Saving Capitalism: For The Many, Not The Few

by Robert B. Reich

Laws governing bankruptcy have been altered to the further advantage of large corporations and financial institutions. In the United States, a wealthy individual can use bankruptcy to shield his fortune from investments that have gone badly, and a corporation can use bankruptcy to abrogate labor contracts. But former students who have borrowed for their education and are having difficulty repaying what they owe, or homeowners who are caught in the downdraft of a major recession and cannot meet their mortgage payments, are not allowed to reorganize their debts under bankruptcy. Here again, the consequence is a hidden redistribution upward.

The threat to capitalism is no longer communism or fascism but a steady undermining of the trust modern societies need for growth and stability.

The meritocratic claim that people are paid what they are worth in the market is a tautology that begs the questions of how the market is organized and whether that organization is morally and economically defensible. In truth, income and wealth increasingly depend on who has the power to set the rules of the game.

the biggest political divide in America in years to come will not be between the Republican and Democratic parties. It will be between the complex of large corporations, Wall Street banks, and the very rich that has fixed the economic and political game to their liking, and the vast majority who, as a result, find themselves in a fix. My conclusion is that the only way to reverse course is for the vast majority who now lack influence over the rules of the game to become organized and unified, in order to re-establish the countervailing power that was the key to widespread prosperity five decades ago.

A market—any market—requires that government make and enforce the rules of the game. In most modern democracies, such rules emanate from legislatures, administrative agencies, and courts. Government doesn’t “intrude” on the “free market.” It creates the market. The rules are neither neutral nor universal, and they are not permanent. Different societies at different times have adopted different versions. The rules partly mirror a society’s evolving norms and values but also reflect who in society has the most power to make or influence them. Yet the interminable debate over whether the “free market” is better than “government” makes it impossible for us to examine who exercises this power, how they benefit from doing so, and whether such rules need to be altered so that more people benefit from them.

those who argue for “less government” are really arguing for a different government—often one that favors them or their patrons.

Power and influence are hidden inside the processes through which market rules are made, and the resulting economic gains and losses are disguised as the “natural” outcomes of “impersonal market forces.” Yet as long as we remain obsessed by the debate over the relative merits of the “free market” and “government,” we have little hope of seeing through the camouflage.

As income and wealth have concentrated at the top, political power has moved there as well. Money and power are inextricably linked. And with power has come influence over the market mechanism. The invisible hand of the marketplace is connected to a wealthy and muscular arm.

Those who claim to be on the side of freedom while ignoring the growing imbalance of economic and political power in America and other advanced economies are not in fact on the side of freedom. They are on the side of those with the power.

In fact, in the first three decades following World War II, corporate managers saw their job as balancing the claims of investors, employees, consumers, and the public at large. The large corporation was in effect “owned” by everyone with a stake in how it performed. The notion that only shareholders count emerged from a period in the 1980s when corporate raiders demanded managers sell off “underperforming” assets, close factories, take on more debt, and fire employees in order to maximize shareholder returns.

It is illegal for Americans to shop at foreign pharmacies for cheaper versions of the same drugs sold in the United States, either branded or generic. In 2012, Congress authorized U.S. Customs to destroy any such medications. The ostensible reason is to protect the public from dangerous counterfeit drugs. But for at least a decade before then, during which time tens of millions of prescriptions were filled over the Internet, no case was reported of Americans having been harmed by medications bought online from a foreign pharmacy. The real reason for the ban is to protect the profits of U.S. pharmaceutical companies, which lobbied intensely for it.

The law allows pharmaceutical companies to pay doctors for prescribing their drugs. Over a five-month period in 2013, doctors received some $380 million in speaking and consulting fees from drug companies and device makers. Some doctors pocketed over half a million dollars each, and others received millions of dollars in royalties from products they had a hand in developing. Doctors claim these payments have no effect on what they prescribe. But why would pharmaceutical companies shell out all this money if it did not provide them a healthy return on their investment?

Drug companies pay the makers of generic drugs to delay their cheaper versions. These so-called pay-for-delay agreements, perfectly legal, generate huge profits both for the original manufacturers and for the generics—profits that come from consumers, from health insurers, and from government agencies paying higher prices than would otherwise be the case. The tactic costs Americans an estimated $3.5 billion a year. Europe doesn’t allow these sorts of payoffs. The major American drugmakers and generics have fought off any attempts to stop them.

Purchasers who check “I accept” might even relinquish their privacy rights. If you want Apple to store personal data on its iCloud, you must first agree to its terms of service, which stipulate: You are solely responsible for maintaining the confidentiality and security of your Account and for all activities that occur on or through your Account…. Provided we have exercised reasonable skill and due care, Apple shall not be responsible for any losses arising out of the unauthorized use of your Account resulting from you not following these rules. In other words, if a hacker grabs compromising photos of you off iCloud and distributes them around the world, that’s too bad. Apple isn’t responsible. Technically, you had a choice because you didn’t have to agree to Apple’s terms of service. As a practical matter, you didn’t have a choice because every other service has the same terms.

The only way graduates can reduce their student debt burden, according to a 1998 law enacted at the behest of the student loan industry, is to prove in a separate lawsuit that repayment would impose an “undue hardship” on them and their dependents. This is a stricter standard than bankruptcy courts apply to gamblers seeking to reduce their gambling debts.

Capitalism, alas, depends on trust. Without trust, people avoid even sensible economic risks. They also begin thinking that if the big guys can get away with cheating in big ways, small guys like them should be able to get away with cheating in small ways—causing even more people to distrust the economic system. Moreover, people who believe the game is rigged are easy prey for political demagogues with fast tongues and dumb ideas.

Government officials like to appear before TV cameras sounding indignant and announcing what appear to be tough penalties against corporate lawbreakers. But the indignation is for the public, and the penalties are often tiny relative to corporate earnings. The penalties emerge from settlements, not trials. In those settlements, corporations do not concede they’ve done anything wrong, and they agree, at most, to vague or paltry statements of fact. That way, they avoid possible lawsuits from shareholders or other private litigants who have been harmed and would otherwise use a conviction against them.

Yet the notion that you’re paid what you’re “worth” is by now so deeply ingrained in the public consciousness that many who earn very little assume it’s their own fault. They feel ashamed of what they see as a personal failure—a lack of brains or a deficiency of character. The same notion allows those who earn vast sums to believe they must be extraordinarily clever, daring, and superior; otherwise, they wouldn’t be doing so well. This reassuring conviction seemingly justifies not only their great wealth but also their high status in society. They would prefer not to view their money as winnings in an economic contest over whose rules they and others like them have disproportionate influence. Presumably they would prefer the public not to see it that way, either.

People are “worth” what they’re paid in the market in the trivial sense that if the market rewards them a certain amount of money they must be. Some confuse this tautology for a moral claim that people deserve what they are paid. One of the most broadly held assumptions about the economy is that individuals are rewarded in direct proportion to their efforts and abilities—that our society is a meritocracy.2 But a moment’s thought reveals many factors other than individual merit that play a role in determining earnings—financial inheritance, personal connections, discrimination in favor of or against someone because of how they look, luck, marriage, and, perhaps most significantly, the society one inhabits. “If we are very generous with ourselves,” economist Herbert Simon once said, “I suppose we might claim that we ‘earned’ as much as one fifth of [our income]. The rest is the patrimony associated with being a member of an enormously productive social system.”

If the rules governing how the market is organized took full account of the benefits to society of various roles and occupations, moreover, some people would be paid far more. Social work, teaching, nursing, and caring for the elderly or for children are among the lowest-paid professions, yet evidence suggests that talented and dedicated people in these positions generate societal benefits far out of proportion to their pay. One such study found that good teachers increase the average present value of their students’ lifetime income by $250,000 per classroom, for example. Presumably, if teaching jobs paid better they would attract many more such teachers.

As if all this weren’t enough, the tax system is biased toward the owners of wealth and against people whose income comes from wages. Capital gains are taxed at a lower rate than ordinary income. Among the biggest winners are CEOs whose options and bonuses are tied to the stock market, which can therefore be treated as capital gains when cashed in. The bull market of 2010 to 2014 gave them all fabulous after-tax windfalls.

But corporate executives and the denizens of Wall Street prefer most workers to have low wages, in order to generate higher corporate profits, which translate into higher returns for shareholders and, directly and indirectly, for themselves. This is not a winning strategy over the long term because higher returns ultimately depend on more sales, which requires that the vast middle class have enough purchasing power to buy what can be produced. But from the limited viewpoint of the CEO of a single large firm, or of an investment banker or fund manager on Wall Street, all operating globally and more concerned about the next quarter’s returns than about profits over the long term, low wages appear advantageous. Low wages are also thought to reduce the risk of inflation, which can erode the value of their assets.

In contrast to decades of nearly stagnant wage growth for most Americans, real average hourly pay in Germany has risen by almost 30 percent since 1985. And as I said earlier, while the percentage of total income going to the top 1 percent in the United States grew from 10 percent in the 1960s to well over 20 percent by 2013, the richest 1 percent of German households continues to receive about 11 percent of total income there. That percentage has remained roughly the same for four decades.

What are called “public schools” in many of America’s wealthy communities aren’t really public at all. In effect, they’re private schools, whose tuition is hidden away in the purchase price of upscale homes there, and in the corresponding property taxes.

The “self-made” man or woman, the symbol of American meritocracy, is disappearing. Six of today’s ten wealthiest Americans are heirs to prominent fortunes.

The reason for the rise of the non-working rich should by now be apparent. As income from work has become more concentrated, a relatively small number of very wealthy Americans have invested their income in capital assets. They have also invested some of it in politics—either directly, through their own contributions and connections, or indirectly, through their corporations, trade associations, and the managers of their financial portfolios.

Consider that in 1978, the richest 1 percent of households accounted for 20 percent of business income. By 2007 they accounted for 49 percent. They were also taking in 75 percent of all capital gains.

Yet the specter of an entire generation that does nothing for its money other than speed-dial its wealth management advisors is not particularly attractive. Nor is it good for our economy and society. It puts more and more of the responsibility for investing a substantial portion of the nation’s assets into the hands of a small number of people who have never had to work for their incomes and have no idea how average people live and what they need. It is also increasingly dangerous to our democracy, as dynastic wealth inevitably and invariably accumulates even more political influence and power.

Those who are rich and becoming ever more so are neither smarter nor morally superior to anyone else. They are, however, often luckier, and more privileged and more powerful. As such, their high net worth does not necessarily reflect their worth as human beings. By the same token, the vast majority who work hard for a living, and struggle against currents that are often pulling them backward and causing them to fear for themselves and their families, are not blameworthy, nor are they alone. Their voices, however, have become muted and many have grown disillusioned or cynical. The laborer who told me that he could have earned more if he “had the brains for it” saw his low pay and lowly status as the product of his own failings rather than of an economic system that has failed him by denying him sufficient bargaining power to do better. Meanwhile, the poor who cannot find their way out of poverty are not losers or failures, either, although that is how many of them view themselves. The far more significant fact is they are utterly powerless in society.

I am not accusing the wealthy of doing anything nefarious or intentionally harmful. There is no reason to suppose that top corporate executives, the successes of Wall Street, and other “high-worth” individuals have conspired to hijack the American economy for themselves. Each has merely behaved rationally in pursuit of his or her private interests. As their wealth has increased, so has their political power, and they have quite naturally used that power to enlarge and entrench their wealth. We can criticize them for being selfish and greedy, but they are no more selfish or greedy than are most other people. And some have been enormously generous with their wealth.

The “free market” serves as a smoke screen for all this. Because of it, the system for distributing economic gains appears to be the natural and inevitable result of neutral forces. The meritocratic ideal presumes that people are paid roughly in proportion to their worth. Those who are paid very little for their work are assumed to be “worth” no more than they receive, and those who are paid a great deal are assumed to be worth no less. It is a small step to view such payments as corresponding to what people deserve in a moral sense. Within this preferred vision of an American meritocracy, the amount of one’s income is equated with one’s virtue, and net worth with moral worth. Attempts to constrain high incomes with taxes or supplement low incomes through government transfers are thereby seen as intrusions into the market that risk undermining efficiency, distorting incentives, and compromising the moral underpinnings of meritocracy.

In 2008, the debt bubble burst, just as a similar bubble had burst in 1929. It is not coincidental that 1928 and 2007 marked the two peaks of income concentration in America over the last hundred years, in which the richest 1 percent raked in more than 23 percent of total income. The economy cannot function without the purchasing power of a large and growing middle class.

This trend is not sustainable, neither economically nor politically. In economic terms, as the middle class and poor receive a declining share of total income, they will lack the purchasing power necessary to keep the economy moving forward. Direct redistributions from the rich sufficient to counter this would be politically infeasible. Meanwhile, as ever-larger numbers of Americans conclude that the game is rigged against them, the social fabric will start to unravel.

In summary, when people feel that the system is unfair and arbitrary and that hard work does not pay off, we all end up losing. This is due to several related negative consequences, including widespread cheating or stealing, mounting distrust, and a willingness to forgo joint gains for the sake of preventing those who are well-off from becoming even better off. The gross national product may nonetheless rise due to additional spending on security personnel, accountants, auditors, lawyers, screening devices, monitoring equipment, and so on, but these defensive expenditures do not improve the quality of life of the typical American.

When capitalism ceases to deliver economic gains to the majority, it eventually stops delivering them at all—even to a wealthy minority at the top.

If history is any guide, reform is likely to begin in America and inspire reform elsewhere. That’s because Americans have always tended to choose pragmatism over ideology. When we have recognized a problem and understood the reason for it, our habit has been to get on with the messy job of solving it. Whenever capitalism has before reached points of crisis, we have not opted for communism or fascism or any other grand scheme. Again and again we have saved capitalism from its own excesses by making necessary corrections. We have counteracted whatever political and economic power has become too concentrated for the system to sustain itself. It is time for us to do so again.

In 1964, just 29 percent of voters believed that government was “run by a few big interests looking out for themselves.” But by 2013, that opinion predominated, with 79 percent of Americans agreeing.

The only way back toward a democracy and economy that work for the majority is for the majority to become politically active once again, establishing a new countervailing power. The moneyed interests will continue to do what they do best—make money. The rest of us must do what we do best—use our voice, our vigor, and our votes to wrest back economic and political control.

If we are able to rid ourselves of the notions that the “free market” exists separately from government, and that people earn what they are worth to society, it will be possible for Americans to view more clearly the underlying choice: not more or less government, but a government responsive either to the demands of a wealthy minority becoming ever wealthier or to the needs of a majority that is becoming relatively poorer and less economically secure. We could then move beyond the ideological brawls that have consumed so much of the political right and left and attend instead to the central challenge of our time—restoring countervailing power to our political-economic system.

Moneyed interests do not want the curtain of the “free market” lifted because that would expose their influence over the rules of the capitalist game and reveal potential alliances that could countervail that power. They would prefer the bottom 90 percent continue to preoccupy themselves with tendentious battles over government’s size (or that it war over noneconomic issues such as same-sex marriage, abortion, guns, race, and religion) than find common economic cause.

Many are also struggling with a financial system whose rules are crafted and enforced by the biggest banks on Wall Street, which have grown bigger after the bailout: small-business owners, who are paying substantially higher interest rates on loans, if they can get loans at all; former students buried under student loan debts; homeowners who owe more on their mortgages than their homes are worth. Others are up against an intellectual property system whose entry barriers are impossibly high: individual inventors trying to bring their ideas to life, lone entrepreneurs trying to start companies, creative artists seeking audiences for their works, consumers merely wanting to share designs or images. Or they are paying through the nose for access to platforms and networks that are costly solely because their corporate owners have created a standard that everyone has to use because so many others are using it—and the corporate owners have been able to hold antitrust enforcers at bay.

the bottom 90 percent of Americans—regardless of whether they are owners of small businesses or working poor, entrepreneurs or student debtors, small investors or homeowners, white or black or Latino, men or women—have far more in common, economically, than they do with the top executives of large corporations, the Wall Street crowd, or America’s wealthy. The bottom 90 percent are losing ground in large part because of upward pre-distributions embedded inside “free market” rules over which those at the top have great influence. If the smaller players understood this dynamic, presumably they would seek to gain greater influence by allying themselves. This alliance, or set of alliances, would form the new countervailing power.

There is simply no way the American economy can be sustained if the richest 10 percent continue to reap all the economic gains while the poorest 90 percent grow poorer; there is no way American democracy can be maintained if the voices of the vast majority continue to be ignored.

Unless one or both of the two major parties in the United States shift away from the established centers of political and economic power, the new countervailing power could emerge in the form of a new party that unites the disaffected, anti-establishment elements of both major parties and gives the 90 percent of Americans who have been losing ground their own political voice.

In a Gallup poll conducted in September 2014, only 35 percent of Americans believed the two major parties adequately represented them, and 58 percent of Americans thought that the Democratic and Republican parties do such a poor job representing the American people that a third major party is needed. This is one of the highest percentages Gallup found since it first raised the question of a third party a decade before. The prior high point in expressed desire for a third party occurred in October 2013, during the partial federal government shutdown. Interestingly, 46 percent of self-described Republicans as well as 47 percent of self-described Democrats feel a third party is needed.

A viable third party is likely to emerge only if both the Democratic and Republican parties are so dependent on big business and Wall Street that neither is able to respond to the emerging views and needs of the vast majority at this juncture in history. Whether it comes about through adaptation by one of the current dominant parties or the emergence of a new third party is less important than that countervailing power be re-established in America. No one should expect this to occur smoothly or easily. The moneyed interests have too much at stake in the prevailing distribution of income, wealth, and political power to passively allow countervailing power to re-emerge. While they would be wise to support it for all the reasons I have enumerated above—mostly, they will do better with a smaller share of a faster-growing economy whose participants enjoy more of the gains and will be more secure in an inclusive society whose citizens feel they are being heard—they will nonetheless resist. The status quo is too comfortable, and the prospect of countervailing power too risky and unpredictable. Yet its re-emergence is inevitable. We cannot continue in the direction we are now headed.

Why should shareholders take prominence over employees? As I have noted, corporations are nothing more than collections of contracts and property rights. They are not “owned” by shareholders the way ordinary goods are owned. It is common for the individual shareholders of large companies to be blissfully unaware of which specific companies they own, or for how long, because their ownership is through pension funds or mutual funds that tend to move quickly into and out of shares of stock, seeking quick speculative gains. If nothing else, high-frequency trading illustrates the irrelevance of stock ownership to effective corporate governance. Shareholder “ownership” is therefore a legal fiction. So is the idea that CEOs and other corporate executives have a fiduciary duty to maximize the value of corporations’ shares of stock. Corporate charters, issued by states, require no such thing. While shareholders select a corporation’s directors, the directors are under no legal obligation to put their interests above all others. Indeed, as we’ve seen, the idea that the sole purpose of a corporation is to maximize shareholder value is relatively new, dating back only to the 1980s. The dominant view in the first decades after World War II was that corporations had responsibilities to all of their stakeholders.

shareholders are not the only parties who invest in the corporation and bear a risk that their investments will drop in value. Workers who have been with the firm for many years may have developed skills and knowledge unique to it. Others may have moved their families to take a job with the firm, buying homes in the community. The community itself may have invested in roads and other infrastructure to accommodate the corporation. By contrast, most shareholders of a large corporation do not put their money into enlarging its productive capacity because most of the value of the stock market has little to do with new infusions of cash. Stocks are more like a vast collection of baseball cards, repeatedly traded.

Where will this end? Imagine a small box—let’s call it an iEverything—capable of producing for you everything you could possibly desire, a modern-day Aladdin’s lamp. You would simply tell it what you want, and—presto!—that item would arrive at your feet. The only problem is that no one will be able to buy it, because no one will have any means of earning money, since the iEverything will do it all. This is obviously fanciful, but when more and more can be done by fewer and fewer people, the profits will go to an ever-smaller circle of executives and owner-investors, leaving the rest with less and less money to buy what can be produced because we will either be unemployed or in low-paying jobs. The economic model that predominated through most of the twentieth century was mass production by many for mass consumption by many. That no longer holds. The model of the future seems likely to be unlimited production by a handful for consumption by whoever can afford it.

Entitled Agrarian Justice and published in 1797, Paine’s essay proposed that every American man and woman be paid fifteen pounds when he or she turned twenty-one, a sum that would serve as a basic minimum income. Revenues for this would come from a tax on the inheritance of land. This, Paine reasoned, would foster economic independence, so crucial to the budding democracy. In setting out the argument for his proposal he noted that private property was a human contrivance.