How Inequality Works
The political upheavals and populist incursions of the past few years owe much to widespread perceptions of inequality and economic injustice in advanced economies. While median wages have stagnated, incomes at the top have continued to rise, and there is growing evidence to suggest that the two phenomena are connected.
PRINCETON – Inequality has been named as a culprit in the populist incursions of 2016 and 2017. But what is inequality, and what role does it play in inhibiting or encouraging growth, or in undermining democracy? Does inequality kill, say, by driving people to suicide or to “deaths of despair”? Or is inequality a necessary evil that we must tolerate at certain levels?
These are questions I am often asked. But, truth be told, none of them is particularly helpful, answerable, or even well posed. Inequality is not so much a cause of economic, political, and social processes as a consequence. Some of these processes are good, some are bad, and some are very bad indeed. Only by sorting the good from the bad (and the very bad) can we understand inequality and what to do about it.
Moreover, inequality is not the same thing as unfairness; and, to my mind, it is the latter that has incited so much political turmoil in the rich world today. Some of the processes that generate inequality are widely seen as fair. But others are deeply and obviously unfair, and have become a legitimate source of anger and disaffection.
In the case of the former, it is hard to object to innovators getting rich by introducing products or services that benefit all mankind. Some of the greatest inequalities today are a consequence of industrial and health revolutions that began around 1750. Originally, these processes benefited just a few countries in northwest Europe. But they have since improved living conditions and health outcomes for billions of people around the world. The inequalities stemming from these advances – both within and between countries – are beneficial and fair, and a key feature of progress generally.
On the other hand, getting rich by bribing the state for special favors is clearly unfair, and rightly resented. Many in the United States – more so than in Europe – automatically regard capitalist or market outcomes as fair, and government action as arbitrary and unfair. They object to government or university-sponsored programs that seem to favor particular groups, such as minorities or immigrants.
This helps to explain why many white working-class Americans have turned against the Democratic Party, which they view as the party of minorities, immigrants, and educated elites. But another reason for growing public discontent is that median real (inflation-adjusted) wages in the US have stagnated over the past 50 years.
There are two different explanations for the divergence between median and top incomes, and it matters a great deal which one is correct. The first attributes it to impersonal and unstoppable processes such as globalization and technological innovation, which have devalued low-skill labor and favored the well educated.
The second explanation is more sinister. It holds that median-income stagnation is actually the direct result of rising incomes and wealth at the top. In this account, the rich are getting richer at the expense of everyone else.
Recent research suggests that there is some truth to the second story, at least in the US. Although globalization and technological change have disrupted traditional work arrangements, both processes have the potential to benefit everyone. The fact that they have not suggests that the wealthy have captured the benefits for themselves. It will take much more work to determine which policies and processes are holding down middle- and working-class wages, and by how much, but what follows is a preliminary list.
First, health-care financing is having a disastrous effect on wages. Because most Americans’ health insurance is provided by their employers, workers’ wages are essentially paying for profits and high salaries in the medical industry. Every year, the US wastes a trillion dollars – about $8,000 per family – more than other rich countries on excessive health-care costs, and has worse health outcomes than nearly all of them. Any one of several European financing alternatives could recoup those funds, but adopting any of them would trigger the fierce resistance of those now profiting from the status quo.
A related problem is increasing market consolidation in many sectors of the economy. As a result of hospital mergers, for example, hospital prices have risen rapidly, but hospital wages have not, despite a decades-long shortage of nurses. Increasing market concentration is probably a factor underpinning slow productivity growth, too. After all, it is easier to reap profits through rent-seeking and monopolization than through innovation and investment.
Another problem is that the US federal minimum wage – currently at $7.25 per hour – has not increased since July 2009. Despite broad public support, raising the minimum wage is always difficult, owing to the disproportionate influence that wealthy firms and donors have in Congress.
Making matters worse, more than 20% of workers are now bound by non-compete clauses, which reduce workers’ bargaining power – and thus their wages. Similarly, 28 US states have now enacted so-called “right-to-work” laws, which forbid collective-bargaining arrangements that would require workers either to join unions or pay union dues. As a result, disputes between businesses and consumers or workers are increasingly settled out of court through arbitration – a process that is overwhelmingly favorable to businesses.
Yet another problem is outsourcing, not just abroad, but also within the US, where businesses are increasingly replacing salaried or full-time workers with independent contractors. The food servers, janitors, and maintenance workers who used to be a part of successful companies are now working for entities with names like AAA-Service Corporation. These companies operate in a highly competitive low-wage industry, and provide few or no benefits and little opportunity for advancement.
The earned income tax credit (EITC) has provided a boost in living standards for many low-paid US workers. But, because it is available only to those who work, it puts downward pressure on wages in a way that unconditional benefits, such as a basic-income grant, would not.
Unskilled immigration also poses a problem for wages, though this is controversial. It is often said that immigrants take jobs that Americans do not want. But such statements are meaningless without some reference to wages. It hard to believe that low-skilled Americans’ wages would have remained as low as they did in the absence of inflows of unskilled immigrants. As the economist Dani Rodrikpointed out 20 years ago, globalization makes demand for labor more elastic. So, even if globalization does not reduce wages directly, it makes it harder for workers to get a pay raise.
Another structural problem is that the stock market rewards not just innovation but also redistribution from labor to capital. This is reflected in the share of profits relative to GDP, which has grown from 20% to 25% over the same period that median wages have stagnated. The increase would be even higher if executive salaries were counted as profits rather than wages.
The final problem on our preliminary list is political. We have entered a period of regulatory bonfires. The Consumer Financial Protection Bureau, despite having uncovered major scandals, is now under threat, as is the 2010 Dodd-Frank legislation, which introduced measures to prevent another financial crisis. Moreover, President Donald Trump has indicated that he wants to eliminate a rule requiring money managers to act in their clients’ best interest. All of the deregulatory “reforms” currently being proposed will benefit capital at the expense of workers and consumers.
The same is true of US Supreme Court rulings in recent years. The court’s decision in Citizens United v. FEC, for example, gave wealthy Americans and even corporations the ability to spend almost unlimited amounts to support candidates and engineer legislative and regulatory outcomes that work in their favor.
If this account of stagnant median wages and rising top wages is correct, then there may be a silver lining to our era of inequality, because it means that the US’s dysfunctional labor market is not an irremediable consequence of unstoppable processes such as globalization and technological change.
Broadly shared progress can be achieved with policies that are designed specifically to benefit consumers and workers. And such policies need not even include redistributive taxation, which many workers oppose. Rather, they can focus on ways to encourage competition and discourage rent-seeking.
With the right policies, capitalist democracy can work better for everyone, not just for the wealthy. We do not need to abolish capitalism or selectively nationalize the means of production. But we do need to put the power of competition back in the service of the middle and working classes.
For years, wealth and income inequalities have been rising within industrialized countries, kicking off a broader debate about technology and globalization. But at the heart of the issue is a fundamental good that has been driving social and economic inequality for centuries: real estate.
MUNICH – Inequality is the leading political and economic issue of the current era, yet debates about it have long suffered from a degree of imprecision. For example, the standard measure of inequality, the Gini coefficient, reduces a country’s entire income distribution to a single number between zero and one, and is thus highly abstract. Similarly, while inequality is rising in many parts of the world, there is no simple correlation between that trend and social discontent or unrest. France is much less unequal than the United States, and yet it has similar or even greater levels of social polarization.
Today’s inequality debate effectively began in 2013 with the publication of French economist Thomas Piketty’s Capital in the Twenty-First Century, which found that the rate of return on capital tends to outpace the rate of growth, thereby causing inequality to increase over time. Specifically, appreciating real-estate values seem to be a fundamental driver of rising inequality. But here, too, one encounters a degree of imprecision. Real estate, after all, is not a homogenous good, because its value famously depends on “location, location, location.” There are elegant castles and palaces that now cost less than small apartments in major cities.
Wealth stirs the most controversy where it is most tangible, such as when physical spaces become status goods: the corner office is desirable precisely because others cannot have it. More broadly, as major cities have become magnets for a global elite, they have become increasingly unaffordable for office workers, policemen, teachers, nurses, and the like. While the latter must endure long, tiresome commutes, elites use global cities as they see fit, often hopping around from place to place. Large swaths of Paris and London are eerily shuttered at night. Manhattan now has nearly a quarter-million vacant apartments.
Whenever violence and revolution have consumed unequal societies, real estate has been a focus of discontent. In the later years of the Western Roman Empire, vast estates catered solely to an aristocratic elite. In a famous homily from this period, St. Ambrose of Milan, reflecting on the Old Testament story of Naboth’s vineyard, decries elites for making “every effort to drive the poor person out from his little plot and turn the needy out from the boundaries of his ancestral fields.”
Likewise, the French social historian Marc Ferro has demonstrated that many urban Russians were driven to the Bolsheviks in 1917 not out of ideological zeal, but because the old regime and the new constitutional parties had proved incapable of providing food and housing. Over the course of World War I, Petrograd had developed an enormous munitions industry, manned by peasant labor conscripted in the countryside and brought to the newly expanded factories. But production planners had neglected the question of where these workers would be housed, and in 1917, the worker committees (soviets) offered an answer: apartments would be confiscated from the aristocrats and bourgeoisie.
A similar pattern played out in other cities where rapid, unplanned wartime industrialization had occurred (Budapest, Munich, Turin). Today’s equivalents are the centers of the new economy, such as Silicon Valley and its high-tech imitators in Europe and Asia. These cities have produced many jobs, but they have utterly failed to accommodate the people who actually live there. As a result, even middle-class professionals are living in cars, vans, and trailers.
And this malaise is not limited to the global cities themselves. Support for Brexit in southeastern England owes something to the perception that London and its immediate surroundings have become unaffordable as a result of too much immigration, international financial activity, and tourism – in short, globalization.
Needless to say, the political response to the real-estate problem has so far been inadequate, even counterproductive. Some large European cities are introducing rent controls, despite the poor track record of such policies. When New York tried similar measures in the twentieth century, the open market dried up, and property was hoarded or traded at a premium on the black market. When the UK rolled out a fiscal subsidy for first-time homebuyers, home prices rose accordingly, offsetting any potential benefit.
Removing tax privileges – as the US did recently by imposing a $10,000 cap on the state- and local-tax deduction – is a slightly better approach. But it will not solve the fundamental problem of supply. Not surprisingly radical, even Bolshevik-style, proposals are making a reappearance. A popular initiative in Berlin, for example, would socialize the holdings of large-scale real-estate owners (those managing more than 3,000 apartments).
The obvious solution to the supply problem, of course, is to build more housing. But new construction can conflict with environmental protections and a city’s architectural heritage, and is often opposed by existing property owners, who do not want the value of their own property to fall.
Sometimes, new construction can create alternative urban magnets, such as when the Spanish city of Bilbao was transformed by the addition of a Frank Gehry-designed Guggenheim Museum. But many declining industrial cities have already tried this solution, and only a few have succeeded. Those that have failed are still run down, and now have the added burden of maintaining new arts infrastructure.
Eventually, the cities and urban areas that are driving the bulk of new wealth creation will provoke a counter-movement. If they price out or otherwise exclude those who earn less, they will have sacrificed the openness that made them attractive in the first place. So, if they want to survive and thrive in today’s egalitarian political climate, they will need to come up with bold solutions.
During a previous period of urban-based dynamism, in the early sixteenth century, rich merchant families built low-rent housing that was then allocated to the poor. One such project, the Fuggerei complex in Augsburg, Germany, still provides low-rent social housing to this day.
If enough such housing cannot be supplied, might a lottery allocation of public accommodation help to stem the encroaching homogeneity of today’s global cities? It is certainly worth a try.
The Exploitation Time Bomb
Worsening economic inequality in recent years is largely the result of policy choices that reflect the political influence and lobbying power of the rich. There is now a self-reinforcing pattern of high profits, low investment, and rising inequality – posing a threat not only to economic growth, but also to democracy.
NEW DELHI – Since reducing inequality became an official goal of the international community, income disparities have widened. This trend, typically blamed on trade liberalization and technological advances that have weakened the bargaining power of labor vis-à-vis capital, has generated a political backlash in many countries, with voters blaming their economic plight on “others” rather than on national policies. And such sentiments of course merely aggravate social tensions without addressing the root causes of worsening inequality.
But in an important new article, University of Cambridge economist José Gabriel Palma argues that national income distributions are the result not of impersonal global forces, but rather of policy choices that reflect the control and lobbying power of the rich. In particular, Palma describes the significant recent increase in inequality in OECD countries, the former socialist economies of Central and Eastern Europe, and China and India, as a process of “reverse catching-up.” These countries, Palma says, increasingly resemble many unequal Latin American economies, with rent-oriented elites grabbing most of the fruits of growth.
In his earlier work, Palma showed how middle and upper-middle income groups’ share of total income has remained remarkably stable in most countries over time, at about one-half. Changes in aggregate income distribution, therefore, resulted largely from changes in the respective shares of the top 10% and the bottom 40% of the population (the ratio between these shares is now called the “Palma ratio”).
In other words, the huge variation in inequality across countries, and particularly between middle-income economies, is essentially the outcome of a fight for around one-half of national income involving one-half of the population. Only in cases of extreme inequality (such as South Africa) did the top 10% also manage to encroach on the income share of the middle.
It is misleading, therefore, to view rising per capita incomes in middle-income countries as indicating a general improvement in standard of living. In unequal middle-income economies such as those in Latin America, the incomes of the top 10% are already on par with those of their rich-country counterparts. The incomes of the bottom 40% are closer to the Sub-Saharan African average.
The driving force behind these trends is market inequality, meaning the income distribution before taxes and government transfers. Most OECD countries continually attempt to mitigate this through the tax and transfer system, resulting in much lower levels of inequality in terms of disposable income.
But fiscal policy is a complicated and increasingly inefficient way to reduce inequality, because today it relies less on progressive taxation and more on transfers that increase public debt. For example, European Union governments’ spending on social protection, health care, and education now accounts for two-thirds of public expenditure, but this is funded by tax policies that let off the rich and big corporations while heavily burdening the middle classes, and by adding to the stock of government debt. As Palma puts it, “in their new tax status, corporations and the very rich now prefer to part‐pay/part‐lend their taxes, and part‐pay/part‐lend their wages.”
In rich countries, middle-income groups have largely maintained their share of national income. But their living standards have fallen, owing to the rising costs of essential goods and services (such as housing, health care, and education), falling real pensions, regressive taxation, and rising personal debt. Most emerging-economy governments, meanwhile, are not implementing significant fiscal measures to reduce market inequality.
The dramatic increase in market inequality reflects the ability of the top 10% to extract more value created by others and to profit from existing assets – including those that should be public property, such as natural resources. Specifically, this increase in value extraction is the result of policies for which the rich have actively lobbied: privatization; deregulation of share buybacks that artificially inflate stock prices; patent laws that make drugs much more expensive; reduction or elimination of top marginal tax rates; and much else.
Giving the rich all this additional income has not resulted in higher investment rates in the OECD or in unequal middle-income countries. Instead, the rich are content to pluck the low-hanging fruit of rent extraction, market manipulation, and lobbying power. High profits therefore coexist with low investment and increasing market inequality, in a self-reinforcing pattern. This trend not only magnifies the risk of economic stagnation and market failures; political changes around the world suggest that it has also become a profound threat to democracy.
Addressing this dangerous state of affairs will require that governments use their power to tax and regulate to channel more private capital into productive spending and increase the amount of public investment financed by progressive taxation, along the lines of a Global Green New Deal. If policymakers fail to mount a response that is proportionate to the problem, the rich will continue to get richer, and the poor to get poorer, faster than ever. Who will address the problem then?
Tackling Inequality Is a Political Choice
Under the United Nations Sustainable Development Agenda for 2030, the world is committed to eliminating extreme poverty and reducing inequality between and within countries. Yet without a far greater effort by governments and multilateral institutions to address inequality in particular, neither objective will be met.
NEW YORK – The world has made impressive strides in reducing extreme poverty, but that progress has slowed considerably in recent years. The problem is clear: eliminating extreme poverty requires tackling inequality.
The good news is that inequality between all people worldwide has declined since 1990, mirroring the reduction in poverty. The bad news is that within-country inequality has risen. Compared to 25 years ago, the average person today is far more likely to live in an economy with higher inequality. And, beyond income and wealth, there are still large disparities – between and within countries – with respect to food and nutrition, health care, education, land, clean water, and other things essential for a full and dignified life.
Far from an inevitable, inequality is a political choice. Governments that want to reduce income and wealth gaps and improve the lives and opportunities available to their poorest have shown both effort and some progress. Since 2015, the United Nations Sustainable Development Goals – specifically Goal 10 – have brought unprecedented attention to this issue.
And at this month’s High-Level Political Forum, the international community has its first chance to take stock of the progress made toward combating inequality, both globally and at the national level. To that end, the World Bank Group and the UN Department of Economic and Social Affairs recently held a preparatory meeting to highlight how governments can step up their efforts in this area. The meeting produced several key findings and outcomes:
· Inequality is frequently driven and compounded by a combination of social circumstances, such as the composition or economic status of one’s family, geographic location, ethnicity, and gender. These factors can all contribute to inequality of opportunity, and all are exacerbated by income inequality itself. And, because inequality of opportunity reduces social mobility from one generation to the next, it creates persistent inequality traps.
· To remove barriers to opportunity, governments must address the root causes of inequality by identifying and eliminating discriminatory laws, not least those that actually criminalize disadvantage. Moreover, given that inequality largely begins in childhood, governments must invest far more in high-quality universal health care and early childhood education. Only by supporting the creation of human capital from an early age can we ensure that inequalities in one generation aren’t passed on to the next.
· Such investments will require additional domestic resources. In general, progressive taxation is critical for increasing government revenues. But so, too, is expanded administrative capacity, so that governments can prevent tax evasion and limit illicit flows of resources across borders. With better resource mobilization, social transfers and protections can become powerful tools for reducing income and wealth disparities.
· Governments need to ensure that the benefits of progressive policies accrue to those who need them most. To that end, policymakers should solicit the perspectives of their underprivileged citizens when crafting and implementing new measures to reduce poverty and inequality. Giving a voice to the poor would yield more authentic analyses of current challenges, while ensuring that resources are directed to where they are needed most.
· Finally, the lack of data is a barrier to effective policy design. To map inequality comprehensively, decision-makers must be able to answer the question of who benefits from any given policy, law, political structure, or cultural norm. Education, climate, health, food security, and infrastructure are just a few of the many areas where governments need more and better data. Though data collection is an expensive, skill-intensive exercise, recent innovations have substantially expanded the options available for governments.
· For example, traditional data sources such as household surveys, which generally fail to capture incomes at the top (including the top 1%), are now being complemented by administrative and tax data to fill in longstanding knowledge gaps. Nonetheless, we will need to develop more and better metrics that capture various manifestations of inequality so that all actors – governments, stakeholders, multilateral institutions, civil society organizations, and the media – can directly measure progress toward achieving SDG 10.
The barriers to inequality-reducing policies often reflect a lack of political will to remove them. Policymakers should recognize that large and persistent disparities between groups are bad not just for the economy, but also for political and social stability. Social cohesion and public trust in institutions cannot be sustained in the absence of equal opportunity and policies that reflect unifying narratives.
World leaders will take stock of the progress made toward the SDGs at a summit in September. They must reaffirm their commitment to the global goals, and specifically to SDG 10. The World Bank Group will focus its energy and resources to see the effort through between now and 2030. But that will not be enough. Reducing inequality within countries and internationally will take a global village.
How Not to Fight Income Inequality
Trying to combat income inequality through mandated wage compression is not just an odd preference. It is a mistake, as Mexico's president-elect, Andrés Manuel López Obrador, will find out in a few years, after much damage has been done.
CAMBRIDGE – Suppose two people hold different opinions about a policy issue. Is it possible to say that one is right and the other wrong, or do they just have different preferences? After all, what is the difference between an odd preference and a mistake?
A preference influences a choice that is expected to deliver the goal the chooser wants to achieve. A mistake is a choice based on a wrong belief about how the world works, so that the outcome is not what the chooser expected. Unfortunately, this may be a costly way to learn. It also may be inconclusive, because it is always possible to attribute the mistake’s bad consequences to other factors.
A case in point is the decision by Mexican President-elect Andrés Manuel López Obrador (AMLO), to lower the salaries of the higher echelons of the civil service, including himself, capping them at $5,707 per month. Many greeted the decision, announced in July, with glee. It showed that AMLO was committed to fiscal austerity and income equality.
But what appears to be a well-articulated preference will prove to be a serious mistake. Unfortunately, AMLO will find out only in a few years, by which point the damage inflicted on Mexico will be huge.
Interfering with market prices to achieve fairness – an idea that harks back to St. Thomas Aquinas and even Aristotle – is probably one of the worst economic policies ever. Governments in many countries regularly set prices – especially for energy, foreign exchange, or credit – artificially low, leading predictably to under-investment and shortages. Venezuela is an extreme case that dramatizes the consequences. But are public sector wages another example of this practice?
The answer is more nuanced. In general, governments pay their employees significantly more on average than the private corporate sector, because government services such as education, health care, justice, and administration are on average more skill-intensive. As a result, government employees have significantly higher levels of schooling – four more years, on average, in Mexico. But even controlling for this, a study by the CAF Development Bank showed that average wages are higher in the public sector in Latin America. In Mexico, government employees’ wages were about 13.5% higher than private-sector wages in 2012.
The same study also showed that wages in the public sector are significantly less unequal than in the private sector. This means that while the public sector pays more than the private sector at the median, the situation is reversed at the top end of the pay scale. This was not the case in Mexico, where the public-sector premium fell to zero but did not become negative. AMLO now wants to join the rest of the continent.
The compressed wage structure that AMLO will introduce typically means that, at the low end, public sector jobs are highly coveted: they offer higher pay, shorter hours, better benefits (such as pensions and health insurance), and greater stability. Turnover tends to be very low and political parties try to make sure that jobs go to their supporters.
By contrast, at the high end, governments often struggle – and often fail – to attract and retain talent. As a consequence, government agencies never develop the deep knowledge, institutional memory, and competence they need to perform their functions effectively. Central banks, with their separate pay scale, often are the exception that proves the rule.
To cope with this competence deficit in their client countries, multilateral development institutions, such as the World Bank, often create project-management units run by higher-paid consultants, and dismantle them when the project is completed. These workarounds are not ideal, because they don’t develop long-term institutional capabilities. To a large extent, Mexico had been an exception, because it paid salaries that enabled the government to attract and retain highly educated career bureaucrats.
Politicians such as AMLO should ask themselves why profit-maximizing firms believe that they cannot boost their bottom lines by saving on senior management salaries. As firms compete for skills, they bid up wages, leaving the public sector with less qualified employees. Clearly, many young people want to work for the government out of an idealistic commitment to public service and as a learning opportunity. But when public-sector wages are depressed, they usually do so for just a few years, before they start a family, and certainly not for a lifetime, which is what many complex public-sector agencies often require.
Is this a problem? Good governments rightly want major firms and the rich to pay their fair share of taxes. They want corporations not to abuse their market power, pollute the environment, or sell unsafe products. They want to protect people from criminal gangs. They want the currency to be stable and financial institutions to be safe, so that people’s savings are secure and taxpayers do not have to bail out the banks. They want public projects that are well conceived and structured, and procurement processes that protect the budget from opportunistic or corrupt suppliers. They want oil and mining concessions to be allocated efficiently and to maximize government revenue.
Trying to accomplish these valuable tasks while paying below-market salaries is penny wise but pound foolish. Tax collectors, regulators, and prosecutors need adequate resources to win their difficult battles.
AMLO’s decision to lower the wages of public employees has already led many high-ranking officials to seek employment elsewhere. Those who are entitled to early retirement are taking it, rather than waiting for AMLO’s cut. Many in AMLO’s own party will celebrate, because they can fill the vacancies with loyalists. But these benefits will come at the cost of a less capable state that is less able to deliver on AMLO’s most cherished goals.
Trying to achieve greater equality through mandated wage compression is not just an odd preference; it is a mistake. It will deliver a state less able to contribute to a more just society.
Stock Buybacks Are the Wrong Target
Legislation banning companies from purchasing their own shares, or conditioning buybacks on investment in workers, would not significantly alter the distribution of wealth. What it would do is undermine the broad cooperation needed to tackle income inequality and a fast-changing labor environment.
MILAN – The surge in stock buybacks in the United States has sparked a high-stakes debate about what corporations can and should do with surpluses they have generated. It is a topic that raises fundamental questions about the role of the public and private sectors in securing inclusive growth patterns.
The debate kicked into high gear recently when US Senators Bernie Sanders and Chuck Schumer wrote an article arguing that corporations should be investing more in employees and the community, rather than buying back stock. They then declared their intention to introduce legislation that would prohibit corporations from buying back their own stock unless they invest in workers first, say, by raising their minimum wage to $15 per hour or offering paid sick leave.
Sanders and Schumer – and many others – are concerned that surpluses or rents are being allocated entirely to shareholders, who tend already to be among the top 10% of income earners. At a time of rising inequality and stagnant wages, investing more of that money in lower-earning workers seems a better option than lavishing more wealth on the wealthy.
But Benn Steil and Benjamin Della Rocca from the Council on Foreign Relations have serious reservations about the logic of Sanders and Schumer’s argument. Based on data showing that buybacks are larger among firms with lower rates of return on capital, they concluded that the capital markets are functioning properly, because the money being returned to investors eventually ends up in higher-return investments. If the government tries to block share buybacks, they argue, corporations are likely to respond by parking the cash in treasuries, thereby recycling capital through an inferior channel.
The practice of recycling capital from low-return uses to other low-return uses – such as through bank lending to troubled enterprises, in order to prevent write-downs and resolve capital-adequacy issues – emerges in periods of financial stress. But it is known to have serious adverse effects on productive investment, because it reduces credit support for healthy enterprises with real growth potential.
There is, however, a more fundamental issue at stake here. Sanders and Schumer seem to want to push publicly traded corporations and capital markets to move faster and more aggressively toward a multi-stakeholder model of corporate governance, rather than the long-dominant shareholder-value model.
There is much to be said for the multi-stakeholder model, and some corporations are already moving toward it. But using legislation to force the change may turn out to be neither practical nor effective. It certainly won’t solve the problem of wealth inequality. After all, even in a multi-stakeholder world, shareholders are among the stakeholders.
Achieving inclusive and sustainable growth patterns will require corporations and the financial sector to align their business models and strategies more closely with broadly shared economic and social objectives. This process will be an exercise in creativity. It must begin with values and clarity of purpose (as BlackRock’s Larry Fink has emphasized), and proceed via experimentation and innovation. Multidimensional measures of economic and social progress, which are already being developed, will go a long way toward supporting such action.
International experience strongly suggests that this process goes most smoothly when business, the financial sector, government, labor, and the education sector all participate. Indeed, without the engagement of the business and financial sectors, barriers to inclusive, sustainable growth will be difficult, if not impossible, to overcome.
Imposing the multi-stakeholder model of corporate governance, or pieces of it, by regulation would sabotage such cooperation. By sending the signal that adverse trends in distribution can be laid mostly at the doorstep of the corporate and financial sectors, this approach promotes an adversarial relationship between government and business. Whatever the political advantages of vilifying a particular sector, they are dwarfed by the disadvantages of blocking effective partnerships that, say, facilitate skills upgrading in a rapidly shifting employment landscape.
To meet the twin challenges of rising wealth and income inequality and a rapidly shifting labor market, government must act as a coordinator of collaborative efforts and partnerships: participants will be willing to make greater contributions if they are confident that complementary inputs are forthcoming. Income support – of the kind that only government can provide – is also vital to give people and families the resources, time, and security to invest in themselves.
When it comes to altering the wealth distribution, the tax system is best suited to the task, assuming that a consensus is forged to use it that way. Many economists (including me) believe that a minimum wage of $15 per hour is a good idea. If there is enough political support, it should be legislated; it should not be slipped in through the back door. To alter the distribution of income, the tax system could also be used, along with measures to bolster the bargaining power of labor.
True, some versions of the multi-stakeholder framework of corporate governance may enhance labor’s influence and help shift the income distribution in the longer term. To be effective, however, the model would need to be implemented as part of a voluntary, cooperative, adaptive learning process. Micromanaging that process would create rigidities in what must be a highly dynamic environment.
The good news is that in every sector, people and organizations – including governments – are engaged in cooperative efforts. And there is useful experience in a range of developed democracies. These “coalitions of the willing” are solving practical problems and rebuilding a sense of social cohesion. But there is a long way to go. Ever-deepening collaboration, not political antagonism, is what will get us there.