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Economic Inequality in America

By Dr. Hassan Shirvani–The impressive body of empirical evidence recently furnished by the French economist Thomas Piketty and his associates clearly demonstrates that there is a worsening trend of income and wealth inequality in America.  This trend, in effect since the  beginning of the 19th century, managed to take a breather in the first half of the 20th century, thanks to the destructive effects of the two World Wars and their intervening the Great Depression.  Following the Second World War, however, the trend towards greater inequality in America resumed anew, with a tendency to accelerate after the early 1980s.  As a result, the richest one percent of Americans now earn roughly a quarter of all incomes and own close to one half of all wealth.  (For the top 10 percent, these ratios are approximately one half and three quarters, respectively.)  In contrast, the poorest fifty percent of Americans now earn only ten percent of national income and have an almost zero net worth.  (The Walton family, for example, has more wealth than the bottom 50 percent of Americans.)  In addition, the same data indicate that the richest groups in America have managed to double their shares of income and wealth over the past thirty years.  Consequently, America has now become the most unequal nation in the Western world.



Given the worsening trend of economic inequality in America, the questions naturally arise as to both its causes and the possibility of its reversal.  As to the causes, there is a long list of potential contributing factors:  First, there has been the triumph of the free-market ideology in the early 1980s, where massive tax cuts, sharp increases in defense spending, significant cuts in social programs, and financial deregulation reversed the New Deal policies of the Great Depression.   As part of this package of new policies, the powers of the labor unions were also drastically curbed, resulting in a long period of wage stagnation and improved corporate profits.  The combination of all these forces resulted in an economic and financial boom that served to boost asset prices and, hence, to further widen the gap between the rich and the poor.  Second, there have been the rapid paces of both globalization and technological progress in recent decades, which have significantly reduced the labor costs through greater reliance on cheap foreign labor, robotization, and the increased use of the internet in corporate sales.  The outcome has once again been a redistribution of income away from the workers and towards the owners of capital assets.  Third, there has been increased deficiencies in corporate governance, where new CEO compensation policies in the form of stock options have resulted in excessive leverage and short term risk taking by myopic managers, with disastrous consequences for long term economic stability and growth.  In addition, the close relations between CEOs and board members have often resulted in highly lucrative pay packages for managers which are hardly justified by their performances.   Fourth, the inequality has been boosted by the increased importance of the financial sector in the American economy.  Trading largely on asymmetric information, many hedge fund managers have succeeded in commanding multibillion-dollar pay packages, often a far cry from their actual contributions to the economy.   Finally, mention should also be made of the substantial returns on the human capital of such entrepreneurs as Bill Gates and Steve Jobs, whose real contributions notwithstanding, still seem to command overly excessive compensations.



In the light of the above, it is important to devise policies aimed at reversing the existing trend towards greater inequality in America.  If unchecked, this trend can lead to undesirable political and social instabilities which can prove detrimental to all.  Briefly, we can start by serious corporate governance reform, in which managerial holds over their boards are loosened and their misplaced pay incentives are corrected.  Next, we need to restore bargaining power to labor unions and protect domestic workers against cheap foreign labor, who are often paid exploitative wages and many of whom are forced to work under inhumane conditions.  At the same time, policies must be designed to help workers earn livable wages and enjoy greater participation in corporate profits and share ownership.  (In those industries where the imposition of the minimum wage laws could result in job losses through automation, income tax credits should be used instead).  In addition, the proceeds from a more equitable taxation should be used to finance higher education, instruction of new skills, and investment in research and development.  Finally, at a time of historically low interest rates and a highly depreciated infrastructure, the US government has an ample opportunity to borrow and invest in a host of capital projects.  Such investments, which will largely pay for themselves, will not only help create jobs for millions of Americans, but also will address the growing inequality problem in America.



For any economy to continue on the path to prosperity, it is vital that all economic stakeholders share fairly in the fruits of progress.  Otherwise, the door is opened to greater political and social instability.  After all, as it is often asserted, the poor do not always starve quietly.  It is thus not only a moral imperative but also a prudent economic policy to ensure an equitable distribution of income and wealth in the society.  In addition, as the lessons of the past three decades indicate, government intervention is also needed to ensure a level playing field for all economic agents.  This is achieved largely through strengthening of government actions in the areas of labor laws, environmental and financial regulation, and information transparency.  Indeed, as we have also learned from the recent financial crisis, any thoughtless weakening of such actions in the name of greater economic and financial liberties can only result in disastrous consequences for all.

Hassan Shirvani, Ph.D.
Professor Cullen Foundation Chair in Economics

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