A Root Cause of 21st Century Inequality: Wall Street

How nice to start a week with Paul Krugman and Larry Summers agreeing with things you have been saying for months. The Demos report, Financialization and Equal Opportunity, looks to the financial sector for causes of and remedies for inequality of wealth and income.

Krugman’s Monday op-ed blasts the notion that the only thing we need to do is train people properly and the critical economic issue of our time, chronic inequality of income and wealth, will be solved. He calls it an evasion on a par with the deficit boogeyman that has so damaged our politics and economy. “This time, the evasion involves trying to divert our national discourse about inequality into a discussion of alleged problems with education.” Instead, Krugman points to the lack of good job opportunities and dismal productivity in the economy.

Last week, Larry Summers made very much the same point concerning our education-centric approach to inequality. Again, he pointed to the simple fact that the economy is not generating sufficient good jobs to remedy the stagnation and deterioration of incomes of the vast majority of the population. He made his remarks at an event sponsored by the Brookings Institute’s Hamilton Project.

Make no mistake, neither Krugman nor Summers is opposed to improving the skills of the American workforce. Demos certainly supports improving education and training. But that is simply not enough to deal with the chronic and dangerous problem of inequality.

While conservatives hold onto the notion that freeing up “makers” will create jobs to employ “takers” and mainstream progressives hope that we can educate our way out of the problem, Demos explores a third rationale for America’s growing inequality. It holds that inequality is growing because the increased wealth of the wealthiest no longer spawns income opportunities for the less well-off households and may actually diminish them. The system is not generating enough potential working household income to maintain acceptable equality.

If the economic structure now constrains (rather than grows) middle and lower income opportunities, training people will not help and could actually make matters worse. More individuals would compete for a finite set of skilled jobs, driving down potential income. This would mean that we are moving in the direction of a zero sum economy in which the rising tide simply does not float the boats of the vast majority of households. In fact, an increasing number find themselves with no boat at all.

There are only two remedies for that condition. Government can simply transfer wealth from the rich to the vast majority of households. It is clear that some direct redistribution is needed. But if the economy structurally increases inequality of income and wealth, redistribution cannot be the sole remedy over the long run. Increasing pre-redistribution inequality would require ever greater redistribution over time.

Krugman identifies the key point: the third rationale can only be true in an environment of rising corporate profits if the economy is burdened my market power.

So what is really going on? Corporate profits have soared as a share of national income, but there is no sign of a rise in the rate of return on investment. How is that possible? Well, it’s what you would expect if rising profits reflect monopoly power rather than returns to capital.

The Demos report identifies a new form of market power that is driving inequality. It is different from predatory monopolies of the past and is wielded by the financial sector. Its source is a confluence of conditions dating from the early 1980s—extraordinary advances in market technology and quantitative analytics, a huge increase in demand for debt investments and deregulation of markets.

This market power altered the economic machine that had previously worked so well to generate simultaneous economic growth and equality, at least for those who were not left out as people of color or other disenfranchised groups. Boring banking—making deposits and making loans—gave way to the trading and derivatives markets as the dominant mechanisms to allocate capital. The financial sector broke away from its traditional role as provider of a service to the long-term growth of the rest of the economy. Finance came to be seen as an independent engine of productive growth rather than as a utility that just happened to be very profitable.

This had happened once before. In the apotheosis of the Gilded Age, bankers broke free of boring banking using monopolistic trusts to acquire industrial concerns in powerful combinations. The bankers and their robber baron friends grabbed control over commerce and markets. This led to antitrust laws and the rise of the Progressive Movement championed by Teddy Roosevelt.

Demos' report shows how, in the “new Gilded Age,” non-financial companies have come to mimic financial firms. Following the dictates of the financial sector (and some perverse incentives generated by compensation schemes), CEOs have become obsessed with trading screens rather than in growing their businesses and jobs.

While different from the prior Gilded Age, the effect is the same: the financial sector has lost track of its core purpose, to serve the interests of the broad economy. It has merged interests with the manufacturing and service economy to create great power that depresses income from labor and the dynastic personal wealth that goes with it.

Taken together, Krugman and Summers have seen that inequality is caused by deep structural flaws rather than simply a skill gap and that these flaws are a function of market power. Hopefully they will follow our lead and identify the actual flaws so that they can be remedied.