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The Real Reason Inequality Is Widening and Average Working Americans Can't Gain Ground

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This post originally ran on Robert Reich’s web page.

For the past quarter-century I’ve
offered in articles, books, and lectures an explanation for why average working
people in advanced nations like the United States have failed to gain ground
and are under increasing economic stress: Put simply, globalization and
technological change have made most of us less competitive. The tasks we used
to do can now be done more cheaply by lower-paid workers abroad or by
computer-driven machines.

My solution—and I’m hardly alone in
suggesting this—has been an activist government that raises taxes on the
wealthy, invests the proceeds in excellent schools and other means people need
to become more productive, and redistributes to the needy. These
recommendations have been vigorously opposed by those who believe the economy
will function better for everyone if government is smaller and if taxes and
redistributions are curtailed.

While the explanation I offered a
quarter-century ago for what has happened is still relevant—indeed, it has become
the standard, widely accepted explanation—I’ve come to believe it overlooks a
critically important phenomenon: the increasing concentration of political
power in a corporate and financial elite that has been able to influence the
rules by which the economy runs. And the governmental solutions I have
propounded, while I believe them still useful, are in some ways beside the
point because they take insufficient account of the government’s more basic
role in setting the rules of the economic game.

Worse yet, the ensuing debate over
the merits of the “free market” versus an activist government has diverted
attention from how the market has come to be organized differently from the way
it was a half-century ago, why its current organization is failing to deliver
the widely shared prosperity it delivered then, and what the basic rules of the
market should be. It has allowed America to cling to the meritocratic tautology
that individuals are paid what they’re “worth” in the market, without examining
the legal and political institutions that define the market. The tautology is
easily confused for a moral claim that people deserve what they are paid. Yet
this claim has meaning only if the legal and political institutions defining
the market are morally justifiable.

                                                         II

Most fundamentally, the standard
explanation for what has happened ignores power. As such, it lures the
unsuspecting into thinking nothing can or should be done to alter what people
are paid because the market has decreed it.

The standard explanation has allowed
some to argue, for example, that the median wage of the bottom 90 percent—which
for the first 30 years after World War II rose in tandem with productivity—has
stagnated for the last 30 years, even as productivity has continued to rise, because
middle-income workers are worth less than they were before new software
technologies and globalization made many of their old jobs redundant. They
therefore have to settle for lower wages and less security. If they want better
jobs, they need more education and better skills. So hath the market decreed.

Yet this market view cannot be the
whole story because it fails to account for much of what we have experienced.
For one thing, it doesn’t clarify why the transformation occurred so suddenly.
The divergence between productivity gains and the median wage began in the late
1970s and early 1980s, and then took off. Yet globalization and technological
change did not suddenly arrive at America’s doorstep in those years. What else
began happening then?

Nor can the standard explanation
account for why other advanced economies facing similar forces of globalization
and technological change did not succumb to them as readily as the United
States. By 2011, the median income in Germany, for example, was rising faster
than it was in the United States, and Germany’s richest 1 percent took home
about 11 percent of total income, before taxes, while America’s richest 1
percent took home more than 17 percent. Why have globalization and
technological change widened inequality in the United States to a much greater
degree?

Nor can the standard explanation
account for why the compensation packages of the top executives of big
companies soared from an average of 20 times that of the typical worker 40
years ago to almost 300 times. Or why the denizens of Wall Street, who in the
1950s and 1960s earned comparatively modest sums, are now paid tens or hundreds
of millions annually. Are they really “worth” that much more now than they were
worth then?

Finally and perhaps most significantly,
the market explanation cannot account for the decline in wages of recent
college graduates. If the market explanation were accurate, college graduates
would command higher wages in line with their greater productivity. After all,
a college education was supposed to boost personal incomes and maintain
American prosperity.

To be sure, young people with college
degrees have continued to do better than people without them. In 2013,
Americans with four-year college degrees earned 98 percent more per hour on
average than people without a college degree. That was a bigger advantage than
the 89 percent premium that college graduates earned relative to non-graduates
five years before, and the 64 percent advantage they held in the early 1980s.

But since 2000, the real average
hourly wages of young college graduates have dropped. The entry-level wages of
female college graduates have dropped by more than 8 percent, and male
graduates by more than 6.5 percent. To state it another way, while a college
education has become a prerequisite for joining the middle class, it is no
longer a sure means for gaining ground once admitted to it. That’s largely
because the middle class’s share of the total economic pie continues to shrink,
while the share going to the top continues to grow. 

                                                         III

A deeper understanding of what has
happened to American incomes over the last 25 years requires an examination of
changes in the organization of the market. These changes stem from a dramatic
increase in the political power of large corporations and Wall Street to change
the rules of the market in ways that have enhanced their profitability, while
reducing the share of economic gains going to the majority of Americans. 

This transformation has amounted to a
redistribution upward, but not as “redistribution” is normally defined. The
government did not tax the middle class and poor and transfer a portion of
their incomes to the rich. The government undertook the upward redistribution
by altering the rules of the game.

Intellectual property rights—patents,
trademarks, and copyrights—have been enlarged and extended, for example. This
has created windfalls for pharmaceuticals, high tech, biotechnology, and many
entertainment companies, which now preserve their monopolies longer than ever.
It has also meant high prices for average consumers, including the highest
pharmaceutical costs of any advanced nation.

At the same time, antitrust laws have
been relaxed for corporations with significant market power. This has meant
large profits for Monsanto, which sets the prices for most of the nation’s seed
corn; for a handful of companies with significant market power over network
portals and platforms (Amazon, Facebook, and Google); for cable companies
facing little or no broadband competition (Comcast, Time Warner, AT&T,
Verizon); and for the largest Wall Street banks, among others. And as with
intellectual property rights, this market power has simultaneously raised
prices and reduced services available to average Americans. (Americans have the
most expensive and slowest broadband of any industrialized nation, for
example.) 

Financial laws and regulations
instituted in the wake of the Great Crash of 1929 and the consequential Great
Depression have been abandoned—restrictions on interstate banking, on the
intermingling of investment and commercial banking, and on banks becoming
publicly held corporations, for example—thereby allowing the largest Wall
Street banks to acquire unprecedented influence over the economy. The growth of
the financial sector, in turn, spawned junk-bond financing, unfriendly
takeovers, private equity and “activist” investing, and the notion that
corporations exist solely to maximize shareholder value.

Bankruptcy laws have been loosened
for large corporations—notably airlines and automobile manufacturers—allowing
them to abrogate labor contracts, threaten closures unless they receive wage
concessions, and leave workers and communities stranded. Notably, bankruptcy
has not been extended to homeowners who are burdened by mortgage debt and owe
more on their homes than the homes are worth, or to graduates laden with
student debt. Meanwhile, the largest banks and auto manufacturers were bailed
out in the downturn of 2008–2009. The result has been to shift the risks of
economic failure onto the backs of average working people and taxpayers.

Contract laws have been altered to
require mandatory arbitration before private judges selected by big
corporations. Securities laws have been relaxed to allow insider trading of
confidential information. CEOs have used stock buybacks to boost share prices
when they cash in their own stock options. Tax laws have created loopholes for
the partners of hedge funds and private-equity funds, special favors for the
oil and gas industry, lower marginal income-tax rates on the highest incomes,
and reduced estate taxes on great wealth.

All these instances represent
distributions upward—toward big corporations and financial firms, and their
executives and shareholders—and away from average working people.

                                                          IV

Meanwhile, corporate executives and
Wall Street managers and traders have done everything possible to prevent the
wages of most workers from rising in tandem with productivity gains, in order
that more of the gains go instead toward corporate profits. Higher corporate
profits have meant higher returns for shareholders and, directly and
indirectly, for the executives and bankers themselves.

Workers worried about keeping their
jobs have been compelled to accept this transformation without fully
understanding its political roots. For example, some of their economic
insecurity has been the direct consequence of trade agreements that have
encouraged American companies to outsource jobs abroad. Since all nations’
markets reflect political decisions about how they are organized, so-called
“free trade” agreements entail complex negotiations about how different market
systems are to be integrated. The most important aspects of such negotiations
concern intellectual property, financial assets, and labor. The first two of these
interests have gained stronger protection in such agreements, at the insistence
of big U.S. corporations and Wall Street. The latter—the interests of average
working Americans in protecting the value of their labor—have gained less
protection, because the voices of working people have been muted. 

Rising job insecurity can also be
traced to high levels of unemployment. Here, too, government policies have
played a significant role. The Great Recession, whose proximate causes were the
bursting of housing and debt bubbles brought on by the deregulation of Wall
Street, hurled millions of Americans out of work. Then, starting in 2010,
Congress opted for austerity because it was more interested in reducing budget
deficits than in stimulating the economy and reducing unemployment. The
resulting joblessness undermined the bargaining power of average workers and
translated into stagnant or declining wages.

Some insecurity has been the result
of shredded safety nets and disappearing labor protections. Public policies
that emerged during the New Deal and World War II had placed most economic
risks squarely on large corporations through strong employment contracts, along
with Social Security, workers’ compensation, 40-hour workweeks with
time-and-a-half for overtime, and employer-provided health benefits (wartime
price controls encouraged such tax-free benefits as substitutes for wage
increases). But in the wake of the junk-bond and takeover mania of the 1980s,
economic risks were shifted to workers. Corporate executives did whatever they
could to reduce payrolls—outsource abroad, install labor-replacing
technologies, and utilize part-time and contract workers. A new set of laws and
regulations facilitated this transformation.

As a result, economic insecurity
became baked into employment. Full-time workers who had put in decades with a
company often found themselves without a job overnight—with no severance pay,
no help finding another job, and no health insurance. Even before the crash of
2008, the Panel Study of Income Dynamics at the University of Michigan found
that over any given two-year stretch in the two preceding decades, about half
of all families experienced some decline in income.

Today, nearly one out of every five
working Americans is in a part-time job. Many are consultants,
freelancers, and independent contractors. Two-thirds are living paycheck
to paycheck. And employment benefits have shriveled. The portion of workers
with any pension connected to their job has fallen from just over half in 1979 to
under 35 percent today. In MetLife’s 2014 survey of employees, 40 percent
anticipated that their employers would reduce benefits even further.

The prevailing insecurity is also a
consequence of the demise of labor unions. Fifty years ago, when General Motors
was the largest employer in America, the typical GM worker earned $35 an hour
in today’s dollars. By 2014, America’s largest employer was Walmart, and the
typical entry-level Walmart worker earned about $9 an hour. 

This does not mean the typical GM
employee a half-century ago was “worth” four times what the typical Walmart
employee in 2014 was worth. The GM worker was not better educated or motivated
than the Walmart worker. The real difference was that GM workers a half-century
ago had a strong union behind them that summoned the collective bargaining
power of all autoworkers to get a substantial share of company revenues for its
members. And because more than a third of workers across America belonged to a
labor union, the bargains those unions struck with employers raised the wages
and benefits of non-unionized workers as well. Non-union firms knew they would
be unionized if they did not come close to matching the union contracts.

Today’s Walmart workers do not have a
union to negotiate a better deal. They are on their own. And because less than
7 percent of today’s private-sector workers are unionized, most employers
across America do not have to match union contracts. This puts unionized firms
at a competitive disadvantage. Public policies have enabled and encouraged this
fundamental change. More states have adopted so-called “right-to-work” laws.
The National Labor Relations Board, understaffed and overburdened, has barely
enforced collective bargaining. When workers have been harassed or fired for
seeking to start a union, the board rewards them back pay—a mere slap on the
wrist of corporations that have violated the law. The result has been a race to
the bottom. 

Given these changes in the
organization of the market, it is not surprising that corporate profits have
increased as a portion of the total economy, while wages have declined. Those
whose income derives directly or indirectly from profits—corporate executives,
Wall Street traders, and shareholders—have done exceedingly well. Those
dependent primarily on wages have not.

                                                         V

The underlying problem, then, is not
that most Americans are “worth” less in the market than they had been, or that
they have been living beyond their means. Nor is it that they lack enough
education to be sufficiently productive. The more basic problem is that the
market itself has become tilted ever more in the direction of moneyed interests
that have exerted disproportionate influence over it, while average workers
have steadily lost bargaining power—both economic and political—to receive as
large a portion of the economy’s gains as they commanded in the first three
decades after World War II. As a result, their means have not kept up with what
the economy could otherwise provide them. 

To attribute this to the impersonal
workings of the “free market” is to disregard the power of large corporations
and the financial sector, which have received a steadily larger share of
economic gains as a result of that power. As their gains have continued to accumulate,
so has their power to accumulate even more.

 Under these circumstances, education
is no panacea. Reversing the scourge of widening inequality requires reversing
the upward distributions within the rules of the market, and giving workers the
bargaining leverage they need to get a larger share of the gains from growth.
Yet neither will be possible as long as large corporations and Wall Street have
the power to prevent such a restructuring. And as they, and the executives and
managers who run them, continue to collect the lion’s share of the income and
wealth generated by the economy, their influence over the politicians,
administrators, and judges who determine the rules of the game may be expected
to grow.

The answer to this conundrum is not
found in economics. It is found in politics. The changes in the organization of
the economy have been reinforcing and cumulative: As more of the nation’s
income flows to large corporations and Wall Street and to those whose earnings
and wealth derive directly from them, the greater is their political influence
over the rules of the market, which in turn enlarges their share of total
income. 

The more dependent politicians become on their financial favors, the
greater is the willingness of such politicians and their appointees to
reorganize the market to the benefit of these moneyed interests. The weaker
unions and other traditional sources of countervailing power become
economically, the less able they are to exert political influence over the
rules of the market, which causes the playing field to tilt even further
against average workers and the poor.

Ultimately, the trend toward widening
inequality in America, as elsewhere, can be reversed only if the vast majority,
whose incomes have stagnated and whose wealth has failed to increase, join
together to demand fundamental change. The most important political competition
over the next decades will not be between the right and left, or between
Republicans and Democrats. It will be between a majority of Americans who have
been losing ground, and an economic elite that refuses to recognize or respond
to its growing distress.

[This article is
from the fall issue of “The American Prospect.”]

Robert Reich
Contributor
Robert B. Reich is Chancellor's Professor of Public Policy at the University of California at Berkeley and Senior Fellow at the Blum Center for Developing Economies. He served as Secretary of Labor in the…
Robert Reich

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