The Price of Inequality: How Today's Divided Society Endangers Our Future

by Joseph E. Stiglitz

executives in other countries around the world emulate their American counterparts. The UK’s High Pay Commission reported that the executive pay at its large companies is heading toward Victorian levels of inequality, vis-à-vis the rest of society (though currently the disparity is only as egregious as it was in the 1920s).90 As the report puts it, “Fair pay within companies matters; it affects productivity, employee engagement and trust in our businesses. Moreover pay in publicly listed companies sets a precedent, and when it is patently not linked to performance, or rewards failure, it sends out the wrong message and is a clear symptom of market failure.”91

the United States not only has the highest level of inequality among the advanced industrial countries, but the level of its inequality is increasing in absolute terms relative to that in other countries. The United States was the most unequal of the advanced industrial countries in the mid-1980s, and it has maintained that position.92 In fact, the gap between it and many other countries has increased: from the mid-1980s France, Hungary, and Belgium have seen no significant increase in inequality, while Turkey and Greece have actually seen a decrease in inequality. We are now approaching the level of inequality that marks dysfunctional societies—it is a club that we would distinctly not want to join, including Iran, Jamaica, Uganda, and the Philippines.93

All of the Scandinavian countries rank much higher than the United States, and each provides not only universal education but also health care to its citizens. The standard mantra in the United States claims that the taxes required to finance these benefits stifle growth. Far from it. Over the period 2000 to 2010, high-taxing Sweden, for example, grew far faster than the United States—the country’s average growth rates have exceeded those of the United States—2.31 percent a year versus 1.85 percent.95 As a former finance minister of one of these countries told me, “We have grown so fast and done so well because we had high taxes.” Of course, what he meant was not that the taxes themselves led to higher growth but that the taxes financed public expenditures—investments in education, technology, and infrastructure—and the public expenditures were what had sustained the high growth—more than offsetting any adverse effects from the higher taxation.

In a modern economy government sets and enforces the rules of the game—what is fair competition, and what actions are deemed anticompetitive and illegal, who gets what in the event of bankruptcy, when a debtor can’t pay all that he owes, what are fraudulent practices and forbidden. Government also gives away resources (both openly and less transparently) and, through taxes and social expenditures, modifies the distribution of income that emerges from the market, shaped as it is by technology and politics.

Economists have a name for these activities: they call them rent seeking, getting income not as a reward to creating wealth but by grabbing a larger share of the wealth that would otherwise have been produced without their effort.

Markets by themselves often fail to produce efficient and desirable outcomes, and there is a role for government in correcting these market failures, that is, designing policies (taxes and regulations) that bring private incentives and social returns into alignment. (Of course, there are often disagreements about the best way of doing it. But few today believe in unfettered financial markets—their failures impose too great a cost on the rest of society—or that firms should be allowed to despoil the environment without restriction.)

The term “rent” was originally used to describe the returns to land, since the owner of land receives these payments by virtue of his ownership and not because of anything he does. This stands in contrast to the situation of workers, for example, whose wages are compensation for the effort they provide. The term “rent” then was extended to include monopoly profits, or monopoly rents, the income that one receives simply from the control of a monopoly. Eventually the term was expanded still further to include the returns on similar ownership claims. If the government gave a company the exclusive right to import a limited amount (a quota) of a good, such as sugar, then the extra return generated as a result of the ownership of those rights was called a “quota-rent.”

Government, as we have seen, shapes market forces. But so do societal norms and social institutions. Indeed, politics, to a large extent, reflects and amplifies societal norms. In many societies, those at the bottom consist disproportionately of groups that suffer, in one way or another, from discrimination. The extent of such discrimination is a matter of societal norms.

A phenomenon akin to what happened in agriculture in the Great Depression may be happening in large swaths of today’s job market. Then increases in agricultural productivity raised the supply of agricultural products, driving down prices and farm incomes relentlessly, year after year, with an occasional exception from a bad harvest. At points, and especially at the beginning of the Depression, the fall was precipitous—a decline of half or more in farmers’ income in three years. When incomes were declining more gradually, workers migrated to new jobs in the cities, and the economy went through an orderly, if difficult, transition. But when prices fell precipitously—and the value of housing and other assets that the farmers owned fell concomitantly—people were suddenly trapped on their farms. They couldn’t afford to move, and their decreased demand for goods made in urban factories caused unemployment in the cities as well.

How, then, can globalization’s advocates claim that everybody will be better off? What the theory says is that everybody could be better off. That is, the winners could compensate the losers. But it doesn’t say that they will—and they usually don’t. In fact, globalization’s advocates often claim that globalization means that they can’t and shouldn’t do this. The taxes that would have to be levied to help the losers would, they claim, make the country less competitive, and in our highly competitive globalized world countries simply can’t afford that. In effect, globalization hurts those at the bottom not only directly but also indirectly, because of the induced cutbacks in social expenditures and progressive taxation.

the decline of unions, from 20.1 percent of wage- and salary-earning U.S. workers in 1980 to 11.9 percent in 2010.31 This has created an imbalance of economic power and a political vacuum. Without the protection afforded by a union, workers have fared even more poorly than they would have otherwise. Market forces have also limited the effectiveness of the unions that remain. The threat of job loss by the moving of jobs abroad has weakened their power. A bad job without decent pay is better than no job. But just as the passage of the Wagner Act during Franklin Delano Roosevelt’s presidency encouraged unionization, Republicans at both the state and the federal levels, in the name of labor flexibility, have worked to weaken them.

Gradually, beginning in the 1980s and 1990s, management realized that the measures taken to fend off outside attacks, combined with weaker unions, also meant that they could take a larger share of the corporate rents for themselves with impunity. Even some financial leaders recognized that “executive compensation in our deeply flawed system of corporate governance has led to grossly excessive executive compensation.”39

Norms of what was “fair” changed too: the executives thought little of taking a bigger slice of the corporate pie, awarding themselves large amounts even as they claimed they had to fire workers and reduce wages to keep the firm alive. In some circles, so engrained did these schizophrenic attitudes to “fairness” become that early in the Great Recession an Obama administration official could say, with a straight face, that it was necessary to honor AIG bonuses, even for the officials who had led the company to need a $182 billion bailout, because of the sanctity of contracts; minutes later he could admonish autoworkers to accept a revision of their contract that would have lowered their compensation enormously.

In December 2011, four to seven years after the subprime lending occurred, Bank of America agreed to a $335 million settlement for its discriminatory practices against African Americans and Hispanics, the largest settlement ever over residential fair lending practices. Wells Fargo and other lenders have been similarly accused of discriminatory practices; Wells, the country’s largest home mortgage lender, paid the Fed $85 million to settle charges that it had brought. In short, discrimination in lending was not limited to isolated instances, but was a pervasive practice.

The top marginal tax rate was lowered from 70 percent under Carter to 28 percent under Reagan; it went up to 39.6 percent under Clinton and down finally to 35 percent under George W. Bush.54 This reduction was supposed to lead to more work and savings, but it didn’t.55 In fact, Reagan had promised that the incentive effects of his tax cuts would be so powerful that tax revenues would increase. And yet, the only thing that increased was the deficit. George W. Bush’s tax cuts weren’t any more successful: savings did not increase; instead the household savings rate fell to a record low (essentially zero).

Many states don’t even make a pretense at progressivity, that is, having a tax system that makes the 1 percent, who can afford it, pay a larger fraction of their income than the poor have to pay. Instead, the sales tax offers a major source of revenue, and because the poor spend a larger fraction of their income, such taxes are often regressive.68

While tax policies can either let the rich get richer or restrain the growth of inequality, expenditure programs can play an especially important role in preventing the poor from becoming poorer. Social Security has almost eliminated poverty among the elderly. Recent research has shown how large these effects can be: the earned-income tax credit, which supplements the income of poor working families, by itself lowers the poverty rate by 2 percentage points. Housing subsidies, food stamps, and school lunch programs all have big effects in lowering poverty.69 A program like the provision of health insurance for poor kids can bring benefits to millions and help ensure that these children have a lower risk of being handicapped for life by an illness or other health problem; this stands in marked contrast to some of the corporate subsidies or tax loopholes that cost much more and the benefits of which go to far fewer people. The United States spent far more on its big bank bailout, which helped the banks to maintain their generous bonuses, than it spent to help those who were unemployed as a result of the recession that the big banks brought about. We created for the banks (and other corporations, like AIG) a much stronger safety net than we created for poor Americans.

Many of the poor have traditionally lived in close proximity to the rich—partly because they provided services to them. This phenomenon in turn led to public schools with students from diverse social and economic backgrounds. As a recent study by Kendra Bischoff and Sean Reardon of Stanford University shows, that is changing: fewer poor are living in proximity to the rich, and fewer rich are living in proximity to the poor.

Community quality depends on residents’ efforts to prevent crime and improve local governance, and the payoff to an individual making that effort is greater for homeowners than for renters, and generally greater for those who live in communities where many other residents make similar efforts to render local government more responsive to community members. Thus there are economic forces that lead from differences in household wealth (and homeownership) to differences in the civic quality of the community in which a household lives.73 U.S. policy to increase low-income ownership rates reflects the understanding that homeownership rates affect neighborhood quality and that growing up in a violent, crime-ridden neighborhood impairs health, personal development, and school outcomes. But homeownership—a major way in the United States that households access better neighborhoods and also accumulate wealth—is not sustainable for households with no wealth to start with and little income.

For instance, the Federal Reserve responded to the 1991 recession with low interest rates and the ready availability of credit, helping to create the tech bubble, a phenomenal increase in the price of technology stocks accompanied by heavy investment in the sector. There was, of course, something real underlying that bubble—technological change, brought about by the communications and computer revolution. The Internet was rightly judged to be a transformative innovation. But the irrational exuberance on the part of investors went well beyond anything that could be justified. Inadequate regulation, bad accounting, and dishonest and incompetent banking also contributed to the tech bubble. Banks famously had touted stocks that they knew were “dogs.” “Incentive” pay provided CEOs with incentives to distort their accounting, to show profits that were far larger than they actually were. The government could have reined this in by regulating the banks, by restricting incentive pay, by enforcing better accounting standards, and by requiring higher margins (the amount of cash that investors have to put down when they buy stock). But the beneficiaries of the tech bubble—and especially the corporate CEOs and the banks—didn’t want the government to intervene: there was a party going on, and it was a party that lasted for several years. They also believed (correctly, as it turned out) that somebody else would clean up the mess. But the politicians of the era were also beneficiaries of ...

George W. Bush succeeded in getting a tax cut targeted at the rich through Congress. Much of the tax cut benefited the very rich: a cut in the rate on dividends, which was reduced from 35 percent to 15 percent, a further cut in capital gains tax rates, from 20 percent to 15 percent, and a gradual elimination of the estate tax.7 But because, as we have noted, the rich save so much of their income, such a tax cut provided only a limited stimulus to the economy. Indeed, as we discuss next, the tax cuts had even some perverse effects. Corporations, realizing that the dividend tax rate was unlikely to remain so low, had every incentive to pay out as much as they felt that they could do safely—without jeopardizing too much the future viability of the firm. But that meant smaller cash reserves left on hand for any investment opportunities that came along. Investment, outside of real estate, actually fell,8 contrary to what some on the right had predicted.9 (Part of the reason for the weak investment, of course, was that during the tech bubble many firms had overinvested.) By the same token, the cut in the estate tax may have discouraged spending; the rich could now safely stow away more money for their children and grandchildren, and they had less incentive to give away money to charities that would have spent the money on good causes.10 Strikingly, the Fed and its chairman at the time, Alan Greenspan, didn’t learn the lessons of the tech bubble. But this was in part because of t...

In the aftermath of the Great Depression, an event preceded by similar excesses, the country enacted strong financial regulations, including the Glass-Steagall Act in 1933 (the law separated investment banks, which managed rich people’s money and issued bonds and stocks, from commercial banks, which are concerned with ordinary people’s money and make loans). These laws, effectively enforced, served the country well: in the decades following passage, the economy was spared the kind of financial crisis that had repeatedly plagued this country (and others). With the dismantling of these regulations in 1999, the excesses returned with even greater force: bankers quickly put to use advances in technology, finance, and economics. The innovations offered ways to increase leverage that circumvented the regulations that remained and that the regulators didn’t fully understand, new ways of engaging in predatory lending, and new ways to deceive unwary credit card users.

The economist Sendhil Mullainathan and psychologist Eldar Shafir have found evidence from experiments that living under scarcity often leads to choices that exacerbate the conditions of scarcity: “The poor borrow at great cost and stay poor. The busy [the time-poor] postpone when they have little time only to become busier.”

In the previous pages, I explained how inequality—in all of its dimensions—has been bad for our economy. As we saw in earlier chapters, there is also a counternarrative, advanced primarily by those on the political right, which focuses on incentives. In this view incentives are essential for making an economy work, and inequality is the inevitable consequence of any incentive system, since some will produce more than others. Any program of redistribution will accordingly necessarily attenuate incentives. Proponents of this view argue, too, that it is wrong to fixate on the inequality of outcomes, particularly in any single year. What matters is lifetime inequality, and what matters even more is opportunity. They then maintain that there is a trade-off between efficiency and equality. While different people may differ in how much efficiency one would be willing to give up to get more equality, in the view of the Right the price we have to pay for any more equality in America is just too great. Indeed, it’s so high that even the middle and the bottom, especially those who depend on government programs, would likely suffer; with a weaker economy, incomes for all would be down, tax revenues would be lower, and government programs would have to be cut. We have argued in this chapter, to the contrary, that we could have a more efficient and productive economy with more equality. In this section, I recap the essential points of divergence: The Right has in mind a perfectly compet...

Mentions Europe but not that EU growth isn't high. The biggest evidence in favor of US lack of social net may be the competitiveness of its companies. The selective comparisons he makes degrades his point.

Stock option incentive pay rewarded executives when there was a stock market boom for which they could fairly claim no credit. It also gave CEOs a big bonus whenever the price of what they sold soared or the price of a critical input fell—regardless of whether there was anything they had done to bring these price changes about. Fuel costs are critical for airlines, meaning that airline CEOs got a bonus anytime the price of oil fell. A good incentive system might base pay on how the company performs relative to others in the industry, but few firms do this. That’s testimony either to their lack of understanding of incentives or to their lack of interest in having a reward structure that is related to performance, or to both.

police states provide rules and punishments for disobeying. It is a system of compliance based on “incentives”—the incentives of threats. But such societies typically do not function well. The enforcers cannot be everywhere to make good on the threats, and if there is a sense that the rules and regulations are unfair, there will be attempts at circumvention. It will be expensive to achieve compliance, and even then it will be only partial. Productivity will be low, and life will be unpleasant. The democratic alternative entails trust and a social compact, an understanding of the responsibilities and rights of different individuals. We tell the truth because it is the right or moral thing to do—knowing the costs imposed on others of the breakdown of the system of trust.

In a series of experiments initially conducted by three German economists, Werner Güth, Rolf Schmittberger, and Bernd Schwarze, a subject was given a certain amount of money, say $100, and was told to divide it between himself and the other player in the game.13 In the first version, called the dictator game, the second player has to accept what he is given. Standard economic theory provides a clear prediction: the first player keeps all of the $100 for himself. Yet in practice, the first player gives the second something, though usually less than half.14 A related experiment gives even stronger evidence of the importance that individuals attach to fairness: most individuals would rather accept an inefficient outcome—even hurting themselves—than an unfair one. In what is known as the ultimatum game, the second player has the right to veto the division proposed by the first player. If the second player exercises his veto, neither party gets anything. Standard economic theory suggests a clear strategy: the first player keeps 99 dollars for himself, giving 1 dollar to the other player, who accepts it, because 1 dollar is better than zero. In fact, offers typically average about 30 to 40 dollars (or 30–40 percent of the total sum in a game with different quantities), and the second player tends to veto the allocation if he is offered less than 20 dollars.15 He is willing to accept some inequity—he realizes he is in the less powerful position—but there is a limit to how much in...

The reluctance of the elites to extend the voting franchise, however objectionable from current perspectives, is understandable. In the UK, until the Reform Act of 1832, only large property owners or people of considerable wealth could vote. The elites didn’t trust what might happen if voting rights were extended. In the Jim Crow South at the end of the nineteenth century, white politicians devised poll taxes that were designed to disenfranchise the former slaves and their descendants, who wouldn’t have the wherewithal to pay.28 Those taxes, combined with literacy tests and sometimes violence and terror, succeeded both in substantially lowering electoral turnouts and in increasing the Democratic vote share.29 In Ecuador, before 1979, only the literate could vote, and the ruling elite made sure that the indigenous people didn’t have sufficient education to qualify. In each case elites feared they would lose their position of power and privilege, and even their wealth, if they extended the voting franchise. Many of the efforts at disenfranchisement, now and in the past, have been directed at disenfranchising the poor; in the 1930s, pauper exclusion laws disenfranchised jobless men and women who were receiving relief.

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.

India had its own version of a subprime mortgage crisis: the hugely successful microcredit schemes that have provided credit to poor farmers and transformed their lives turned ugly once the profit motive was introduced. Initially developed by Muhammad Yunus of the Grameen Bank and Sir Fazle Hasan Abed of BRAC in Bangladesh, microcredit schemes transformed millions of lives by giving the poorest, who had never banked, access to small loans. Women were the main beneficiaries. Allowed to raise chickens and engage in other productive activities, they were able to improve living standards in their families and their communities. But then for-profit banks discovered that there “was money at the bottom of the pyramid.”27 Those on the bottom rung had little, but they were so numerous that taking a small amount from each of them was worth it. Banks all over the world enthusiastically embraced microfinance for the poor. In India the banks seized upon the new opportunities, realizing that poor Indian families would pay high interest rates for loans not just to improve livelihoods but to pay for medicines for sick parents or to finance a wedding for a daughter.28 They could cloak these loans in a mantle of civic virtue, describing them as “microcredit,” as if they were the same thing that Grameen and BRAC were doing in neighboring Bangladesh—until a wave of suicides from farmers overburdened with debt called attention to the fact that they were not the same.

The administration’s response to the massive violations of the rule of law by the banks reflects our new style of corruption: the Obama administration actually fought against attempts by states to hold the banks accountable. Indeed, one of the federal-government controlled banks36 threatened to cease doing business in Massachusetts when that state’s attorney general brought suit against the banks. Massachusetts attorney general Martha Coakley had tried to reach a settlement with the banks for over a year, but they had proved intransigent and uncooperative. To them the crimes they had committed were just a matter for negotiation. The banks (she charged) had acted both deceptively and fraudulently; they had not only improperly foreclosed on troubled borrowers (citing fourteen instances), relying to do so on fraudulent legal documentation, but they had also, in many cases, promised to modify loans for homeowners and then reneged on the promise. The problems were not accidental but systematic, with the MERS recording system “corrupting” the framework put into place by the state for recording ownership. The Massachusetts attorney general was explicit in rejecting the “too big to be accountable” argument: “The banks may think that they are too big to fail or too big to care about the impact of their actions, but we believe they are not too big to have to obey the law.”

The critical point to bear in mind in thinking about deficit reduction is that the recession caused the deficits, not the other way around. More austerity will only worsen the downturn, and the hoped-for improvement in the fiscal position will not emerge.

The causes of the reversal in the U.S. fiscal position provide a clear prescription for how to put it on a firm foundation: reverse the Bush era tax cuts for millionaires, end the wars and scale back defense spending, allow the government to negotiate drug prices, and, most importantly, put the country back to work. Restoring the country to full employment would do more than anything else to improve the country’s fiscal position.

There are other ways of raising revenues—simply stop giving away resources at below-market prices to oil, gas, and mining companies. The giveaways can be thought of as a subsidy to these companies. The government needs to make sure that it’s not giving away willy-nilly billions of dollars, as it does when it allows TV stations to use spectrum without charge, when it allows mining companies to pay a minimal royalty, rather than auctioning off the rights to exploit these natural resources, when it conducts a fire sale on oil and gas leases, rather than a well-designed auction to maximize the revenue to the public.

Doesn't address the additional barrier to entry created by taxes, good or bad.

Levying additional taxes involves a simple principle: go where the money is. Since money has been increasingly going to the top, that’s where additional tax revenues have to come from. It’s really that simple. It used to be said that the top didn’t have enough money to fill the hole in the deficit; but that’s becoming less and less true. With those in the top 1 percent getting more than 20 percent of the nation’s income, an incremental 10 percent tax on their income (without loopholes) would generate revenues equal to some 2 percent of the nation’s GDP.

There is another strategy that can stimulate the economy, even if there is an insistence that the deficit now not increase; it is based on a long-standing principle called the balanced-budget multiplier. If the government simultaneously increases taxes and increases expenditure—so that the current deficit remains unchanged—the economy is stimulated. Of course, the taxes by themselves dampen the economy, but the expenditures stimulate it. The analysis shows unambiguously that the stimulative effect is considerably greater than the contractionary effect. If the tax and expenditure increases are chosen carefully, the increase in GDP can be two to three times the increase in spending.23 And while the deficit is neither increased nor decreased immediately—by assumption—the national debt is decreased over the intermediate term, because of the increased tax revenues from the increased growth that is brought about.

Raising taxes on the very rich reduces spending by at most around 80 cents on the dollar; lowering taxes at the bottom increases spending at almost 100 cents on the dollar. Hence making the tax system more progressive not only reduces inequality but stimulates the economy as well.

Europe’s crisis is not an accident, but it’s not caused by excessive long-term debts and deficits or by the “welfare” state. It’s caused by excessive austerity—cutbacks in government expenditures that predictably led to the recession of 2012—and a flawed monetary arrangement, the euro. When the euro was introduced, most disinterested economists were skeptical. Changes in exchange rates and interest rates are critical for helping economies adjust. If all of the European countries were buffeted by the same shocks, then a single adjustment of the exchange rate and interest rate would do for all. But different European economies are buffeted by markedly different shocks. The euro had taken away two adjustment mechanisms, and put nothing in its place. It was a political project; politicians thought that sharing a currency would move the countries closer together, but there wasn’t enough cohesion within Europe to do what needed to be done to make the euro work. All they agreed upon was not to have too large deficits and debts. But as Spain and Ireland so aptly showed, that wasn’t enough. There was hope that over the years, the political project would be finished. But when things were going well, there was no momentum to do anything further; and after the crisis, which affected different countries so differently, there was no will. The countries could agree only on further belt tightening, which forced Europe into a double-dip recession.

This book has argued that, in many ways, our economic system has benefited those at the top, at the expense of the rest, and that this system is far removed from what has been called “the achievement model of income determination,” in which incomes reflect contributions to society. In this chapter we focus on the contribution of our macroeconomic policy to this outcome—before, during, and after the crisis.

We’ve already noted a number of ways that the Fed helped the banks and the bankers, especially in the crisis. The Federal Reserve lends to the banks at very low interest rates, rates that, especially in times of crisis, are far below the market rate. If a bank can borrow at close to zero, and buy a long-term government bond yielding, say, 3 percent, it makes a nifty 3 percent profit for doing nothing.13 Lend the banking system a trillion dollars a year, and that’s a $30 billion gift. But banks can often do better—they can lend to triple A–rated firms, prime customers, at much higher interest rates. If they can lend at just 10 percent, then the government’s willingness to lend them a trillion dollars at close to zero interest rate is a $100 billion a year gift.14

Maintaining the kind of society and the kind of government that serve all the people—consistent with principles of justice, fair play, and opportunity—doesn’t happen by itself. Somebody has to look after it. Otherwise our government and our institutions get captured by special interests. At the very least, we need countervailing powers. But our society and our polity have grown off kilter. All human institutions are fallible; all have their weaknesses. No one proposes abolishing large corporations because so many exploit their workers or damage the environment or engage in anticompetitive practices. Rather, we recognize the dangers, we impose regulations, we attempt to alter behavior, knowing that we will never fully succeed, but that these reforms can improve behavior. And yet, our attitude toward unions has been the opposite. They are vilified, and in many states there are explicit attempts to undermine them, but there is no recognition of the important role that they can play in countervailing other special interests and in defending the basic social protections that are necessary if workers are to accept change and to adjust to the changing economic environment.