Countries with high inequality tend to underinvest in their collective… (Wes Bausmith / For The Times…)
Despite what the debt and deficit hawks would have you believe, we can't cut our way back to prosperity. No large economy has ever recovered from serious recession through austerity. But there is another factor holding our economy back: inequality.
Any solution to today's problems requires addressing the economy's underlying weakness: a deficiency in aggregate demand. Firms won't invest if there is no demand for their products. And one of the key reasons for lack of demand is America's level of inequality — the highest in the advanced countries.
Because those at the top spend a much smaller portion of their income than those in the bottom and middle, when money moves from the bottom and middle to the top (as has been happening in America in the last dozen years), demand drops. The best way to promote employment today and sustained economic growth for the future, therefore, is to focus on the underlying problem of inequality. And this better economic performance in turn will generate more tax revenue, improving the country's fiscal position.
Even supply-side economists, who emphasize the importance of increasing productivity, should understand the benefits of attacking inequality. America's inequality does not come solely from market forces; those are at play in all advanced countries. Rather, much of the growth of income and wealth at the top in recent decades has come from what economists call rent-seeking — activities directed more at increasing the share of the pie they get rather than increasing the size of the pie itself.
Some examples: Corporate executives in the U.S. take advantage of deficiencies in our corporate governance laws to seize an increasing share of corporate revenue, enriching themselves at the expense of other stakeholders. Pharmaceutical companies successfully lobbied to prohibit the federal government — the largest buyer of drugs — from bargaining over drug prices, resulting in taxpayers overpaying by an estimated half a trillion dollars in about a decade. Mineral companies get resources at below competitive prices. Oil companies and other corporations get "gifts" in the hundreds of billions of dollars a year in corporate welfare, through special benefits hidden in the tax code. Some of this rent-seeking is very subtle — our bankruptcy laws give derivatives (such as those risky products that led to the $150-billion AIG bailout) priority but say that student debt can't be discharged, even in bankruptcy.
Rent-seeking distorts the economy and makes it less efficient. When, for instance, speculation gains get taxed at a lower rate than true innovation, resources that could support productivity-enhancing activities get diverted to gambling in the stock market and other financial markets. So too, much of the income in the financial sector, including that derived from predatory lending and abusive credit card practices, derives not from making our economy more efficient but from rent-seeking.
If we curbed these abuses by the financial sector, more resources (especially the scarce talent of some of our brightest young people) might be devoted to making a stronger economy rather than to exploiting the financially unsophisticated. And the banks might actually go back to the boring business of lending rather than high-risk and often opaque speculation.
Curbing rent-seeking is not that complicated (aside from the politics). It would take better financial regulations, fairer and better-designed bankruptcy laws, stronger and better-enforced antitrust laws, corporate governance laws that limit the power of CEOs to effectively set their own pay, and, in all of these areas, more transparency. Because so much of the income at the top is from rent-seeking, more progressive taxation (and in particular, taxation of capital gains) is necessary to discourage it. And if the additional revenue is used by the government for high-return public investments, there are double benefits.
Countries with high inequality tend to underinvest in their collective well-being, spending too little on such things as education, technology and infrastructure. The wealthy don't need public schools and parks. That's another reason economies with high inequality grow more slowly. Indeed, the United States has grown much more slowly since the 1980s, while inequality has been growing more rapidly than it did in the decades after World War II, when the country grew together.