmenttoPromoteEconomicGrowth:TheFederalGovernment’sRole,”October1995.Alargebodyofliteraturedocumentsthevalueofgovernmentinvestments.See,e.g.,DavidAlanAschauer,“IsGovernmentSpendingStimulative?”ContemporaryEconomicPolicy8,no.4(1990):30–46.Aschauerhasalsoshownthatpubliccapitalinvestmentcanimprovereturnstoprivatecapital,alongwiththedirectbenefitsitprovides.SeeAschauer,“DoesPublicCapitalCrowdOutPrivateCapital,”JournalofMonetaryEconomics24,no.2(1989):121–88.22.ThisissomethingthatBenBernankehighlightedinaMay16,2011,speech,“PromotingResearchandDevelopment:TheGovernment’sRole,”availableathttp://www.federalreserve.gov/newsevents/speech/bernanke20110516a.htm(accessedMarch3,2012).“First,sincethe1970s,R&DspendingbythefederalgovernmenthastrendeddownasashareofGDP,whiletheshareofR&Ddonebytheprivatesectorhascorrespondinglyincreased.Second,theshareofR&Dspendingtargetedtobasicresearch,asopposedtomoreappliedR&Dactivities,hasalsobeendeclining.Thesetwotrends—thedeclinesintheshareofbasicresearchandinthefederalshareofR&Dspending—arerelated,asgovernmentR&Dspendingtendstobemoreheavilyweightedtowardbasicresearchandscience.Thedecliningemphasisonbasicresearchissomewhatconcerningbecausefundamentalresearchisultimatelythesourceofmostinnovation,albeitoftenwithlonglags.Indeed,someeconomistshavearguedthat,becauseofthepotentiallyhighsocialreturntobasicresearch,expandedgovernmentsupportforR&Dcould,overtime,significantlyboosteconomicgrowth.”Indeed,realfederalinvestmentinbasicresearchdecreasedfrom$4.3billionin2003to$3.9in2008,adjustedforinflation.Seetable6ofNationalScienceBoard,“ScienceandEngineering240 Indicators:2010,”NationalScienceFoundation,2010,availableathttp://www.nsf.gov/statistics/nsf10314/content.cfm?pub_id=4000&id=2(accessedMarch3,2012).AlbertM.Linkandothershaveshownthatthereisadirectlinkbetweenbasicresearchandproductivitygrowth.SeeLink,“BasicResearchandProductivityIncreaseinManufacturing:AdditionalEvidence,”AmericanEconomicReview71,no.5(1981):1111–12.23.StudiesbytheHealth,Education,LaborandPensions(HELP)Committeehaveshownthatfor-profitcollegesaredrasticallymoreexpensive,spendlessperstudentthannonprofitandpublicinstitutions,leadthenationinwithdrawalrates—upto84percentforsomeassociate’sdegreeprograms—andaccountfor50percentofallstudentloandefaults,eventhoughtheyenrollonlyabout13percentofAmericanhighereducationstudents.Thesefindingsandotherscanbeviewedathttp://harkin.senate.gov/help/forprofitcolleges.cfm(accessedFebruary15,2012).24.Some66percentoffour-yearundergraduatestudentsgraduatedwithsomedebtin2007–08,andtheaveragecumulativedebtincurredwas$27,803.Averagecumulativedebthasbeenincreasingatarateinexcessof5percentperyear.ThesefigureswerecalculatedbyFinAid.orgusingthedataanalysissystemforthe2007–08NationalPostsecondaryStudentAidStudy(NPSAS),conductedbytheNationalCenterforEducationStatisticsattheU.S.DepartmentofEducation.25.Thisincluded784lobbyists(nearly2perU.S.representative)fromtheoilindustryand262fromtheminingindustry;totalspendingfortheenergyandnaturalresourcesindustry’slobbyingwas$387.8millionin2011.Financial-sectorspendingonlobbyingisevengreater.DataisfromOpenSectrets.org,thewebsiteoftheCenterforResponsivePolitics;seeinparticularhttp://www.opensecrets.org/lobby/top.php?indexType=c(accessedMarch5,2012).26.Classicreferencesonrentseeking,demonstratingtheirdissipativeeffectsandestimatingtheircosts,areGordonTullock,“TheWelfareCostsofTariffs,Monopolies,andTheft,”EconomicInquiry5,no.3,(1967):224–32;andAnnKrueger,“ThePoliticalEconomyoftheRent-SeekingSociety,”AmericanEconomicReview64,no.3(1974):291–303.Interestingly,eventheeffortsofthosewithgreaterabilitytoappropriateforthemselvesreturnscommensuratewiththeirabilitiescanleadtoanequilibriuminwhichnotonlyothersarelesswell-offbuteventheyaretoo,astheyspendmoney(stayinschoollonger)andtakeotheractionstodifferentiatethemselves.SeeJ.E.Stiglitz,“TheTheoryofScreening,EducationandtheDistributionofIncome,”AmericanEconomicReview65,no.3(June1975):283–300.27.SeeBureauofEconomicAnalysis,NationalIncomeandProductAccountsTable,“Table6.16D.CorporateProfitsbyIndustry,”availableathttp://www.bea.gov/National/nipaweb/SelectTable.asp.28.Thisisbasedonplausibleindustryassertionsaboutthefees.TimHammonds,presidentandCEOofFoodMarketingInstitute,hassaid,“Howbigistheproblem?Theinterchangefeeasupermarketpayswhenacustomerpayswithplasticismorethanthemoneythatflowstotheretailer’sbottomline;it’softendouble.Doesthatseemrighttoyou?Theserviceproviderusingacomputerizedpaymentnetworkisgettingmoredollarsfromthetransactionthanthenetprofitforthemerchantwhoprovidesthelabor,theland,thefixtures,thelightandtheheat,andthestorethatstockstheproducts.”Hammonds,speechtotheFMIMidwinterExecutiveConference(January24,2006),availableathttp://c0462491.cdn.cloudfiles.rackspacecloud.com/Hammonds_Interchange_Speech.pdf(accessedMarch6,2012).29.SeeMarc-AndréGagnonandJoelLexchin,“TheCostofPushingPills:ANewEstimateofPharmaceuticalPromotionExpendituresintheUnitedStates,”PLoSMedicine5,no.1(January2008):1–6.30.In2009theUnitedStatesspentabout17.4percentofGDP,amountingtoalmost$8,000percapita.TheNetherlandsandFrancewerethenexttwohighestcountries,spending12.0percentand11.8percentofGDP,respectively.TheaverageOECDspendingwas$3,223.OECDHealthData2011,databaseavailableathttp://www.oecd.org/document/30/0,3746,en_2649_37407_12968734_1_1_1_37407,00.html(accessedMarch3,2012).31.“TheMeasurementofEconomicPerformanceandSocialProgressRevisited—ReflectionsandOverview,”September,16,2009,CMEPSP,availableathttp://www.stiglitz-sen-fitoussi.fr/documents/overview-eng.pdf(accessedFebruary15,2012),afollow-uptothereportoftheCommissionontheMeasurementofEconomicPerformanceandSocialProgress.AlsoavailableasJosephStiglitz,AmartyaSen,andJean-PaulFitoussi,MismeasuringOurLives(NewYork:NewPress,2010).32.FiguresareavailablefromtheIMFWorldEconomicOutlookDatabase,availableathttp://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx(accessedFebruary12,2012).33.Someclaim,however,thatthequotationisonlyapocryphal.Seehttp://www.dirksencenter.org/print_emd_billionhere.htm.34.SeetheCommissionontheMeasurementofEconomicPerformanceandSocialProgress.35.StephenP.Magee,WilliamA.Brock,andLeslieYoung,BlackHoleTariffsandEndogenousPolicyTheory:PoliticalEconomyinGeneralEquilibrium(NewYork:CambridgeUniversityPress,1989).Notsurprisinglyanarmyoflawyersisreadytocometothedefenseofthelegalprofessionandtochallengethesefindings.SeeGeorgeL.Priest,“Lawyers,Liability,andLawReform:EffectsonAmericanEconomicGrowthandTradeCompetitiveness”(1993),FacultyScholarshipSeries,availableat624.http://digitalcommons.law.yale.edu/fss_papers/624.36.SeeAndreiShleiferandRobertW.Vishny,TheGrabbingHand:Government241 PathologiesandTheirCures(Cambridge:HarvardUniversityPress,1998).37.Thetheoryisthatfearofpunishmentafterthefactwillprovideincentivesforfirmstobehavewell.Butfirmswellarmedwithlawyersknowthattheyoftenwillescapepunishment.Andbesides,takingriskswiththeenvironmentincreasesprofitstoday,andshortsightedmanagersaremoreconcernedwiththerealityoftoday’sprofitsthanwhatmighthappentoprofitssometimeinthefuture.Theinterestsofthemanagersmaynotbewellalignedwiththeinterestsofthefirm,andtheinterestsofthefirmarenotwellalignedwiththoseofsocietymorebroadly.38.Knownastheproblemofmoralhazard.39.Forafullerdiscussionoftheseissues,seeL.BilmesandJ.E.Stiglitz,TheThreeTrillionDollarWar(NewYork:Norton,2008).40.TheIraqwarwasputentirelyonthecreditcard:whenthewarstarted,theUnitedStatesalreadyhadadeficit.Butinsteadofraisingtaxestopayforit,thegovernmentloweredtaxesin2003.41.QuotationisfromMarshall’s1895PrinciplesofEconomics.Itappearsonp.555ofthe8thed.(London:Macmillan,1920).42.H.Leibenstein,EconomicBackwardnessandEconomicGrowth(NewYork:Wiley,1957).43.SeePaulGlewwe,HananG.Jacoby,andElizabethM.King;“EarlyChildhoodNutritionandAcademicAchievement:ALongitudinalAnalysis,”JournalofPublicEconomics81,no.3(September2001):345–68.Forarecentreviewofliterature,seeDouglasAlmondandJanetCurrie,“HumanCapitalDevelopmentbeforeAgeFive,”inHandbookofLaborEconomics,vol.4b,ed.OrleyAshenfelterandDavidCard(NewYork:Elsevier,2011),1315–486.44.MullainathanandShafirarewritingabook,ThePackingProblem:Time,Money,andtheScienceofScarcity.Thequotationinthetextisfromtheirmanuscriptasreportedonhttp://westallen.typepad.com/idealawg/2011/07/are-you-money-poor.html.Theirargumentisvividlyexplainedinhttp://www.youtube.com/watch?v=5Aw_czU1bm0.45.Myownworkhasfocusedonabroadanalysisofhowhigherwagescanincreaseproductivity,throughloweringlaborturnover,improvingincentives,improvingthequalityofthelaborforce,andimprovingmorale.Thetheoriesareknowncollectivelyas“efficiencywagetheories”andwerediscussedinmyreviewpaper“TheCausesandConsequencesoftheDependenceofQualityonPrices,”JournalofEconomicLiterature25(1987):1–48,aswellasinmyNobelPrizelecture,publishedas“InformationandtheChangeintheParadigminEconomics,”AmericanEconomicReview92,no.3(June2002):460–501.GeorgeAkerlof(whosharedwithmethe2001NobelPrizeinEconomics)andJanetYellen(currentlyvicechairoftheFederalReserve)havefurtherarticulatedhowtheperceptionofunfairnesscanundermineeffort.SeeAkerlofandYellen,“TheFair-WageEffortHypothesisandUnemployment,”QuarterlyJournalofEconomics105(1990):255–83.JosephW.Harderlookedatacontextinwhichtherewereobjectivemeasuresofperformance—baseballandbasketball—andshowedthat“underrewardedindividualsbehavedlesscooperativelyandmoreselfishly.”“PlayforPay:EffectsofInequityinaPay-for-PerformanceContext,”AdministrativeScienceQuarterly37(1992):321–35.46.AlanB.KruegerandAlexandreMas,“Strikes,Scabs,andTreadSeparations:LaborStrifeandtheProductionofDefectiveBridgestone/FirestoneTires,”JournalofPoliticalEconomy112,no.2(2004):253–89.47.AlainCohn,ErnstFehr,andLorenzGoette,“FairnessandEffort—EvidencefromaFieldExperiment,”WorkingPaper,October2008;andAlainCohn,ErnstFehr,BenediktHerrmann,andFredericSchneider,“SocialComparisonintheWorkplace:EvidencefromaFieldExperiment,”IZAWorkingPaper5550,March2011.48.MarianneBertrandandAdairMorsehaveusedanexpressionsimillartoour“trickle-downbehaviorism.”They’vedocumentedtheimportanceoftrickle-downconsumerism,showingthatnotonlydoesspendingincreaseifonelivesinacommunitywithhigherincomeinequality,butsodobankruptcyandself-reportedfinancialdistress.Interestingly,theyalsoshowthatpoliticiansinsuchcommunitiessupportmeasurestomakecreditmoreavailable—perhapsinashortsightedattempttomakepoorerindividualsfeelbetterbybeingableto(temporarily)consumemore.See“Trickle-downconsumption,”workingpaper,February2012,availableat(http://isites.harvard.edu/fs/docs/icb.topic964076.files/BertrandMorseTrickleDown_textandtables.RobertFrankofCornellUniversity,AdamSethLevineoftheUniversityofMichigan,andOegeDijkoftheEuropeanUniversityInstitutehaveputforwardasimilarhypothesis,called“expenditurecascades.”Theyprovideempiricalevidencethatincreasedincomeinequalityisassociatedwith“overspending,”reflectedin,forinstance,higherbankruptcyrates.See“ExpenditureCascades,”availableathttp://ssrn.com/abstract=1690612,Oct12,2010.49.AsurveyoftheevidenceforbothdevelopedanddevelopingcountriesisinAndrewE.ClarkandClaudiaSenik,“WillGDPGrowthIncreaseHappinenssinDevelopingCountries?,”ParisSchoolofEconomics,WorkingPaperno.2010-43,March2011.50.JohnMaynardKeynes,EconomicPossibilitiesforOurGrandchildren:EssaysinPersuasion(originallypublished1930)(NewYork:Norton,1963),pp.358–73.Thediscussionheredrawsuponmyreflectionsonthatessay:“TowardaGeneralTheoryofConsumerism:ReflectionsonKeynes’EconomicPossibilitiesforOurGrandchildren,”inRevisitingKeynes:EconomicPossibilitiesforOurGrandchildren,ed.G.PigaandL.Pecchi(Cambridge:MITPress,2008),pp.41–87.Seealsotheotheressaysinthatvolume.51.AdamSmith,LecturesonJurisprudence,ed.RonaldL.Meek,D.D.Raphael,andPeterStein(NewYork:ClarendonPress,1978),(A)vi.54.ThecitationandanalysisareinDanielLuban,“AdamSmithonVanity,Domination,andHistory,”242 ModernIntellectualHistory,forthcoming.52.Forthelong-runsurvivaloftheplanet,there’ssomethingelsewrongwithAmerica’sanswer:excessiveconsumptionofmaterialgoodsleadstoglobalwarmingandputstheearthinperil.53.Thoughincentivesareatthecoreoftheconservativejustificationforinequality,theyalsoappealto“fairness.”Seechapter2foracritique.54.Wealthintheformofcollateralplaysakindofcatalyticroleratherthanaroleofinputthatgetsusedupintheprocessofproducingoutput.SeeK.Hoff,“MarketFailuresandtheDistributionofWealth:APerspectivefromtheEconomicsofInformation,”PoliticsandSociety24,no.4(1996):411–32;andHoff,“TheSecondTheoremoftheSecondBest,”JournalofPublicEconomics25(1994):223–42.55.TheexcitingstoryistoldinthebestsellerbyDavaSobel,Longitude:TheTrueStoryofaLoneGeniusWhoSolvedtheGreatestScientificProblemofHisTime(NewYork:Walker,1995).56.Technically,theproblemswithincentivepayarisewhenthereareinformationasymmetries.Theemployerdoesn’tfullyknowthequalityoftheproductsproducedbytheworker(otherwise,hewouldspecifythat).Inatrial,thejudgeandjuryworrythatthestrengthofanexpert’sopinionmightbeaffectedifhiscompensationdependedontheoutcomeofthetrial.57.Giventhis,onemightask,whyarethoseinfinance,supposedlyexpertsineconomics,soweddedtothesedistortionaryincentiveschemes.Theanswer,asweexplainedearlier,relatestofailuresincorporategovernance:theseschemesallowthemtomoreeasilydivertmoreofthecorporaterevenuetothemselves.58.SeePatrickBolton,JoseScheinkman,andWeiXiong,“ExecutiveCompensationandShort-TermistBehaviourinSpeculativeMarkets,”ReviewofEconomicStudies73,no.3(2006):577–610.59.Opponentsclaimedthattherewasnowaythatonecouldaccuratelyvaluetheoptions,butattheCouncilofEconomicAdviserswedevisedawayofprovidingatleastalowerboundontheestimate—afarbetterestimatethanthezerovalueassociatedwithcurrentaccountingpractices.60.SeeB.NalebuffandJ.E.Stiglitz,“Information,CompetitionandMarkets,”AmericanEconomicReview73,no.2(May1983):278–84;B.NalebuffandJ.E.Stiglitz,“PrizesandIncentives:TowardaGeneralTheoryofCompensationandCompetition,”BellJournal14,no.1(Spring1983):21–43;andJ.E.Stiglitz,“DesignofLaborContracts:EconomicsofIncentivesandRisk-Sharing,”inIncentives,CooperationandRiskSharing,ed.H.Nalbantian(Totowa,NJ:Rowman&Allanheld,1987),pp.47–68.243 61.DasguptaParthaandPaulA.David,“TowardaNewEconomicsofScience,”ResearchPolicy2,no.5(September1994):487–521.62.ThestudywasconductedinHaifa,Israel,bytwoeconomists,UriGneezyandAldoRustichini,andpublishedas“AFineIsaPrice,”JournalofLegalStudies29,no.1(January2000):1–17.Avarietyofexperimentsconfirmthepowerofintrinsicrewards,incomparisonwithextrinsicrewards.See,e.g.,GneezyandRustichini,“PayEnoughorDon’tPayAtAll,”QuarterlyJournalofEconomics115,no.3(2000):791–810.Oneexplanationforwhy“high-performanceworksystems”(inwhichworkersaregivenmoreresponsibility)performbetteristhattheyenhancetrustandaperceptionofintrinsicreward.SeeEileenAppelbaum,ThomasBailey,PeterBerg,andArneKalleberg,ManufacturingAdvantage:WhyHigh-PerformanceWorkSystemsPayOff(Ithaca:CornellUniversityPress,2000).SeealsoJ.E.Stiglitz,“DemocraticDevelopmentastheFruitsofLabor,”inTheRebelWithin,ed.Ha-JoonChang(London:WimbledonPublishing,2001),pp.279–315.(OriginallykeynoteaddressattheIndustrialRelationsResearchAssociation,Boston,January2000.)63.Akeyinsightofmodernindustrialorganizationisthatinimperfectlycompetitivemarkets—andmostmarketsareimperfectlycompetitive—onecangetaheadandincreaseprofitsnotjustbyperformingbetterbutalsobyensuringthatone’srivalperformsmorepoorly.Profits—andbonuses—canincrease,butsocietalwelfarecanbedecreased.Thistheoryiscalled“raisingrivalscosts.”SeeStevenC.SalopandDavidT.Scheffman“RaisingRivals’Costs,”AmericanEconomicReview73,no.2(May1983):267–71.64.Agoodempiricalreviewis“Team-BasedRewards:CurrentEmpiricalEvidenceandDirectionsforFutureResearch,”ResearchinOrganizationalBehavior20(1998):141–83.Amorerecentstudyhasshownhowcompetitionamongworkersunderminesworkplaceproductivity.SeeJeffreyCarpenter,PeterHansMatthews,andJohnSchirm,“TournamentsandOfficePolitics:EvidencefromaRealEffortExperiment,”AmericanEconomicReview100,no.1(2010):504–17.65.Again,well-beingattheworkplacewassomethingthattheCommitteefortheMeasurementofEconomicSocialProgressemphasized.66.SeeGeraldMarwellandRuthE.Ames,“EconomistsFreeRide,DoesAnyoneElse?,”JournalofPublicEconomics15(June1981):295–310;JohnR.CarterandMichaelD.Irons,“AreEconomistsDifferent,andIfSo,Why?,”JournalofEconomicPerspectives5,no.2(Spring1991):171–77;GüntherSchulzeandBjornFrank,“DoesEconomicsMakeCitizensCorrupt?,”JournalofEconomicBehaviorandOrganization43,no.1(2000):101–13;RobertH.Frank,ThomasGilovich,andDennisT.Regan,“DoesStudyingEconomicsInhibitCooperation?,”JournalofEconomicPerspectives7,no.2(Spring1993):159–71;ReinhardSeltenandAxelOckenfels,“AnExperimentalSolidarityGame,”JournalofEconomicBehaviorandOrganization34,no.4(March1998):517–39.67.FidanAnaKurtulusandDougKruseshowthatinthisrecession,andinpastones,employee-ownedfirmsdidbetter,maintaininghigherlevelsofemployment,thandidothers.See“HowDidEmployeeOwnershipFirmsWeathertheLastTwoRecessions?EmployeeOwnershipandEmploymentStabilityintheUS:1999–2008,”PowerPointpresentationgivenatMid-YearFellowsWorkshopinHonorofLouisO.Kelso,February24–25,2011,atRutgersSchoolofManagementandLaborRelations.68.SeePeterDiamondandEmmanuelSaez,“TheCaseforaProgressiveTax:FromBasicResearchtoPolicyRecommendations,”JournalofEconomicPerspectives25,no.4(2011):165–90;andThomasPiketty,EmmanuelSaez,andStefanieStantcheva,“OptimalTaxationofTopLaborIncomes:ATaleofThreeElasticities,”NBERWorkingPaper17616,2011,availableathttp://www.nber.org/papers/w17616(accessedMarch1,2012).Foranaccessiblediscussionofthesecondpaper’sfindings,seethesameauthors’article“Taxingthe1%:WhytheTopTaxRateCouldBeover80%,”Vox,December8,2011,availableathttp://www.voxeu.org/index.php?q=node/7402(accessedMarch6,2012).Someearlier,idealizedeconomicmodelssuggestedthatitwasoptimalnottotaxinterestincome(incomefromcapital),butsubsequentresearchshowedthatthisresultwasnotrobust:capitaltaxationisdesirable.See,e.g.,ThomasPikettyandEmmanuelSaez,“ATheoryofOptimalCapitalTaxation,”workingpaper,2011,ParisSchoolofEconomicsandUniversityofCaliforniaatBerkeley,availableathttp://elsa.berkeley.edu/~saez/piketty-saez1_1_11optKtax.pdf(accessedFebruary27,2012);andJ.E.Stiglitz,“ParetoEfficientTaxationandExpenditurePolicies,withApplicationstotheTaxationofCapital,PublicInvestment,andExternalities,”presentedatconferenceinhonorofAgnarSandmo,Bergen,Norway,January1998.69.Whichallowedthoseinprivateequityfirmsandhedgefundstobetaxedontheirreturns—includingwhattheyreceivedfrommanagingotherpeople’smoney—atthefavorablecapitalgainstaxrate.70.AlexanderJ.Field,AGreatLeapForward:1930sDepressionandU.S.EconomicGrowth(NewHaven:YaleUniversityPress,2011).71.Thisisthethrustoftheanalysisof“optimalredistributivetaxation,”discussedinanearlierfootnote.72.Inaspeech(October26,2011)entitled“SavingtheAmericanIdea:RejectingFear,Envy,andthePhilosophyofDivision”deliveredinresponsetotheCBOreportdetailingAmerica’sgrowinginequality,ascitedinJonathanChait,“NoSuchThingasEqualOpportunity,”NewYork,November7,2011,pp.14–16.73.Ibid.74.Ibid.75.SeeTorstenPerssonandGuidoTabellini,“IsInequalityHarmfulforGrowth?,”AmericanEconomicReview84,no.3(June1994):600–21.244 ChapterFiveADEMOCRACYINPERIL1.Foratextbookexposition,andadiscussionoftheimplications,forinstance,foreducationexpendituresortheprogressivityofthetaxsystem,seeJ.E.Stiglitz,TheEconomicsofthePublicSector,3rded.(NewYork:W.W.Norton,2000).Forearliertheoreticaldiscussions,seeAnthonyDowns,“AnEconomicTheoryofPoliticalActioninaDemocracy,”JournalofPoliticalEconomy65,no.2(1957):135–50;HaroldHotelling,“StabilityinCompetition,”EconomicJournal39,no.153(1929):41–57;andKennethJ.Arrow,SocialChoiceandIndividualValues,2nded.(NewYork:Wiley,1963).2.EdwardWyatt,“S.E.C.IsAvoidingToughSanctionsforLargeBanks,”NewYorkTimes,February3,2012,p.A1.Thearticleprovidesadetailedanalysis,citingasanexampleJPMorganChase,which“hassettledsixfraudcasesinthelast13years,includingonewitha$228millionsettlementlastsummer,butithasobtainedatleast22waivers,inpartbyarguingthatithas‘astrongrecordofcompliancewithsecuritieslaws.’”3.Thisisundoubtedlyoneofthereasonswhy,intheUnitedStates,voterturnoutamongAfricanAmericanshassofrequentlylaggedbehindthatofwhites,andturnoutamongthepoorhaslaggedbehindthatofbetter-offothergroups.AmericahadsolongexcludedAfricanAmericansfromenjoyingfullrightsthatevenwhenvotingrestrictionswerelifted,thecommunity’sfaithintheelectoralprocessremainedseriouslyharmed.See,e.g.,MarkLopezandPaulTaylor,“Dissectingthe2008Electorate:MostDiverseinU.S.History,”PewResearchCenter,April30,2009,availableathttp://pewresearch.org/assets/pdf/dissecting-2008-electorate.pdf.4.Thestrengthoffaithindemocraticprocessesis,however,remarkable.OneinterpretationforwhyittooksolongfortheOccupyWallStreetproteststoemergewasthatmanyhopedthatthepoliticalprocesswould“work”toreininthefinancialsectorandredressthecountry’seconomicproblems.Itwasonlywhenitwasevidentthattheydidnotthatprotestsbecamewidespread.Thestrongvoterturnoutin2008(thehighestsince1968)reflectsthepowerofhope.War,too,elicitsastrongsenseofcivicidentity,perhapsaccountingfortherelativelyhighvoterturnoutin2004.5.Economichistorianshaveemphasizedtheroleoftrustinthedevelopmentofmoderncapitalism.See,e.g.,D.McCloskeyTheBourgeoisVirtues:EthicsforanAgeofCommerce(Chicago:UniversityofChicagoPress,2006);andJ.Mokyr,TheEnlightenedEconomy(NewHaven:YaleUniversityPress,2011).TheyhavearguedthatBritain’ssuccessintheIndustrialRevolutiondependedonitsnormsagainstopportunism.AsMokyrputsit,“opportunisticbehaviorwasmadesotaboothatinonlyafewcaseswasitnecessarytousetheformalinstitutionstopunishdeviants….Entrepreneurialsuccesswasbasedlessonmulti-talentedgeniusesthanonsuccessfulcooperationbetweenindividualswhohadgoodreasontothinktheycouldtrustoneanother”(pp.384–86).Trustwasalsooneofthereasonsthatcertainclose-knitethniccommunitiesandcertainothercommunitiestookonapivotalroleintheearlydevelopmentofcapitalism.See,e.g.,AvnerGreif,“ReputationandCoalitionsinMedievalTrade:EvidenceontheMaghribiTraders,”JournalofEconomicHistory49,no.4(1989):857–82;andGreif,“ContractEnforceabilityandEconomicInstitutionsinEarlyTrade:TheMaghribiTraders’Coalition,”AmericanEconomicReview83,no.3(1993):525–48.AlbertHirschman,agreateconomistwhoseinsightsreachedbeyondeconomics,hasmadesimilarobservations.See,e.g.,hisThePassionsandtheInterests(Princeton:PrincetonUniversityPress,1977).6.ThequotationisfromG.W.Kolodko,FromShocktoTherapy:ThePoliticalEconomyofPostsocialistTransformation(NewYork:OxfordUniversityPress,2000).Theabsenceoftrustmadeitdifficultnotonlytobeproductive,particularlywhenchainsofproductionlinkedmanyspecializedproducers,butalsotobuildthekindofrule-of-lawinstitutionsthatwouldmaketheeconomyproductiveunderafreemarket.Thatis,buildinginstitutionsitselfrequirestrust.SeeO.BlanchardandM.Kremer,“Disorganization,”QuarterlyJournalofEconomics112,no.4(November1997):1091–126;K.HoffandJ.E.Stiglitz,“AftertheBigBang?ObstaclestotheEmergenceoftheRuleofLawinPost-CommunistSocieties,”AmericanEconomicReview94,no.3(June2004):753–63;andK.HoffandJ.E.Stiglitz,“ExitingaLawlessState,”EconomicJournal118,no.531(August2008):1474–97.7.Thus,toputitinsomewhatmoretechnicalterms,people’spreferencesareconditional;whattheywanttododependsonwhattheybelieveotherpeopledo.Whatmattersisoftennotthelegalnorm(whatyouaresupposedtodo)butthedescriptivenorm(whatyoubelievemostotherpeopledo).Forthisreason,asthephilosopherCristinaBicchieripointsout,“beneficialdescriptivenormsarefragile.”Bicchieri,TheGrammarofSociety(NewYork:CambridgeUniversityPress,2006),p.68.8.ApollconductedbyGallupandtheBetterBusinessBureaufoundthatthetrustAmericanshaveinthebusinessestheydealwitheverydaydeclined14percentbetweenSeptember2007andApril2008alone.See“BBB/GallupTrustinBusinessIndex:ExecutiveSummary—SurveyResultsConsumers’RatingofCompaniesTheyRegularlyDealWith,April2008,”availableathttp://www.bbb.org/us/storage/0/Shared%20Documents/Survey%20II%20-%20BBB%20Gallup%20-%20Executive%20Summary%20-%2025%20Aug%2008.pdf(accessedMarch4,2012).ANewYorkTimes/CBSNewspollinOctober2011similarlyfoundthatAmericans’trustinCongressandinWashingtonmoregenerallyhaddippedtoall-timelows.Just9percentofAmericansapprovedofCongress,andjust10percentthoughttheycould“trustthegovernmentinWashingtontodowhatisright”all245 ormostofthetime.See“Americans’ApprovalofCongressDipstoSingleDigits,”NewYorkTimes,October25,2011,availableathttp://www.nytimes.com/interactive/2011/10/25/us/politics/approval-of-congress-drops-to-single-digits.html(accessedMarch4,2012).9.SeeWalterY.Oi,“LaborasaQuasi-fixedFactor,”JournalofPoliticalEconomy70(1962):538–55;andRobertM.Solow,“DistributionintheLongandShortRun,”inTheDistributionofNationalIncome:ProceedingsofaConferenceHeldbytheInternationalEconomicsAssociationatPalermo,ed.JeanMarchalandBernardDucrois(NewYork:St.Martin’sPress,1968),pp.449–66.SeealsoTrumanBewley,WhyWagesDon’tFallduringRecessions(Cambridge:HarvardUniversityPress,1999);andCraigBurnside,MartinEichenbaum,andSergioRebelo,“LaborHoardingandtheBusinessCycle,”JournalofPoliticalEconomy101,no.2(April1993):245–73.10.Seethediscussioninchapter4andthereferencescitedthere.11.This,aswenotedinchapter4,isoneofthecentraltenetsofefficiencywagetheory.Forbroaderdiscussionsofwhatissometimescalledthe“highqualityworkplace,”seechapter4.Otherreferencescanbefoundinmypaper“DemocraticDevelopmentastheFruitsofLabor,”inTheRebelWithin,ed.Ha-JoonChang(London:WimbledonPublishing,2001),pp.279–315.ErnstFehrandKlausM.Schmidtshowthatworkplacesthatusesbonusestopromoteeffort—asystemthatreliesontrustforcompensation(workerstrustthattheywillreceivethebonus)—performbetterthanthosethatrelyonstandardperformance-basedpiecerateincentiveschemes.ErnstFehrandSchmidt,“FairnessandIncentivesinaMulti-taskPrincipal-AgentModel,”ScandinavianJournalofEconomics106,no.3(2004):453–74.Seechapter4formorediscussionofhowworkplacesthattreatworkersbetteralsodowellindownturns.12.Again,apointemphasizedbytheCommissionontheMeasurementofEconomicPerformanceandSocialProgress.13.SeeWernerGüth,RolfSchmittberger,andBerndSchwarze,“AnExperimentalAnalysisofUltimatumBargaining,”JournalofEconomicBehaviorandOrganization3(December1982):367–88.14.Theexperimentalsoshowsthatanindividual’sconstructoffairnessisshapedbythecircumstances.Evenifheknowshewasrandomlychosentobethe“dictator,”heactsasifhebelievesitisappropriatetokeepmorethanhalfforhimself.Interestingly,ifthesecondplayerbeginsthegamewithsomemoney,andthefirsthastherighttotakeawaysomethingfromthesecond,thenthefirstplayerismuchlesslikelytogivethesecondplayeranything.InanexperimentbyJohnList,thefractionofpositiveoffersfromthefirstplayerfellfrom71percentto10percent.Thisreflectsthemotivationtoavoidthemostselfishfeasibleactionwiththeotherplayer.Itshowsthatfairnessisconstruednot,ornotonly,intermsofwhattheotherplayergets,butalsointermsofwhattheotherplayergetsrelativetohisworstpossibleoutcome.Therealizationthathecouldabusethesecondplayerevenmore,bytakingsomethingfromhim,makesthefirstplayerfeelbetteraboutamoreunfairdivision.SeeList,“OntheInterpretationofGivinginDictatorGames,”JournalofPoliticalEconomy115,no.3(2007):482–93.15.Foradiscussionoftheseoutcomes(andthesumspeoplewillacceptorvetoinultimatumgames),seeColinCamererandRichardThaler,“Anomalies:Ultimatums,DictatorsandManners,”JournalofEconomicPerspectives9,no.2(1995):209–19.16.Forasampleofthelargeliterature,see,e.g.,DanielKahneman,JackL.Knetsch,andRichardH.Thaler,“FairnessandtheAssumptionsofEconomics,”JournalofBusiness59,no.4(1986):S285–S300;GaryE.BoltonandAxelOckenfels,“ERC:ATheoryofEquity,Reciprocity,andCompetition,”AmericanEconomicReview90,no.1(March2000):166–93;ArminFalk,ErnstFehr,andUrsFischbacher,“OntheNatureofFairBehavior,”EconomicInquiry41,no.1(January2003):20–26;DanielKahneman,JackL.Knetsch,andRichardH.Thaler,“FairnessasaConstraintonProfitSeeking:EntitlementsintheMarket,”AmericanEconomicReview76,no.4(1986):728–41;AmartyaSen,“MoralCodesandEconomicSuccess,”inMarketCapitalismandMoralValues,ed.C.S.BrittanandA.Hamlin(Brookfield,VT:Aldershot,1995).17.Moraleisdestroyed.Theimplicationshavebeenexploredinthebranchoftheliteratureineconomicsnotedearlier,calledtheefficiencywagetheory,describinghowwagesaffectproductivity.See,inparticular,GeorgeA.AkerlofandJanetL.Yellen,“TheFairWage-EffortHypothesisandUnemployment,”QuarterlyJournalofEconomics105,no.2(1990):255–83.18.See“FrustrationwithCongressCouldHurtRepublicanIncumbents,”PewResearchCenterforthePeopleandthePress,p.13,basedonpollconductedDecember7–11,2011,availableathttp://www.people-press.org/files/legacy-pdf/12-15-11%20Congress%20and%20Economy%20release.pdf(accessedMarch4,2012).19.WashingtonPost/ABCpoll,January12–15,2012,availableathttp://www.washingtonpost.com/wp-srv/politics/polls/postabcpoll_011512.html(accessedMarch4,2012).20.MichaelI.NortonandDanAriely,“BuildingaBetterAmerica–OneWealthQuintileataTime,”PerspectivesonPsychologicalScience6,no.1(2011):9–12.21.Asweexplainatgreaterlengthbelow,itisnotthatthereisan“establishment,”whichhasgottentogethertocreatethecurrentsystemasitexiststoday.Rather,oureconomicandpoliticalsystemevolves,butmoneyedinterestsusetheirwealthandinfluenceastheycantoshapeit.Andtheshapethathasemergedismuchlikethatwhichmighthaveemergedhadtheygottentogethertoshapeitintheirowninterests.246 22.See,e.g.,BenH.Bagdikian,TheNewMediaMonopoly(Boston:BeaconPress,2004);RobertW.McChesney,ThePoliticalEconomyofMedia:EnduringIssues,EmergingDilemmas(NewYork:MonthlyReviewPress,2008).23.SeeJohnKennethGalbraith,AmericanCapitalism:TheConceptofCountervailingPower(NewYork:NewAmericanLibrary,1952).24.Foranexcellentdiscussionoftheseissues,seeAndréSchiffrin,WordsandMoney(NewYork:Verso,2010).25.Inasense,theproblemisworse:themediadependheavilyonadvertising,andthethreatofwithdrawalofadvertising(ortheworryoveralossofadvertisingrevenues)caninhibitfullcoverageofcorporatemisdeeds.26.SeeStefanoDellaVignaandEthanKaplan,“TheFoxNewsEffect:MediaBiasandVoting,”QuarterlyJournalofEconomics122,no.3(2007):1187–234.ThecaseoftheformerItalianprimeministerSilvioBerlusconi,whousedhistelevisionempiretosolidifyhisholdonpowerforseventeenyears,providesanexcellentillustrationofhowcontrolofthemediacanaffectpoliticaloutcomes.27.TheInternethasexposedthebiasesanddistortionsinmainstreammedia,butalsoprovidedmoreextensiveaccesstoadiversityofviewpoints.Atthesametime,the“businessmodel”oftheInternetdoesn’tprovidetheresourcesforthekindofin-depthinvestigativereportingthathasenabledthepresstoserveasaneffectivecheckonabusesinboththepublicandtheprivatesectors.Finally,aswenoteinchapter6,theInternetcanleadtothepolarizationofperspectivesthatinhibitsdemocraticcompromise.28.Indeed,Democraticprimarieswererestrictedtowhites,andsincetheDemocraticPartydominatedtheelectoralprocess,AfricanAmericanswereeffectivelydisenfranchised.29.SureshNaiduofColumbiaUniversityshowsthat“polltaxesandliteracytestseachloweredoverallelectoralturnoutby10–23%andincreasedtheDemocraticvoteshareinnationalelectionsby5%–10%.”Hiscleverandcarefulresearchmethodologyentailscomparingadjacentcounty-pairsthatstraddlestateboundaries.Seehis“Suffrage,Schooling,andSortinginthePost-BellumU.S.South,”workingpaper,ColumbiaUniversity,2010,availableathttp://iserp.columbia.edu/sites/default/files/suresh_naidu_working_paper.pdf.30.Othertargetedgroups(withsimilarpoliticalobjectives)includeimmigrantsandblue-collarworkers.SeeAlexanderKeyssar,“TheSqueezeonVoting,”InternationalHeraldTribune,February15,2012,p.9;andKeyssar,TheRighttoVote:TheContestedHistoryofDemocracyintheUnitedStates(NewYork:BasicBooks,2000).Hecitesinstancesofvoters’beingrequiredto“bringtheirsealednaturalizationpaperstothepollsortopresentwrittenevidencethattheyhadcanceledtheirregistrationatanypreviousaddressortoregisterannually,inperson,ononeofonlytwoTuesdays.”Morerecently,attemptstoeffectivelydisenfranchiseHispanicvoterscenteronbilingualballots.See,e.g.,AdamSerwer,“GingrichandRomneyWanttoSayAdiostoBilingualBallots,”MotherJones,January30,2012,availableathttp://motherjones.com/politics/2012/01/gingrich-and-romney-want-say-adios-bilingual-ballots.Ofcourse,themostsignificantdisenfranchisementwasthatofwomen,whoseattitudes,e.g.,towarandtosocialissuesareoftenmarkedlydifferentfromthoseofmen.Clearly,thedisenfranchisementaffectedtheoutcomeofpoliticalprocesses.31.SeeWalterDeanBurnham,“DemocracyinPeril:TheAmericanTurnoutProblemandthePathtoPlutocracy,”RooseveltInstituteWorkingPaperno.5,December1,2010;FrancesFoxPivenandRichardA.Cloward,“GovernmentStatisticsandConflictingExplanationsofNonvoting,”PS:PoliticalScienceandPolitics22,no.3(September1989):580–88;andPivenandCloward,“NationalVoterRegistrationReform:HowItMightBeWon,”ibid.21,no.4(Autumn1988):868–75.32.Evensomeonewiththemeanstovotebutwithoutacarwillhavelessofanincentivetogetthedriver’sIDtovote,sincethemarginalcostofvotingishigher.MorethanadozenstateshavepassedIDlawssince2005.SeeKeyssar,“TheSqueezeonVoting.”33.See“Inaccurate,Costly,andInefficient:EvidenceThatAmerica’sVoterRegistrationSystemNeedsanUpgrade,”PewCenterontheStates,reportreleasedFebruary14,2012,availableathttp://www.pewcenteronthestates.org/uploadedFiles/Pew_Upgrading_Voter_Registration.pdf(accessedMarch4,2012).Thereportalsoidentifieslargenumbersofinaccuraciesorinvalidregistrations,someoneineight.34.Itwasoneofmany5-to-4decisionsunderChiefJusticeRoberts.Another,equallyimportantdecisionwastheCourt’s2011strikingdown(inArizonaFreeEnterpriseClubv.Bennett)thestateofArizona’sattempttoredresstheimbalanceofpoliticalpowercreatedbyanimbalanceofeconomicpowerbyprovidingadditionalfundstothecandidateswhowerelesssuccessfulinraisingprivatecampaignmoney.TrustintheCourtisimportant,becauseinanysocietytherewillbedisputes,anditisvitalthatthecourtsbeviewedasfairarbitersofsuchdisputes.ButiftheCourtisviewedasnotfair—astakingsides,evenbeforetheargumentshavebeenpresented—thentheCourt’smainsourceofstrength,itscredibilityandtheinfluenceithasinthecourtofpublicopinion,willquicklydisappear.Inothercountriesmarkedbyhighlevelsofdivisiveness,thenotionofanindependentjudiciaryislookeduponwithskepticism,andthecourt’spronouncementsareseenasessentiallypoliticalasthatofanyotherbranchofgovernment.35.Infact,economistsrefertosucharrangementsas“implicit”contracts,enforcedsometimesevenmoreeffectivelythanexplicitcontracts,throughthedesignofrepeatedgames,whereparticipantsknowofthesevereconsequencesof247 failuretoliveuptothetacitunderstandings.36.Congresscouldhaverequiredthat,beforeanysuchcontributionsweremade,shareholdershadtovote.ButSenatorSchumerandotherstryingtolimittheimpactofCitizensUnitedwereunabletopassthisorotherlegislationcircumscribingthepoliticalpowerofcorporations.Theincreasedpowerofmoniedinterestsisalreadybeingfeltintheelectionof2012,wherenoncandidatepoliticalactioncommittees(workingonbehalfofparticularcandidates)werespendingmoremoneythanthecandidatesthemselves,andoftenengagedinverynegativeadvertising.37.Ineffect,withthefilibuster,the“decisive”voter(intheSenate)isnotthemedianbutthevoteratthe40thpercentile.SincethefilibusterrulesarenotamatteroftheConstitution,butdecidedbyeachCongress,thereisaninterestingquestion:Whydoesthe“median”votercedecontroltothe40thpercentilevoter?ThefilibusterwascreatedtoprotectminorityrightsonissuesthattheminoritybelievedwereofcriticalimportancebutnotprotectedbytheBillofRights.Theironyisthatitwasusedmostlyinissuesofcivilrights,toabrogatetherightsofAfricanAmericans.EzraKlein,“BreakingtheFilibusterinOneGraph,”WashingtonPost,December23,2010,availableathttp://voices.washingtonpost.com/ezra-klein/2010/12/breaking_the_filibuster_in_one.html,providesdatashowingthe“shocking”riseinthenumberoffilibusters—anegligiblenumberaquartercenturyago,butaround140filingstoendafilibusterinthelastCongress.Todaythefilibusterisusedasamatterofroutineand,togetherwithcampaigncontributions,enhancestheabilityofmoneyedintereststoexercisetheirpoliticalinfluenceevenwhenwhattheywantiscountertotheinterestsofthemajority.38.Manyfactorscontributetovoterparticipation.Disillusionmentanddisenfranchisement,uponwhichthischapterfocuses,areimportant.Personalitiesmatter.Sotoodoeswar(note,e.g.,therelativelyhighturnoutin2004).39.Burnham,“DemocracyinPeril,”citesdatashowingthatthosestateswheredisenfranchasementanddisempowermenthavebeenthestrongest(theSouth)havealsohadtheworstvoterturnout.Theratehasbeenaslowas1.8percentinSouthCarolina(inthehouseelectionof1926)andfallenbelow30percent—usuallywellbelowthatnumber—inmanyofthesouthernstatesinelectionsheldoverthepast110years.Althoughtherewasaslightincreaseinvoterturnoutinthe2008presidentialelection,thelasttimevoterturnoutinapresidentialelectionexceeded60percentwas1968,andthelasttimeitexceeded70percentwas1900.Seehttp://www.presidency.ucsb.edu/data/turnout.php.ComparethistocountriessuchasGermany,whereturnoutforparliamentaryelectionshasneverdippedbelow70percentinthelast60years,orFrance,whereparliamentaryelectionturnouthasonlydippedbelow60percentonceinthelast60years,andwhereturnoutforpresidentialelectionshasalwaysbeenatleast77percentandoftenmuchmoresince1965.SeeVoterTurnoutdatabaseoftheInternationalInstituteofDemocracyandElectoralAssistance,availableathttp://www.idea.int/vt/.40.Suchalowturnoutisespeciallystrikinggiventhatyoungpeoplehavesomuchmoreatstake—alifetimeofconsequencesasaresultofgovernmentpoliciesthatmightbeenactednow.41.Thiswasevident,e.g.,intheturnoutinearlyRepublicanprimariesandcaucusesin2012:1percentofMaine’sregisteredvotersturnedoutforitscaucuses,16percentinFlorida,3percentinNevada.ThenatureofthebiasisillustratedbySouthCarolina’sprimary:98percentofvoterswerewhite(66percentofthepopulationiswhite),72percentwere45orolder(medianageis36),two-thirdswereevangelicalChristians(exitpollsinthe2008generalelectionhad40percentevangelicals).Similarbiasesarereflectedinstancesonparticularissues.WhileevidentlyamongRepublicanprimaryvotersthereisstrongoppositiontomandatedhealthinsurancecoverageofcontraception,aNewYorkTimespollinFebruary2012suggeststhatsuchprovisionshaveatwo-to-onepopularsupport.SeeErikEckholm,“PollFindsWideSupportforBirthControlCoverage,”NewYorkTimes,March1,2012,availableathttp://www.nytimes.com/2012/03/02/us/politics/americans-divided-on-birth-control-coverage-poll-finds.html(accessedMarch4,2012).42.Citizensarenotrequiredtovote,onlytocometothepollingstation.Themandatelargelyresolvesthe“votingparadox”wediscussedearlierinthechapter.43.ThismeansareversaloftheCourtdecisioninArizonaFreeEnterpriseClubv.BennettandinCitizensUnitedv.FederalElectionCommission.44.SeeWashingtonPost/ABCNewspollfromApril26,2010,whichshowedtwo-thirdsofAmericansfavoredstricterfinancialregulation.Availableathttp://abcnews.go.com/images/PollingUnit/1109a1FinancialRegulation.pdf(accessedMarch4,2012).45.PaulKrugman,“Oligarchy,AmericanStyle,”NewYorkTimes,November4,2011,availableathttp://www.nytimes.com/2011/11/04/opinion/oligarchy-american-style.html(accessedMarch1,2012).46.PresidentObamaputitequallyforcefullyinhisOsawatomie,Kansas,addressonDecember6,2011:“[I]n1910,TeddyRooseveltcameheretoOsawatomie….Ourcountry,”hesaid,“…meansnothingunlessitmeansthetriumphofarealdemocracy…ofaneconomicsystemunderwhicheachmanshallbeguaranteedtheopportunitytoshowthebestthatthereishim.”Thepresidentwentontosay,“Inequalityalsodistortsourdemocracy.Itgivesanoutsizedvoicetothefewwhocanaffordhigh-pricedlobbyistsandunlimitedcampaigncontributions,anditrunstheriskofsellingoutourdemocracytothehighestbidder.ItleaveseveryoneelserightlysuspiciousthatthesysteminWashingtonisriggedagainst248 them,thatourelectedrepresentativesaren’tlookingoutfortheinterestsofmostAmericans.”47.Thereisathirdexplanationthatmayplaysomerole.Politicsinademocracyrequirestheformationofcoalitions.Ouranalysishasproceededasiftheonlyissuesthatindividualscaredaboutwereeconomicissues.Butvotersalsocareaboutsocialissues,andtheychoosecandidatesthatreflecttheirperspectives,weightingindifferentwayssocialandeconomicissues.Atleastforawhile,Republicansformedacoalitionofsocialandeconomicconservatives,whichthoughitadvancedanagendathatwasconsistentwiththedesiresofthesocialconservatives,wasoftenagainsttheireconomicinterests.SeeThomasFrank,What’stheMatterwithKansas?HowConservativesWontheHeartofAmerica(NewYork:MetropolitanBooks,2004).48.TherearemanyparallelsbetweenglobalfinancialproblemsandthoseintheUnitedStates:inmanycases,itisthebanksthatactivelyencouragedtheexcessindebtedness,thatpersuadedindividualsandcountriestotakeonmoredebtthantheyshouldhave.Insomecases,mattersareevenworse:EastAsia,withitshighsavingsrate,hadnoneedtoborrowfromabroad.ButtheUnitedStatesandotheradvancedindustrialcountries(bothdirectly,andindirectly,throughtheIMF)putpressureonthesecountriestoallowtheirfirmstoborrowfreelyfromWesternbanks.Moneyflowedin.Butwhenattitudeschangedabouttheprospectsoftheregion,moneyrushedoutthedoor,andthustheregionfacedthe1997EastAsiacrisis.Thebanksmadelargeprofitsasmoneyflowedin,but,throughthegoodofficesoftheIMFandtheU.S.Treasury,theyalsomademoneyafterthecrisis,byforcingthecountriestohavefiresalesoftheirassets.SeeJ.E.Stiglitz,GlobalizationandItsDiscontents(NewYork:Norton,2002).49.Foramoreextensivediscussion,seeJ.E.Stiglitz,2006,MakingGlobalizationWork(NewYork:Norton,2003),chap.8;andDavidHale,“NewfoundlandandtheGlobalDebtCrisis,”Globalist,April28,2003,availableathttp://www.theglobalist.com/StoryId.aspx?StoryId=3088(accessedMarch7,2012).50.Technically,thegovernmentswerevotedinbytheirparliament;butmany,ifnotmost,oftheparliamentariansfelttheyhadlittlechoice.51.Foranaccountofofficialsandbanks’reactions—andtheimpactonbanksandthestockmarket—seeQuentinPeel,RichardMilne,andKarenHope,“EULeadersBattletoSaveGreekDeal,”FinancialTimes,November1,2011,availableathttp://www.ft.com/intl/cms/s/0/cc377942-0472-11e1-ac2a-00144feabdc0.html#axzz1oBCs0Dlj(accessedMarch4,2012).52.Inthatelection,GoldmanSachswentsofarastocreatetheGoldmanSachs“Lulameter”tomeasurerisksassociatedwithMr.daSilva’schancesofbecomingpresident,withtheimplicitnotionthathiselectionputatriskinvestmentsinthatcountry.Seehttp://moya.bus.miami.edu/~sandrade/Lulameter_GS.pdf.Apparentlythatreport(linkabove)gotthemintoabitoftroubleastheysubsequentlybackedoff.TheNewYorkTimesreported,“Goldman,Sachsseemstohavedistanceditselffromareportitsstrategistsreleasedearlierthisyearusinga‘Lulameter.’Sincethen,PauloLeme,itsmanagingdirectorforemergingmarketsresearch,haspresentedarelativelybalancedviewofBrazil’sprospects.”Availableathttp://www.nytimes.com/2002/10/12/business/worldbusiness/12BRAZ.html?pagewanted=all.53.Aswenotedinchapter3,eventheIMFhasnowconcededthatattimescapitalcontrolsmaybedesirable.Thereisalargeliteratureonthesubject.See,e.g.,JonathanD.Ostryetal.,“CapitalInflows:TheRoleofControls,”IMFStaffPositionnote10/04,February19,2010,availableathttp://www.imf.org/external/pubs/ft/spn/2010/spn1004.pdf(accessedDecember28,2011),andthemoreextensivediscussionoftheissueinthenextchapter.54.TheGlobalizationParadox:DemocracyandtheFutureoftheWorldEconomy(NewYork:W.W.Norton,2011).55.Thehighcostsofmedicinethatresultalsoplayanimportantroleintheimmiserationofthoseatthebottom.SeeStiglitz,MakingGlobalizationWork,chap.4,forafullerdiscussionoftheissuessurroundingintellectualpropertyrights.56.Asanexample,noonebelievesthatanyincentivewasprovidedbytheextensionofcopyrighttoseventyyearsaftertheauthor’sdeathforworksalreadycreatedundertheolder,morerestrictiveregime.ItwassimplyaprovisionthatenhancedrentsforDisneyandotherownersofcopyrightedmaterial.Developingcountrieshaveworried,inparticular,abouthowintellectualpropertyregimesimposedonthemhaverestrictedaccesstogenericdrugs,forcingthemtopaypricesbeyondthosetheycanafford,leadingtountoldnumbersofunnecessarydeaths.57.Theseprovisionsarecalled“regulatorytakings.”Foradiscussionofthiscontroversy,see,e.g.,Stiglitz,MakingGlobalizationWork,chap.7,andJ.E.Stiglitz,“RegulatingMultinationalCorporations:TowardsPrinciplesofCross-borderLegalFrameworksinaGlobalizedWorldBalancingRightsandResponsibilities,”AmericanUniversityInternationalLawReview23,no.3(2007):451–58,GrotiusLecturepresentedatthe101stAnnualMeetingoftheAmericanSocietyforInternationalLaw,Washington,DC,March28,2007,andthereferencescitedthere.58.Ishouldemphasizethatitisnotthatthe1percenthas“conspired”toensurethatthiswouldhappen;rather,itpushedforrulesofgamesthathavehadthateffect—andthathaveserveditsinterestswell.Seethediscussionofchapter6.59.Laterwearguethattoalargeextentthe1percent(likethebankers)havebeenshortsighted—theyhavepushedforpoliciesthatmaybeintheirshort-runinterests,butnotintheirlong-runinterests.249 ChapterSix1984ISUPONUS1.Leninsawtheshapingofpublicopinionasessentialinbringingontherevolution,buttosomeextentallcountriesandallleadersdevelopnarrativesthatshapehowpeopleperceivetheirgovernmentandcountry.Anticolonialleadershadaneasiertimepersuadingthecitizensoftheircountryoftheillegitimacyofcolonialrule.2.Adscouldprovideinformation,e.g.,aboutwhatgoodsareavailableatwhatprices.Butstatementsabouttheattributesofaproductbytheseller(unlessaccompaniedbyamoney-backguarantee)wouldbetakenasjustself-serving.TherearePtolemaicattemptstodescribeads,likethatoftheoldMarlborocowboy(retiredintheUnitedStatesaroundtheturnofthecenturyafteraforty-five-yearstint),asprovidingconsumersinformation:mostindividualswhobuythecigarettesarenotcowboys,butmayidentifythemselvesashardy,likeacowboy.Theadconveyedinformationaboutwhatkindofpersonenjoysthisbrandofcigarette,andtheadwouldhavebeensuccessful,andpersisted,onlyifthosewhoself-identifythemselvesinthiswaydoinfactenjoytheproduct.3.Inchapter4wearguedfortheimportanceofpubliclyprovidedgoodsandasenseofsocialcohesionandeconomicfairnessandjustice.Amajordivideinvotingpatternsacrossstatesisamongtheaffluent,withmoreofthemoreaffluentin“liberal”statesseeminglyrecognizingthis(andtreatingsocialjusticeasabasicvalueinitsownright)thanintheconservativestates.PaulKrugman,“MoochersagainstWelfare,”NewYorkTimes,February16,2012,availableathttp://www.nytimes.com/2012/02/17/opinion/krugman-moochers-against-welfare.html?_r=1&scp=1&sq=krugman%20moochers&st=cse(accessedFebruary20,2012).KrugmancitestheworkofAndrewGelmanofColumbiaUniversity,whohasshownthatthericheverywherevotemoreconservatively,butitistherichinpoorstateswhovotemuchmoreconservatively—leadingtothephenomenonofRepublicans’oftenrepresentingpoorerstates.SeeGelman,RedState,BlueState,RichState,PoorState:WhyAmericansVotetheWayTheyDo(Prince-ton:PrincetonUniversityPress,2010).4.SuzanneMettlerofCornellUniversitycitesstatisticsshowingthat44percentofSocialSecurityrecipients,43percentofrecipientsofunemploymentbenefits,and40percentofthoseonMedicaresaythatthey“havenotusedagovernmentprogram.”CitedinKrugman,“MoochersagainstWelfare.”SeeSuzanneMettler,“ReconstitutingtheSubmergedState:TheChallengesofSocialPolicyReformintheObamaEra,”PerspectivesonPolitics8,no.3(2010):803–24.Thispartiallyaccountsforthequandarythatstatesthatarethelargestrecipientsoffederalassistancetendtobemostagainstgovernmentprograms.Seealsotheanecdotedescribedbelow,inthenextsection,involvingtheelderlyobjectingtoObama-carebecauseitthreatenedtosocializeMedicare.5.SeeMichaelI.NortonandDanAriely,“BuildingaBetterAmerica—OneWealthQuintileataTime,”PerspectivesonPsychologicalScience6,no.1(2011):9–12.6.Seethesurveyontheperceptionofinequalityintheworld,conductedbytheFondationJean-Jaurès,availableat(inFrench)http://www.jean-jaures.org/Publications/Dossiers-d-actualite/Enquete-sur-la-perception-des-inegalites-dans-le-monde(accessedMarch4,2012).7.SeeR.BenabouandE.A.Ok,“SocialMobilityandtheDemandforRedistribution:ThePOUMHypothesis,”QuarterlyJournalofEconomics116(2001):447–87;K.K.CharlesandE.Hurst,“TheCorrelationofWealthacrossGenerations,”JournalofPoliticalEconomy111,no.6(2003):1155–82;andL.A.Keister,GettingRich:America’sNewRichandHowTheyGotThatWay(Cambridge:CambridgeUniversityPress,2005).8.FromCharlotteCavaille,“PerceptionsofInequalitiesintheWorld:FoodforThought,”availableatinequalitiesblog.wordpress.com/2011/09/27/perceptions-of-inequality-in-the-world-food-for-thought(accessedDecember19,2011).Sheprovidesaninterestinginterpretation,quotingAlexisdeTocqueville’sclassicwork:“Wheninequalityofconditionsisthecommonlawofsociety,themostmarkedinequalitiesdonotstriketheeye;wheneverythingisnearlyonthesamelevel,theslightestaremarkedenoughtohurtit.Hencethedesireforequalityalwaysbecomesmoreinsatiableinproportionasequalityismorecomplete.”DemocracyinAmerica(Middlesex,UK:EchoLibrary,2007),p.428.9.Thetenetsofrationality,inthejargonofeconomics,arethatindividualsmaximizeawell-definedutilityfunction(orhaveawell-definedsetofpreferences)andmaximizethatwithrationalexpectations.ThealternativeperspectiveofbehavioraleconomicsisexpressedinthetitleofthepopularbookbyDanAriely,PredictablyIrrational:TheHiddenForcesThatShapeOurDecisions(NewYork:HarperCollins,2008).10.Theseideashavebeguntobeusedinthecontextofpolitics.SeeGeorgeLakoff,Don’tThinkofanElephant!KnowYourValuesandFrametheDebate(WhiteRiverJunction,VT:ChelseaGreen,2004).11.Thisiscalledtheanchoringeffect.SeediscussionsofanchoringandframingeffectsonjudgmentsandpreferencesinDanielKahneman,PaulSlovic,andAmosTversky,eds.,JudgmentunderUncertainty:HeuristicsandBiases(Cambridge:CambridgeUniversityPress,1982);andDanielKahnemanandAmosTversky,eds.,Choices,ValuesandFrames(NewYork:CambridgeUniversityPress,2000).Forapopularandrecentdiscussion,seeDanielKahneman,Thinking,FastandSlow(NewYork:Farrar,StrausandGiroux,2011);andRichardThalerandCassSunstein,Nudge:ImprovingDecisionsaboutHealth,Wealth,andHappiness(NewHavenandLondon:YaleUniversityPress,2008).12.Seethediscussionofframingeffectsinthecaseoftheintroductionof250 lifecyclefundsinU.S.401(k)plansinNingTang,OliviaS.Mitchell,GaryR.Mottola,andStephenP.Utkus,“TheEfficiencyofSponsorandParticipantPortfolioChoicesin401(k)Plans,”JournalofPublicEconomics84,nos.11–12(2010):1073–85;andOliviaS.Mitchell,GaryR.Mottola,StephenP.Utkus,andTakeshiYamaguchi,“Default,FramingandSpilloverEffects:TheCaseofLifecycleFundsin401(k)Plans,”NBERWorkingPapers15108,2009.13.Thus,theRightwantedtobelievethatitwasthegovernmentthatcausedtheproblem,andnotthemarket;soitdiscountedevidencethatitwasthemarketsthathadfailed—that,forinstance,thesubprimemortgagedebaclebeganintheprivatesector,andthatevenatthepeak,theperformanceofFannieMaemortgageswasbetterthanthatoftheprivatesector.14.Thereisbynowalargeliteratureonconfirmatorybias.See,e.g.,MatthewRabinandJoelSchrag,“FirstImpressionsMatter:AModelofConfirmatoryBias,”QuarterlyJournalofEconomics114,no.1(1999):37–82.15.See,inparticular,KarlaHoffandJosephE.Stiglitz,“EquilibriumFictions:ACognitiveApproachtoSocietalRigidity,”AmericanEconomicReview100,no.2(May2010):141–46;HoffandStiglitz,“TheRoleofCognitiveFramesinSocietalRigidityandChange,”WorldBank,2011,availableathttp://www.ewi-ssl.pitt.edu/econ/files/seminars/110405_sem814_Karla%20Hoff.pdf(accessedMarch4,2012),andthereferencescitedthere.Theauthorsexplainhowequilibriumfictionsmayplayaroleinsustainingdiscrimination.Thosewhobelieveincastedifferencesarecognitivelymoresensitivetofailuresofthepurportedinferiorcasteandignoretheirsuccesses.Evenworse,individualswhobelievethattheyareinferiorwillbehavethatway.16.Persuasivemarketingisthegentlestandmosthonestwaythatcorporationstrytomanipulatebehavior.Thecigarettecompaniessecretlymadetheirproductsmoreaddictive,renderingitmorelikelythatsmokerswouldcontinuetosmoke.DavidKessler,theformerheadoftheFoodandDrugAdministrationwholedtheU.S.governmentchargeagainstthecigarettecompanies,pointsoutthatproducersoffastfoods,snacks,andotherproductsdoquitesimilarthings(evenifitisn’tpreciselyaddiction),throughtheirfineunderstandingofhowsmellsandtastesstimulatethebrainandcreatecravings.SeeKessler,TheEndofOvereating:TakingControloftheInsatiableAmericanAppetite(NewYork:RodaleBooks,2009).17.JohnMaynardKeynes,TheGeneralTheoryofEmployment,Interest,andMoney(NewYork:Harcourt,Brace&World,1936),p.383.18.SeeGeorgeSoros,TheSorosLectures:AttheCentralEuropeanUniversity(NewYork:PublicAffairs,2010).19.SeeinparticularthereportTheFinancialCrisisInquiryReportofthebipartisanNationalCommissionontheCausesoftheFinancialandEconomicCrisisintheUnitedStates,whichconcludedthatFannieMaeandFreddieMac“contributedtothecrisis,butwerenotaprimarycause”(p.xxvi).Thereportisavailableathttp://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf(accessedFebruary20,2012).Onlyonemember,PeterJ.WallisonoftheAmericanEnterpriseInstitute,dissented.Other,moreacademicstudieshaveconfirmedandsupportedtheirfindings.20.Seethediscussionofstatisticaldiscriminationinchapter5.21.SeeKarlaHoffandPriyankaPandey,“Discrimination,SocialIdentity,andDurableInequalities,”AmericanEconomicReview96,no.2(May2006):206–11;andHoffandPandey,“MakingUpPeople:TheBehavioralEffectsofCaste,”WorkingPaper,WorldBank.Alargeliteratureinsocialpsychologyshowsthat“priming”astereotypedidentity(thatis,makingitsalient)shiftsperformanceinthedirectionofthestereotype.SeeC.M.Steele,WhistlingVivaldiandOtherCluestoHowStereotypesAffectUs(NewYork:Norton,2010);andMichaelInz-lichtandToniSchmader,eds.,StereotypeThreat:Theory,Process,andApplication(NewYork:OxfordUniversityPress,2012).22.Ofcourse,neithergovernmentnormarketsareperfect.AsI’llexplainlaterinthechapter,whiletherearemanyinstancesofgovernmentfailures,theypaleincomparisonwiththelossesfromprivatesectorfailures—inparticular,thosesurroundingtheGreatRecession.23.In1772theEastIndiaCompanywaslenthundredsofthousandsofpoundsbytheBankofEnglandafteracombinationoffactors,includingafamineinBengalandastockmarketcrashinLondon,threatenedthecompany’ssurvival.FromNickRobins,TheCorporationThatChangedtheWorld(London:PlutoPress,2006),p.97.24.Whileitmightbeintheinterestsofanindividualorgrouptoworktoalterperceptionsinwaysthatadvanceparticularinterests,typicallychangedoesn’thappeninsuchaconcertedway.Thereisnogeneralforuminwhichplotsarehatched,noopportunityforaconspiracy.25.SeeRichardDawkins,TheSelfishGene,30thanniversaryed.(Oxford:OxfordUniversityPress,2006).26.SeeTheFinancialCrisisInquiryReport.27.InJanuary2012,thePewResearchCenterreleasedapollthatfoundanevendivideinperceptions:about46percentoftherespondents(Americans)believedthatrichpeopleobtainedtheirwealthbecausetheywere“fortunateenoughtobefromwealthyfamiliesorhavetherightconnections,”while43percentthoughttheywerewealthybecauseof“theirownhardwork,ambition,oreducation.”Thesamepollfoundthat58percentofDemocrats“saywealthismainlyduetofamilymoneyorknowingtherightpeople.AnidenticalproportionofRepublicanssaywealthismainlyaconsequenceofhardwork,ambitionorhavingthenecessaryeducationtogetahead.”See“RisingShareofAmericansSeeConflictbetweenRichandPoor,”reportofthePewResearchCenter,January11,2012,availableathttp://www.pewsocialtrends.org/2012/01/11/rising-share-of-americans-see-conflict-between-rich-and-poor/?src=prc-headline(accessedMarch4,2012).251 28.Oneotherchangehasoccurredrecentlythatmayaffectthefutureevolutionofideasandbeliefsandreinforcestheproblemsposedbyconfirmatorybiasnotedearlier:theriseandproliferationoftheInternethasmadeiteasierforindividualstocreatetheirown“communities”—groupsthatsharethesameinformation.Inthepast,mostAmericanswouldhavehadasharedexperienceofwatchingthenationalTVnewsonCBS,ABC,orNBC.Butnowthereexistsaplethoraofcablechannels,someappealingtotheleft,sometotheright.AnindividualwhowantstobereinforcedinhisconservativeviewscanturntoFoxNews.Theviewstowhichheisexposedhavebeenpreselectedtoconformtohisbeliefs.Theconsequenceistheriskoffurtherpolarizationofbeliefs.Thefactthatbeliefsaboutinequalityarethussopolarizedhasobviousimplicationsfortheabilityofoursocietytodealwiththeproblemonthebasisofanationalconsensus.Foradiscussionoftheseissues,see,e.g.,CassSunstein,Infotopia:HowManyMindsProduceKnowledge(NewYork:OxfordUniversityPress,2006),wherehesuggeststhatpeoplearetrappedin“informationcocoons,”shieldedfrominformationatoddswiththeirpreconceptions.CharlesLordandcoauthorscarriedoutimportantresearchonbeliefpolarization:theyshowedresearchresultsonthedeathpenaltytotwogroupsofpeople,pro–andanti–capitalpunishment.Theyfoundthatpeopletendedtoholdthatresearchthatagreedwiththeiroriginalviewshadbeenbetterconductedandwasmoreconvincingthanresearchthatconflictedwiththeiroriginalviews,andtheytendedtohaveastrongerpositionafterreadingaboutresearchthatsupportedtheirposition.CharlesLord,LeeRoss,andMarkLepper,“BiasedAssimilationandAttitudePolarization:TheEffectsofPriorTheoriesonSubsequentlyConsideredEvidence,”JournalofPersonalityandSocialPsychology37,no.11(1979):2098–109.29.HoffandStiglitz,“EquilibriumFictions”and“TheRoleofCognitiveFrames.”SeealsoGlennC.Loury,AnatomyofRacialInequality(Cambridge:HarvardUniversityPress,2002).30.The“Swiftboat”attackonSenatorKerryisalegendaryexampleof“marketing”withnobasisinfact,whichnonethelesswasextraordinarilyeffective.ForadiscussionofthiscaseandalistofresourcesfromtheNewYorkTimes,seetheNewYorkTimes“TimesTopic”on“SwiftVeteransforTruth,”availableathttp://topics.nytimes.com/topics/reference/timestopics/organizations/s/swift_boat_veterans_for_t(accessedMarch4,2012).31.SeeRichardH.Thaler,“WhenBusinessCan’tForeseeOutrage,”NewYorkTimes,November19,2011,p.BU4.SeeDanielKahneman,JackKnetsch,andRichardH.Thaler,“FairnessandtheAssumptionsofEconomics,”JournalofBusiness59,no4(1986):S285–300.AmelieGoosensandPierre-GuillaumeMeon,“TheImpactofStudyingEconomics,andOtherDisciplines,ontheBeliefThatVoluntaryExchangeMakesEveryoneBetterOff,”UniversityofBrusselsworkingpaper,2010,showthattherearebothselectionandlearningeffects.Foranoverview,seeJohnR.CarterandMichaelD.Irons,“AreEconomistsDifferent,andIfSo,Why?”JournalofEconomicPerspectives5,no.2(Spring1991):171–77;andAlexandraHaferkamp,DetlefFetchenhauer,FrankBelschak,andDominikEnste,“EfficiencyversusFairness:TheEvaluationofLaborMarketPoliciesbyEconomistsandLaypeople,”JournalofEconomicPsychology30,no.4(August2009):527–39.SeealsoRobertKuttner,EverythingforSale:TheVirtuesandLimitsofMarkets(NewYork:Knopf,1997);andWilliamLazonick,BusinessOrganizationsandtheMythoftheMarketEconomy(NewYork:CambridgeUniversityPress,1991).Forasomewhatdifferentperspective,seeBryanCaplan,“SystematicallyBiasedBeliefsaboutEconomics:RobustEvidenceofJudgementalAnomaliesfromtheSurveyofAmericansandEconomistsontheEconomy,”EconomicJournal,April2002,pp.433–58.32.TheJohnM.OlinFoundation,namedaftertheindustrialistwhoendowedit,fundedahugearrayofresearchthatinjectedlawschoolsandotheracademicdialoguewithconservativeeconomicideasuntilitsclosingin2003.TheNationalReviewwriterJohnJ.Miller,whohaswrittenabookcelebratingthefoundationtitledAGiftofFreedom:HowtheJohnM.OlinFoundationChangedAmerica(SanFrancisco:EncounterBooks,2006),describedthefoundation’sinfluencethisway:“IfconservativeintellectualsandorganizationswereNASCARvehicles,thenjustabouteveryoneofthemwouldsportatleastanOlinbumpersticker—andagoodnumberwouldhaveO-L-I-Nsplashedacrosstheirhoods.”SeeMiller,“Foundation’sEnd,”NationalReview,April6,2005,availableathttp://www.nationalreview.com/articles/214092/foundations-end/john-j-miller(accessedMarch4,2012).33.Itisinterestinghowlittleeffortismadetopersuadethoseoftheotherside.Thereasonisthatthepersonontheothersidehasalreadysuchastrongframe,aperspective,throughwhichheseestheworld,thatthecontraryevidenceishighlydiscountedandtheconfirmingevidencegivenundueweight.34.AccordingtotheWashingtonPost,thisincidentoccurredatatownhallmeetinginteractioninSimpsonville,NorthCarolina,in2009,whereamanstoodupandmadethiscomplainttothethenRepresentativeRobertInglis.SeePhilipRucker,“Sen.DeMintofS.C.IsVoiceofOppositiontoHealth-CareReform,”WashingtonPost,July28,2009,availableathttp://www.washingtonpost.com/wp-dyn/content/article/2009/07/27/AR2009072703066.html?hpid=topnews&sid=ST2009072703107(accessedFebruary20,2012).35.ItwasperhapsnotcoincidentalthatakeymemberoftheClintoneconomicsteamhadreceivedasubstantialbonuswellabovethe$1millionthresholdpriortojoiningtheadministration.36.SeeSanfordGrossmanandJ.E.Stiglitz,“InformationandCompetitivePriceSystems,”AmericanEconomicReview66,no.2(May1976):246–53;andSanfordGrossmanandJ.E.Stiglitz,“OntheImpossibilityofInformationallyEfficient252 Markets,”AmericanEconomicReview70,no.3(June1980):393–408.37.SeeJustinFox,TheMythoftheRationalMarket(NewYork:HarperBusiness,2009).38.Thiswasequivalenttoalossofmorethanatrilliondollars.ThestocksofeightmajorcompaniesintheS&P500(includingAccenture)felltoonecentpershare;thepricesofotherstocks(includingSotheby’s,Apple,andHewlett-Packard)increasedtoover$100,000.Obviously,nothingrealcouldaccountforsuchchanges.Marketswereclearlynotbeingefficient.AreportoftheU.S.SecuritiesandExchangeCommissionandtheCommodityFuturesTradingCommission“portrayedamarketsofragmentedandfragilethatasinglelargetradecouldsendstocksintoasuddenspiral.”“FindingsRegardingtheMarketEventsofMay6,2010,”reportdatedSeptember30,2010.IservedonanadvisorypaneltotheSEC/CFTConmarketreformsmotivatedbytheflashcrash.Itsreportisavailableathttp://www.sec.gov/news/studies/2010/marketeventsreport.pdf.39.Taxchangesareanarenawhereframingisparticularlycontentious:doesoneexpress,say,ataxcutintermsofthepercentreductionintheirtaxrate,intheabsolutereductionintheirtaxrate,orintermsoftheabsolutedollarvaluethatgoestoeachgroup.InonewayofpresentingtheBushtaxcuts,thetop1percentwerethebigbeneficiaries,withone-thirdofthebenefitsgoingtothetop1percent(two-thirdsofthebenefitswenttothetop20percent)and1percentofthebenefitsgoingtothebottom20percent.AndrewFieldhouse,“TheBushTaxCutsDisproportionatelyBenefittedtheWealthy,”EconomicPolicyInstitute,June4,2011.Butdefendersofthetaxcutpointoutthatthetoppaysalargefractionofoveralltaxes.40.UnderthelawthatwaspassedonDecember17,2010,thisisthetax-exemptamountfor2012(adjustedupwardforinflation).SeethewebsiteoftheIRS,http://www.irs.gov/businesses/small/article/0,,id=164871,00.html(accessedMarch26,2012).Atthetimeofthiswriting,unlessCongresspassesnewlegislation(whichislikely)theexemptionwillrevertto$1millionin2013.41.LarryBartels,“HomerGetsaTaxCut:InequalityandPublicPolicyintheAmericanMind,”PerspectivesonPolitics3,no.1(2005):15–31,arguesthat“mostordinarycitizensareremarkablyignorantanduncertainabouttheworkingsofthetaxsystemandthepolicyoptionsunderconsideration,oractuallyadopted.”Inthecaseoftheestatetax,JoelSlemrod,“TheRoleofMisconceptionsinSupportforRegressiveTaxReform,”NationalTaxJournal59,no.1(2006):57–75,findsthatamajorityofpeopleeitherbelievethattheestatetaxaffects“most”families(49percent)ordonotknowhowmanyfamiliesitaffects(20percent).Infact,itaffectsonly2percentoffamilies.JohnSides,“Stories,Science,andPublicOpinionabouttheEstateTax,”GeorgeWashingtonUniversity,2011,showsthatcorrectinformationaboutwhoactuallypaystheestatetaxdoesincreasesupportfortheestatetax.42.InanABCNewsandtheWashingtonPostpollinDecember2010,52percentoftheparticipantsfavoredincreasingtheexemptiononinheritancetaxes.Seehttp://abcnews.go.com/Politics/obama-gop-tax-deal-abc-news-washington-post-poll-support/story?id=12382152#.TvzvAjXWark.43.Alittle-knownprovisionofcurrentlawallowscapitalgainstototallyescapetaxationupondeath.Theprovisioniscalled“stepupofbasis,”i.e.,thoseinheritingtheassetaretaxedonlyonthecapitalgainfromthetimetheyinheritit.Thereisnoeconomicjustificationforthis;infact,itleadstolargedistortionsinbehavior.Legislationin2010providedsomelimitationstothestepupofbasis.44.Obamadefendedthebankbailoutsbyarguingthatnationalizationofbanks(whichmightbetterhavebeendescribedas“playingbytherulesofcapitalism,”sinceitwouldputbankswithinsufficientcapitalintoconservatorship)mighthaveworkedwellforSweden,butwasnotagoodoptionintheUnitedStates,becauseofthesmallernumbersofbanksinSwedenandbecausewe“havedifferenttraditionsinthiscountry.”TerryMoraninterviewwithPresidentObama,Nightline,ABCNews,transcript,February10,2009,availableathttp://abcnews.go.com/Politics/Business/story?id=6844330&page=1#.T3CknDEgcs1(accessedMarch26,2012).45.Theadministrationandthebankshavetriedtoshapeperceptionsaboutthebailout,byarguingthatinfactthemoneywasfullyrepaid.Weexplaininchapter9what’swrongwiththeircontention.MostAmericanshaveremainedoutragedatthebailout.46.InFebruary2012theadministration,recognizingthatitshousingprogramshadsofarfailedtodomuchtostemthefloodofforeclosures,letalonetoresuscitatethehousingmarket,proposedamultibillion-dollarprogramforhomeownerrefinancing.See“FactSheet:PresidentObama’sPlantoHelpResponsibleHomeownersandHealtheHousingMarket,”WhiteHouserelease,availableathttp://www.whitehouse.gov/the-press-office/2012/02/01/fact-sheet-president-obama-s-plan-help-responsible-homeowners-and-heal-h(accessedMarch26,2012).47.Therewasanotherpossiblereasonforthereluctancetohelphomeowners.Theyunderstoodthattherewasalimittothegovernment’slargesse,tohowmuchitwouldspendtosupportthebanksandtohelphomeownerswiththeirmortgages.Themoremoneytohomeowners,thelesstherewouldbeforthebanks.Giventheprecariousfinancialpositionofthebanks—atthetime,itwasuncertainjusthowmuchtheywouldneedtostayafloat—theirfirstimperativewassecuringasmuchmoneyaspossibleforthebanks.Theydidsetasideabout$50billionfromtheToxicAssetReliefProgramformortgagerestructuring,butinterestingly,theObamaadministrationhasspentonlyabout$3.4billionofthisamount—suggestingthatitwastheresistanceofthebanks,morethanthemoneyitself,thathasbeen253 therealimpedimenttorestructuring.48.Eventheuseoftheterm“moralhazard”(asopposedthemoreneutralterm“incentiveeffects”)hasemotiveovertones,suggestingthatthereissomethingimmoralabouttheseparticularincentiveresponses.AstheUniversityofPennsylvanialawprofessorTomBakerputit,theterm“helpsdenythatrefusingtoshare[theburdensoflife]ismean-spiritedorself-interested.”(QuotedinShailaDewan,“MoralHazard:ATempest-tossedIdea,”NewYorkTimes,February26,2012,p.BU1.)Infact,thereislittleevidencethattherewouldbeserious“moralhazardconsequences”evenofagenerousprogramtohelphomeowners.ShaunDonovan,secretaryoftheDepartmentofHousingandUrbanDevelopment,arguesthat“onlyabout10or15percentofAmericanswhocanstillpaytheirmortgagestrytowalkawayfromtheirdebt.”Ibid.ThegeneraltheoryofmoralhazardwasdevelopedinthemidsixtiesandseventiesbyArrow,Mirrlees,Ross,andStiglitz.See,e.g.,KennethArrow,AspectsoftheTheoryofRiskBearing(Helsinki,Finland:YrjöJahnssoninSäätiö,1965);JamesMirrlees,“TheTheoryofMoralHazardandUnobservableBehaviourI,”ReviewofEconomicStudies66,no.1(1999):3–21;S.Ross,“TheEconomicTheoryofAgency:ThePrincipal’sProblem,”AmericanEconomicReview63,no.2(1973):134–39;andJ.E.Stig-litz,“IncentivesandRiskSharinginSharecropping,”ReviewofEconomicStudies41,no.2(1974):219–55.Forabroaderdiscussionoftheterm,seeTomBaker,“OntheGenealogyofMoralHazard,”TexasLawReview75(1996):237.49.AlsoUKregulatorsarepushingfornewpowerofautomaticsanctionsofseniorbankexecutivesforpoordecisionstheymakethatleadtobankfailures.See“TheFailureoftheRoyalBankofScotland:FinancialServicesAuthorityBoardReport,”FinancialServicesAuthority(December2011),availableathttp://www.fsa.gov.uk/static/pubs/other/rbs.pdf(accessedMarch26,2012).50.Initially,therewasevenareluctancetolimitbonusesorcompensationmoregenerally,although,aftertheuproaroverbankbonuses,someconstraintswereimposed.51.Thefervorwithwhichthebanksdiscussedhomeowners’moralhazardisreminiscentofAndrewMellon’sadvicetoHerbertHoover,“liquidatelabor,liquidatestocks,liquidatefarmers,liquidaterealestate…itwillpurgetherottennessoutofthesystem.Highcostsoflivingandhighlivingwillcomedown.Peoplewillworkharder,liveamoremorallife.Valueswillbeadjusted,andenterprisingpeoplewillpickupfromlesscompetentpeople.”HerbertHoover,Memoirs,vol.3(NewYork:Macmillan,1952),p.30.Thebankersdidnotperceivethesamemoralforceforthemselveswhenitwastimeforthemtobebailedout.52.Forinstance,adebt-to-equityconversionthatgivesthelenderashareinthecapitalgainwhenthehouseissoldinreturnforawrite-downoftheprincipal.Homeownersstillhaveanincentivetomaintaintheirhomes,housesaren’tthrownontothemarket,depressinghousingprices;familiesaregivena“freshstart”(abasicprincipleinallbankruptcylaw);thecostlyforeclosureprocessisavoided.Thehomeownerpaysaprice—thelossof(asubstantialfraction)ofhiscapitalgain,so“moralhazard”isaverted.InFreefall(NewYork:Norton,2010),Irefertothisasahomeowners’Chapter11,bywayofanalogytolawsgoverningcorporations,thatgivecorporationsafreshstartbyallowingasimilarconversionofdebttoequity.53.Thereisonemoreconsequenceofthefailuretoaddressthemortgagecrisis.Notonlydidn’twegiveafreshstarttoAmerica’sfamilies,wedidn’tgiveafreshstarttothemortgageindustryitself,whichremainsongovernmentlifesupport.WhiletheRighttalksaboutthevirtuesoftheprivatesector,thisvitalsectoroftheeconomyremainsdominatedbygovernmentasnoothersectoroftheeconomy.Today,nearly90percentofnewmortgagesarebeingbackedbytheU.S.government,mostlythroughFannieMaeandFreddieMac,whicharenowgovernmentowned.54.Aswenotedearlier,AdamSmith,thefounderofmoderneconomics,wasfarmoreskepticalabouttheabilityofmarketstoleadtoefficientoutcomesthanhislatter-dayfollowers;hewas,forinstance,concernedaboutmonopoliesandwasawareofmanyoftheothermarketimperfectionstowhichmoderneconomicshascalledattention.55.InastudywithScottWallsteinpreparedwhileIwaschairmanofPresidentClinton’sCouncilofEconomicAdvisers:“SupportingResearchandDevelopmenttoPromoteEconomicGrowth:TheFederalGovernment’sRole,”CouncilofEconomicAdvisers,October1995.56.Asmeasured,e.g.,bytheUNDPHumanDevelopmentIndicators.Seethediscussioninthefinalsectionofthischapter.57.KennethRogoffandCarmenM.Reinhardt,ThisTimeIsDifferent:EightCenturiesofFinancialFolly(Princeton:PrincetonUniversityPress,2009),describehundredsoffinancialcrisesinthelasteighthundredyears,eighteenbankingcrisesinthedevelopedworldsinceWorldWarIIalone.Earlier,thelateCharlesKindlebergerofMITdescribedrepeatedcrisesinhisclassicManias,Panics,andCrashes:AHistoryofFinancialCrises(NewYork:BasicBooks,1978).58.TheCongressionalBudgetOffice(CBO)hasfoundthatadministrativecostsunderthepublicMedicareplanarelessthan2percentofexpenditures,comparedwithapproximately11percentforprivateplansunderMedicareAdvantage.(CBO,“DesigningaPremiumSupportSystemforMedicare,”November2006,12.)AccordingtoCentersforMedicareandMedicaidServices,Medicare’sinflation-adjustedcostperbeneficiaryincreased500percentfrom1969to2009,whiletheprivateinsurancecompanies’real-costincreased800percentforthesameperiod.Seehttps://www.cms.gov/nationalhealthexpenddata/02_nationalhealthaccountshistorical.aspSimilarly,severalstudiessuggestthatthecostofMedicaid,thehealthprogramforthepoor,islowerthaniftheserviceswereprovidedprivately.SeeJack254 HadleyandJohnHolahan,“IsHealthCareSpendingHigherunderMedicaidorPrivateInsurance?”Inquiry40,no.4(Winter2003–04):323–42;and“Medicaid:ALower-CostApproachtoServingaHigh-CostPopulation,”policybriefbytheKaiserCommissiononMedicaidandtheUninsured,March2004.SeealsoPaulKrugman,“MedicareSavesMoney,”June12,2011,availableathttp://www.nytimes.com/2011/06/13/opinion/13krugman.html.59.Astudyofpartialprivatizationofsocialsecurity(pensions)intheUKshowedthatthesetransactions’costsineffectloweredpensionsby40percent;takinganextra1percentoutinoneyearmightnotseemlikealot,butwhentakenyearafteryear,theamountscumulate.SeeMamtaMurthi,MichaelOrszag,andPeterOrszag“AdministrativeCostsunderaDecentralizedApproachtoIndividualAccounts:LessonsfromtheUnitedKingdom,”inNewIdeasaboutOldAgeSecurity,ed.R.HolzmannandJ.Stiglitz(Washington,DC:WorldBank:2001).60.SeeProjectonGovernmentOversight’sreport,“BadBusiness:BillionsofTaxpayerDollarsWastedonHiringContractors,”September13,2011,availableathttp://www.pogo.org/pogo-files/reports/contract-oversight/bad-business/co-gp-20110913.html(accessedFebruary22,2012).ReportedinRonNixon,“GovernmentPaysMoreinContracts,StudyFinds,”NewYorkTimes,September12,2011.61.Seethecommission’sfinalreport,“TransformingWartimeContracting:ControllingCosts,ReducingRisks,”issuedAugust31,2011,availableathttp://www.wartimecontracting.gov/docs/CWC_FinalReport-lowres.pdf.ReportedbyNathanHodge,“StudyFindsExtensiveWasteinWarContracting,”WallStreetJournal,September1,2011,availableathttp://online.wsj.com/article/SB10001424053111904716604576542703010051380.html(accessedMarch26,2012).62.StiglitzandBilmes,TheThreeTrillionDollarWar:TheTrueCostoftheIraqConflict(NewYork:Norton,2008).63.Wenotedinchapter2thattheworld’srichestperson,CarlosSlim,hadhisfortunebuiltintheprivatizationofMexico’stelephonemonopoly.SopervasiveiscorruptionintheprivatizationprocessthatinmybookGlobalizationandItsDiscontentsIreferredtoitas“briberization.”64.IdescribetheearlierepisodesofthisunfortunatedramainGlobalizationandItsDiscontents.Thesagaofwhathappenedsince—repeatedattemptstogetgovernmentsubsidies—withthecompanyonthevergeofbankruptcytoday,confirmsthecriticismsleveledatthetime.Forotherdiscussions,seePeterR.Orszag,“PrivatizationoftheU.S.EnrichmentCorporation:AnEconomicAnalysis,”presentedattheBrookingsInstitution,February2000.SeealsoDanielGuttman,“TheUnitedStatesEnrichmentCorporation:AFailingPrivatization,”AsianJournalofPublicAdministration23,no.2(2001):247–72.ThemostrecentepisodesaredescribedinGeoffreySea,“USECPushbackonCoffinLidofUraniumProject,”availableathttp://ecowatch.org/2011/usec-pushback-on-coffin-lid-of-uranium-project/.65.In2010totalcontributionswere$639billion.Seehttp://www.ssa.gov/policy/docs/statcomps/supplement/2011/oasdi.html.66.Moreover,noprivateinsurancecompanyprovidesinsuranceagainsttheriskofinflation,which,thoughlownow,couldbecomeonceagainhigh,asitwasinthe1970s.67.Seehttp://www.nytimes.com/2006/11/26/business/yourmoney/26every.html.ChrisLeonard,whodescribesmorefullyhowthoseatthetoptrytoaffectperceptionsoftherest,devotesachaptertoclasswarfare.Henotesthat,intheusualcharacterization,it“isalwayswagedupward,neverdownward,”anall-purposeweapontobebroughtoutwheneverredistributivepoliciesortaxesonthetopareputonthetable.Heobservesthatit“referencesaconflictwithoutanyconceivablemobilizedarmy.”RichPeopleThings:RealLifeSecretsofthePredatorClass(NewYork:HaymarketBooks,2010),pp.53–55.68.TheU.S.federalgovernmentspentabout$140billiononitsTemporaryAssistancetoNeedyFamiliesandAssistanceandAidtoFamilieswithDependentChildrenprogramsintheformof“ExpendituresonCashBenefitsandAdministration”between1990and2006.See“2008IndicatorsofWelfareDependence,AppendixA,ProgramData,”providedbytheU.S.DepartmentofHealthandHumanServices,availableathttp://aspe.hhs.gov/hsp/indicators08/apa.shtml#ftanf2(accessedMarch4,2012).69.See,e.g.,thekeynoteaddressbyDominiqueStrauss-Kahn,managingdirector,InternationalMonetaryFund,Nanjing,March31,2011“IntheIMF,inparticular,whilethetraditionhadlongbeenthatcapitalcontrolsshouldnotbepartofthetoolbox,wearenowmoreopentotheiruseinappropriatecircumstances,althoughofcoursecountriesshouldbecarefulnottousethemassubstitutesforgoodmacroeconomicpolicies.”Availableathttp://www.imf.org/external/np/speeches/2011/033111.htm(accessedFebruary22,2011).70.DwightEisenhowerremarkedaboutSwedenataRepublicanNationalCommitteebreakfastin1960,“IhavebeenreadingquiteanarticleontheexperimentofalmostcompletepaternalisminafriendlyEuropeancountry.Thiscountryhasatremendousrecordforsocialisticoperation,followingasocialisticphilosophy,andtherecordshowsthattheirrateofsuicidehasgoneupalmostunbelievablyandIthinktheywerealmostthelowestnationintheworldforthat.Now,theyhavemorethantwiceourrate.Drunkennesshasgoneup.Lackofambitionisdiscernibleonallsides.”DwightD.Eisenhower:RemarksattheRepublicanNationalCommitteeBreakfast,Chicago,Illinois,July27,1960.PublicPapersofthePresidentsoftheUnitedStates,DwightD.Eisenhower(Washington,DC:GovernmentPrintingOffice,1999),p.605.71.Inmakingcomparisonsacrosscountries,onehastoadjustfordifferencesin255 costofliving.Atcurrentexchangerates(e.g.,howmanyeurostradeforadollar),livingmaybecheaperinonecountrythaninanother.(Thedifferencecandepend,ofcourse,onwhatonespendsone’smoneyon.SomeonehavingtobuyhealthcareintheUnitedStateshasamuchlowerstandardoflivingthatacomparablysickpersoninFrance.)Economistsrefertothecomparisonsattemptingtomake(albeitimperfect)adjustmentsforcostoflivingasPPP(purchasingpowerparity)comparisons.Forinstance,intermsofofficialexchangerates,percapitaGDPin2010intheUnitedStateswasmorethan10timesthatinChina;adjustingforPPP,itis6timesthatinChina.SeeWorldBankIndicatorsdatabase,availableathttp://databank.worldbank.org/ddp/home.do?Step=12&id=4&CNO=2(accessedMarch26,2012).72.SeeJanetCurrieofPrincetonUniversity,“InequalityatBirth:SomeCausesandConsequences,”andthediscussionofherworkinchapter1.73.Foradiscussionofsomeofthesecosts(notalleasytoquantify)tothepeopleofPapuaNewGuinea,seethe2011HumanRightsWatchreport“Gold’sCostlyDividend:HumanRightsImpactsofPapuaNewGuinea’sPorgeraGoldMine,”availableathttp://www.hrw.org/sites/default/files/reports/png0211webwcover.pdf(accessedMarch7,2012).74.ConvenedbyPresidentSarkozyofFrance.ItsreportisavailableasJean-PaulFitoussi,AmartyaSen,andJosephE.Stiglitz,MismeasuringOurLives:WhyGDPDoesn’tAddUp(NewYork:NewPress,2010),andavailableathttp://www.stiglitz-sen-fitoussi.fr/en/index.htm.(TranslationsareavailableinChinese,Korean,Italian,andotherlanguages.)75.Thispointwasmaderightatthestart,bytheearlydeveloperofthenationalincomeaccounts,SimonKuznets,whonotedthat“thewelfareofanationcanscarcelybeinferredfromameasureofnationalincome.”Kuznets,“NationalIncome,1929–1932,”73rdU.S.Cong.,2dsess.,1934,Senatedoc.no.124,p.7.ChapterSevenJUSTICEFORALL?HOWINEQUALITYISERODINGTHERULEOFLAW1.Therearemanyinstanceswherelawscanbeseenaspreservinginequities.Thelawsthatprotectedandpreservedslaveryofferthemostprofoundexample.Althoughslavescouldn’tvote,theConstitutiontreatedeachslaveasthree-fifthsofapersonforpurposesofcongressionalrepresentation,thusguaranteeingdisproportionaterepresentationingovernmentforthewhiteslaveownersoftheSouth.IntheaftermathoftheCivilWar,JimCrowlawsensuredsegregationandtheeconomicdisempowermentofAfricanAmericans.LikefeudalisminEuropecenturiesearlier,landownerswereabletohirelaboratmorefavorableterms:inthiscase,theruleoflawwasusedtoenhancethewealthandincomeofwhitelandowners.Thereisalargeliteraturedescribinglaborcoercionandlegalframeworksthathelpedenforceit.See,e.g.,S.Naidu,“RecruitmentRestrictionsandLaborMarkets:EvidencefromthePostbellumU.S.South,”JournalofLaborEconomics28,no.2(2010):413–45;StanleyEngerman,“EconomicAdjustmentstoEmancipationintheUnitedStatesandBritishWestIndies,”JournalofInterdisciplinaryHistory13(1982):191–220;S.NaiduandN.Yuchtman,“HowGreenWasMyValley?CoerciveContractEnforcementin19thCenturyIndustrialBritain,”NBERWorkingPaperno.17051,2011,availableathttp://www.nber.org/papers/w17051(accessedMarch4,2012).2.Theasyettotallyunsolvedproblemofnuclearwastedisposalisanotherexampleofnuclearpowerplants’nothavingtofullyinternalizethecostsoftheiroperations.Withmaterialthatremainsdangerousfortensofthousandsofyears,thecostofdealingwiththewasteisbequeathedtofuturegenerations,whetherornotthecompanythatrunstheplantisaroundbythattime.3.Thequestionismademorecomplexbecauseofthehiddenandopensubsidiestootherformsofenergyproduction,suchascoal.Themarketissodistortedthatit’shardtojudgewhatmightemergeinanefficientmarketplace.4.Thesettlementprocessisstillunderway.BPspent$20billiontoestablishtheGulfCoastClaimsFacility.Thefund,whichisadministeredbyKennethFeinberg,haspaidorapprovedforpaymentatotalof$7.96billionasofFebruary2012,accordingtotheBPwebsite,availableathttp://www.bp.com/sectiongenericarticle.do?categoryId=9036580&contentId=7067577(accessedMarch4,2012).Thestructureofthefundhasnotbeenwithoutcriticism.Onelegalscholarcharacterizeditthus:“TheGulfCoastClaimsFacilityrepresentsanunnoticedincrementaltrendtowardthelawless,privateresolutionofmassclaims.Thisresolution(inthecaseoftheGCCF)wascreatedbyaculpabledefendant,unboundedbylegalnorms,andadministeredbyaheroicspecialmasterwithlimitlessunreviewablediscretion,whoalsoisintheemployofthemalefactor.WhateverelsemaybearguedonbehalfoftheGCCF,thiscannotbeagooddevelopment.”L.Mullenix,“PrometheusUnbound:TheGulfCoastClaimsFacilityasaMeansforResolvingMassTortClaims—AFundTooFar,”LouisianaLawReview71(2011):823.Asthisbookgoestopress,anout-of-courtsettlementbetweenBPandthelawyersfortheplaintiffsisbeingconsidered.“AccordReachedSettlingLawsuitoverBPOilSpill,”NewYorkTimes,March3,2012,p.A1.PropublicamaintainedanactivemediaoversightoftheaftermathoftheBPspill,includingcorruptionintheclean-upprocess.Seehttp://www.propublica.org/topic/gulf-oil-spill/.5.R.H.Coase,“TheProblemofSocialCost,”JournalofLawandEconomics3(1960):1–44.6.Thisisespeciallythecasewhenthereareinformationasymmetries—whereone256 partyhaseasieraccesstoinformation.Ifonegrouphaslessinformationabouttheharmthananother(acommonsituation),thenthemoreinformedisinabetterpositiontoavoidtheharm.Othermarketimperfectionscanalsoaffecttheefficiencyofalternativeassignmentsofpropertyrights.Forexample,ifonegroupiscreditconstrained,itmaynotbeabletopay.7.Inmanycases,itisnotalwaysclearwhoisexertinganexternalityonwhom.Thedriverwhocollideswithanothervehiclewouldnothavegotintoanaccidentiftheotherdriverhadnotbeenontheroad.Otherpeople’ssmokingcouldnotleadtocancerinanonsmokerifthenonsmokerhadnotexposedhimselftothe“secondary”effectsofsmokersbybeinginthevicinityofthesmoker.Intheseandmostothercases,thereisabroadconsensus:thosewhodrivesafelyshouldhavetherighttodrivewithoutworryingabouttheriskofanaccidentfromarecklessdriver;ordinarycitizensshouldhavetherighttobreathecleanair.8.JohnStuartMillinOnLiberty(1869)distinguishesbetweenother-regardingandself-regardingspheresofaction.Inhistheory,individualshavetherighttoperformanactioninsofarastheydonotharmothers.9.Andtoshapebeliefsandperceptionsthatshapethepresumptionsthataresocriticalasjudgesandjuriesmakejudgmentsaboutthemeritsofeithersideinacourtcase.10.Foradiscussion,seeG.MorgensonandJoshuaRosner,RecklessEndangerment:HowOutsizedAmbition,Greed,andCorruptionLedtoEconomicArmageddon(NewYork:TimesBooks,2011).Morespecifically,theratingsagenciesclaimedthattheycouldnotrateRMBSbasedonmortgagesoriginatedinNewJerseyandGeorgia,onthegroundsthattheRMBSholderwouldbeliableunderstateConsumerProtectionorPredatoryLendingLaw.UndertheGeorgialaw,unlimitedpunitivedamagesforpredatorylendingundertheGeorgiaFairLendingActwouldextendtoRMBSholdersinduecourse.ThisledtotheamendmentoftheGeorgiapredatorylendingstatutein2003.AsimilarchainofeventshappenedinNewJersey,leadingtotheamendmentoftheNewJerseyHomeownershipSecurityActof2002toappeaselendersinJune2004.SeealsothediscussioninB.Keys,T.Mukherjee,A.Seru,andV.Vig,“DidSecuritizationLeadtoLaxScreening?EvidencefromSubprimeLoans,”QuarterlyJournalofEconomics125,no.1(2010):307–62.11.Oneofthemostimportantadditionalaspectswasthepreemptionbyfederalbankregulators,notablytheOfficeoftheControlleroftheCurrency(OCC),whichistheagencyintheTreasurychargedwithoverseeingbanks,andOTS(theOfficeofThriftSupervision,originallysetuptooverseethesavingsandloansinstitutions),ofstricterstateregulationbyclaimingjurisdictionovernationalbanks.Thismeantthatifastatetriedtoregulatebanksinitsstatemorestrictly,thetighterstandardswouldextendonlytostate-charteredbanks,whichwouldthenbelesscompetitivethanthenationallycharteredinstitutions.Makingmattersworse,“somestates,suchasGeorgia,haveparityorwildcardlawsthatexemptstate-charteredbanksandthriftsandtheirsubsidiariesfromstateanti-predatorylendinglawstothesameextentasnationalbanksandfederalthrifts….”P.McCoyandE.Reunart,“TheLegalInfrastructureofSubprimeandNontraditionalHomeMortgages,”JointCenterforHousingStudiesHarvardUniversity,UCC08-05.TheheadoftheOCCtriedtoallayworriesaboutthispreemption:“Ourapproach…protectsconsumerswhereabusivepracticesarefound.”Speechavailableathttp://www.occ.gov/static/news-issuances/news-releases/2003/nr-occ-2003-57.pdf.SeethebroaderdiscussionoftheroleofpreemptioninMikeKonczalathttp://rortybomb.wordpress.com/2010/03/01/cfpa-i-preemption-or-what-a-bad-cfpa-would-look-like/.12.SeemyFreefall(NewYork:Norton,2010)forafullerdiscussionofthewholevarietyofbadfinancialproductsandtheconsequences.13.JustastheFoodandDrugAdministrationprotectsconsumersagainstdeceptive,dangerous,andineffectivedrugs.14.EvidencedbythefactthatjustshortlyafterEuropeanregulatorssubjectedoneofEurope’slargerbankstoastresstest—toseehowwellitwoulddoinadverseconditions—anditpassedbrilliantly,thebankcollapsed.Privateratingagencies,too,havedemonstratedthattheyarenotuptothetask.15.Inthefirstsetofdeals,taxpayersgotbackabout65centsonthedollar,butinlaterdeals,especiallywithAIGandCitbank,theygotbackabout41centsonthedollar.SeeCongressionalOversightPanel,“ValuingTreasury’sAcquisitions,”FebruaryOversightReport,February6,2009,availableathttp://cop.senate.gov/reports/library/report-020609-cop.cfm.Whilethelegalsystemisstackedagainstordinarycitizens,themagnitudeofthebanks’badbehaviorwassolargethattherewassomeaccountability—thoughnotenoughtooffsetthehugeprofitstheyhadmadeintheirpredatorylending,whichwasoftentargetedatpoorAfricanAmericansandHispanics.Seechapter3foramoreextensivediscussion.16.Whilemanymortgageswerenonrecourse(thatis,creditorscouldclaimonlythehouse—theycouldn’tgoaftertheborrower’sotherassets),andthusmightnotbeaffectedbythisprovision,mostofthesubprimelendinginvolvedsecondmortgages,whichwererecourse.Thechangeinthebankruptcylawappliedtosuchloans.17.Overdraftfeesaveragebetween$30and$35atransactionandhaverisenbyalmostafifthoverthepastfiveyears.In2011theywereestimatedtoincreasebankearningsby$30billion.Ninetypercentofthefeesarepaidby10percentofthecustomers,mostlylowincome.Theattempttocurbthefeesin2010failed,partlybecausecustomersweremisledbythebanks.Thedirectorofthenewconsumeragency,RichardCordray,criticizedbankpracticesdesignedtoensurethatcustomersdidnotunderstandthefeestheyfaced.ANewYorkTimeseditorialdescribedbankpracticesthat“deliberatelyburiedinformation,requiring257 consumerstovisitthreeWebpagesandscrollthrough50pagesoftexttofindfeeinformation.”“AFurtherLookatOverdraftFees,”NewYorkTimes,February27,2012,p.A16(availableathttp://www.nytimes.com/2012/02/27/opinion/a-further-look-at-overdraft-fees.html,accessedMarch4,2012),citinginpartdatafromMoebsServices,aresearchcompanythathasconductedstudiesforbothgovernmentandsomebanks.SeealsoFDICStudyofBankOverdraftPrograms,November2008.ExecutiveSummaryavailableathttp://www.fdic.gov/bank/analytical/overdraft/FDIC138_ExecutiveSummary_v508.pdf(accessedFebruary22,2012).18.Theycallitaregulatorytaking.Butanychangeinlawthataffectscontractsorpropertyhasredistributiveconsequences.19.See,e.g.,“WheretheJobsAre,theTrainingMayNotBe,”NewYorkTimes,March22012,p.A1.Thearticlereports,“Technical,engineering,andhealthcareexpertiseareamongthefewskillsinhugedemandevenintoday’slacklusterjobmarket.Theyarealso,unfortunately,someofthemostexpensivesubjectstoteach.”Asaresult,thearticle,notessevenstateshaveeliminatedengineeringandcomputersciencedepartments.ItdescribesacommunitycollegeinNorthCarolina—astatewithaseverenursingshortage—where“nursingprogramapplicantssooutnumberavailableslotsthatthereisawaitinglistjusttogetonthewaitinglist.”20.Inchapter4wepresenteddatashowingthehighlevelofindebtednessofthetwo-thirdsofstudentsgraduatingwithdebts—inexcessof$25,000.Ifparentalloanswereincluded,thenumbersweremorethanathirdhigher.Onaverage,studentsatthesefor-profitschoolshave45percentmoredebtthanstudentsatotherschools.Theseaveragenumbersmaskthefactthatlargenumbershaveextraordinarilyhighstudentdebts,especiallyatthefor-profitschools.Almostone-quarterofthosewhoreceivedbachelor’sdegreesatfor-profitschoolsin2008borrowedmorethan$40,000,comparedwith5percentatpublicinstitutionsand14percentatnot-for-profitcolleges.Indebtednesshasincreasedmarkedlyoverthepastdecade.Studentswhoearnedabachelor’sdegreein2008borrowed50percentmore,ininflation-adjusteddollars,thanthosewhograduatedin1996;forthoseearninganassociate’sdegree,indebtednesshaddoubled.See“SubprimeOpportunity:TheUnfulfilledPromiseofFor-ProfitCollegesandUniversities,”EducationTrust,November2010,availableathttp://www.edtrust.org/sites/edtrust.org/files/publications/files/Subprime_report.pdf“TheRiseofCollegeStudentBorrowing,”studyofthePewResearchCenter,releasedNovember23,2010,availableathttp://www.pewsocialtrends.org/files/2010/11/social-trends-2010-student-borrowing.pdf(accessedMarch4,2012);andtheProjectonStudentDebt,“StudentDebtandtheClassof2010,”November2011,availableathttp://projectonstudentdebt.org/pub_view.php?idx=791(accessedMarch4,2012).Forexcellentreportingontheseissues,seeTamarLewin,“ReportFindsLowGraduationRatesatFor-ProfitColleges,”NewYorkTimes,November23,2010,accessibleathttp://www.nytimes.com/2010/11/24/education/24colleges.html(accessedJanuary29,2012);andTamarLewin,“CollegeGraduates’DebtBurdenGrew,YetAgain,in2010,”NewYorkTimes,November2,2011.21.Moreaccurately,itextendednondischargeabilitytoprivatesectorlenders,andthat’swheretheperverseincentivessetinwithparticularforce.22.Ifthispartoftheeducationmarketworkedbetter,reputationeffectswouldexertdisciplineandprovideincentives.U.S.Newsevenreportsloandefaultratesforlargeonline-orientedfor-profitschools,withKaplanUniversityscoringaremarkable17.2percent(incontrasttotheprivatenot-for-profitschoolaverageof4percent).TheUniversityofPhoenixhasa12.9percentdefaultrate.Yetthesenumbersdon’tseemtodeterenrollment,ornotenough.Seehttp://www.usnews.com/education/online-education/articles/2010/09/15/loan-default-rates-at-prominent-online-universities(accessedMarch5,2012).23.Only22percentofthefirst-time,full-timebachelor’sdegreestudentsatfor-profitcollegesgraduatewithinsixyears,55percentatpublicinstitutions,and65percentatprivatenonprofitcolleges.See“SubprimeOpportunity,”EducationTrust,2010.24.Theschoolshavenotonlylargedropoutratesbut,giventhat,alsolargedefaultrates.Some8.8percentofstudentloanborrowerswhoenteredrepaymentin2009haddefaultedbytheendof2010,upfrom7percentforthepreviouscohort,withmorethanhalfoftheincreasecomingfromfor-profitschools.SeeEricLichtblau,“WithLobbyingBlitz,For-ProfitCollegesDilutedNewRules,”NewYorkTimes,December9,2011,andProjectonStudentDebt,“SharpUptickinFederalStudentLoanDefaultRates,”September12,2011.ANewYorkTimeseditorial(“FraudandOnlineLearning,”October5,2011)pointsouttherampantfraudinthefor-profiteducationsector:“TheDepartmentofEducation’sOfficeoftheInspectorGeneralclaimsithasopened100investigationssince2005andisreviewing49complaints.”25.AsaresultoflegislationsignedbyPresidentObamainMarch2010,privatebanksnolongerhandledfederallybackedstudentloans.TheCBO(CongressionalBudgetOffice)estimatedthatthenetsavingswasinexcessof$60billionoveradecade—ineffect,theamountthattaxpayershadhandedthebanksasagift.CBO,“CostsandPolicyOptionsforFederalStudentLoanPrograms,”March2010,availableathttp://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/110xx/doc11043/03-25-studentloans.pdf(accessedFebruary22,2012).26.Highinterestratespredictablyleadtomoreriskforseveralreasons.Onlythoseengagedinhigh-riskactivitiesarewillingtopaythehighinterestrates(the“selection”effect);togetreturnstopaybacktheloanwithinterest258 requirestheborrowertoundertakehighlyriskyactivities(theincentiveeffect);andlenders,comfortedbythehighreturnstheygetfromthoseloansthatarepaidback,mayputlesseffortintoscreening.SeeJ.E.StiglitzandA.Weiss,“CreditRationinginMarketswithImperfectInformation,”AmericanEconomicReview71,no.3(June1981):393–410.IntheUnitedStatesbeginningin1980,federallawsincreasinglypreemptedstatelawsthatattemptedtorestrictusury.27.SeeC.K.Prahalad,TheFortuneattheBottomofthePyramid:EradicatingPovertythroughProfits(UpperSaddleRiver,NJ:PrenticeHall,2005).28.TheformergovernoroftheReserveBankofIndiaexplicitlymadethelinkbetweenmicrocreditinIndiaandAmerica’ssubprimelending:Y.V.Reddy“MicrofinanceinIndiaIslikeSubprimeLending,”EconomicTimes,November23,2010,availableathttp://articles.economictimes.indiatimes.com/2010-11-23/news/27602978_1_priority-sector-lending-sks-microfinance-microfinance-industry.29.TheFBI’smortgagefraudunitreportsthatfraudcontinuedtobeelevatedinto2010.Mortgagefraud–relatedsuspiciousactivityreports(SARs)rosesixfoldfrom2003to2007.(Ofcourse,withthepoppingofthehousingbubble,buyersweremoresensitivetohavingbeendeceived.)SeeFBIMortgageFraudReports,datafrom2007and2010reports,availableathttp://www.fbi.gov/stats-services/publications/mortgage-fraud-2010andhttp://www.fbi.gov/stats-services/publications/mortgage-fraud-2007/mortgage-fraud-2007.30.ThelegalissuesthisgaverisetoaresurveyedinChristopherL.Peterson,“TwoFaces:DemystifyingtheMortgageElectronicRegistrationSystem’sLandTitleTheory,”WilliamandMaryLawReview53,no.1(2011):111–61(quotedmaterialisfromp.138),availableathttp://scholarship.law.wm.edu/wmlr/vol53/iss1/4(accessedMarch4,2012).31.AstheSupremeCourtseemstohaveclaimedintheCitizensUnitedcase.32.PhilAngelides,whoheadedtheFinancialCrisisInquiryCommissionintothecausesofthecrisis,notedthat“todaytherateoffederalprosecutionsforfinancialfraudislessthanhalfofwhatitwas”duringthesavingsandloancrisis.Healsonotedthathisbudgetforinvestigatingthecrisis,includingthemisdeedsofthebanks,was$9.8million—roughlyone-seventhofthebudgetofOliverStone’sWallStreet:MoneyNeverSleeps.See“WillWallStreetEverFaceJustice,”NewYorkTimes,March2,2012,availableathttp://www.nytimes.com/2012/03/02/opinion/will-wall-street-ever-face-justice.html(accessedMarch6,2012).SeeW.K.Black,K.Calavita,andH.N.Pontell,“TheSavingsandLoanDebacleofthe1980s:White-CollarCrimeorRiskyBusiness?,”LawandPolicy17,no.1(1995):23–55.Onourcurrentcrisis,seeMattStoller,“TreatForeclosureasaCrimeScene,”Politico,December15,2011.JamieGalbraithoftheUniversityofTexashasbeenforcefullymakingthesamecase.Thebanksviolatedotherlawsaswell—withlimitedprosecution.TheOfficeoftheComptrolleroftheCurrency,thefederalnationalbankregulator,reportedinNovember2011that5,000active-dutymembersoftheU.S.militarymayhavebeenunlawfullyforeclosedupon(thiswasinastudyofjusttennationalbanks).S.Nasiripour,“USLendersReviewMilitaryForeclosures,”FinancialTimes,November28,2011.33.Thefailuretoprosecutethebanksisonlyoneaspectofthefailuretoholdthefinancialsectoraccountable.TheFinancialInquiryCommissiondescribedhowClaytonHoldings,hiredbymorethantwentymajorfinancialinstitutionstodo“duediligence”onthemortgagesthatthebankswerehandling(ensuring,e.g.,thattheywerenotfraudulentandtherehadbeencompliancewithlegalprocedures)sampled2to3percent,andeveninthissmallsample,detectedsignificantnumbersofdefectiveloans.Butthebanksdidn’tinsistthattheother97percentbeinvestigated,anddidn’tdiscloseinformationaboutdefectiveloanstoinvestors,asrequiredbysecuritieslaw.Evidently,thereisstillnoprosecutionforthisaspectoftheviolationofthelaw.SeeAngelides,“WillWallStreetEverFaceJustice.”34.Itishardtogetprecisenumbers.AtthetimeoftheforeclosureagreementinJanuary2012,reportsputthenumbersinforeclosuresincetheburstingofthehousingbubbleatnearly8million.SeeD.Kravitz,“Banks’AgreementtoOverhaulMortgageIndustrySenttoStates,”AssociatedPress,January24,2012.TheNewYorkFedgovernorWilliamDudleysuggestedthatthepaceofforeclosuresin2012and2013couldincrease(technically,realestatetransferredintothehandsofthebanks)—toashighas1.8millionperyear,upfromaround1.1millionin2011andaround600,000in2010.Dudley,“HousingandtheEconomicRecovery,”RemarksattheNewJerseyBankersAssociationEconomicForum,Iselin,NJ,availableathttp://www.newyorkfed.org/newsevents/speeches/2012/dud120106.html(accessedJanuary29,2012).35.Campaignfundraisingonjudicialelectionsmorethandoubledinthelastdecade—itroseto$206.9millionin2000–09from$83.3millionin1990–99.Chiefjusticeshavebeendefeatedbywell-moniedchallengers;“attackads”haveincreasinglyfoundtheirwayontotelevision.SeeJ.Sample,A.Skaggs,J.Blitzer,andL.Casey,“TheNewPoliticsofJudicialElections,2000–2009:DecadeofChange,”BrennanCenterforJustice,NewYorkUniversitySchoolofLaw.Thereisalsoanincreasingperceptionthatjusticeisbeingbought:whileas,expected,citizensfearthat“campaigncontributionsaffecttheoutcomeofcourtroomdecisions,”whatisevenmorestrikingisthat“nearlyhalfofstatejudgesagree.”Seethewebsitehttp://www.brennancenter.org/content/resource/the_new_politics_of_judicial_electionsMarch7,2012).36.Ally,formerlyGMAC,inwhichthegovernmenthas74percentownership.37.QuotedinGretchenMorgenson,“MassachusettsSues5MajorBanksoverForeclosurePractices,”NewYorkTimes,December2,2011,pp.B1,B9.NewYork259 State’sattorneygeneralEricSchneidermanalsosuedBankAmerica,WellsFargo,andJPMorganChase,describingwhattheydidas“bizarreandcomplex,”anendrunaroundthetraditionalpublicrecordingsystem.Themotivewasclear:saving$2billioninrecordingfees.MERS,ofcourse,deniedthecharges.“NewYorkSues3BigBanksOverMortgageDatabase,”NewYorkTimes,February4,2012,p.B6.38.BasedonananalysisofdatafromLenderProcessingServices.Onaverage,ittook792daysforlargeloans,611forsmallloans.Thedifferenceswereespeciallylargeinstatesthatrequiredcourtproceedings.Still,inCalifornia,astatethatdoesn’t,foreclosuresonlargemortgagestook50percentlongerthanonsmallones,671daysvs.445.Interestingly,beforethemortgagecrisis,whenthe“ordinary”ruleoflawwasworking,therewasessentiallynodifference,251daysforlargemortgages,260forsmallones.SeeShellyBanjoandNickTimiraos,“FortheCostliestHomes,ForeclosureComesSlowly,”WallStreetJournal,February28,2012,availableathttp://online.wsj.com/article/SB10001424052970204369404577209181305152266.html.39.Ourcomplexlegalsystemcontributestothecostsanduncertainty.Theoilcompanieshavetried(inpartsuccessfully)tolimittheirliabilityfor,e.g.,offshoreoildisasters.Courtshavelimitedliabilityforeconomicdamagesresultingfrom,say,anoilspilltothosemostdirectlyaffected.InthecaseoftheExxonValdezoilspill,thismeantthatmanyofthosewhowereinjuredbythedestructionofthefishingindustrycouldn’trecovertheirlostprofits.TheOilPollutionActof1990triedtocorrectsomeoftheselimitations.Butthefulltestingofthelegalframework—withthelegionsoflawyersthatlikelywillbemountedbyBP,attemptingtolimitwhatithastopayout—willtakeyears.Foradiscussionexemplifyingthecomplexityofthelegalframework,seeRonenPerry,“TheDeepwaterHorizonOilSpillandtheLimitsofCivilLiability,”WashingtonLawReview86,no.1(2011):1–68.40.Thepatentsystemhaslongbeenusedinsuchanunfairanddiscriminatoryway.PatentfeesintheUKfromthestartmadeaccesstothepatentsystemavailableonlytothewealthy.SeeZ.KahnandK.Sokoloff,“PatentInstitutions,IndustrialOrganizationandEarlyTechnologicalChange:BritainandtheUnitedStates,1790–1850,”inTechnologicalRevolutionsinEurope,ed.M.BergandK.Bruland(Cheltenham,UK:Elgar,1998).B.ZorinaKahnhasnoted,“Prohibitivelyhighcosts…limitedaccesstopropertyrightsininvention.Theseconstraintsfavouredtheeliteclassesofthosewithwealthorexceptionaltechnicalqualifications.Inventorswhowishedtoobtainprotectionthroughouttherealmhadtocontendwiththebureaucracyofthreepatentsystems,andtopayfeesthatrangedfrom£100foranEnglishpatentto£300forpropertyrightsthatextendedtoIrelandandScotland.”Khan,“IntellectualPropertyandEconomicDevelopment:LessonsfromAmericanandEuropeanHistory,”mimeo,2003.SeealsoB.ZorinaKhan,TheDemocratizationofInvention:PatentsandCopyrightsinAmericanDevelopment,1790–1920(NewYork:CambridgeUniversityPress,2005).41.Lowercourtssometimesruleoneway,highercourtstheother,withtheentirelegalprocessstretchingoutforaverylongtime.Moreover,somejurisdictionsmayrecognizethepatent,othersrejectit.SeeS.Decker,“NTPWinsCourtRulingon7PatentsfromApple,AT&TCases,”Bloomberg,August1,2011.Foranearlierandbroaderdiscussionoftheseissues,seeJ.E.Stiglitz,MakingGlobalizationWork(NewYork:W.W.Norton,2006).42.Therearealternativewaysoforganizingthepatentsystemthatcanavoidthescopeforextortion,suchastheliabilitysystem,whereindividualshavetherighttouseanypatent,uponpaymentofa“reasonable”fee.Alternativewaysoforganizingtheintellectualpropertyregimecancreateamorelevelplayingfield.Smallchangesintherulescanhavelargedistributiveconsequences.TherewasaheateddebateintheUnitedStatesconcerningthemovefromasystemwherethepatentwasgiventothe“firsttofile”ratherthan“firsttoinvent.”Thefirsttofilegivesabigadvantagetobigcorporationsthathaveontheirstaffslargenumbersofpatentlawyers,readytofileapatentapplicationthesecondapatentableinnovationoccurs.SeetheworkofJeromeH.Reichman,includinghis“SavingthePatentLawfromItself:InformalRemarksconcerningtheSystemicProblemsAfflictingDevelopedIntellectualPropertyRegimes,”AdvancesinGenetics50(2003):289–303,andthereferencescitedthere.43.EdwardWyatt,“JudgeBlocksCitigroupSettlementwithS.E.C.,”NewYorkTimes,November28,2011.ChapterEightTHEBATTLEOFTHEBUDGET1.Thereportofthecommissionisavailableathttp://www.fiscalcommission.gov/sites/fiscalcommission.gov/files/documents/TheMomentofTruth12_1_2.BipartisanPolicyCenterDebtReductionTaskForce(chairedbyformerSenateBudgetCommitteechairmanPeteDomeniciandformerWhiteHousebudgetdirectorandFederalReservevicechairAliceRivlin,andincludednineteenformerWhiteHouseandCabinetofficials,formerSenateandHousemembers,formergovernorsandmayors,andbusiness,labor,andotherleaders).Theirreport,“RestoringAmerica’sFuture,”isavailableathttp://www.bipartisanpolicy.org/sites/default/files/BPC%20FINAL%20REPORT%20FOR%20PRINTER%2002%20(accessedMarch5,2012).3.Titled“RoadmapforAmerica’sFuture,”theproposalsareavailableathttp://www.roadmap.republicans.budget.house.gov/(accessedMarch5,2012).TheHouseofRepresentativespassedavariantofhisbudgetonApril15,2011,availableathttp://budget.house.gov/UploadedFiles/PathToProsperityFY2012.pdf260 (accessedMarch5,2012).4.Theceilinglimitshowmuchthegovernmentcanborrow.ButCongresshadalsopassedlawsmandatingexpendituresandassessingcertaintaxes.AlthoughCongresslegislatestaxrates,thetaxrevenuesdependonhowwelltheeconomyisdoing.Iftheeconomyisdoingwell,revenuesarehigh;inrecessions,revenuesarelow.Asthegovernmentborrowsmoreyearafteryear,thetotalamountofdebtincreases.Congress,somewhatinconsistently,alsosetsalimitontheamountthatthegovernmentcanborrow.Withoutanagreementtoincreasetheceiling,somethought,thegovernmentwouldbeforcedtoshutdown.Inanycase,itwouldfaceanimpossiblesituation:eitherthelawspecifyingwhatwastobespenthadtobebroken,orthelawspecifyinghowmuchcouldbeborrowedhadtobeviolated.5.DuringtestimonyinCongressonJanuary25,2001,Greenspangavesupportfornear-termtaxcutsandexpressedworriesaboutthegovernment’spayingoffitsdebttooquickly.“Butcontinuingtorunsurplusesbeyondthepointatwhichwereachzeroornear-zerofederaldebtbringstocenterstagethecriticallonger-termfiscalpolicyissueofwhetherthefederalgovernmentshouldaccumulatelargequantitiesofprivate(moretechnicallynonfederal)assets.Atzerodebt,thecontinuingunifiedbudgetsurplusescurrentlyprojectedimplyamajoraccumulationofprivateassetsbythefederalgovernment.ThisdevelopmentshouldfactormateriallyintothepoliciesyouandtheAdministrationchoosetopursue….Intoday’scontext,wheretaxreductionappearsrequiredinanyeventoverthenextseveralyearstoassistinforestallingtheaccumulationofprivateassets,startingthatprocesssoonerratherthanlaterlikelywouldhelpsmooththetransitiontolonger-termfiscalbalance,”hesaid.“Andshouldcurrenteconomicweaknessspreadbeyondwhatnowappearslikely,havingataxcutinplacemay,infact,donoticeablegood.”See“TestimonyofChairmanAlanGreenspan:OutlookfortheFederalBudgetandImplicationsforFiscalPolicy,”beforetheCommitteeontheBudget,U.S.Senate,January25,2001,availableathttp://www.federalreserve.gov/boarddocs/testimony/2001/20010125/default.htm(accessedMarch5,2011).6.SeetheCBO’s“CurrentBudgetProjections:SelectedTablesfromCBO’sBudgetandEconomicOutlook:AnUpdate,”August2010,pp.9–10,availableathttp://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/117xx/doc11705/budgetprojections.pdf(accessedFebruary22,2012).ThisestimateincludesanadjustmentforthemagnifiedeffectofboththeEconomicGrowthandTaxReliefReconciliationActof2001andtheJobsandGrowthTaxReliefReconciliationActof2003.7.EconomicPolicyInstitute,“EconomicSnapshot,”May18,2011,availableathttp://www.epi.org/publication/what_goes_into_a_budget_deficit/(accessedMarch5,2012),basedonCBOdata.TheTaxRelief,UnemploymentInsuranceReauthorization,andJobCreationActof2010,notonlyextendedtheBushtaxcutsbytwoyears;itintroducedothertaxexpenditures.TheCBOestimatedthattheactwouldexpandthedeficitby$390billionin2011,andby$407billionin2012.See“TheBudgetandEconomicOutlook:FiscalYears2011to2021,”CBO2011,availableathttp://budget.senate.gov/democratic/index.cfm/files/serve?File_id=94312aeb-8a73-41cd-b774-8533403f83a6(accessedMarch5,2012).InJanuary2012theCBOprojectedadeficitfortheyearofabout$1.1trillion.See“TheBudgetandEconomicOutlook:FiscalYears2012to2022,”CBO2012,availableathttp://cbo.gov/sites/default/files/cbofiles/attachments/01-31-2012_Outlook.pdf(accessedMarch5,2012).8.Inpresentdiscountedterms,expressedintoday’sdollars.SeeJ.E.StiglitzandLindaBilmes,TestimonybeforetheU.S.CongressHearingontheEconomicCostsoftheIraqWar,October24,2007,http://www.hks.harvard.edu/news-events/news/testimonies/linda-bilmes-testifies-before-us-house-of-representatives-commitee-on-the-budget-on-the-economic-costs-of-the-iraq-war);andLindaJ.BilmesandJ.E.Stiglitz,TheThreeTrillionDollarWar:TheTrueCostoftheIraqConflict(NewYork:Norton,2008).Othershaveprovidedevenhighernumbers.TheEisenhowerStudyGroupResearchProjectestimatesthatasofJune2011,$3.2–$4trillionhadbeenspentorobligatedinthewarsinIraq,Afghanistan,andPakistansince2001.See“TheCostsofWarsince2001:Iraq,Afghanistan,andPakistan,”availableathttp://costsofwar.org/sites/default/files/Costs%20of%20War%20Executive%20Summary.pdf(accessedMarch5,2012).9.“FundingforOperationsinAfghanistanandIraqandforRelatedActivities”wasprojectedtocost$145billionfor2012.See“TheBudgetandEconomicOutlook:FiscalYears2012to2022,”CBO2012,availableathttp://cbo.gov/sites/default/files/cbofiles/attachments/01-31-2012_Outlook.pdf(accessedMarch5,2012).Seethenextfootnoteforwhythisalmostsurelyrepresentedanunder-estimateofwarspending.10.BilmesandStiglitz,inTheThreeTrillionDollarWar,estimatethatthecumulativeincreaseindefensespendingbetween2003and2008beyondcostsattributedtothewarat$600billion.Asubstantialfractionofthiswas,infact,hiddenwarspending.11.See“DefenceCosts,”Economist,June8,2011,availableathttp://www.economist.com/blogs/dailychart/2011/06/military-spending(accessedMarch7,2012).ForanadditionaldiscussionseeBilmesandStiglitz,TheThreeTrillionDollarWar.12.See“LockheedF-35CostControlsin$662BillionDefenseBill,”Businessweek,December15,2011,availableathttp://www.businessweek.com/news/2011-12-15/lockheed-f-35-cost-controls-in-662-billion-defense-bill.html.13.Seethediscussioninchapter3forcostestimatesofthisprovision.14.CBOestimate,seep.117of“TheBudgetandEconomicOutlook:FiscalYears261 2012to2022,”CBO2012,availableathttp://cbo.gov/sites/default/files/cbofiles/attachments/01-31-2012_Outlook.pdf(accessedMarch5,2012).15.TheU.S.governmentbenefitedfromthebubble,forawhile,whichmaskeditstruefinancialposition,asitdidthatofordinaryAmericans:someoftherevenueswerefromartificialcapitalgainsandprofitsfrombubbleprices,sothatevenafterreversingthefouractionsdescribedabove,theremightstillbeadeficit.Besides,healthcareinflationhasexceededoverallinflation,necessitatingfurtherexpendituresforMedicareandMedicaid.16.Ofcourse,thecapitalgainstaxcutwasonlypartofthestoryofthecreationofthebubble.Laxregulationsandlowinterestratesalsoplayedarole.17.SeeAntonKorinekandJ.E.Stiglitz,“DividendTaxationandIntertemporalTaxArbitrage,”JournalofPublicEconomics93(2009):142–59.Theadvocatesofthepreferentialtaxtreatmentfordividendsmadeoneotherargument:itwasunfairtotaxbothcorporateprofitsanddividends.Originally,thepreferentialtreatmentwassupposedtoextendonlytofirmsthatactuallypaidtaxes;buttheninoneofthosefrequentlast-minuteswitches,thatrestrictionwasdropped.Theresultisanevengreaterinequity—incomethatescapescorporateprofitstaxesand,then,whenit’spaidout,istaxedatalowerratethancomparableincomeofwageearners.18.Theactualinefficiencyofthemunicipaltaxprovisionislessthanthishypotheticalexamplesuggests.Onestudysuggestedthatsome“20percentofthebenefitfromthemunicipal-bondexemptionunintentionallyleakstobondbuyersfromhigher-incometaxbrackets.”SeeJordanEizengaandSethHanlon,“TaxExpenditureoftheWeek:Tax-ExemptBonds,”March2,2011,websiteoftheCenterforAmericanProgress,http://www.americanprogress.org/issues/2011/03/te030211.html(accessedMarch5,2012),citingT.J.Atwood,“ImplicitTaxes:EvidencefromTaxable,AMT,andTax-ExemptStateandLocalGovernmentBondYields,”JournaloftheAmericanTaxationAssociation25,no.1(2003):1–20.19.SeeHenryGeorge,ProgressandPoverty:AnInquiryintotheCauseofIndustrialDepressionsandofIncreaseofWantwithIncreaseofWealth:TheRemedy(1879).WithRichardArnott,Ishowedthattherewereconditionsinwhicha100percenttaxonsuchrentswas,infact,theoptimaltax.Seeour“AggregateLandRents,ExpenditureonPublicGoodsandOptimalCitySize,”QuarterlyJournalofEconomics93,no.4(November1979):471–500.Thereisonequalificationthatisimportantwhenproducerscan’tadequatelyinsurethemselvesagainsttheriskstheybear.Thengovernmentshouldnotrelyheavilyonalandtaxoranyothertaxbasedonfixedquantities,becauseitwillimposeahighburdenrelativetoincomeinbadyears,andalowburdeningoodyears.SeeK.Hoff,“LandTaxes,OutputTaxes,andSharecropping:WasHenryGeorgeRight?”WorldBankEconomicReview5(1991):93–112;andX.Meng,N.Qian,andP.Yared,“TheInstitutionalCausesofChina’sGreatFamine,”YaleUniversitymanuscript,2010,availableathttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=1671744(accessedMarch5,2012).20.Thepriceofsuchresourcescanbedecomposedintotwoparts—arent,plusthecostofextraction.21.Itisevenpossibletoauctionoffsubsidies,tomakesurethattheygotowheretheyarevaluedthemost.AprovisiongivingtheDepartmentofAgriculturediscretiontodosowasincludedinthe1995farmbill,butneverimplemented.22.Aswenotedinearlierchapters,adefenseofthesesubsidiesisthattheyincreaseemployment.Butaswenotedthere,too,theresponsibilityformaintainingtheeconomyatfullemploymentlieswithmacroeconomicpolicy(monetarypolicyandfiscalpolicy).Ifmacroeconomicpolicyismanagedwell,wecanhaveaneconomyatfullemployment,withoutthesesubsidies.Ifmacroeconomicpolicyisnotmanagedwell,wewon’thavefullemployment,evenwiththesubsidies.23.Thebalanced-budgetmultiplierisnormallyassumedtobearoundunity.Butiftaxesareincreasedontherich,whootherwisewouldhavesavedalot,andexpenditureincreasesarefocusedon“highmultiplier”activities,likeinvestmentsineducation,thenthebalanced-budgetmultipliercanbemuchlarger.24.Membersofthecommissiondopayhomagetotheneedforamoreprogressivetaxsystem,butwhattheyrecommendedwasalmostsurelyalessprogressiveone.Theyprovideanillustrativedistributionalanalysis(whichfocusesonlyontheindividualincometaxchanges,notontheimpactofthecorporateincometaxchangesoroncutbacksinexpenditures).Evenintheiranalysis,thelargestpercentageincreaseinaveragefederaltaxesisimposedonthesecondquintile—13.5percent,comparedwith10.4percentforthetopquintile.Atthesametime,someoftheirloophole-closingreformsdomakeanimportantcontributiontoincreasingprogressivity.Almosthalfoftheirincreasedtaxrevenuescomefromthetop1percent—consistentwiththerecommendationsmadeearlierinthischapter.25.Forsmallcorporations,therewouldbeataxincreaseundertheirproposal.26.Forastandardtextbooktreatmentofthisissue,seeJ.E.Stiglitz,TheEconomicsofthePublicSector,3rded.(NewYork:Norton,2000).Fortheoriginaltheoreticalanalysis,seeJosephE.Stiglitz,“Taxation,CorporateFinancialPolicy,andtheCostofCapital,”JournalofPublicEconomics2(February1973):1–34.27.TheBowles-SimpsonCommission,initsfinalreport,wasmorecareful.Itarguedthatthenewtaxcode“mustincludeprovisions(insomecasespermanent,inotherstemporary)for…mortgageinterestonlyforprincipleresidences,employer-providedhealthinsurance,charitablegiving;[and]retirementsavings262 andpensions.”28.Thereisevidencethatindenselypopulatedareas—whicharepreciselytheareasinwhichhomeownershipislikelytoimprovecommunitiesthroughhighervotingratesandmoreparticipationincollectiveaction—themortgageinterestdeductiondoesnotincreasehomeownerhipratesandmayactuallylowerthem.Becausethesupplyofhousinginsuchareasisinelastic,muchofthemortgageinterestdeductioniscapitalizedintohousingpricesinthoseareas.Atthehigherhousingprice,fewerlow-tomoderate-incomehouseholdsgainfromhomeowningratherthanrenting.SeeC.A.HilberandT.M.Turner,“TheMortgageInterestDeductionandItsImpactonHomeownershipDecisions,”SERCDiscussionPapers,55,LondonSchoolofEconomics,2010,availableathttp://personal.lse.ac.uk/hilber/hilber_wp/Hilber_Turner_2010_08.pdf(accessedMarch5,2012).29.Mostoftheproposalsdidtakesomeaccountofthis,bypostponingtheimplementationoftheircuts,butonlybriefly,perhapsbecausetheyhadanexcessivelyoptimisticviewofrecovery.UnderBowles-Simpson,cuts(relativetowhatpublicspendingotherwisewouldhavebeen)beginin2012.Yet,asthisbookgoestopress,theCongressionalBudgetOfficeprojectsthattheeconomywillnotbebacktofullemploymentbefore2018,andtheFedissopessimisticthatithassaidthatinterestrateswillremainnearzerothroughtheendof2014.30.Asanobviousexample,ataxcredittocorporationsthatdoinvestprovidesincentivesforfirmstoinvestandprovidesthemthecashtodoso.31.Inaworldofperfectcompetition,pricesaredrivendownruthlesslytomarginalcosts,andmarginalcostsaredrivendownruthlesslytothelowestlevelconsistentwithcurrenttechnology.Butforavarietyofreasons,competitioninthehealthcaresector,andespeciallyinhealthinsurance,isfarfromperfect.Oneofthereasonsthattheprivatesectorhassuchhightransactionscostsisthatcompaniesdevoteconsiderableeffortsto“creamskimming,”toensuringthatthosewhomtheyinsurearehealthy,oratleasthealthierthanaverage.Anotherreasonisthat,inthepresenceofexcessprofits,theyspendconsiderableresourcesrecruitinggoodcustomers,e.g.,throughadvertising.32.ManyoftheserecommendationsareconsistentwiththoseofBowles-Simpson.33.GaryEngelhardtandJonathanGrubershowthatincreasesinSocialSecuritybenefitscanexplainallofthe17percentagepointdeclineinpovertythatoccurredbetween1960and2000.“SocialSecurityandtheEvolutionofElderlyPoverty,”NBERWorkingPaper10466(2004).34.ThomasFergusonandRobertJohnson,“AWorldUpsideDown?DeficitFantasiesintheGreatRecession,”RooseveltInstituteWorkingPaperno.7,2010.35.TheObamahealthcareprogramcontainsanumberofprovisionsthataredesignedtobringdownthecostsofhealthcare.Itistoosoontotellforsurehoweffectivethesewillbe.36.That’snotquitetrue:evenpromisedfuturecuts,iftheyarecredible,maybeadamperontheeconomynow,ashouseholds,knowingthatSocialSecurityandMedicarearebeingcut,willhavetosavemorenow,toprotectthemselves;andeventhoughhighersavinginthelongrunisgood,theshort-runimpact—lessconsumption—willnotbegoodforrecovery.37.Avariantofthis,remarkablyheldbysomeseriouseconomists,isthattheyaren’treallyunemployed;they’rejust“enjoying”leisure.Ofcourse,normally,someoneenjoyingleisureshouldbehappy,whichisnotthecaseformostofthoseoutofajob.But,inthisview,that’saproblemforpsychology,notforeconomics.38.Thisis,ofcourse,betterthanattheworstoftherecession,whenthereweresevenapplicantsforeveryjob.(BureauofLaborStatisticshttp://www.bls.gov/news.release/jolts.htm).Reportedly,whenMcDonald’sadvertisedthatitwasgoingtohire50,000workers,1millionapplicantsshowedup!SeeLesliePatton,“McDonald’sHires62,000inU.S.Event,24%MoreThanPlanned,”Bloomberg,April28,2011,availableathttp://www.bloomberg.com/news/2011-04-28/mcdonald-s-hires-62-000-during-national-event-24-more-than-planned.html(accessedMarch5,2012).39.Indeed,thereisanargumentthatunemploymentinsurancemightactuallyenhancetheefficiencyofthelaborsearchmarket,sincethosewhowereleastdesirousofajobandleastlikelytogetajobwouldbethefirsttodropout.Indoingso,searchcostswereloweredforothers,andthosewhodidgetajobweremorelikelytobebettermatched.IamindebtedtoGeorgeAkerloffordiscussionsonthispoint.40.GrowthofrealGDP(percentchangefromprecedingyear)for2010:UnitedStates(2.9),Sweden(5.3),Germany(3.5).Employmentgrowth(percentchangefromprecedingyear)for2010:UnitedStates(–0.6),Sweden(1.0),Germany(0.5).SeeOECDathttp://www.oecd.org/document/22/0,3746,en_2649_39023495_43221014_1_1_1_1,00.html#taxesChapter4explainedavarietyofshort-andlonger-termbenefitsofgreatersocialprotection—greaterrisktaking,greaterstability,andmorepoliticalsupportformeasures,liketradeopening,that,ifwellmanaged,canhelpimproveeconomicperformance,allofwhichcancontributetohigherlong-termgrowth.41.Forthepositionofthoseopposingpublicinvestmenttobecoherentrequirestheadditionalassumptionthattheredonotexistpublicinvestmentopportunitieswithhighreturns.But,aswediscussedearlier,itiswidelyrecognizedthattherearemanyhigh-returninvestmentsininfrastructure,education,andresearch,amongotherthings.42.Inaddition,mostoftheexamplesentailcountrieswithflexibleexchangerates.Lowerexchangeratesgeneratemoreexports.TheU.S.exchangerateistoalargeextentoutsideofitscontrol:ifEurope’scrisisworsens,forinstance,263 theeuromaydeclinerelativetothedollarandtheUnitedStateswillhaveahardertimeexporting.43.SeeArjunJayadevandMikeKonczal,“TheBoomNottheSlump:TheRightTimeforAusterity,”RooseveltInstitute,August23,2010,andtheirforcefulcritiqueofAlbertoAlesinaandSilviaArdagna,“LargeChangesinFiscalPolicy:TaxesVersusSpending,”NBERWorkingPaperno.15438,2009.TheIMFhascometosimilarconclusions.SeealsoOlivierJ.Blanchard,DavidRomer,MichaelSpence,andJosephE.Stiglitz,eds.,IntheWakeoftheCrisis:LeadingEconomistsReassessEconomicPolicy(Cambridge:MITPress,2012),andinparticularthearticlebyRobertSolow,“FiscalPolicy,”pp.73–76.SeealsoJaimeGuajardo,DanielLeigh,andAndreaPescatori,“ExpansionaryAusterity:NewInternationalEvidence,”IMFworkingpaper,July2011.44.SeeDomenicoDelliGatti,MauroGallegati,BruceC.Greenwald,AlbertoRusso,andJosephE.Stiglitz,“SectoralImbalancesandLongRunCrises,”paperpresentedtotheInternationalEconomicAssociationmeeting,Beijing,July2011,andforthcominginitsproceedings.Foramoreaccessibleversion,seeJ.E.Stig-litz,“TheBookofJobs,”VanityFair,January2012,pp.28–32,availableathttp://www.vanityfair.com/politics/2012/01/stiglitz-depression-201201(accessedMarch5,2012).45.SeeSumnerH.Slichter,“TheDownturnof1937,”ReviewofEconomicStatistics20(1938):97–110;KennethD.Roose,“TheRecessionof1937–38,”JournalofPoliticalEconomy56,no.3(June1948):239–48;andE.CaryBrown,“FiscalPolicyinthe’Thirties:AReappraisal,”AmericanEconomicReview46,no.5(December1956):857–79.46.Aswe’vearguedelsewhere,however,thefinancialsectorisnotfullybacktohealth.Manyofthesmallerbanks,responsibleforsomuchlendingtothecountry’ssmallandmedium-sizeenterprises,stillfaceproblems.Nonetheless,overall,investmentoutsideofrealestatehasbeenlargelyrestoredtoprecrisislevels.PrivatenonresidentialfixedinvestmentasapercentageofGDPwasaround10.0percentinthesecondquarterof2011,whilethehistoricalpostwaraverageis10.7percent(thoughwenotethatGDPhasfallenbelowtrend).Equipmentandsoftwareinvestmentbyfirmsinrealtermswasabout8.2percentofGDPinearly2011comparedwithahighof8.4percentin2007and6.6percentatthepeakofthecrisisinthefourthquarterof2008.47.Anditaffectedjudgmentsaboutthevalueofapoliticalbattletogetalarger,longer,andbetter-designedstimulus.Acriticalweaknessofthestimuluswasthatathirdofitwenttohouseholdtaxcuts,whichhadproventhemselvesrelativelyineffectiveearlier(theBushtaxcutsof2008).Foramoreextensivediscussionofthedesignflaws,seeJ.E.Stigliltz,Freefall(NewYork:Norton,2010).48.Asthecrisishascontinued,officialshavebecomemorecautious.TheFed’sannouncementthatitexpectsinterestratestobenearzeroatleastuntiltheendof2014—saying,ineffect,thatthedownturnforwhichitsprecrisispoliciesbearconsiderableculpabilitywouldlastatleastsevenyears.(TherecessionbeganinDecember2007.)49.Inaperiodofprolongedunderutilizationofcapacity,oneisconcernednotjustabouttheimmediateimpactofthespendingbutalsoabouttheeffectseventwoorthreeyearsdowntheline,whentheeconomyisstillweak.Someofwhatisnotspenttodayisspentinthesefutureyears,stimulatingtheeconomy,andtheknowledgethatthisissomayprovideevenmorestimulustotheeconomynow.SeeP.NearyandJ.E.Stiglitz,“TowardaReconstructionofKeynesianEconomics:ExpectationsandConstrainedEquilibria,”QuarterlyJournalofEconomics98,suppl.(1983):199–228.Moreover,oneofthereasonsthatmoneydoesn’tgetrecycled—toincreaseGDPevenmore—is“leakages,”tospendingabroad.Butwhenothercountries(suchasthoseinEurope)arealsoweak,spendingabroadincreasestheirincome,andtheyreciprocate,spendingmoreonimports,includingfromgoodsfromtheUnitedStates.Oneis,accordingly,interestedinlong-runglobalmultipliers,notjustshort-runnationalmultipliers.Thesemultipliersarelikelytobelarge,muchlargerthanthe1.5numberusuallyused.SeeUnitedNations,“ReportoftheCommissionofExpertsofthePresidentoftheUnitedNationsGeneralAssemblyonReformsoftheInternationalMonetaryandFinancialSystem”(alsoknownastheStiglitzCommission),NewYork:UnitedNations,September2009,publishedasTheStiglitzReport(NewYork:NewPress,2010).Forarecentsurvey,seeJonathanA.Parker,“OnMeasuringtheEffectsofFiscalPolicyinRecessions,”JournalofEconomicLiterature49no.3(2011):703–18.Manyofthestatisticalstudiescitedbythoseclaimingasmallmultiplierarebadlyflawed,sincetheyrelyheavilyonperiodsinwhichtheeconomyisatornearfullemploymentand/orwheremonetaryauthoritieshavetakenoffsettingactions—increasinginterestrates.Thedifficultyisthatperiodsoflonganddeepdownturns,suchastheGreatDepressionandtheGreatRecession,arerelativelyrare,andthatimpedestheuseofstatisticalanalyses.50.Thereisastandardargumentamongconservativesagainstdeficitspending,thattheanticipationofincreasedtaxliabilitiesinthefuturesoincreasessavings,asworkerstodayprepareforthosefuturetaxburdens,thataggregatedemandisunaffected.TheargumentiscalledtheBarro-Ricardianequivalencetheorem,aftertheHarvardprofessorRobertBarro,whodiscusseditinhispaper“OntheDeterminationofthePublicDebt,”JournalofPoliticalEconomy87,no.5(1979):940–71.Butsubsequentwork,suchasmypaper“OntheRelevanceorIrrelevanceofPublicFinancialPolicy,”inTheEconomicsofPublicDebt:ProceedingsofaConferenceHeldbytheInternationalEconomicAssociationatStanford,California(London:MacmillanPress,1988),pp.4–76,explainsthattheresultholdstrueonlyonverypeculiarconditions,e.g.,perfectcapitalmarkets264 andperfectaltruismacrossgenerations.Infact,whenBushloweredhistaxesontherichandthedeficitsoared,householdsavingsratesfell,movinginjusttheoppositedirectionpredictedbyBarro’stheory.ChapterNineAMACROECONOMICPOLICYANDACENTRALBANKBYANDFORTHE1PERCENT1.Inflationhawks—monetarypolicymakerswhoseemtohaveanobsessionwitheventheslightestincreaseininflation—maintainthattheeconomysitsonaprecipice;eventheslightestincreaseininflationcansettheeconomydownthewaywardpathofhigherandhigherinflation.Thereisnostatisticalsupportforthisview,asthe1997EconomicReportofthePresidentpointedout.2.Criticswillsaythatit’sallwellandgoodtopointthisoutafterthecrisis—ourunderstandingsarealwaysbetterintwenty-twentyhindsight.ButthefactofthematteristhatIandotherswhoraisedtheseconcernsabouttheobsessivefocusoninflationpointedouttheseriskswellbeforethecrisis.3.Thisispartlybecause,withinterestratessolow,theircostofcapitalisverylow;partlybecausethehighunemploymenthasputdownwardpressureonlaborcosts;andpartlybecauselargeAmericanfirmsearnmuchoftheirprofitsoverseas,includingintheemergingmarkets,whichquicklyrecoveredfromtheGreatRecessionandhavebeendoingverywell.Somemayclaimthattheverywealthysufferedagreatdealfromthecrashofthestockmarket—thattheylostmorethanthoseatthebottomandinthemiddleeverhopedtohavehad.ButthestatisticsgivenearlieronthelossesinnetwealthofHispanicsandAfricanAmericans(andevenofthemedianwhiteAmerican)showhowdevastatingthecrisiswasforthem.4.SeeJasonFurmanandJosephE.Stiglitz,“EconomicConsequencesofIncomeInequality,”inIncomeInequality:IssuesandPolicyOptions:ASymposium([KansasCity]:FederalReserveBankofKansasCity,1998),pp.221–63,availableathttp://www.kc.frb.org/publicat/sympos/1998/s98stiglitz.pdf(accessedMarch30,2012).5.“IntheU.S.non-farmbusinesssector,realmedianhourlywagesroseatanaverageannualrateof0.33percentbetween1980and2005,whilelabourproductivityincreasedatanaverageannualrateof1.73percentoverthesameperiod.”PeterHarrison,“MedianWagesandProductivityGrowthinStudyofLiving,CanadaandtheUnitesStates,”CenterforStudyofLivingStandardsResearchNote2009-2,July2009.Therearelargecumulativeeffects.Lookingonlyattheperiodbetween1989and2011,whileproductivity(privatesectorplusstateandlocalgovernment)wasupmorethan60percent,wagesoverthesameperiodwereuponly20percent.SeeHeidiShierholzandLawrenceMishel,“Sustained,HighJoblessnessCausesLastingDamagetoWages,Benefits,Income,andWealth,”EconomicPolicyInstitute,August31,2011.ShierholzandMishelprovideamorecompletedescriptionofwhathashappenedtowagesin“TheSadButTrueStoryofWagesinAmerica,”EconomicPolicyInstitute,IssueBriefno.297,March14,2011.6.Medianhourlywages(alloccupations),adjustedforinflation,werelowerin2007thanin2001(basedoncalculationsfromBureauofLaborStatisticsdata).7.Forminimumwagehistory,seetheU.S.DepartmentofLaborwebsite,http://www.dol.gov/whd/minwage/chart.htm.8.Onaverage,outsideofrecessions,whenbenefitsaretemporarilyincreased(oftenwithacontentiouscongressionalfight),only25percentofunemployedworkersreceiveunemploymentassistance,andtheirassistancereplaces,onaverage,lessthanhalfofthelostincome.(CenteronBudgetandPolicyPriorities,“IntroductiontoUnemploymentInsurance,”April16,2010.)TheUnitedStatesprovidesmuchpoorerunemploymentinsurancethandomanyotheradvancedindustrialcountries.Forinstance,while(outsideofperiodsofhighunemployment)theUnitedStatesprovidesforsixmonthsunemploymentinsurance,onlyItalyandtheCzechRepublicprovideless;Franceprovidesfor23months,Germany12,andDenmark48(fromOECDEmploymentOutlook,2006,p.60).Intermsofreplacementrate(thefractionofnormalincomethatunemploymentinsurancereplaces),theUnitedStatesisalsolow:duringthefirstyearofanunemploymentspell,France’sreplacementrateis67.3percent,Germany’s,64.9percent,Denmark’s,72.6percent,andtheUnitedStates’only44.9percent(fromOECDEmploymentOutlook,2011,p.40).9.See,e.g.,GretchenMorgenson,“0.2%interest?YouBetWe’llComplain,”NewYorkTimes,March4,2012,availableathttp://www.nytimes.com/2012/03/04/business/low-rates-for-savers-are-reason-for-complaint-fair-game.html(accessedMarch5,2012).10.Someeconomists—suchastheColumbiaeconomistMichaelWoodford;see“BernankeNeedsInflationforQE2toSetSail,”FinancialTimes,October11,2010,availableathttp://www.ft.com/intl/cms/s/0/4d54e574-d57a-11df-8e86-00144feabdc0.html#axzz1oHWZWjKv(accessedMarch5,2012)—havesuggestedthattheFedcommititselftoamaintaininginflationatagivenlevel.Withinflationof,say,4percentandinterestratesof0percent,therealinterestratewouldbeminus4percent.Whatisimpedingeconomicrecovery(inthisview)isthe“zerolowerbound”tointerestrates.Ifindthisapproachunpersuasive—puttingasidethedifficultyoftheFed’scrediblycommittingitselftoahighinflationrate.Theanalysisjustpresentedexplainswhyaverylowrealinterestratemayactuallyreduceaggregatedemand.ThesituationintheUnitedStatestodayismarkedlydifferentfromthatintheGreatDepression,whenrapidlyfallingprices265 meantthatrealinterestrateswereveryhigh.Realinterestratesarealreadynegative,andthesenegativerealinterestrateshavenotelicitedthehoped-forresponse.Thosewhoadvocatesuchpolicies(andotherrelatedpolicies,likenominalGDPtargeting)typicallyputexcessivefocusontheroleofrealT-billratesindeterminingthelevelofeconomicactivity.Equallyormoreimportantiscreditavailabilityandthetermsatwhichcreditismadeavailabletofirms.SeeBruceGreenwaldandJ.E.Stiglitz,TowardsaNewParadigminMonetaryEconomics(Cambridge:CambridgeUniversityPress,2003).11.Theconsumptionofthepoorandmiddleis,aswehavenoted,oftenconstrainedbytheirresources,butthisisnotsotrueofthoseatthetop,whichiswhyincreasingtemporarilytheircapacitytoconsumetodayisnotlikelytohavemucheffectonconsumptionlevels.12.IamindebtedtoMiguelMorinforhisanalysisofthisandhisinsightsonthisissue.13.Itdoesinvolvesomerisk—thatthelong-termbondwilldecreaseinvalue—butwiththegovernmentsystematicallysocializinglosses,theriskisborneatleastpartiallybytaxpayers.14.BloombergcalculatedmoreconservativelythateasyaccesstotheFederalReserveamountedtoagifttothebanksof$13billion,BloombergMarketsMagazinereportsinitsJanuary2012issue.SeeBobIvry,BradleyKeoun,andPhilKuntz,“SecretFedLoansGaveBanks$13BillionUndisclosedtoCongress,”availableathttp://mobile.bloomberg.com/news/2011-11-28/secret-fed-loans-undisclosed-to-congress-gave-banks-13-billion-in-income(accessedMarch5,2012).Theclaimthatthegovernmenthadbeenrepaidonthemoneythatithadgiventothebankswasnothingbutashellgame:theFedineffectgavethebanksthemoneythattheythenpassedontothegovernment.15.Bankshavelonghadareserverequirement—aminimumproportionofliquidfundsthattheyarerequiredtomaintain.TheFederalReserve’sexplanationforwhy,in2008,ithadchosentopayinterestonexcessreservesdepositedwithReserveBanksispostedonitswebsite:“Theinabilitytopayinterestonbalancesheldtosatisfyreserverequirementsessentiallyimposesataxondepositoryinstitutionsequaltotheinterestthatmightotherwisehavebeenearnedbyinvestingthosebalancesinaninterest-bearingasset.Payinginterestonrequiredreservebalanceseffectivelyeliminatesthistax….Payinginterestonexcessbalancesshouldhelptoestablishalowerboundonthefederalfundsratebylesseningtheincentiveforinstitutionstotradebalancesinthemarketatratesmuchbelowtheratepaidonexcessbalances.PayinginterestonexcessbalanceswillpermittheFederalReservetoprovidesufficientliquiditytosupportfinancialstabilitywhileimplementingthemonetarypolicythatisappropriateinlightoftheSystem’smacroeconomicobjectivesofmaximumemploymentandpricestability.”Seehttp://www.federalreserve.gov/monetarypolicy/ior_faqs.htm#4(accessedMarch5,2012).ThepricetagfortheFed’s0.25percentinterestratepaidonthecurrentamountofexcessreservesdepositedwithReserveBanks—about$1.5trillion—islikelyalmost$4billiondollarsayear.See,forexcessreservesamount,thewebsiteoftheFederalReserveBankofSt.LouisFed,http://research.stlouisfed.org/fred2/series/EXCRESNS(accessedMarch5,2012).16.BruceGreenwaldandIhaveargued,inTowardsaNewParadigminMonetaryEconomics,thattheroleofinterestrateshasbeengreatlyexaggeratedbycentralbanks;equally,andinsomecasesmore,importantistheavailabilityofcredit.Payingbanksontheirreservesheldatthecentralbankbothraisestheinterestratesthatbankswillchargecustomersandreducesthecredittheymakeavailable.Throughbothchannels,thepolicyhasadverseconsequences.ButtheFederalReserveevidentlyshuntedtheseconcernsaside,asitfocusedonitsmoreimmediatebusinessoftransferringmoneytothebanks.Itmightdefendtheseactionsashelpingrecapitalizethebanks,andbankrecapitalizationwould,itwashoped,leadeventuallytomorelending.Buttherewerebetterwaysofrecapitalizingthebanks.17.Chapter6providesadescriptionofthebattleoverperceptionsinthebankbailout—didwehavetodowhatwedidinordertosavetheentireeconomy?18.Forabreakdownofwherethemoneywent,seehttp://projects.propublica.org/bailout/list/index.19.Between2009andFebruary2012,398wentbankrupt.Seehttp://www.fdic.gov/bank/individual/failed/banklist.html.20.AsofSeptember30,2011(themostrecentdataavailable),theFDIC’s“ProblemList”had844institutionswithassetsof$339billion.SeeFDICQuarterlyBankingProfileandFederalDepositInsuranceCorporation,FailedBankList,availableathttp://www2.fdic.gov/qbp/2011sep/qbp.pdf(accessedFebruary24,2012).21.Probablythemostimportantderegulatorymeasurewastherepealin1999,underPresidentClinton,ofpartoftheGlass-SteagallActof1933whichseparatedinvestmentbanks(responsibleformanagingwealthyindividuals’andcorporations’money)andcommercialbanks.TherepealisalsoknownastheCitigroupReliefActbecauseitlegalizedamergerofCitibankwithsecuritiesandinsuranceservicesthathadoccurredin1998.DuringdebateintheHouseofRepresentatives,RepresentativeJohnDingellarguedthatthebillwouldleadbankstobecome“toobigtofail,”andthatthiswouldleadtoabailoutbythefederalgovernment.AschairmanoftheCouncilofEconomicAdvisersfrom1995to1997,Ihadopposed(successfully)therepeal,onthosegrounds,aswellasbecauseoftheriskofconflictsofinterests(betweentheroleoftheissuerofnewsecurities,byaninvestmentbank,andprovidingoperatingfunds,asacommercialbank)andbecauseofthedangerthattherisk-takingcultureof266 investmentbankswouldcontaminatetherightlymoreconservativecultureofcommericialbanks.Allthreeworriesprovedjustified.HadGreenspanopposedtherepeal,itisunlikelyitwouldhavebeenpassed.TheroleoftheFedchairmanandthesecretaryofTreasuryinopposingregulationofderivativesiswelldocumented.SeeJ.E.Stiglitz,Freefall(NewYork:W.W.Norton,2010),andStiglitz,TheRoaringNineties(NewYork:W.W.Norton,2003),andthereferencescitedthere.22.See,e.g.,AlanGreenspan,speechatCreditUnionNationalAssociation2004GovernmentalAffairsConference,Washington,DC,February23,2004,though,afterforcefullypointingoutthatthosewhohadtakenoutvariable-ratemortgagesdidmuchbetterthanthosewhohadtakenoutfixed-ratemortgages,hedidissuesomewarningsthatthingscouldhaveturnedoutdifferently,i.e.,thattherewasstillrisk.23.DeanBakerandTravisMcArthurhaveestimatedthatthedifferencebetweentheinterestratesatwhichtoo-big-to-failbankscanraisecapitalandtheratesmallerbankshaveaccesstoincreasedfrom0.29percentagepoints—whereithadbeenforaboutsevenyearsbeforethecrisis—to0.78percentagepointsinamatterofmonthsafterthebailouts.This,theyargue,showsthatmarketsrecognizedthattoo-big-to-failbankshadbecome“officialgovernmentpolicy,”andimplied“agovernmentsubsidyof$34.1billionayeartothe18bankholdingcompanieswithmorethan$100billioninassetsinthefirstquarterof2009.”BakerandMcArthur,“TheValueofthe‘TooBigtoFail’BigBankSubsidy,”CenterforEconomicandPolicyResearch,September2009,availableathttp://www.cepr.net/documents/publications/too-big-to-fail-2009-09.pdf(accessedMarch5,2012).InJanuary2010Obamadiscussedthepossibilityofimposingataxtooffsetthisadvantage.Hedidn’tpursuethis,infaceoftheoppositionfromthebanks(andperhapseventhosewithintheadministration).24.Thereisahugeliteratureonthesubjectdiscussedinthissection.Myownviewsaresetoutinalectureinmemoryofoneofthegreateconomistsofthetwentiethcentury,andthe(first)NobelPrizewinnerineconomics,JanTinbergen,deliveredattheCentralBankofNetherlands,“CentralBankinginaDemocraticSociety,”DeEconomist146,no.2(July1998):199–226,esp.28.SeealsoAlexCukierman,CentralBankStrategy,Credibility,andIndependence(Cambridge:MITPress,1992);andJ.Furman,“CentralBankIndependence,Indexing,andtheMacroeconomy,”unpublished1997manuscript.25.Seechapter3formoredetails.26.EdwardM.Gramlichnotonlyanticipatedthebubbleanditsbreakingbutalsoarguedforcefullythatsomethingshouldbedonetoavoidtheforeclosures.TheFeddidnothingoneitherfront.SeehisbookSubprimeMortgages:America’sLatestBoomandBust(Washington,DC:UrbanInstitute,2007).27.Thiswasapositionthatwasclearlypoliticalandconsistentwithhisknownideologicalviews.Seechapter8foradiscussionofthespeciousargumentsthatwereputforwardindefenseofhisposition.28.The2010Dodd-Frankregulatoryreformbillmadesomeimprovementsingovernance.29.“RemarksbyGovernorBenS.Bernanke,”October2004,availableathttp://www.federalreserve.gov/boarddocs/speeches/2004/200410072/default.htm.30.Anargumentsometimesputforwardforsecrecyisthatdisclosinginformationwillroilthemarkets,andcouldleadtoarunagainstabankthathasborrowedmoneyfromtheFed.Butatissueinthiscasewasdisclosureofinformationlongafterthetransactionshadoccurred.Besides,capitalmarketscan’texercisedisciplineintheabsenceofrelevantinformation.Thosewhoadvocatesecrecyareadvocatingpoliciesthatwouldunderminethedisciplineofthemarketplace.31.JPMorganChasebenefitedthroughtheBearStearnsbailout.Inanotherinstanceofquestionablegovernance,StephenFriedmanbecamechairmanoftheFederalReserveBankofNewYorkinJanuary2008,whilehewassimultaneouslyamemberoftheboardofGoldmanSachsandhadalargeholdinginGoldmanstock.HeresignedinMay2009afterthecontroversyovertheobviousconflictsofinterest(includingsharepurchases,whichenabledhimtomake$3million).SeeJoeHagan,“TenaciousG,”NewYork,July26,2009,availableathttp://nymag.com/news/business/58094/(accessedMarch28,2012);andKateKellyandJonHilsenrath,“NewYorkFedChairman’sTiestoGoldmanRaiseQuestions,”WallStreetJournal,May4,2009,p.A1.32.See,e.g.,BinyaminApplebaumandJoCravenMcGinty,“TheFed’sCrisisLending:ABillionHere,aThousandThere,”NewYorkTimes,March31,2011,availableathttp://www.nytimes.com/2011/04/01/business/economy/01fed.html(accessedMarch5,2012).Fromthearticle:“AndtheFedhelpedtosavesomeofthelargestbanksinEuropebypumpingdesperatelyneededdollarsintotheirAmericansubsidiaries.Infact,thebiggestborrowerfromtheFedprogramwasDexia,aFrench-Belgianbankthatfrequentlyheldmorethan$30billioninoutstandingloansfromtheprogramfromlate2008toearly2009.”33.Thecentralmissionofacentralbank(suchastheFed)istoactasalenderoflastresortforthebankswithinthecountry,thatis,whennooneelseiswillingtolendtobanksthataresolvent(i.e.,whoseassetsexceeditsliabilities),theFedstepsintoprovideliquidity.34.OnMarch27,2007,BernanketestifiedbeforeCongress,“Althoughtheturmoilinthesubprimemortgagemarkethascreatedseverefinancialproblemsformanyindividualsandfamilies,theimplicationsofthesedevelopmentsforthehousingmarketasawholearelessclear.Theongoingtighteningoflendingstandards,althoughanappropriatemarketresponse,willreducesomewhattheeffectivedemandforhousing,andforeclosedpropertieswilladdtotheinventoriesofunsoldhomes.Atthisjuncture,however,theimpactonthebroadereconomyandfinancial267 marketsoftheproblemsinthesubprimemarketseemslikelytobecontained.Inparticular,mortgagestoprimeborrowersandfixed-ratemortgagestoallclassesofborrowerscontinuetoperformwell,withlowratesofdelinquency.Wewillcontinuetomonitorthissituationclosely.”See“ChairmanBenS.Bernanke:TheEconomicOutlook:BeforetheJointEconomicCommittee,U.S.Congress,”availableathttp://www.federalreserve.gov/newsevents/testimony/bernanke20070328a.htm(accessedFebruary24,2012).35.Thereareotherimportantinstitutionalreformsthatwouldmakeforamoreeffectivemonetarypolicy.Afashionabledoctrineineconomicsholdsthatseparateinstitutionsshouldbecreatedtopursuedifferentobjectivesandtocontroldifferentinstruments.Inthisview,thecentralbankshouldfocusoninflation,anditsinstrumentofchoiceshouldbetheinterestrate.Fiscalauthoritiesshouldfocusonemployment,usingtaxandexpenditurepolicy.Unfortunately,whileinsomeverysimpletheoreticalmodelsthisinstitutionalarrangementcanachievedesirableoutcomes,intherealworldthereneedstobecoordination.Itisoftendesirabletousemultipleinstrumentstopursueevenasingleobjective.Banklendingisasaffectedbyregulatoryrequirements(likecapitaladequacystandards)asbyinterestrates;andquantitativerestrictions(e.g.,downpaymentsonhousing)canbeamuchmoreeffectiveinstrumentincontrollingexcessesthanabluntinstrumentliketheinterestrate.36.ThesenseoflossofsovereigntythatcountriesinEuropehavefeltisreflectedinastatementmadebyGiulioTremonti,Italy’sfinanceministeratthetime,privatelytoagroupofEuropeanfinanceministers.HeisquotedassayingthatinAugusthisgovernmenthadreceivedtwothreateningletters—onefromaterroristgroup,theotherfromtheECB.“TheonefromtheECBwasworse.”FromMarcusWalker,CharlesForelle,andStacMeichtry,“DeepeningCrisisoverEuroPitsLeaderagainstLeader,”WallStreetJournal,December30,2011.37.AnalternativeexplanationisthattheECBknowsthatthefinancialsystemlackstransparencyandknowsthatinvestorsknowthattheycannotgaugetheimpactofaninvoluntarydefault,whichcouldcausecreditmarketstofreeze,reprisingtheaftermathofLehmanBrothers’collapseinSeptember2008.TheECBshouldhaveinsistedonmoretransparency—indeed,thatshouldhavebeenoneofthemainlessonsof2008.Regulatorsshouldnothaveallowedthebankstospeculateastheydid;ifanything,theyshouldhaverequiredthatthebanksbuyinsurance—andtheninsistedonrestructuringinawaythatensuredthattheinsurancepaysoff.Theoneargumentthatseems,atleastsuperficially,toputthepublicinterestfirstisthataninvoluntaryrestructuringmightleadtofinancialcontagion,withlargeeurozoneeconomieslikeItaly,Spain,andevenFrancefacingasharp,andperhapsprohibitive,riseinborrowingcosts.Butthatraisesthequestionofwhyaninvoluntaryrestructuringshouldleadtoworsecontagionthanavoluntaryrestructuringofcomparabledepth.Ifthebankingsystemwerewellregulated,withbanksholdingsovereignshavingpurchasedinsurance,aninvoluntaryrestructuringshouldperturbfinancialmarketsless.Anotherexplanationisthatbyinsistingonitsvoluntariness,theECBmaybetryingtoensurethattherestructuringisnotdeep.ItmightworrythatifGreecegetsawaywithadeepinvoluntaryrestructuring,otherswouldbetemptedtotryitaswell.Financialmarkets,worriedaboutthis,wouldimmediatelyraiseinterestratesonotherat-riskeurozonecountries,largeandsmall.Buttheriskiestcountriesalreadyhavebeenshutoutoffinancialmarkets,sothepossibilityofapanicreactionisoflimitedconsequence.Moreover,theywouldbetemptedtodosoonlyifGreecewereindeedbetter-offrestructuringthannotdoingso.Thatistrue,butthere’snonewsinthat.Intheend,therestructuringdidtriggeracreditevent,andtherewasnotraumatothefinancialmarkets—theECB’sconcernswereprovenbaseless.38.OnJuly15,2011,theEuropeanBankingAuthority,aspartofitsEuropeanbankstresstests,gaveDexiaacleanbillofhealth(http://www.bloomberg.com/news/2011-10-13/no-1-financial-strength-ranking-spells-doom-commentary-by-jonathan-weil.html).OnOctober4,2011,Dexiasharesfell22percent.OnOctober10,2011,Dexiawasbailedout(http://online.wsj.com/article/SB10001424052970203633104576620720705508498.html).TheECB’spositionwasodderstill.WhetheracrediteventhadoccurredwasdeterminedbyasecretcommitteeoftheInternationalSecuritiesDealersAssociation(ISDA),whichmightbedescribedasacooperativegroup—oracartel—ofthewritersofderivatives,someofwhommighthaveastrongfinancialinterestintheoutcome.They—ortheiremployer—mightreceiveorhavetopaybillions.Onememberofthecommitteereportedlyevenusedherpositiontotrytoinfluencebondholders’cooperationinrestructuring,hintingthatiftheydidn’t,thecommitteemightstillputahighbaronwhetheritwasorwasnota“default”event.ThedecisionsoftheISDAwerenotappealable,eithertoarbitrationortothecourts.ItseemedcuriousthattheECBwasapparentlywillingtodelegateauthoritytoaprivateinstitution,operatinginsecret,onwhatwasorwasnotanacceptablerestructuring.Somuchfordemocraticaccountability.39.Theterm“Chicagoschool”hascometorefertoMiltonFriedmanandhisdiscipleswhobelievedinmarketfundamentalism,theideathatunfetteredmarketsarealwaysefficientevenintheabsenceofgovernmentregulation.MiltonFriedmantaughtformanyyearsattheUniversityofChicago.But,ofcourse,manyeconomistswhoteachtheredonotsubscribetomarketfundamentalism—andmanyeconomistsatotherschoolsdo.Seechapter3foralongerdiscussion.40.SeethewebsiteoftheBoardofGovernorsoftheFederalReserveforthemostup-to-datebalancesheetfigures,http://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm.41.There’sanothertheoryoftheGreatDepressionthatisrelevanttowhathasbeengoingonmorerecently.SomeputblamefortheGreatDepressiononthegold268 standard.Itimpededadjustment.Countriesthatleftthegoldstandarddidbetter.Insomeways,theeurohasimposedonEuropesomeofthesamekindofrigiditythatthegoldstandardimposedonmuchoftheworldinthe1930s.Andyet,there’sasensethatthegoldstandarddidn’tcausetheGreatDepression,justastheeurodidn’tcausetheGreatRecession.Theoriginsofthedisturbancetotheeconomylayelsewhere.Andsomeofthebenefitsaccruingtothosecountriesthatleftthegoldstandardwereattheexpenseofothers.Iftheyhadallmovedtoaflexibleexchangeratesystem,wouldthat,byitself,havebeensufficienttorestoretheglobaleconomytoprosperity?Idoubtit.42.Foradiscussionofthesebubblesandtherepeatedfinancialcrisesthatareoftenassociatedwiththeburstingofthebubbles,seeCharlesKindleberger,Manias,Panics,andCrashes:AHistoryofFinancialCrises(NewYork:BasicBooks,1978),andKennethRogoffandCarmenM.Reinhardt,ThisTimeIsDifferent:EightCenturiesofFinancialFolly(Princeton:PrincetonUniversityPress,2009).43.Or,similarly,increasingmarginsinthepurchaseofstock(whichactlikeahousedownpayment).Interestingly,inthetechbubblesofthe1990s,thepossibilityofincreasingmarginrequirementswasbrieflydiscussed,butthenevidentlydismissed:perhapsthefreemarketersthatdominatedtheFeddidn’tlikethiskindofinterferencewiththewondersofthemarket.SeeJ.E.Stiglitz,TheRoaringNineties:ANewHistoryoftheWorld’sMostProsperousDecade(NewYork:W.W.Norton,2004).44.AmongthelistofthosewhohaveofficiallyadoptedinflationtargetinginoneformoranotherareIsrael,theCzechRepublic,Poland,Brazil,Chile,Colombia,SouthAfrica,Thailand,Korea,Mexico,Hungary,Peru,thePhilippines,Slovakia,Indonesia,Romania,NewZealand,Canada,theUnitedKingdom,Sweden,Australia,Iceland,andNorway.TheUnitedStatesneverfullyadoptedinflationtargeting—aswehavenoted,theFederalReserve’smandaterequiresthatitlookalsoatthelevelofunemploymentandtherateofgrowth.Butoverlongperiodsoftime,itspolicieshavebeenlittledifferentfromthoseofcountriesthathaveexplicitlyadoptedinflationtargeting.45.Thislistisnotmeanttobeexhaustive.Anotherhypothesisisthatthebestwaytofightinflation—regardlessofitssource—wastoincreaseinterestrates.Thereareothermacroeconomictools(fiscalpolicy),andevenwithinthedomainofmonetarypolicy,thereareotherinstruments(e.g.,restrainingcreditavailabilitythroughraisingreserverequirements).Itcanbeshownthatthebestwaytorespondtoinflationdependsonthesourceofthedisturbance—whatcausedtheboutofinflation.46.Thereisanotherrationalefortheviewthatacentralbankshouldfocusonlyoninflation.Itisn’tthattheadvocatesofinflationtargetingdon’trecognizetheimportanceoftheseotherissues,butratherthattheybelievethatthereshouldbedifferentinstitutionsandpolicyinstrumentsfordifferentobjectives.Fiscalauthorities,forinstance,mightwanttofocusonunemployment,orevenondistribution.ThenotionthattherecanbeasimplepairingofinstrumentsandobjectivesisassociatedwiththeNobelPrize–winningeconomistTingbergen.Thisnotionisvalidinsimplelinearmodels.However,it’sknownnowthatit’snottrueingeneral,andespeciallysointhecontextofuncertainty.47.SeedataonthewebsiteoftheWorldBank,“Inflation,consumerprices(annual%),”availableathttp://data.worldbank.org/indicator/fp.cpi.totl.zg(accessedMarch5,2012).48.Indeed,giventhesizeoftheU.S.economy,aslowdowntheremightconceivablyhavehadafarbiggereffectonglobalpricesthanaslowdowninanydevelopingcountry,whichsuggeststhat,fromaglobalperspective,U.S.interestrates,notthoseindevelopingcountries,shouldhavebeenraised.49.Formanydevelopingcountries,highoilandfoodpricesrepresentatriplethreat:notonlydoimportingcountrieshavetopaymoreforgrain;theyhavetopaymoretobringittotheircountriesandstillmoretodeliverittoconsumerswhomaylivealongdistancefromports.50.Inpractice,inflationtargetingisoftenimplementedinlessdoctrinaireways.Becausecentralbankershavetosaytheyarecommittedtofightinginflation,ithasbecomederigueurforthemtodeclarethattheyareengagedininflationtargeting.Butthebettercentralbankersknowthatraisinginterestrateswon’tdampeninflationmuchwhentheinflationis“imported”andtheeconomyisnotoverheated.Theyknow,too,thattheyhavetolookafterotherthings,liketheexchangerateandfinancialstability.Somecentralbankersdon’talwaysacknowledgethesenuances:theyseeinflationtodayandraiseinterestrates,eventhoughtheeconomyisslowingdownandthefulleffectofthehigherrateswillbefeltsixtoeighteenmonthslater,whentheslowdownhasalreadyoccurred.Totakeoneexample,theECBraiseditsinterestratesinApril2011inresponsetothethreatofinflationfromrisingoilpriceseventhoughunemploymentwasstillnear10percentandexpectedtoremainso.Theeconomylaterslowed,inflationdidnotincrease,andthepolicyhadtobereversed.51.TheseissuesarediscussedmoreextensivelyinStiglitz,Freefall;EconomicReportofthePresident,1997;andJ.E.Stiglitz,“ReflectionsontheNaturalRateHypothesis,”JournalofEconomicPerspectives11,no.1(Winter1997):3–10.52.Indeed,bysomecalculations,SocialSecurityisoverindexed,i.e.,individualsareactuallybetter-offwheninflationincreases,oratleastthathasbeenthecaseinthepast,overextendedperiodsoftime.SeetheBoskinreport,“TowardaMoreAccurateMeasureoftheCostofLiving,”December4,1996,availableathttp://www.ssa.gov/history/reports/boskinrpt.html.53.Countriesinwhichthereispersistenthighandvariableunemploymenttypicallyputinclausesthatprovideforautomaticadjustmentsinwagesto269 changesinthecostofliving(calledCOLA,costoflivingadjustment).54.See,e.g.,RobertJ.Shiller,IrrationalExuberance,2nded.(Princeton:Prince-tonUniversityPress,2005.ForS&P/Case-ShillerHomePriceIndicesseehttp://www.standardandpoors.com/indices/sp-case-shiller-home-price-indices/en/us/?indexId=spusa-cashpidff—p-us–(accessedMarch52012).55.Thatrequiresthatthedecelerationofinflationfromanincreaseinunemploymentisweakerthantheaccelerationofinflationfromadecreaseinunemployment.SeeStiglitz,“ReflectionsontheNaturalRateHypothesis.”Thereisahugeliteratureonthehypothesisthat,inthelongrun,therelationshipbetweentheaccelerationofinflationandunemploymentisvertical(“theverticalPhillipscurve”).See,inparticular,EdmundS.Phelps,“PhillipsCurves,ExpectationsofInflationandOptimalEmploymentoverTime,”Economica,n.s.,34,no.3(1967):254–81;andMiltonFriedman,“TheRoleofMonetaryPolicy,”AmericanEconomicReview58,no.1(1968):1–17.56.See,inparticular,ArjunJayadevandMikeKonczal,“TheStagnatingLaborMarket,”RooseveltInstitute,September19,2010.Iftheonlyprobleminthelabormarketwasamismatch,thenoneshouldseewagesrisinginthemanysectorsinwhichtherewasashortage,andgiventhedownwardrigidityofwages,averagewagesshouldberising.Onepieceofevidencethatissometimesalludedtoisthattherehasbeenanincreaseinvacanciesrelativetothenumberofunemployed.Butthismayhavemoretodowiththechangingjobcompositionofthosesectorsoftheeconomythataredoingwellandexpanding.Foranexcellentoverview—comingdowntothesamepolicyconclusion—seePeterA.Diamond’sLecturefortheSverigesRiksbankPrizeinEconomicSciencesinMemoryofAlfredNobel,“Unemployment,Vacancies,Wages,”AmericanEconomicReview101,no.4(June2011):1045–72.57.SeeCatherineRampell,“WheretheJobsAre,theTrainingMayNotBe,”NewYorkTimes,March1,2012,availableathttp://www.nytimes.com/2012/03/02/business/dealbook/state-cutbacks-curb-training-in-jobs-critical-to-economy.html(accessedMarch5,2012).58.BenS.Bernanke,“ImplicationsoftheFinancialCrisisforEconomics,”speechattheConferenceCo-sponsoredbytheCenterforEconomicPolicyStudiesandtheBendheimCenterforFinance,PrincetonUniversity,September24,2010.ChapterTenTHEWAYFORWARD:ANOTHERWORLDISPOSSIBLE1.Seechapter1foramoredetaileddiscussionofthetrend2.ThisisoneofthemajorinsightsoftheNobelPrize–winningeconomistsFrancoModiglianiandMertonMiller.Forapplicationstothebankingsector,seeJosephE.Stiglitz,“OntheNeedforIncreasedCapitalRequirementsforBanksandFurtherActionstoImprovetheSafetyandSoundnessofAmerica’sBankingSystem:TestimonybeforetheSenateBankingCommittee,”August3,2011;A.R.Admati,P.M.DeMarzo,M.F.Hellwig,andP.Pfleiderer,“Fallacies,IrrelevantFacts,andMythsintheDiscussionofCapitalRegulation:WhyBankEquityIsNotExpensive,”StanfordUniversityWorkingPaperno.86,2010,andthereferencescitedthere.3.Thebanksarenowsuggestingthattradingderivativesonexchangesmayexposethefinancialsystemtomoresystemicrisk,becauseoftheriskthatundercapitalizedexchangeswillimplode.There’saneasyanswer:requiretheexchangestobeadequatelycapitalized,backedupbyjointandseveralliabilityforallthosetradingontheexchanges.There’snoreasonthattherisksofthosetradingintheseexplosiveproductsshouldbeshiftedtoothers.4.NewZealandandtheScandinaviancountriesareexamplesofcountriesthathavesoughtsuchalternativeswithsomesuccess.SeeMarieBismarkandRonPaterson,“No-FaultCompensationinNewZealand:HarmonizingInjuryCompensation,ProviderAccountability,andPatientSafety,”HealthAffairs25,no.1(2006):278–83;andAlanM.Scarrow,2008,“TortReform:AlternativeModels,”ClinicalNeurosurgery55(2008):121–25.5.Thealternativeminimumtax—ensuringthattherichpaidatleastacertainminimumrateontheirincome—wasnotabadidea;butthewayitwasstructuredwasflawed,becauseitaddedcomplexityandeventuallybroughtintoitsnetnotjusttheverywealthybutmanyordinaryAmericansaswell.6.Seethefullerdiscussioninchapters2and3andThomasPiketty,EmmanuelSaez,andStefanieStantcheva,“OptimalTaxationofTopLaborIncomes:ATaleofThreeElasticities,”NBERWorkingPaper17616,availableathttp://www.nber.org/papers/w17616;andPeterDiamondandEmmanuelSaez,“TheCaseforaProgressiveTax:FromBasicResearchtoPolicyRecommendations,”JournalofEconomicPerspectives25,no.4(2011):165–90.Aswenotedearlier,PresidentObamahasendorsedthe“Buffettrule,”thenotionthatthetaxsystem,ataminimum,shouldbeprogressive,withthoseatthetoppayingatleastashigharateasotherAmericans.7.Becausetaxesonrentsarenondistortionary,taxesonincomederived(atleasttosomeextent)fromrentsshouldbehigher.See,e.g.,ParthaDasguptaandJ.E.Stiglitz,“DifferentialTaxation,PublicGoods,andEconomicEfficiency,”ReviewofEconomicStudies38,no.2(April1971):151–74.Totheextentthatwecantargetrentsinourtaxonhigher-incomeindividuals,thereisinfactnoadverseeffect:theonlydifferenceisthatthepublicwillbecompensatedalittlemoreforthecoststhatthesemonopolistsimposeonthem.8.Inchapter6wenotedapeculiarfeatureofourtaxsystem:capitalgains(largely)escapetaxationwhenassetsarepassedontoheirs.Thatfactdistortsbehavior.Eliminatingthisprovision(calledstepupofbasis)wouldbothcreate270 bothafairerandamoreefficienttaxsystem.Conservativesharpontheadverseeffectsonsmallbusinessesandfarms.Aswenotedearlier(chapter6),thevast,vastmajorityofsmallbusinessesfallwellbelowcurrentlydiscussedthresholdsfortheestatetax($5millionforasingleindividualor,effectively,$10millionforamarriedcouple).Inaddition,thereareprovisionsthatallowthepaymentoftheestatetaxtobespreadovermanyyears,sothattherewillbenoorminimalinterruptiontotheconductofthebusiness.Additionally,thestatisticsshowthatthetop10percentofincomeearnersaccountfornearly98percentofallestatetaxreturns;thetop1percentaccountfor35percentallbythemselves.SeeLeonardE.Burman,KatherineLim,andJeffreyRohaly,“BackfromtheGrave:RevenueandDistributionalEffectsofReformingtheFederalEstateTax,”UrbanBrookingsTaxPolicyCenter,October20,2008,availableathttp://www.taxpolicycenter.org/UploadedPDF/411777_back_grave.pdf(accessedFebruary28,2012).In2009,ayearinwhichtheexemptionwaslowerthanitisnow,itisestimatedthatjust1.6percentofallfarmshadtopayanestatetax.SeeRonDurst,“FederalTaxPoliciesandFarmHouseholds,”USDAEconomicInformationBulletin,no.54,May2009,p.15,availableathttp://www.ers.usda.gov/Publications/EIB54/EIB54.pdf(accessedFebruary28,2012).Ithasbeenestimatedthatamere1.3percentofalltaxableestatesaresmallbusinessesorfarms.See“TheEstateTax:MythsandRealities,”CenteronBudgetandPolicyPriorities,February23,2009,availableathttp://www.cbpp.org/files/estatetaxmyths.pdf(accessedFebruary28,2012).9.Foraninterestingdiscussion,seeStevenBrill,ClassWarfare:InsidetheFighttoFixAmerica’sSchools(NewYork:SimonandSchuster,2011).10.Thedistinctiveaspectoftheseisthattheyincreasehomeownerequity,ratherthanencouragingdebt,thepeculiarfeatureofcurrenttaxprograms.11.Itdidsetupaprocessthat,inthelongrun,mayleadtoamoreefficienthealthcaresystem,thoughitdidnotdirectlyattackthetwomajorsourcesofinefficienciesdiscussedbelow,oratleastdidn’tdosoasmuchasitcouldandshouldhave.12.SeeJ.E.Stiglitz,MakingGlobalizationWork(NewYork:W.W.Norton,2006).13.Asinallareasoftaxandregulatorypolicy,circumventionisaproblem,andakeychallengeforgovernmentistooutsmartsuchattemptsbycorporations.14.SeeU.S.CensusBureauwebsite,“U.S.InternationalTradeinGoodsandServicesHighlights,”February10,2012,http://www.census.gov/indicator/www/ustrade.html(accessedMarch6,2012).15.Inthe1990s,wemaintainedatradedeficitandfullemployment,evenwithagovernmentsurplus;butthecircumstanceswereunusual—aninvestmentburstfueledbyastockmarketbubble(thetechbubble).Anditwasnotsustainable.Inchapter8weexplainedhowonecouldstimulatetheeconomyevenwithintheconfinesofalimitedbudgetdeficit,butthepoliticsofwhatisrequired(undercurrentcircumstances)maymakeeventhisunachievable.16.PartofthereasonforthetradeimbalancesistheroleoftheUnitedStatesasareservecurrency.Otherswanttoholddollarsasbackingfortheircountryandtheircurrency.TheconsequencesisthatweareexportingT-bills(U.S.short-termbonds),ratherthanautomobiles.ExportingT-bills,however,doesn’tcreatejobs.Inspiteofglobalrecognitionoftheanachronisticsystem—itmakesnosensefortheUnitedStatestoplaysuchadisproportionateroleintheglobalmonetarysysteminthemultipolarworldofthetwenty-firstcentury—theObamaadministrationhasresistedchange,partiallyoutofworrythatiftheUnitedStateswasnotthereservecurrency,itwouldbemoredifficulttoborrowsocheaply.ButtheUnitedStatespaysahighpriceforthisexorbitantprivilege.SeeUnitedNations,2009,“ReportoftheCommissionofExpertsofthePresidentoftheUnitedNationsGeneralAssemblyonReformsoftheInternationalMonetaryandFinancialSystem”(alsoknownastheStiglitzCommission)NewYork:UnitedNations,September2009,publishedasTheStiglitzReport(NewYork:NewPress,2010);andStiglitz,MakingGlobalizationWork,chap.9.17.Here’sonesuggestionproposedbyWarrenBuffett.Foreverydollarofexports,thegovernmentcouldissueanimport“chit.”Importerscouldimportonlyiftheyhadtheappropriatenumberofchits.Ifimporterswantedtoimportmorethanexporterssucceededinexporting,thepriceofchitswouldrise,untildemandequaledsupply:amarketmechanismforrestoringtradebalance,andhelpingrestoretheU.S.economytofullemployment.Internationaltraderulesaresufficientlycomplexthatitisoftendifficulttoascertainwhatisorisnotallowed.Thus,thereissomedebateaboutwhetherorunderwhatcircumstancesthisproposalisconsistentwithWTOrules.SeeBuffett,“America’sGrowingTradeDeficitIsSellingtheNationOutfromUnderUs.Here’saWaytoFixtheProblem—AndWeNeedtoDoItNow,”Fortune,October26,2003,availableathttp://www.berkshirehathaway.com/letters/growing.pdf(accessedMarch6,2012).18.Seechapter8andthereferencescitedthere.19.AnnHarrison(UCBerkeleyandNBER)andJasonScorse(MontereyInstituteofInternationalStudies)report,similarly,thatthecombinationofantisweatshopactivitismplusaminimumwageledtoamorethan50percentincreaseinrealwagesforunskilledworkersinforeignplants.Interestingly,whileactivismhadanimpactonwages,ithadnoadverseeffectonemployment.“MultinationalsandAnti-SweatshopActivism”http://www.econ.ucdavis.edu/seminars/papers/146/1461.pdf.20.AlexanderJ.Field,AGreatLeapForward:1930sDepressionandU.S.EconomicGrowth(NewHaven:YaleUniversityPress,2011).21.Theyarecalled“GSE,”government-sponsoredenterprises,becausetheywereoriginallystartedbythegovernment.Theyhadlongbeenturnedovertotheprivatesector—FannieMaein1968—butthegovernmenttookthemoverinthemidst271 ofthefinancialcrisis.22.Orinwhichtheyholdasubstantialfraction,throughtheirholdingsofsecurities.23.Chapter4definedtheconceptofa“publicgood”inthetechnicalsenseinwhicheconomistsusethatterm—somethingfromwhicheveryonebenefits.Becauseeveryonebenefits,whetherhepaysforthegoodornot,everyoneistemptedtoletotherspayforthegood—whichisreferredtoasbeingafreerider.That’swhysuchgoodshavetobepubliclyprovidediftheyaretobeprovidedinadequatesupply.24.Somerestraintsremained—suchasthatcontributionstoSuper-PoliticalActionCommittees(Super-Pacs)couldnotbedirectlycoordinatedwiththecampaigncommitteesofcandidates.25.FromWalterDeanBurnham,“DemocracyinPeril:TheAmericanTurnoutProblemandthePathtoPlutocracy,”RooseveltInstituteWorkingPaperno.5,December1,2010.DataforAustraliarefertomaximumpollovertheperiod1975to1996;fortheUnitedStates,forthesomewhatlongerperiod1974–2008.26.Forinstance,insystemswhererepresentationinCongress(parliament)areproportionaltothetotalvotegarneredinastate.Somecountrieshaveamixof“district”representatives(aswehave)andproportionalrepresentation.27.AdamSmithunderstoodasmuch.SeehisTheTheoryofMoralSentiments(1759),publishedin2000byPrometheusBooks,inAmherst,NY.SeealsoEmmaRothschildandAmartyaSen,“AdamSmith’sEconomics,”TheCambridgeCompaniontoAdamSmith(Cambridge:CampbridgeUniversityPress,2006),pp.319–65,especiallythediscussionofthecommonwealthbeginningonp.347.272 INDEXAbed,FazleHasan,196AcaciaResearchCorporation,203Accenture,360advertising,147,335,348,354seealsomarketingaffirmativeaction,282Afghanistan,143,176,209,211,218Africa,23,40AfricanAmericans:discriminationagainst,68,69,70,71,129,303,305,308,328,367,369disenfranchisementof,345,349wealthof,13,70,71,329,384agriculture:governmentsubsidiesin,51,64,179,180,320,326,379inGreatDepression,56–57,231,233AIG,35,49,67,180,253,369airlines,deregulationof,317airtrafficcontrollers,65AlienTortsStatute,59Ally,374Alperovitz,Gar,78alternativeminimumtax,394AmericanAirlines,318AmericanTobaccoCompany,317Andreessen,Marc,318Angelides,Phil,372antiglobalizationmovement,xiii,277Apple,203,360ArabSpring,ix–xi,xiv,287ArcherDanielsMidland(ADM),51,320Arnall,Roland,333Asia,64,157financialcrisisin,61,231,352,353AT&T,44,203,317Atkinson,AnthonyB.,xxiiiauctiontheory,50austerity,207,220,221,230–36Australia,5,14,18,22,135,286autoworkers,67balanced-budgetmultiplier,217–18,379Bangladesh,microcreditschemesin,196,197bankers:bonusesfor,x,xiv,xv,21,79,141,169,245,247,270,319,333,363criminalprosecutionof,xvi,70,119,199,205–6,372,373economicinfluenceof,xxii–xxiii,79–80,240privateincentivesof,33,34,87,90,96,109–10riskybehaviorby,xi,xxiii,37,90,101,109,171,198,239–40,246,247,269,270,336,387seealsocorporations;financialmarkets;financialsectorBankofAmerica,70,374bankruptcy:corporate,313derivativesclaimsin,49,271governmentregulationof,30personal,10,275,301reformof,58studentdebtin,58,94,195,196,265,271,323,371seealsoChapter11;foreclosuresbankruptcylaw,193–97,201,202,270,271,284Bardeen,John,41Bartel,Larry,xxivBasov,Nikolay,315BearStearns,388Belgium,19,22,286Berlusconi,Silvio,349Bernanke,Ben,247,248,252,257,389Berners-Lee,Tim,41,315Bhutan,122,312Bilmes,Linda,176BipartisanPolicyCenter,207Bischoff,Kendra,75BlackBerry,203Blankfein,Lloyd,124273 Bloomberg,Michael,xivbondholders,168,240,261bonds,municipal,212,378Bowles,Erskine,207Bowles-SimpsonDeficitReductionCommission,207,221,379,380Brattain,Walter,41Brazil,5,51,249economicgrowthin,139,298,353Bridgestone/Firestone,104BritishPetroleum(BP),xviii,99,189,190,367,374“Buffettrule,”395Buffett,Warren,77,180,269,333,395,396Burnham,WalterDean,130Bush,GeorgeW.,71,73,86,87,97,101,114,169,177,208,212,221,228,330,360,383Bushadministration,xiv,167,168,171,178business:anticompetitivebehaviorin,44–46,317,318corruptionin,176governmentpartnershipswith,174governmentregulationof,47innovationsin,35,46,41,78,96,178–79,314,315politicalpowerof,47,50,51,62,95,99,101,111,131–32,135,136,285,286,319,325,350teamworkin,113,343trustin,121–22seealsocorporations;financialsectorbusiness,small,61,167,225,226,241,245,395California,electricitymarketliberalizationin,177–78campaignfinance,37,47,131–32,135,136,162,196,200,206,285–86,319,325,350,373,397Canada,5,18,19capital,59,323social,122–23,125,135capitalcontrols,60,181,182,277,353capitalgains,71–72,87,88,115,211,274,297,298,315,330,361,378,395Cardoso,Enrique,5Carter,Jimmy,71CaymanIslands,270cellphones,98,203,274CensusBureau,U.S.,27,305CentralIntelligenceAgency(CIA),209Chait,Jonathan,19,116–17Chapter11,284,313,363seealsobankruptcyChavez,Hugo,40Cheney,Richard,101Chicagoschool,44–45,47,256,317,391childcare,10,301Chile,141,258China,19,54,64,249,280economicstrengthof,144,175inflationin,259–60Citibank,204–5,369,387cities,communitysegregationin,75–76CitizensUnitedv.FederalElectionCommission,131,135,285,350civilrights,133,158classwarfare,180,222ClaytonHoldings,373Clinton,Bill,71,87,99,114,175,179,330,387Clintonadministration,48,50,163,180,249,360Coakley,Martha,200Coase,Ronald,190cognitivecapture,48,100,161–62,249Colbert,Jean-Baptiste,32colleges,19,307–8CommissionontheMeasurementofEconomicPerformanceandSocialProgress,xxix,185,304,339,347CommissiononWartimeContractinginIraqandAfghanistan,176communism,failureof,104,123,157,163,292competition:excessprofitsand,35,36,43inglobalization,60,141,142governmentregulationof,xiii,30,31,35,36,39,40,44,47,57,89,175,267,269,270–71imperfect,34,35seealsomonopoliesCongress,U.S.,60,86,194,221,252,262,288,311,317,320corporateinfluencein,48,50,95,99,194,285lobbyingin,48,95,185,324taxlegislationin,87,251,376seealsoHouseofRepresentatives,U.S.;Senate,U.S.CongressionalOversightPanel,193consumerism,104–6,341consumerprotection,136,175,192,193,197contracts,197,271Cordray,Richard,370corporategovernancelaws,31,38,39,41,57,66–67,87,111,270,271corporations,xviii,91,100–101,147,348deregulationin,89,102,177–78274 dishonestaccountingin,87,110,111,271dividendpaymentsby,88,212economicinfluenceof,xxii–xxiiiexecutivecompensationin,3,21,31,40,42,65,66,67,79,87,104,109,110,111,153–54,271,296,309,316,328,333governmentmunificencetoward,40,48,49–51,97,99,136,179–80,189,191,210,214,215,216,222,224,228,272–73idea-shapingby,147,150–51,160,179legaladvantagesof,66,132,189–90,191,202,272,327,374patentcontrolby,43,202–3risk-takingby,xviii,99,189,339shareholderinfluencein,31,66,67,135,271,285,328taxationof,62,73–74,95,115,142,179,214,215,221–22,224,225,270,272,273–74,278,283,296,331astaxshelters,73,270,296seealsobusinessCouncilofEconomicAdvisers,99,110,174,179,185,330,387creditdefaultswaps(CDSes),46,248,255,256creditworthiness,58,108Crick,Francis,41crime,15,69,303,304Daly,Lew,78debitcards,324debt:international,138U.S.,207,217,219seealsobankruptcy;creditdefaultswaps(CDSes);deficitreduction;foreclosures;predatorylending;studentloansdebtceiling,207,376DeclarationofIndependence,158DefenseDepartment,U.S.,209defenseindustry,governmentprocurementin,40,101,176,210,224,272deficit,U.S.,114,115,179,208–11,251,279,330,340,383deficitreduction,207–32,237,256,279,377expenditureimplicationsof,93,115,217Right’sinsistenceon,216,217,229strategiesfor,211–16,224,228,235,236democracy,U.S.,118–45corruptionin,132,143,162,200diminishingconfidencein,xii,120–21,127–28,129,131,132,133,134,143,144,250–54,288disenfranchisementin,129–35,345globalizationand,138–45ideologicalbattleover,155,162media’srolein,128–29,135,136,163,252,286trustand,125–26weakeningof,136–38,142seealsopolitics,U.S.DemocraticParty,U.S.,116,117,130,349,358Denmark,18,19,183,385derivatives,35–36,43,49,219,246,247,253,256,269,270,271,313,320,387,390,394developingworld,xii,16,141,157,233,289financialsector’sinfluencein,181–82inflationin,259,392laborin,63,64,326,397Dexia,256,390Diamond,Peter,319Dingell,John,387Dirksen,Everett,97–98discrimination,53,68–71,201,282,356disenfranchisement,129–31,134–35,146,349,351dividends,72,88,212,378Dodd-Frankbill,119,136–37,193,247,269,388Donovan,Shaun,362earned-incometaxcredit,74,277EastAsiafinancialcrisis,61,231,352,353EastIndiaCompany,43,357EconomicMobilityProject,18,19EconomicPolicyInstitute,19economics:behavioral,113,148,150–51,152,356collectiveactionin,93confidencein,231development,102discriminationtheoriesin,68–69distributionofendowmentsin,30–31efficiencyin,xi,34,35,36,56,59–60,62,126,363externalitiesin,34,173,188,190,257,316gametheoryin,44,68idea-shapingin,147,148–62informationasymmetriesin,34,44,68–69,173,257perceptionsin,161,184Right’sviewof,xxii,25–27,44,106,107,108,114,116,152,155,157,161,173standardmodelof,xxv–xxvi,30,33,44–45,47,53,65,77,113,126,146–47,149,150,182–83,243,257,260–61,266–67supply-side,221,224–25,235,282,283275 trade-offsin,239,264trickle-down,6–7,62,154,282seealsofinancialmarketseconomy,U.S.:alternativeframeworksfor,xxi–xxii,xxiii,88,154–55,264bubblesin,54,85,86,87,88–89,183,211,258,261–62,271,378,391conventionalviewof,xxiii,6,7,25,27,92,107,152,182–84,229,258,267,292demandin,56,57,85,86–89,91,225,230,236,242,250,263,282,334Ginicoefficientin,23,303,309,310globalinfluenceof,143,145grossdomesticproductin,15,62,83,97,98–99,105,182–84,185,211,215,218,234,268grossnationalproductin,184growthin,4,6,7,22,24,92,100,117,143,157,175,178,217,237,264,268,279,282–84,298,336idea-shapingand,148,151–52,154–55,163–79,182–85,222,236,256–63inefficiencyin,xi,xiv,xx,xxii,6,58,83,84,85,89,90,91,92–106,107,117,165–66,207,266–67inflationin,241,259instabilityin,5,84–91,117,165,176,240,246,254,258,264,271,336monopoliesin,41–42,44–47mythsin,224–36politics’linkagewith,xi,xix–xx,xxiv,34,38–39,47,52–53,59,65,66,89,118,131,135,138,151,173,266,287,288–89,348privatizationin,176–77,226,228productivityin,50,54,56,62,65,67,78,90,92–106,108,114,115,117,124,125,127,283,336,384reformin,267,268–85savingin,1,13,39,70,71,85,88,171,233,244,330,380,383sizeof,392stimulusfor,86,211,216–18,232–34,236structuralchangesin,53–54,56,232–33,235,263,277,285unfairnessin,x,xi,xii,xiv,xx,xxii,2,6–7,114–15,117,127,133,134,143,144,169,173,174,189,191,204,239,244,245–46,266–67,268,348seealsofinancialmarketseducation,7,112,143,160,161costof,57,75,94,275governmentsupportfor,5,15,75,84,93,102,108,115,155,196,216,217,263,267,275,281,282,283inequalityin,xiv,19,20,30–31,68,75,94,102,108,160,307–8,322laborsupplyand,53,55,80nutritionand,102,308parentalcircumstances’effecton,18,20,76,94,108,307states’fundingof,195,263,304seealsostudentloansEgypt,138,291Einstein,Albert,41Eisenhower,Dwight,366elderly:populationgrowthof,279povertyamong,17,26,74,227,306retirementincomeof,177,244elections,U.S.,134,170,251–52seealsocampaignfinance;politics,U.S.;votingemergingmarkets,54,143,181,233,383employment,50,69,75,76,189,211parentalcircumstances’effecton,18,76,307restoring,222,225,257,278–81,284,285,380,396seealsolabor;unemploymentenergyindustry,51corporaterecklessnessin,xviii,99,189,339,374andglobalwarming,xviii,160lobbyingby,95,185,338rentseekingby,40,49–50,99,272,367subsidiesto,179,180,189,214,367Enlightenment,30,156Enron,177–78environment:coststo,98–99,100,185,188–89,272,339,374protectionof,122,141,178,184,217,283seealsoglobalwarming;resourcesenvironmentaljusticemovement,184,308equilibriumfictions,150,157,356,358Ericcson,203estatetaxes,73,76,88,166,167,274,361,395ethanolsubsidy,50–51,180,320euro,220,391Europe,22,55,105,141,155,280,286economicmobilityin,18,117,265financialcrisisin,24,138,141,182,219,220,231,235–36,254–56,369,381,389–91globalization’seffectin,63,64inequalityin,xiv,5,23inflationin,241,255,259,393unemploymentin,278,291EuropeanCentralBank(ECB),138,182,220,249,255,256,390,391,393EuropeanCommission,214exchangerates,280276 Exxon,xviii,160ExxonValdez,374fairness:changingviewsof,67,148,153–55,347economists’perceptionsof,161importanceof,xiv,114,117,126–27,135,163,214,266inlabor,103–4,127FannieMae,158,284,356,363,397FederalBureauofInvestigation(FBI),197,372FederalCommunicationsCommission(FCC),47,335FederalDepositInsuranceCorporation(FDIC),247FederalReserve,U.S.,71,245,248,249,252,253,258,266appointeesto,47,48,133,249–50,319,388banklendingby,37,49,243,245–46financialsector’sfavoringby,37,49,243,245–48,249,251–54,258,264,324,385–86monetarypoliciesof,85,86,88,133,177,208,234,239–40,243–45,248,250,251,252,254,257–58,259,262,264,279,380,382,385,389,392OpenMarketCommitteeof,252oversightof,251,252politicalnatureof,250,251regulatorypositionof,246,247,248,387,388Ferguson,Thomas,xxivFields,Alex,283filibusters,132–33,286,350,351FinancialAccountingStandardsBoard,110FinancialCrisisInquiryCommission,seeAngelides,Phil;NationalCommissionontheCausesoftheFinancialandEconomicCrisisintheUnitedStatesfinancialcrisisof2008,x,xiv,xvii,xix,xxii,xxiii,1,3,13,33,49,61,77,79,91,152,155,166,167–69,171,174,175,180,213,232,246,254–55,260,314causesof,xi,33,34,37,49,90,175,213,258,264criminalprosecutionfor,xv–xvi,70,119,199,372,373economicsituationpriorto,53–54,84–85seealsoGreatRecession;subprimecrisisfinancialmarkets:deregulationof,5,49,60,81,89–92,102,152,157,175–76,177,181–82,240,246–48,249,258,387distributiveimpactof,173–74equilibriumfictionsin,152,175failuresin,xi–xiii,xvii,xviii,6,34,41,90,107–8,173,241,291,313globalizationin,59–61,139–40,141–42,181–82,277,280,324,325governmentregulationof,xiii,xx,xxi–xxii,28,33–34,35,36,37,38–39,40,44,47–48,80,87,119,136–37,141–42,152,155,170,173,178–79,192–93,247,248,250,269–70,324,369,388ideologicalperceptionsof,154,155,156–57,158,163–66,172–79,186,257,258,261,313,317,356informationasymmetriesin,36–37,110,124,165–66,313,388internationaldebtin,139legalunderpinningsof,42,43pricediscoveryin,164–65transparencyin,35–36,247,269,390seealsobankers;business;economy,U.S.;stockmarketfinancialsector,49,87,169,170,219,226,228,382abusivecreditcardpracticesin,37,40,90,96,98,119,124,164,240,246,269,270,274,314anticompetitivebehaviorin,35–36,46–47,247,269,270,318;seealsomonopoliescriminalbehaviorin,198,199,200–201,204–6,372,373FederalReserve’sfavoringof,37,49,243,245–48,249,251–54,258,264,324,385–86governmentbailoutsin,xiv–xv,37,60,74,101,155,166–69,171,172,175,180,193,198,213,233,234,245–46,252–53,258,269,324,361,362governmentlendingto,37,49,110,243,245–46growthof,79–81,240,246–48,271hiddensubsidiesto,222,223,240,247,387incentivepayin,78–79,87,109–10,342internationalinfluenceof,181–82,186–87legalsystem’sfavoringof,191–202,203,204–6moraldeprivationin,xvii–xviii,xxiii,37–38,70,197–98,201,314politicalpowerof,34,37,41,48,61,135,136–37,193,194,200,202,319,324,338predatorylendingby,xvii,37,40,58,70,90,119,124,191–93,194,197–98,201,239,246,249,269–70,313,314,333,369purposeof,62,96,142,175,281,314ratingsagenciesin,192,217,219rentseekingby,36–39,40,41,166,270securitiesfraudin,204–6studentloanpracticesin,94,195,196,201,323,371taxeson,213–14,215,247,248trustin,123–24,346undercapitalizationin,247,256,386seealsobankersFinland,18,19fiscalpolicy,278–79,285seealsogovernment,U.S.,macroeconomicpoliciesofflashtrading,165–66foodstamps,74,211,277,305,306foreclosures,x,xii,xv,1,10,13,23,169–70,197–202,271,293,302,362,277 363,369,374,388seealsomortgagerestructuring;subprimecrisisforeignpolicy,U.S.,101framing,cognitive,149–50,160,163,186,360France,18,22,97,183,214,351,385FreddieMac,158,284,363Friedman,Milton,44,157,257,258,317,391Friedman,Stephen,388FUD,45G-8,143G-20,143,185Galbraith,Jamie,81Galbraith,JohnKenneth,128gametheory,44,68Gates,Bill,42,315GE,222,330,331Geithner,Tim,48George,Henry,212Georgia,191–92,368Germany,18,23,214,230,259,280,351,385gerrymandering,132,135,286GettysburgAddress,137GIBill,5,55Ginicoefficient,23–24,303,309,310Glass-SteagallAct,90,387globalization,58–64,79,80,156,184,259,260competitionin,60,141,142democracyand,138–45drawbacksof,60,62,63,142,324financial,59–61,139–40,141–42,181–82,277,280,324,325inequalityand,60,63–64,79,80,140,142,144,145laborand,56,59–60,61,63,64,80,233,277,278,280,281,324,325managementof,xiii,61,64,80,137,142,144,145,277–78taxesand,62,63,142,278GlobalizationandItsDiscontents(Stiglitz),61,181globalwarming,xii,xiii,144,160,341seealsoenvironmentGoldenRule(Ferguson),xxivGoldmanSachs,61,124,205,253,353,388Google,174,203government,U.S.:bankbailoutsby,xiv–xv,37,60,74,101,155,166–69,171,172,175,180,193,198,213,233,234,245–46,252–53,258,269,324,361,362budgetcutsin,207,216,221,226–28,229,230–36budgetof,207–37collectiveactionthrough,82,93,107,117,121,125,281–82ideologicalperceptionsof,93–94,154–55,156–57,158,172–79,186,257,258,261,356inequality-supportingpoliciesof,6,28,31,32,52,57–58,74,75–76,77,79,81,82,153investmentby,23,40,80,84,88,92–94,102,114,115,155,174,216,217,218,230,232–33,263,267,273,279,281,282–83,381litigationby,203,204macroeconomicpoliciesof,38,62,64,80,82,85,86,102,133,225,230,231,236,237,238–64,279,379,392marketregulationby,xiii,xx,xxi–xxii,5,28,34,35,36,37,38–39,44,47–48,49,60,80,81,87,89–92,102,119,136–37,141–42,152,170,173,175–76,177–79,192–93,246–48,250,258,269–70,324,369,387,388media’srelationshipwith,128,135,136,252militaryspendingby,40,101,176,209,210,211,216,218,224,340munificenceof,32,40,42,48–51,97,99,101,136,173,176,179–80,189,191,210,211,213,214,215,216,222,224,228,271–73researchfundedby,78,92,93,102,174,216,283,337sizeof,93–94,155,156–57,216,221,236–37,251,256,257socialspendingby,2,5,14,15,16–17,26,63,74,77,79,84,85,86,108,173,208,210,211,215–16,226–28,231–32,237,276–77,299,365,380seealsopolitics,U.S.governmentprocurement,40,49,101,176,210,224GreatDepression,5,56–57,90,156–57,175,231,233,257,267,383,385,391GreatRecession51,70,118,165,195,227,234causesof,197,202,252,280deficitconsequencesof,207,210–11effectsof,1–2,9–17,27,82,91,197,238–39,276–77,287,357,383ideologicalinterpretationsof,157,158,161,175joblessrecoveryfrom,244–45,264laboroutcomesof,57,65,124–25,241–42,250,301,380monetarypolicyin,240,257–58profit-makingin,29,67,110,241resourcewastein,90,241savingsdepletedby,1,13,70stimuluspackagein,86,211,232–34,236,382wagesharein,29,57,65,67,328worseningof,217,230seealsofinancialcrisisof2008Greece,22,142financialcrisisin,138–39,141,182,219–20,231,255,316,390Greenspan,Alan,48,88,208,246,248,251,258,376,387grossdomesticproduct(GDP),182–85,268seealsoeconomy,U.S.,grossdomesticproductin278 grossnationalproduct(GNP),184–85Güth,Werner,126Hacker,JacobS.,xxivHalliburtonCorporation,101,210,272Hammonds,Tim,338Harrison,John,109healthcare,12,44,155,222,263costof,10,97,109,265,273,274,276,301,317,353,378,380governmentassistancewith,14,23,31,70,74,226,276;seealsoMedicareinefficiencyin,176,183,228,380,395Obama’sreformof,14,163,276racialdiscriminationin,70,303healthindustry,95,97,176seealsopharmaceuticalindustryHemsley,Stephen,42Hewlett-Packard(HP),203,360Hispanics:discriminationagainst,68,70,328,369wealthof,13,329,384Holder,Eric,199homeownership,76,108,152,157,161,171,223,379Hoover,Herbert,231HouseofRepresentatives,U.S.,93,100,134,207FinancialServicesCommitteeof,136seealsoCongress,U.S.;Senate,U.S.housingdiscrimination,70–71,308housingmarket:bubblein,54,85,88–89,183,191–93,211,232,243,262,378,388collapseof,3,8,13,89,91,169,198,223,285,294,296,302,311,314,363recoveryin,284–85seealsoforeclosures;mortgagerestructuring;predatorylending;subprimecrisishousingsubsidies,74humanrights,59,155ideas:democracyand,185evolutionof,156–59,160immigration,53,227,296imprisonment,15,70,303,304–5incentivepay,78–79,87,107,108–14,153–54,163,173,205,342,343,347incomeredistribution,85,211criticismsof,xxii,106government’srolein,30–31,71–76,155,238,279politicallimitationof,32,77India,152–53,196–97,249IndustrialRevolution,30,105,345inequality:alternativemodelsof,81–82consequencesof,83–117,125,133–35,147,148,186,187–206,233deficitreductionand,221–24determinantsof,xii,28,30–31,33–39,79–82,267,271,276educational,xiv,19,20,30–31,68,75,94,102,108,160,307–8,322efficiencyand,106–16,117globalization’seffecton,60,63–64,79,80,140,142,144,145government’srolein,6,28,30–32,52,57–58,74,75–76,77,79,81,82,147,153,172–73,190,207historical,29–30,332income,2,3,4,7–8,9,22,24,25,26,27,29,30,52,53,54,55,56,57,71,72,77,79–80,81,85,86,127,153,178,183,202,233,240,241,267,294–95,296,297,298,299,300,311,328,332,335;seealsoincomeredistributionandinstability,5,84–92,117,240justificationsfor,27,29,30,77–78,81,154,156,342lifetime,26,106,310,311macroeconomicfactorsin,238–64markets’effecton,52–82perceptionsof,127,147–48,152–55,159,160,179,184remediesfor,29,107,114–17,213,237,268–85,287rentseekingand,32,38,40,77,107,173,213andsocialdistance,148,160societaleffectsof,xii,xvi–xvii,xx,xxii,2,18,20,27,65,76,84,90,100,104–6,117,326–27societalfactorsin,53,64–71,82,84,282inflation,219,239,240,241,242,248–49,255,259–60,261,262,263,279,365,378,383,384,385,391,392,393Informant,The,320infrastructure,88,92,93,102,115,117,155,216,267,283innovation:inbusiness,35,41,46,78,96,178–79,314,315directionof,58,244,270,283–84patentlawand,43,202scientific,41,78,93,100,202insuranceindustry,176,177,228,274,276intellectualproperty,140,202–3,316,323,354,375seealsopatentsinterestrates,3,7,49,71,80,86,88,110,177,208,209,217,234,242,243,244,245,251,259,260,261,262,283,380,382,385,386,392279 InternationalMonetaryFund(IMF),60,61,91–92,138,141,181–82,231,316,353Internet,41,45,87,115,174,349,358interns,internships,76,332intrinsicrewards,111–12investment:globalizationand,60,73,74private,6,73,74,86,87,88,92,222,225,226,230,235,243,244,283,335,382public,23,40,80,84,88,92–94,102,114,115,155,174,216,217,218,230,232–33,263,267,273,279,281,282–83,381Iran,22,23IraqWar,101,143,176,209,210,211,340Ireland,financialcrisisin,182,210,219,220,255,256irrigation,122,322Israel,14,262Italy,18financialcrisisin,138–39,255,389–90Japan,14,19,308Jobs,Steve,41,315JPMorganChase,345,374,388judges,44,200,373JusticeDepartment,U.S.,199,318Kerry,John,359Kessler,David,357Keynes,JohnMaynard,86,105,151,267King,Mervyn,248Korea,16,19KruegerandMas,104Krugman,Paul,137labor,55,152bargainingpowerof,61,64,277,281;seealsolaborunionsdemandfor,38,53–57,61,63indevelopingworld,63,64,326,397discriminationin,68–70,71fairnessin,103–4,127freemobilityof,59–60,61–62globalization’seffecton,56,59–60,61,63,64,80,233,277,280,281,324,325GreatRecession’seffecton,29,57,65,67,91,124–25,231,241–42,250,380macroeconomicpoliciesaffecting,80,225,279motivationof,102,103polarizationof,8–9,56,79,80,133,277public-sector,57,322inrecessions,29,67,124andsocialcapital,124–25structuralchangesin,53–54,56,232–33,263,280–81,285technology’seffecton,53,54–56,63,79,80,277,280,283,334womenin,14workhoursand,9,14,26,327seealsoemployment;unemployment;wageslaborunions,38,57,64–65,66,67,79,80,281–82,327LatinAmerica,23,40,84,231Latvia,austerityin,231Lauder,Ronald,72lawyers,42–43,99–101,190,203,339Lay,Ken,178legalsystem,U.S.,187–206alternativeframeworksfor,188,202banks’deceptionin,198,199,200,201,373burdenofproofin,199–200contractsin,197corporateadvantagesin,66,132,189–90,191,203,272,327,374costsin,100,189–90,202distributiveconsequencesof,190,193,271,317,370economicbiasin,44FederalReserveaccountabilityin,252financialcrisisprosecutionin,xv–xvi,70,119,199,372,373financialsector’sfavoringin,191–202,203,204–6informationasymmetriesin,271,368politicalinfluencein,44,190–91,200propertyrightsin,190,194,197,198,199purposeof,100,188–91reformof,273rentseekingin,42,43,203,273andsocialresponsibility,121unfairnessin,42,43,100,189–90,191–202,203,206,368,373,375LehmanBrothers,253,313,390Leme,Paulo,353Lenin,Vladimir,354Lessig,Lawrence,xxivLG,203Lincoln,Abraham,137List,John,347lobbying,48,95,101,185,196,319,324,325,338LockheedMartin,210280 LondonInterbankOfferedRate(Libor),47Longitude(Sobel),109LuladaSilva,LuizInácio,5,139,353Luxembourg,183,286manufacturing:compensationshiftsin,65,328joblossesin,54,56,57,232–33,285,321societalimpactof,156marginalproductivitytheory,30,33,77,267marketing,150–51,160,162,357,359MarlboroMan,151,354marriage,economicinsecurityand,15,303Marshall,Alfred,102Marx,Karl,30,292Massachusetts,200–201McCarty,Nolan,xxivMcDonald’s,381media,128–29,134,135,136,160,163,252,272,286,335,348,349,358Medicaid,14,228,277,378Medicare,17,48,97,147,163,176,210,228–29,265,320,355,364,378,380Mexico,16,42,64,138,176,365MFGlobalHoldings,313microcredit,196–97Microsoft,42,44,45–46,74,203,317,318,319middleclass,54,117,137assistanceto,29,274economicinsecurityof,xvii,12–14,23,26,103,265–66globalization’seffecton,63,64GreatRecession’seffecton,10hollowingoutof,2,9,25,38,84,133,300incomeof,3,4,7,8,9,14,25,54,56,57,63,72,240,297,298,300,385recoveryof,29,225taxdeductionsfor,222–24,379unfairpoliciestoward,xv,xxiiwealthsourcesof,3,8,13–14,91,167MiddleEast,40seealsoArabSpringMill,JohnStuart,368monetarism,257,258–59monetarypolicy,85,86,88,133,177,208,234,239–40,248,250,251,252,254,257–58,259,261,262,263–64,380,382,385,389,392distributiveconsequencesof,243–45,264,279idea-shapingin,256–63monopolies31,32,35,39–47,95,97,140,213,270–71,274,316,318moralhazard,171,229,256,362,363MortgageElectronicRegistrySystem(MERS),198,201,374mortgagefraud,198,201,372,373mortgagerestructuring,169–72,201–2,284–85,362,363mortgages,taxdeductionsfor,222,223,379mortgagesecurities,205Mosaic,318motivation,102,103,111–12Motorola,203Mozilo,Angelo,333Mueller,Edward,42Mullainathan,Sendhil,103municipalbonds,212,378NationalAcademyofSciences,26NationalCenterforSupercomputingApplications,318NationalCommissionontheCausesoftheFinancialandEconomicCrisisintheUnitedStates,357,358NationalEconomicCouncil,180Netherlands,19,22Netscape,45–46,318NewDeal,xiii,88,231Newfoundland,138NewYorkTimes,11,119,205Nokia,203NorthAmericanFreeTradeAgreement,141Norway,22,23,183,220NTP,Inc.,203Obama,Barack,x,352deficitreductionby,207andethanolsubsidy,51FederalReservenomineesof,319financialcrisisresponseof,xv,168,169,361healthcareprogramof,14,163,276taxpositionof,395Obamaadministration,xiv,67,170,171,200,250,284,362,396OccupyWallStreet,ix–xiv,xix–xxi,102,116,118,127,134,345“Ofthe1%,forthe1%,bythe1%”(Stiglitz),xiOlinFoundation,44,3591percent:definitionof,xxiieconomicframework’sfavoringof,xx,xxii,31,34,62,67,91,117,131,142,173,174,189,191,204,239,244,245–46,264,348,354281 economicsecurityof,18,19,25globalization’sbenefitsto,62,64,142idea-shapingby,129,134,137,146–86,211,236,256,287incomeof,2,4,8,25,52,72,85,215,267,294,295,297,298,299,300,315,332,335legalframework’sfavoringof,188,191,202,206,273media’scontrolby,129,134,286politicalpowerof,xix,32,67,83,86,89,101,118,119,120–21,129,131–33,134,137,138,146,191,267,285,348,351publicperceptionof,20–21,146,154,159,358reformaimedat,29,268–74rentseekingby,32,38,41–43,77savingby,85,88,223,275smallgovernmentpreferenceof,93socialcontractviolationby,xvi–xviisocialcontributionsof,27,41,77–78,96,266socialnorms’shapingby,53taxationof,5,38,42–43,62,71–73,74,76,77,84,86,87–88,114,115,116,138,142,159,167,208,209,211,212,214–15,218,221,223,224,225,226,256,274,275,294,312,335,344,360,383,394valuechangein,288wealthof,2,3,8,25,32,38,56,72,73,80,84,166–67,295seealsocorporations;financialsectorOrganizationforEconomicCooperationandDevelopment(OECD),16,185Orshansky,Mollie,305Ostrom,Elinor,322overdrafts,194,370Pager,Devah,69PapuaNewGuinea,184patents,43,202,203,316,374,375seealsointellectualpropertypensionfunds,227–28PersonalResponsibilityandWorkOpportunityReconciliationAct,17PewFoundation,20pharmaceuticalindustry:governmentmunificencetoward,40,48,97,210,211,224,228,272,276researchin,97seealsohealthindustryPierson,Paul,xxivPiketty,Thomas,xxiii,114Pinochet,Augusto,258polarization,8–9PolarizedAmerica(McCarty,Poole,andRosenthal),xxivpolicelineups,149policestates,125politics,U.S.:cognitivecapturein,161–62corporateinfluencein,34,37,41,47,48,50,51,61,62,95,99,101,111,131–32,135,136–37,200,202,285,286,319,324,325,338,350distributiveconsequencesof,31,52,58,239,277,278,322economy’slinkagewith,xi,xix–xx,xxiv,34,38–39,47,52–53,59,65,66,89,118,131,135,138,151,173,266,287,288–89,348idea-shapingin,129,137,148,149,151–52,153–55,159–62,163,166–72,175,180,185,186,285legalconsequencesof,190–91media’srolein,129,134,135,136,160,163,286reformof,135–36,267,285–86regulatorycapturein,47–48,248,249–50,253,264societalfactorsin,64unfairnessin,x,xi,xii,xviii–xx,31–32,39,41,83,101,114–15,118,119,120–21,127,129,131–33,134,135,136–37,138,144,146,191,196,200,202,267,285,286,319,324,325,338,348,350,351votingin,119–21,129–31,133,134,135,137,286,288,325,345,349,350,351,355seealsodemocracy,U.S.;government,U.S.pollution,213,215,224seealsoenvironmentPoole,KeithT.,xxivpoor:assistanceto,xii,29,225,274banks’exploitationof,xvii,37,40,58,70,94,154,196–97,201,271,369cognitiveresourcesof,103crimeand,15economicinsecurityof,xvii,12–14,23,26,103economicmobilityof,4,18–19,94,117educationof,19,20,31,75,94,102environmentalconditionsof,184,308foodneedsof,16,102,305–6globalization’seffecton,63,64healthcareof,14,31,70,74,276,353homeownershipby,76,108,152,157,161,171,223incomeof,4,8,9–10,14,16,25,63,72,240,297,298,300,332,385inflation’seffecton,261politicaldisenfranchisementof,127,130–31,133,134,135publicspending’seffecton,2,10,14,15,16–17,26,31,63,74,277savingby,224,275segregationof,75–76taxationof,74,88,218unfairpoliciestoward,xv,xxii282 unfavorableviewof,26,27,154,160,171,229,312wealthsourcesof,3,8,13,70,82,167,171,172seealsoUnitedStates,povertyinPortugal,financialcrisisin,231,255povertygap,16povertytrap,20predatorylending,xvii,37,40,58,70,90,119,124,191–93,194,197–98,201,239,246,249,269–70,313,314,333,369seealsoforeclosuresprivatization,42,176–77,226,228,316,364,365ProgressiveEra,xiiiProkhorov,Aleksandr,315propertyrights,190,194,197,198,199,323,368protectionism,278psychology,idea-shapingand,147,148–62publicgoods,seeinvestment,publicpublicschools,75quotas,39racism,159seealsodiscriminationrailroads,32,42,116Rakoff,Judge,204–5ratingsagencies,192,217,219Reagan,Ronald,5,65,71,114,175,221,246realpolitik,292Reardon,Sean,75recessionof1991,86–87recessionof2001,245regulatorycapture,47–48,248,249–50,253,264Reich,Robert,179Rent-a-Center,313–14rentseeking,28–51,95–101,107,115,140,144,166,176,210,218,228,266,267,268,270,272,276,328,367competitionin,98consumerexploitationand,98,154,272andeconomicgrowth,39,100formsof,36–37,39,40inequalityand,32,38,40,77,107,173,213inlegalsystem,42,43,203,273monopoliesand,39,40,41–42,43–47,95,97,140,213,270–71,274fromnaturalresources,39–40,49–50,99,272participantsin,41–43,316remediesfor,107,269–73resourcewastein,95,96,99,100taxeson,39,115,212–14,215,274,395Republic,Lost(Lessig),xxivRepublicanParty,U.S.,65,130,207,351–52,355,358ResearchinMotion,203resources:inGDPcalculation,98–99,185governmentassignmentof,30,32,39–40,49–50,214,215,224,272,314,316preservationof,80,100,283,322taxeson,39–40,213seealsoenvironmentretirement:agefor,227choicesabout,149–50savingfor,12–13,149–50,177,223,227–28,244seealsoSocialSecurityretirementbenefits,12–13Right:economicideasof,xxii,25–27,44,106,107,108,114,116,152,155,157,161,167,175,216–17,220–21,222,225,226,229,236,274,282,283,292,312,356legalreformagendaof,273RIM,203riskaversion,91riskmarkets,34,108RMBS,368robo-signing,198,199Rockefeller,JohnD.,42,44Rodrik,Dani,140Romney,Mitt,27Roosevelt,FranklinDelano,88,232Roosevelt,Theodore,44Rosenthal,Howard,xxivRubin,Bob,180Russia,42,123,200,316seealsoSovietUnionRyan,Paul,116,207,228Saez,Emmanuel,xxiii,114salestax,74Samsung,203Sarkozy,Nicolas,185SaudiArabia,280savings:283 household,1,13,39,70,71,85,233,244,330,380,383ofpoor,224,275retirement,12–13,149–50,177,223,244,330ofwealthy,85,88,223,275SavingsandLoanCrisis,119,199Scandinavia,175,263,286scarcity,30Schmittberger,Rolf,126Schneiderman,Eric,374schoollunchprograms,74,102schools:for-profit,75,195,196,201,275,323,371public,75Schwarze,Bernd,126science,41,78,93,100,112,140,202,263SecuritiesandExchangeCommission(SEC),47,110,119,204–6Senate,U.S.,247BankingCommitteeof,250,319seealsoCongress,U.S.;HouseofRepresentatives,U.S.Shafir,Eldar,103Shelby,Richard,319ShermanAnti-TrustAct,317Shiller,Robert,262Shockley,William,41Simpson,AlanK.,207Singapore,19,141slavery,156,367Slim,Carlos,42,365Smith,Adam,33–34,106,313,341,363,397Sobel,Dava,109socialcapital,122–23,125,135socialDarwinism,292socialism,163socialresponsibility,100,112,120,121SocialSecurity,17,74,176,177,226,227,229,261,266,277,306,355,380SocialSecurityAdministration,305socialspending:effectsof,2,5,10,14,15,16–17,26,31,63,74,77,79,84,108,173,277incomedistributionand,30,77,79,299inresource-richcountries,40Soros,George,151Sotheby’s,360South,blackdisenfranchisementin,129,367SouthAfrica,23SovietUnion,collapseof,104,123seealsoRussiaSpain,x,xviii,16,214financialcrisisin,210,219,220,255Sprint,44Standard&Poor’s,192StandardOilCompany,42,317Stantcheva,Stefanie,114Stigler,George,44stimuluspackage,211,232–34,236,382valueof,86stockmarket,3,8,13,54,164,165–66,177,244,296,312,360,383stockoptions,110,111Strauss-Kahn,Dominique,91–92studentloans,58,94–95,195–96,201,265,271,275,323,338,370–71subprimecrisis,xvii,2,194,202,250,253,356,369legalsettlementsof,70–71profit-makingin,77seealsoforeclosures;predatorylendingsubsidies,39,40,50–51,64,81,99,179–80,189,191,213,214,216,222,320,367,379tofinancialsector,222,223,240,247,387hidden,39,40,81,99,173,191,213,214,222,223,224,240,247,272–73,367,387seealsogovernment,U.S.,munificenceofSupremeCourt,U.S.,131,132,285,317,318,350Sweden,366economicmobilityin,18financialcrisisresponsein,168,169,361financialstabilityin,220GDPof,183inequalityin,23,127laborin,230taxsystemin,22Switzerland,183tariffs,50,61,325taxes:alternativeminimum,394oncapitalgains,71–72,87,88,115,211,274,330,361,378,395corporate,62,73–74,95,115,142,179,214,215,221–22,224,225,270,272,273–74,278,283,296,331economicgrowthand,22–23,84,86,88andeconomicstimulus,216,217,218,221estate,73,76,88,166,167,274,361,395onfinancialsector,213–14,215,247,248284 globalizationand,62,63,142,278incomedistributionand,30,31,72loopholesin,42–43,72,115,212,214,215,221,222,272,273marketcorrectionthrough,34middle-classdeductionsin,222–24,379andnationaldebt,207,376onnaturalresources,39–40,213onpollution,213,215,224onpoor,74,88,218progressive,5,31,107,114–16,142,212,218,273–74,379,395Reagan’srevisionof,5,71,114,221regressive,38,74,77,79,157,208,214,237,251,299onrentseeking,39,115,212–14,215,274,395Right’sviewof,216state,74onwealthy,5,38,42–43,62,71–73,74,76,77,84,86,87–88,114,115,116,138,142,159,167,208,209,211,212,214–15,218,221,223,224,225,226,256,274,275,294,312,335,344,360,383,394technology:bubblein,85,87,88,89,211,243,391,396economicimpactof,30,79,80governmentinvestmentin,15,93,115,155,174,217,267,281,283idea-shapingand,156labordemandand,53,54–56,63,79,80,277,280,283,334monopoliesin,42,44,45–46,96andstocktrading,165telecommunications:governmentauctionof,50monopolizationin,44,97,98seealsotechnologyTEPCO,189Thaler,Richard,161Thatcher,Margaret,316Thucydides,29Tingbergen,392T-Mobile,44,203tobaccoindustry,xviii,151,160,354,357Tocqueville,Alexisde,288Townes,Charles,41ToxicAssetReliefProgram(TARP),362trade:agreementson,140,141,324–25,326austerityand,231globalizationof,61–64,144,324–25,326imbalancesin,279–80,396Treasurybills,177,208,217,396TreasuryDepartment,U.S.,61,246,253,258,353,369Tremonti,Giulio,389trust,115,120,121–26,134,346Turing,Alan,41Turkey,22,23unemployment,xii,xv,11–12,13,74,89,91,179,207,393extentof,1,10–11,15,75,301,302macroeconomicpoliciesaffecting,38,61,62,64,82,85,86,230,231,236,237,238,239,240,241,242,251,259,260,261,262,263,379inmanufacturing,54,56,57,232–33,285,321politicalimportanceof,251–52stimuluspackage’seffecton,232,236underreportingof,11,15,291,304–5ofyouth,x,xviii–xix,12,265unemploymentinsurance,xv,11–12,16,23,74,210,211,218,229,242,276,291,301,355,381,384,385UnequalDemocracy:ThePoliticalEconomyoftheNewGildedAge(Bartel),xxivUnionCarbide,189UnitedAutomobileWorkers(UAW),57UnitedKingdom,21,129,214austerityin,220,231economicmobilityin,18,19financialcrisisresponsein,171,362–63privatizationin,176,316,364UnitedNationsDevelopmentProgram(UNDP),22UnitedStates:alternativefuturesof,289averagetaxratein,72–73battleofideasin,154–55,157–59,162–86changingsocialpatternsin,14–15classdistinctionsin,xvi–xvii,20,180,292consumptionin,13,54,84–85,86,89,104–6,183,233,234,235,244,311,380,385costoflivingin,366crimein,15economichistoryof,4–5,6economicmobilityin,xv,4,5,18–19,25,94,117,147,265,267,307educationalattainmentin,55familystressesin,10,14,26,95,106,169–70globalinfluenceof,xii,137–38,143–44,145,155,254,277–78globalization’seffectin,62,63,64,184incomeinequalityin,2,3,4,7–8,9,22,24,25,26,27,29,30,53,54,55,56,57,71,72,77,79–80,81,85,86,127,153,178,183,202,233,240,241,267,294–95,296,297,298,299,300,311,328,332,335285 inequalitycyclein,xi,xii,xiv,xx,xxii,3–4,18,31,76,77,82,86–89,91,267infantandmaternalmortalityin,14,302,303internationalcomparisonsto,21–24,25,52,73,97,98,183,309,366laborforcepolarizationin,8–9,56,79,80,133,277libertyin,190lifeexpectancyin,14,303lifetimeinequalityin,26,311livingstandardsin,xii,14–15,16,24,25,26,95,98,99,183–84,240,266,267,268medianincomein,22,295–96,297,299,300neighborhoodsegregationin,75–76opportunityin,xv,3,4,17–20,25,75–76,94–95,108,116,117,126,127,160,265,266,268,273,275,282,287,290povertyin,16–17,26,27,38,84,298,305,306,311,332;seealsopoorvaluesystemof,xv,xvii,xx,144,187,266,288,289,292wealthdistributionin,2,3,7,8,13–14,24,25,32,38,56,70,72,73,76,80,82,91,93,108,147,167,171,172,202,275,295,384seealsoeconomy,U.S.;government,U.S.;politics,U.S.UniversalDeclarationofHumanRights,289,323uranium,176UruguayRoundTradeAgreement,140U.S.EnrichmentCorporation(USEC),176–77Uzbekistan,122–23VanityFair,xiVenezuela,40,138Verizon,44,203Volcker,Paul,248,314voting,119–21,137,288,325,351,355costto,119–20,350disenfranchisementin,129–31,133,134,135,345,349mandatory,135,286,352votingparadox,119–20,352wages,8,9,29,38,39,52,53–57,60,61,63,65,67,68,69,79,91,229,230,233,236,263,327,335costoflivingadjustmentsto,393discriminationin,68,69efficiencyand,102–4,340globalization’seffecton,60,61,63,277GreatRecession’seffecton,29,57,65,67,91,231,241,242,265,328,384inflationand,261minimum,242,297public-sector,57,322societalfactorsin,65,67,68,69seealsoincentivepay;inequality,incomeWagnerAct,64Wallison,PeterJ.,357WallStreetJournal,201Waltonfamily,8war,economicimpactof,101Warren,Elizabeth,193Watson,JamesD.,41wealth,dynamicsof,30–31,275wealthtransfers,32welfaresystem,17WellsFargo,70–71,374Winner-Take-AllPolitics(HackerandPierson),xxivwomen:discriminationagainst,68incomeof,299,328inlaborforce,14microcreditloansto,196words,163WorldBank,povertymeasureof,16WorldTradeOrganization(WTO),140WorldWarII,102WorldWideWebConsortium,315Yahoo!,203youth:financialsector’semploymentof,96povertyamong,17socialsituationof,14–15,265,303unemploymentamong,x,xviii–xix,12,265votingby,134,351seealsostudentloansYunus,Muhammad,196Zuckerberg,Mark,41286 Copyright©2012byJosephE.StiglitzAllrightsreservedFirstEditionForinformationaboutpermissiontoreproduceselectionsfromthisbook,writetoPermissions,W.W.Norton&Company,Inc.,500FifthAvenue,NewYork,NY10110Forinformationaboutspecialdiscountsforbulkpurchases,pleasecontactW.W.NortonSpecialSalesatspecialsales@wwnorton.comor800-233-4830Productionmanager:DevonZahnLibraryofCongressCataloging-in-PublicationDataStiglitz,JosephE.Thepriceofinequality:howtoday’sdividedsocietyendangersourfuture/JosephE.Stiglitz.—1sted.p.cm.Includesbibliographicalreferencesandindex.ISBN978-0-393-08869-4(hbk.)1.Incomedistribution—Socialaspects—UnitedStates.2.Equality—UnitedStates.3.UnitedStates—Economicconditions—21stcentury.4.UnitedStates—Socialconditions—21stcentury.I.Title.HC110.I5S8672012305.50973—dc232012014811eISBN:978-0-393-08906-6W.W.Norton&Company,Inc.500FifthAvenue,NewYork,N.Y.10110www.wwnorton.comW.W.Norton&CompanyLtd.CastleHouse,75/76WellsStreet,LondonW1T3QT1234567890287