The fierce urgency of fixing economic inequality
By Lawrence Summers
The opinions expressed are his own.
The principal problem facing the United States and Europe for the next few years is an output shortfall caused by lack of demand. Nothing would do more to increase the incomes of all citizens—poor, middle class and rich—than an increase in demand, which would bring with it increases in incomes, living standards, and confidence. A more rapid recovery than now appears likely would reverse, at least partially, a growing disillusionment with almost all institutions and doubts about the future.
It would be, however, a serious mistake to suppose that our only problems are cyclical or amenable to macroeconomic solutions. Just as evolution from an agricultural to an industrial economy had far reaching implications for society, so too will the evolution from an industrial to a knowledge economy. Witness structural trends that predate the Great Recession and will be with us long after recovery is achieved: The most important of these is the strong shift in the market reward for a small minority of persons, relative to the rewards available to everyone else. In the United States, according to a recent CBO study, the incomes of the top 1 percent of the population have, after adjusting for inflation, risen by 275 percent from 1979 to 2007. At the same time, incomes for the middle class (in the study, the middle 60 percent of the income scale) grew by only 40 percent. Even this dismal figure overstates the fortunes of typical Americans; the number unable to find work or who have abandoned the job search has risen. In 1965, only 1 in 20 men between ages 25 and 54 was not working. By the end of this decade it will likely be 1 in 6—even if a full cyclical recovery is achieved.
To highlight the disturbing trends in a different way, one calculation suggests that if income distribution had remained constant in the U.S. over the 1979-2007 period, incomes of the top 1 percent would be 59 percent or $780,000 lower and the incomes of the average member of the bottom 80 percent of the population would be 21 percent or over $10,000 dollars higher.
Those looking to remain serene in the face of these trends, or who favor policies that would disproportionately cut taxes at the high end and so exacerbate inequality, assert, for example, that what could be called “snapshot inequality” is not a problem, as long as there is mobility within people’s lifetimes and across generations. The reality is that there is too little of both. Inequality in lifetime incomes is already only marginally smaller than inequality in a single year. And tragically, according to the best available information, intergenerational mobility in the United States is now poor by international standards, and, probably for the first time in U.S. history, is no longer improving. To take just one statistic, the share of students in college coming from families in the lowest quarter of the income distribution has fallen over the last generation, while the share from the richest has actually increased. Given the pressures associated with recession, it appears that more elite American colleges and universities have dropped need-blind admissions than have adopted it in recent years.
Why has the top 1 percent of the population done so well relative to the rest of the population? Probably the answer lies substantially in changes in technology and in globalization. When George Eastman revolutionized photography he did very well, and because he needed a large number of Americans to carry out his vision, the city of Rochester had a thriving middle class for two generations. When Steve Jobs revolutionized personal computing, he and the shareholders in Apple (who are spread all over the world) did very well, but a much smaller benefit flowed to middle class American workers, both because production was outsourced and because the production of computers and software was not terribly labor intensive. In the same way, the moves from small independent bookstores to megastores like Barnes and Noble, and now to Amazon and e-books, have meant that more books at less cost are available to consumers, but also mean fewer jobs for middle class workers in retail, publishing and distribution, and greater rewards for superstar authors and entrepreneurs who are transforming the way content is delivered. One other manifestation of progress is that increasingly sophisticated financial markets have provided ever-greater opportunities for those like Warren Buffett, with the ability to detect errors in prevailing valuations, to profit handsomely.
There is no issue that will be more important to the politics of the industrialized world over the next generation than its response to a market system that distributes rewards increasingly inequitably and generates growing disaffection in the middle class. To date, the dialogue has been distressingly polarized. On one side, the debate is framed in zero-sum terms and the disappointing lack of income growth for middle class workers is blamed on the success of the wealthy. Those with this view should ask themselves whether it would be better if the U.S. had more entrepreneurs like those who founded Apple, Google, Microsoft and Facebook, or fewer. Each did contribute significantly to rising inequality. It is easy to resent the level and the extent of the increase in CEO salaries in the United States, but it bears emphasis that firms that have a single owner, such as private equity firms, often pay successful CEOs more than public companies do. And for all their problems, American global companies over the last two decades have done very well compared to those headquartered in more egalitarian societies. When great fortunes are earned by providing great products or services that benefit large numbers of people, they should not be denigrated.
At the same time, those who are quick to label any expression of concern about rising inequality as either misplaced or a product of class warfare are even further off base. The extent of the change in the income distribution is such that it is no longer true that the overall growth rate of the economy is the principal determinant of middle class income growth—how the growth pie is sliced is at least equally important. The observation that most of the increase in inequality reflects gains for those at the very top—at the expense of everyone else—further belies the idea that simply strengthening the economy will reduce inequality. Indeed, focusing on American competitiveness, as many urge, could easily exacerbate inequality while doing little for most Americans, if that focus is placed on measures like corporate tax cuts or the protection of intellectual property for companies who are not primarily producing in the United States.
What then, is the right response to rising inequality? There are today too few good ideas in the political discourse, and the development of better ones is crucial to our democracy. But here are several:
First, government must be careful to insure that it does not facilitate increases in inequality by rewarding the wealthy with special concessions. Where governments dispose of assets or allocate licenses, there is a compelling case for more use of auctions to which all have access. Where government provides insurance—implicit or explicit—it is important that premiums be set as much as possible on a market basis rather than in consultation with the affected industry. A general posture for government of standing up for capitalism rather than particular well-connected capitalists would also help.
Second, there is scope for pro-fairness, pro-growth tax reform. A time when more and more great fortunes being created and government has larger and larger deficits is hardly a time for the estate tax to be eviscerated. With smaller families and ever more bifurcation in the investment opportunities open to the wealthy, there is a real risk that the old idea of “shirt sleeves to shirt sleeves in three generations” will be obsolete, and those with wealth will be able to endow dynasties. There is no reason why tax changes in a period of sharply rising inequality should reinforce the trends in pretax incomes produced by the marketplace.
Third, the public sector must insure that there is greater equity in areas of the most fundamental importance. It will always be the case in a market economy that some will have mansions, art, and the ability to travel in lavish fashion. What is far more troubling is that the ability of children of middle class families to attend college has been seriously compromised by increasing tuitions and sharp cutbacks at public universities and colleges. At the same time, in many parts of the country, a gap has opened between the quality of the private school education offered to the children of the rich and the public school educations enjoyed by everyone else. Most alarming is the near doubling, over the last generation, in the gap between the life expectancy of the affluent and the ordinary.
Neither the politics of polarization nor those of noblesse oblige on the part of the fortunate will serve to protect the interests of the middle class in the post-industrial economy. We will have to find ways to do better.
Photo: An Occupy Wall Street demonstrator projects a message on the side of the Verizon Building during what protest organizers called a “Day of Action” in New York. REUTERS/Jessica Rinaldi