September 10, 2007
Liberalism and the New Inequality
The 2008 financial crisis and Great Recession that followed offered a bracing rebuke to those of us who had reassured ourselves that the increasingly unequal American economy would self-correct once it reached some natural trigger point of unfairness. After the 1929 crash, which was preceded by similarly high levels of inequality, top earners saw their share of national income shrink by one-third, and then continue to shrink until 1969. Many progressives hoped something similar would occur after the collapse of 2008, but no such correction was forthcoming. American inequality is nearly as high today as it was before the crash.
One obvious difference is that, in 1929, government intervention was minimal: there were no bank bailouts, auto rescues, or stimulus efforts. The free market was left to destroy fortunes, ill-gained or not, thereby reducing gross inequalities in wealth. But greater equality after the crash came at a very high price: the Great Depression. So while the response to the 2008 crisis sustained the top-heavy structure of the American economy, it also averted the free fall that threw tens of millions of Americans into unemployment and breadlines throughout the 1930s. Nationalizing the banks, as many critics of the Troubled Asset Relief Program suggest, might have distributed the costs and benefits of the bailouts more fairly. And going forward, higher income taxes on the rich, along with more strongly redistributive social programs might succeed in mitigating some degree of inequality. But there are also powerful socioeconomic forces driving inequality. That is, the high levels of economic inequality we have witnessed over the last decade might be inescapable to some degree.
In our affluent but unequal society, poverty is a relative, not an absolute, condition. High levels of inequality coexist with rising living standards, even for those at the bottom. Meanwhile, due to rising wealth and asset ownership among all Americans, including the poor, the fortunes of the majority are increasingly tied to those of the elite. The sooner we confront these structural forces, the sooner we can move on to constructing a new social contract befitting this new economic age.
Globalization and the rising value of knowledge-based work mean that those at the top of the knowledge economy are increasingly able to charge a premium for their labor in a global marketplace -- even as that same marketplace de-skills the labor of many occupations. The rich used to derive almost all of their income from capital, rent, and business profits, and little from wages. But today, as economists Thomas Piketty and Emmanuel Saez show, the top one percent of Americans derive a significant (and growing) share of economic resources from wages.1 Meanwhile, global supply chains and new telecommunications technologies are enabling both outsourcing and global economies of scale that exert downward pressure on most workers' wages.
These trends are ominously self-reinforcing. Education -- and the skills, connections, and credentials that come with it -- is the critical determinant of success in the new knowledge economy. Due to greater social and economic inequality and segregation, poor and working-class people must cross an educational gap that is widening at precisely the moment when education has become most critical to their economic prospects.
Yet even as that gap grows, the interests of workers are increasingly yoked to those of their bosses. Half of Americans today have direct or indirect investments in the stock market, largely thanks to the shift to defined contribution pension plans and the ease of Internet investing.2 But while most of us are in it for a penny, it's still the super wealthy who are in for a pound. A study by the St. Louis Federal Reserve Bank found that the richest 10 percent own upwards of 85 percent of stocks and other financial assets.3 So if the rest of us want to save our 401ks, we have to save the status quo for the robber barons of Wall Street in the process.
The same is true for housing. Home equity makes up an ever-greater share of household wealth the lower your rank on the income ladder. Back in 1930, less than half of Americans lived in a home they owned; by the housing market peak in the 2000s, the rate hit close to 70 percent.4 Now we all have a stake in real estate values. A sluggish housing market used to be good news for many at the bottom of the pyramid thanks to falling rents. But today, when most of us have our life savings in a home or use our house as an ATM through home equity lines of credit, price drops are devastating.
Many policy scholars, myself included, have argued that wider-spread asset ownership increases opportunity, teaches good financial habits, orients poor children to the future, and ultimately increases the public's stake in capitalism and the rule of law. But we must be honest about the fact that an "ownership society" (to use former President George W. Bush's term) also means a country in which the economic interests of the wealthy and the non-wealthy are increasingly tied to each other. The problem is that while in absolute terms, everyone wants the same things -- rising house and stock prices -- in relative terms, those in the middle (and bottom) fall further and further behind. In an economy in which those at the top already control the lion's share of wealth, economic growth need not be disproportionate itself in order to disproportionately benefit the wealthy.
As such, today's historically high levels of inequality appear likely to remain a long-term structural feature of the American economy. The expansion of assets and ownership down the income distribution has meant that the economic interests of those at the top of the income ladder and those at the bottom are increasingly difficult to disentangle. This development, combined with America's culture of competitive individualism, makes both class conflict and redistributive social policies increasingly unlikely.
These sobering trends aside, we should not overlook the reality that Americans remain wealthy by any global or historical perspective and are getting wealthier still. Even among the poorest Americans, life expectancy has risen, infant mortality has decreased, homicides are down, and educational attainment is up. While poverty persists and the poor are still disproportionately victims of crime, incarceration, ill health, and higher mortality, their overall wealth and standard of living have risen.
Statistics showing that real wages have stagnated since 1973 are misleading. Wage statistics calculate "real dollars" over time only by adjusting for inflation, which is measured by totaling the cost of a set of common consumer goods in a basket. This makes inflation an accurate short-term measure, but it's a terrible long-term one because the average consumer's actual basket of goods changes a lot more rapidly than the theoretical basket of goods the Bureau of Labor Statistics (BLS) uses to calculate the Consumer Price Index.
Mobile phones are just one example. Though they first hit the consumer market in 1983, the BLS did not factor mobile phones into the inflation rate until 15 years later. Consequently, the BLS missed the massive price declines. Moreover, today's lower cell phone prices do not reflect the value of quality improvements. Just think of the difference between a 1995 cell phone and your iPhone today.
As a result, the focus on wages misses the point. Basic living standards have risen for virtually every American even as real wages have stagnated. Whether we pay less at Wal-Mart while earning less, or pay more while taking in higher wages, the end result is the same.
The idea that greater inequality, as opposed to greater poverty, results in worse social outcomes at a societal level is also highly questionable. Consider poor health outcomes, which have been widely linked to high levels of social inequality. Careful statistical analyses have shown that the observed correlation between income inequality on the one hand and health outcomes on the other is really an artifact of the non-linear relationship between individual income and health.
In other words, since an additional dollar is worth more to you health-wise if you are poor than if you are rich, merely comparing countries, states, or counties with more unequal income distributions will make it appear as though those places have worse health outcomes than their more equal counterparts. But what's driving the difference is absolute income, not relative income shares. For instance, health outcomes are worse in the United States than many European countries, not because of our higher levels of inequality, but rather because of our higher levels of poverty.
If living standards for those at the bottom of the income distribution have demonstrably improved over the last 40 years and research has not been able to establish a causal link between inequality and life outcomes, should we still concern ourselves with societal inequality?
We should, but not for the reasons typically given. Consider that as society becomes more affluent and basic material needs are increasingly satisfied for even the poorest Americans, more and more of our consumption takes on a relative dimension. The economic shift from absolute to relative goods can be seen in household budgets. As recently as the 1950s, the typical American family spent one-third of its income on food while low-income families spent about half of their incomes on the same.5 Today, food makes up only 17 percent of the average poor family's budget, and almost one-third of that (30 percent) is spent eating out. Meanwhile housing now represents about 40 percent of household budgets for low-income Americans.6
While we all need food and a roof over our heads, what drives the rising cost of housing for the poor are the relative dimensions of the housing market, not the absolute ones. Today even poor Americans live in substantially larger homes than they did three or four decades ago. Competition for housing in better school districts, with increasing square footage, is largely responsible for increasing the share of household budgets allocated to housing among all Americans.
In his 1976 classic, The Social Limits to Growth, Fred Hirsch called these relative goods "positional goods" due to their relative and inherently limited nature.7 While everyone can, at least theoretically, own a home and pursue an education, it is impossible for everyone to own a beachfront home or go to Harvard. And it turns out that these types of positional goods represent the greatest obstacles to economic mobility for those at the bottom of the income distribution.
In my own research into the intergenerational effects of social class on educational and occupational outcomes, I have demonstrated that the most important determinants of those outcomes are parental wealth and education. By contrast, I found that race, parental income, and parental occupation did not matter at all. It is perhaps no coincidence that the key determinants of success and social mobility in America -- education and wealth (which continues to be dominated by home equity for most American families) -- are both positional goods. Moreover, the two are linked: housing values are closely related to school performance.
In addition to the fact that more of the economy may contain this relative status nature, the provision of certain key goods and services is predicated on a need for high-skill workers. Consider three of the biggest costs to families -- education, health care, and housing -- and how they are linked to skill and status. Higher education is expensive because it presents the double whammy of being a relative status good (to the extent that degrees, prestige, and comparative advantage in the labor market matter) that is provided by high-skilled employees. Health care, however, is typically not a status good (we just want to be cured and don't begrudge others for being healthy) but still requires very highly skilled workers. Conversely, housing generally requires less-skilled workers, but has become highly relative for many American families seeking ever-larger McMansions and top-notch school districts.
This simple table illustrates the interactions between the relative nature of goods and the labor skill level required to produce them. Whereas the New Deal and its offspring policies were meant to insure American households from going without basic material necessities that were absolute in nature (the upper-left quadrant), the major sources of economic anxiety today relate to high-skill services that are often relative (i.e., status) goods (the lower-right quadrant). Relative deprivation is a much trickier problem to solve and will require a fundamentally different approach to social policy.
The challenge is exacerbated by the fact that the most relative and/or high-skill quadrants appear to be linked to each other: housing becomes an intense status good by virtue of the fact that it is linked to the education system (thanks to the financing of education through local property taxes plus the desire of high-income parents to surround their kids with other wealthy peers). Wealth, meanwhile, is largely held in the form of primary residence equity for most American families. And health care expenses are the single biggest cause of bankruptcy in the United States.
In some respects, the age of affluent inequality should facilitate the creation of a new social contract capable of improving social and economic mobility. In theory, high levels of inequality should make it easier to concentrate the tax burden on the shoulders of a small minority. While our national tax debate seems to belie this claim, evidence from local school districts, compiled by economists Sean Corcoran and William Evans, shows that higher inequality leads to greater investment in public schooling through higher taxes.8 Moreover, the enormous private fortunes of our new gilded age have often been invested in a variety of socially beneficial ways. We can thank the benevolent tycoons of generations past, such as Andrew Carnegie and the Rockefeller family, for the New York Public Library and the Green Revolution, respectively. Today, Bill Gates's and Warren Buffett's private funding decisions have greatly advanced the global fight against malaria.
Nonetheless, we are unlikely to return to the 90 percent marginal tax rates of the postwar era. Nor can we reasonably depend upon the benevolence of the super wealthy to make up for the failings of our present social safety net. In the end, progressives would be well served to focus less on soaking the rich and more on raising sufficient revenues to minimize the consequences of the positional arms race.
A good place to start would be to eliminate incentives for taxpayers to game the system by treating all income equally. We could raise dividend taxes and capital gains taxes to the same level as the top marginal tax bracket on wages, tax health and other benefits as income, and convert the estate tax to an inheritance tax that hits heirs at the same rate. This proposal might even appeal to conservatives if it were tied to provisions that established a flat tax that eliminated deductions and a national sales, or value-added, tax that held federal revenues to one-quarter of the GDP.
Taken together, these measures, combined with a raise on the payroll tax cap above the current $120,000 level, would probably end up being no less progressive than the current tax system. In addition, we might be able to shore up the Social Security trust fund and rein in health care spending, for additional budgetary savings above and beyond those that will be triggered by the Affordable Care Act.
A simpler and fairer tax system will still be hard pressed to address the ways in which social and economic inequality is self-reinforcing. Addressing these dynamics will require us to limit the importance of socioeconomic disparities by reducing the opportunity for distinctions in the areas of housing, education, and other status goods.
We should start by challenging skill-based credentialing monopolies in areas such as health care and education. For example, health care could be provided more affordably if everyone was willing to see nurse practitioners or medical assistants in drive-through clinics and forsake the latest high-tech tests and procedures. College could be more affordable if we adopted an open courseware model and de-emphasized the need for face-to-face contact with faculty members.
We also need to reduce the relative nature of health care, housing, and education by delinking them from each other. For instance, decoupling school district funding from local property taxes, or allowing public school choice across district or municipality lines, could increase access to higher-quality education for those at the bottom of the income ladder. Health care reform may help sever the tie between health care and the housing sector, resulting in less risk of mortgage default or bankruptcy when twin calamities, job loss and negative health events, occur simultaneously.
Still, the incentives for economic segregation are likely to remain high and the challenges to overcoming them loom large, suggesting the consideration of more radical ideas. One approach would randomly assign every child to a pool of 10,000 people across the United States at birth that she would stay in until her death. Each "pod" of 10,000 people would levy taxes to be distributed among the members to cover things that welfare and education policies typically cover (e.g., K-12 schooling, health care, disability payments, food stamps). Because the pods are relatively small in number, members could direct spending to try to maximize benefit through online budget negotiations and voting. And while siblings would end up in the same pods, parents would already have been assigned to pods long before they gave birth and would likely not end up in the same pods as their partners or children.
Such a system could re-create the social fabric of the 18th century small town in 21st century cyber-network fashion, thereby reducing segregation and halting widespread withdrawal from the public sphere. Since individuals would not be located in the same geographic area as the rest of the members of their pod, health care, education, and other social programs would need to be provided through mechanisms such as vouchers that relied on free market allocation of the actual service wherever pod members lived. This system would create better incentives for preventative care, educational investments, etc., since individuals would have an interest in keeping the lifetime costs of their risk pool down.
Less radically, if we funded private school vouchers we could sever the link between place of residence and quality of school. This approach would only succeed if we combined this free market approach to education, which should appeal to conservatives, with a commitment to economic diversity, which should appeal to progressives. Yes, fund private school attendance with vouchers, but require participating schools to enroll students from across the income spectrum, thereby increasing opportunity for education and facilitating entrance into the knowledge class.
Liberals may object to this as privatization, but there is nothing inherently egalitarian about public institutions. Unlike its public counterpart (and rival) UC Berkeley, Stanford, a highly endowed, private university, charges no tuition for families with incomes under $100,000. Of course, this is only possible because Stanford has the financial resources to dial down its sticker price to lure less wealthy families. As it stands currently, the University of California system writ large -- largely thanks to its population of community college transfer students -- is one of the success stories when it comes to income diversity. Private institutions may need to be nudged (or even required) to spend their considerable resources on admitting low-income students (such as community college transfers).
Pods? Facebook-style democracy? Harvard online? It sounds bizarre, to be sure. But what should be clear is that the basic structure of the American economy has profoundly changed, as has the nature of poverty and inequality. The old New Deal safety net was created to prevent absolute deprivation, which, thanks to rising, if unequally distributed prosperity, is largely a thing of the past. In this new age of affluent inequality, we need to find ways to turn that safety net on its side and make it into a rope lattice everyone can climb. /
1. Piketty, Thomas & Emmanuel Saez. 2003. "Income Inequality in the United States 1913-1998." The Quarterly Journal of Economics. February. (back)
2. Jacobe, Dennis. 2011. "In U.S., 54% Have Stock Market Investments, Lowest Since 1999." Gallup. April 20th. (back)
3. Guo, Hui. 2001. A Simple Model of Limited Stock Market Participation. Federal Reserve Bank of St. Louis. May/June. (back)
4. United States Census Bureau. Housing Characteristics in the US. (back)
5. US Bureau of Labor Statistics. 2006. "100 Years of Consumer Spending." BLS Report 991; Conley, Dalton. 2005. "Poverty and Life Chances: The Conceptualization and Study of the Poor." Sage Handbook of Sociology, Eds. Craig Calhoun, Chris Rojek and Bryan S. Turner. London: Sage Limited, U.K. (back)
6. US Bureau of Labor Statistics. 2010. Food for Thought. November; Holland, Laurence H. M. and David M. Ewalt. 2006. "How Americans Make and Spend Their Money. Forbes. July 19th. (back)
7. Hirsch, Fred. 1976. The Social Limits to Growth. Cambridge, Mass: Harvard University Press. (back)
8. Corcoran, Sean & William N. Evans. 2010. Income Inequality, the Median Voter, and the Support for Public Education. NBER Working Paper No. 16097. (back)
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