Income Inequality: Is There Any Hope for Change?

by Hank Van den Berg
UNL Professor of Economics

The popularity of Thomas Piketty’s book, Capital in the Twenty-First Century, suggests that people are finally waking up to the fact that economic inequality has increased sharply over the past 40 years. Piketty presents a great many charts and tables, based entirely on official U.S. government data, to show that both income and wealth have become as unequal as they were during the ‘Roaring Twenties’ of capitalist excess. What is frustrating is that this rise in inequality in the U.S., the highest among all developed countries, comes after New Deal programs and subsequent social legislation actually greatly reduced inequality during the 1950s and 1960s.

Even more troubling is Piketty’s finding that just in the past five years inequality has continued to grow. The wealthiest 10 percent have recovered from the financial collapse very nicely, but the rest of the U.S. population has not. There is no sign of the growing inequality reversing itself. We must change the system; we cannot just tweak it.

Piketty’s Solution

Piketty traces the growing inequality to the relative growth of returns to capital as opposed to labor. Reasoning that the highest income earners derive relatively more of their income from stocks, bonds and other forms of business ownership, he points to the growing ease with which capital (ownership of real and financial assets) can move from one country to another as a fundamental cause of the growing inequality. Indeed, there is much evidence suggesting we are in a vigorous race-to-the-bottom tax competition among countries. Piketty therefore recommends that all countries agree to tax capital at similar rates in order to avoid this aggressive tax avoidance that corporations and financial conglomerates use to boost their earnings and push the tax burden onto geographically immobile workers and property owners.

Still, it is unfortunate that Piketty does not go much further with his recommendations. In fact, I would argue that Piketty’s recommendation for tax reform misses the real causes of inequality, which is that our economic system is designed to generate inequality.

Thorstein Veblen Knew Better

Karl Marx very clearly explained why capitalism leads to the concentration of income and wealth (accumulated income). But, since we cannot bring up Marx’s name in today’s political environment, I would like to bring up instead a good American (Midwestern) economist: Thorstein Veblen. One of America’s greatest intellectuals, Veblen is famous for his 1899 work, The Theory of the Leisure Class, a best-seller that helped to focus the population on inequality at the turn of the last century. Less known is Veblen’s 1904 work, Theory of Business Enterprise. This work presents a very lucid picture of how business firms operate and expand the wealth of their owners.

Veblen thoroughly debunks the widely promoted idea that profit-maximizing business enterprises—as if guided by an invisible hand—unknowingly act in accordance with everyone’s well-being. He presents a great many examples from his period that clearly show business, or what he calls “the going concern,” fundamentally works to enable its continued existence, which means to earn a profit, and it will do so in whatever ways are easiest and most promising. He specifically found that the going concern seeks to survive by engaging in activities that have less and less to do with general welfare, and more and more to do with their own financial gain. Veblen described the three degrees of separation that inevitably caused self-interested behavior to lose touch with general well-being.

First, going businesses ‘engineer’ their production in ways that tend to reduce the benefits to both their workers (the humans who make the production happen) and consumers (the humans who get to ‘enjoy’ the finished products). Efficiency and cost-reductions become paramount to the production process. Engineers replace labor with machines and labor-saving technologies at one end, and at the other end the economies of scale from standardization result in products that less closely match human needs and wants.

Secondly, profits gain precedence over even production. According to Veblen, the managers, accountants and marketers gain at the expense of the engineers, and the whole purpose of the business loses touch with the fundamental purpose of production of goods and services that ultimately provide for people’s needs and wants. Increasingly, managers avoid production altogether by outsourcing to other firms and countries. Also, marketers ‘create’ demand by manipulating human sensitivities through advertising and public relations activities (appropriately called “propaganda” by Veblen) in order to sell goods and services that the going concern wants to sell but people did not previously know they ‘needed.’ And the accountants dutifully sanction all this growing separation between what people truly need and want and what business wants to provide in the name of “maximizing shareholder value.”

The third degree of separation leads to a complete separation of business activities from human needs and wants. A good example here would be programmed obsolescence—a common business practice whereby a firm actually provides worse products in order to boost its sales. Or firms engage in propaganda, like Apple and other gadget producers, to hype new models in order to induce people to prematurely abandon nearly identical products they already own.

Financial firms provide another good example of Veblen’s third degree of separation. Today in the U.S., financial firms generate earnings equal to over 7 percent of gross domestic product (GDP). In the 1950s and 1960s their income equaled only 2 percent of GDP, even though the overall global economy grew faster than it has with the financial industry earning 7 percent of GDP. Financial firms, and their owners and highly-paid employees, thus have been able to capture an extra 5 percent of all national income over the past 40 years not by performing tasks (resource allocation) that benefit everyone, but by finding ways to earn income from buying and selling financial assets, charging assorted fees for routine financial procedures previously provided for free, and engineering financial bubbles. In order to deal with the growing inequality, we must grasp why and how this diversion of income happened.

It Is the System, Stupid

Our economic system indeed tends to concentrate wealth. We should expect nothing else from a system in which the dominant business organizations actually work to separate themselves from providing for the general welfare of the population. Firms tend to link their chances of survival to increasing profits, and profits can often be improved by paying workers less, outsourcing production to low-cost countries, standardizing products, reducing product quality, deceiving consumers, etc. Modern financial firms have achieved the ultimate propaganda victory by convincing everyone that moving stocks and bonds around financial markets (the average stock is now held for less than eleven minutes) somehow makes them better off!

Because he understood what business was all about, Veblen understood much better than Piketty that it would be extremely difficult to change the distribution of income and wealth. Veblen makes us appreciate how unique the New Deal really was. It took an unprecedented economic depression, a unique independent president, and a massive popular uprising to enable government to overcome the power of the business and financial elite. That this elite was able to, after 40 years of deregulation and globalization, undo the New Deal programs (persistently across both Republican and Democratic administrations) further shows how hard it is to achieve economic equality.

We Are an Oligarchy,
Not a Democracy

The reality is that business and financial corporations, with their management thoroughly separated from any need or urge to satisfy the needs and wants of their workers, suppliers, customers or the citizenry at large, aggressively use their wealth to influence the media, manipulate the social culture, and buy influence in government. This enables them to create conditions for amassing even more wealth, which they then use to further increase their control of culture, institutions and government, and so forth. That is, they use their wealth to shape the world in ways that further increase profits at the expense of workers and consumers.

The scope of corporate control in the U.S. is vividly depicted by Martin Gilens of Princeton University and Benjamin Page of Northwestern University. These professors of political science performed a tedious, but fundamentally straightforward, exercise to find out who really drives government political decisions and economic policies. Gilens and Page identified 1,779 different policy issues in the U.S., carefully classified these policies as favoring the interests of wealthy elite or the average (50th percentile in the income distribution) member of society, and then traced which of these policy issues were actually acted upon by Congress and the president. Using straightforward statistical analysis, they find zero correlation between enacted laws and policies and the interests of the average citizen and a very significant correlation between enacted laws and policies and the interests of business and the wealthy elite.

Gilens and Page thus conclude that the U.S. is not a democracy; it is an oligarchy. Specifically, they conclude:
What do our findings say about democracy in America? They certainly constitute troubling news for advocates of ‘populistic’ democracy, who want governments to respond primarily or exclusively to the policy preferences of their citizens. In the United States, our findings indicate, the majority does not rule—at least not in the causal sense of actually determining policy outcomes. When a majority of citizens disagrees with economic elites and/or with organized interests, they generally lose. Moreover, because of the strong status quo bias built into the U.S. political system, even when fairly large majorities of Americans favor policy change, they generally do not get it. (Gilens and Page (2014), “Testing Theories of American Politics: Elites, Interest Groups, and Average Citizens,” forthcoming in Perspectives on Politics.)

Hence, while polls suggest a great majority of Americans want healthcare for all, we get a costly new healthcare program that forces a few more people to buy healthcare at industry-set prices and actually undermines Medicaid and the public provisioning of healthcare. Most Americans have opposed entering foreign wars, but the federal government has nevertheless managed to start or join wars throughout our history. And, as Veblen would predict, our government, in close cooperation with business elites, is putting together two new trade agreements whose terms greatly favor capital over labor—that is, whose terms exactly contradict Piketty’s policy suggestion of taxing capital more and uniformly across countries. The oligarchic system is undoubtedly powerful.

Unfortunately, Veblen did not provide a blueprint for how we can get our democracy back—an obvious necessity if we are to forcibly reduce the degrees of separation between human well-being and the aims of business organizations.

How we achieve a popular democracy is something we need to figure out for ourselves.

Will we need another national emergency (like we had during the Great Depression), another social uprising that mobilizes and unites the public (instead of atomized ‘complaint shoppers’ acting on their own), and some authentically independent political leaders (instead of the business tools we now have in office) to change the system?

It’s hard to tell what will work. Voting for the least of two evils clearly does not work. Perhaps climate change will be the emergency that triggers the unified popular reaction that will wrestle control of our government and culture away from the business and financial elite.

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