Economic inequality a crisis for capitalism

Increasing economic inequality and decreasing mobility have entered mainstream consciousness and been identified as among the most pressing challenges of capitalist societies like the United States in the 21st century. Today, capitalism has a distinctly pejorative interpretation here in its free-market Mecca.

Increasingly, Americans are questioning the ideology of capitalism itself. This crisis manifests itself prominently among the nuevo millennial socialists for whom capitalism is all about profit. For them, profit is a bad word. They ignore the reality that in any economic system people hope to gain more value from things than they put into them, and that this is true in whatever you do in life.

According to a new Harris Poll, more millennials would prefer to live in a socialist country (44 percent) than a capitalist one (42 percent). The percentage of millennials who would prefer socialism to capitalism is a full 10 points higher than that of the general population. What’s more, this crowd rejects capitalism as an economic system because it benefits the wealthy and powerful; poses large social costs; and contributes to the obscene prosperity of a tiny, privileged minority.

Alternatively, proponents of capitalism argue that it is the only system humans have developed that maintains both improvement in living standards and individual freedom. Despite criticism that it is morally bankrupt, capitalism has spread prosperity across the planet. Free markets have generated enormous wealth in recent decades, as documented by the World Bank delivering millions of people out of poverty and raising living standards throughout the world. In 1990, about 40 percent of the global population lived on less than $1.90 a day, according to the World Bank; today it is less than 10 percent.

But the story is different for the average American. Since the 1970s, their wages have stagnated. Since the 1990s, cheap imports made available by NAFTA and Chinese accession to the World Trade Organization benefited consumers, but depressed wages and robbed blue-collar Americans of the secure manufacturing jobs and the health and retirement benefits that went with them.

Technological advances certainly played a major role in worker displacement, but trade policy also contributed to the U.S. losing seven million of its 19.2 million manufacturing jobs from 1980 to 2015. Yes, consumers have enjoyed lower costs for imported products, but displaced workers in the United States have paid the price and contributed to what has been labeled the crisis of capitalism: the growing gap between haves and the have-nots.

How then to define capitalism? In theory it is another ism that describes an economic way of life, a system that emphasizes private ownership of personal property and business assets, property rights that protect ownership, the sanctity of private contracts, using prices to allocate resources efficiently, a reliance on competition and incentives, voluntary exchanges between consenting adults, profit maximization, an effective legal system and limited state intervention.

In practice, capitalism is not monolithic; it takes many forms. For instance, in the United States, government plays a more limited role in economic decisions than under China’s form of market driven state capitalism. There, the government has a substantial role in shaping the rules of the market and is a significant player in the economy. In the Russian style of state capitalism, the Kremlin relies on both direct government intervention in key economic sectors and control of politically connected businessmen to promote the interests of the Russian state and those who run it.

Like any economic system, capitalism is a human institution and, as such, is imperfect. It should be judged on the basis of whether it is the best system available, not the best imaginable. And it is capable of reform. As the saying goes “nothing is forever, not now, not ever, never.”

Finally it is worth remembering, to paraphrase John Kenneth Galbraith’s comment, “under capitalism man exploits man while under socialism the reverse obtains.”

 Originally Published: May 11, 2019.

Not everyone considers socialism a Cracker Jack idea

Capitalism seemed untouchable several decades ago, but not today. Many politicians aspiring to high office, such as Senator Bernie Sanders, a self-declared democratic socialist, are making the case for the inevitable and Darwinian triumph of socialism.

It is unclear what socialism means to them. It is a word that means many things to many people and has taken many forms. The modern version is different from the textbook variety of public ownership of the means of production, distribution, and exchange, leaving to individuals only the free discretion over consumer goods and creating a paradise on earth. Publicly owned property is preferable to private enterprise, with everyone acting virtuously and focusing on the greater good.

Is it the ideal commonwealth in Plato’s Republic, with a ruling class that has no property of its own and shares all things in common? Or a more robust version of New Deal Liberalism, or perhaps Northern European social democracy? What about the path taken in Venezuela, North Korea, and Cuba?

Or is it a planned economy with benevolent bureaucrats taking the place of free-market capitalism and playing the omniscient busybody in economic affairs to create more opportunity for the underprivileged; open the horizons of education to all, eliminate discriminatory practices based on sex, religion, race, or social class; regulate and reorganize the economy for the benefit of the whole community; protect the environment; provide adequate Social Security and universal health care for the sick, unemployed and aged in a utopian ideal of total equality of opportunity and outcome?

The term has become a blank canvas as presidential candidates embracing some of these ideas become more outspoken about socialism as the solution to problems of social and economic equality, and embracing a political wish list that includes Medicare for All, a Green New Deal and free public college. All grand ideas if they work.

These proposals have great appeal to millennials, the term generally used to refer to people born after 1980 and before 2000. Millennials outnumber baby boomers as the largest generational cohort in American society.

Recent surveys of Americans 18 to 34 find that 45 percent have a positive view of socialism. It gets even higher marks from Hispanics, Asian- and African-Americans. This attraction may have less to do with their understanding of socialism and more to do with their discontent with the current economic system. In contrast, only 26 percent of baby boomers would prefer to live in a socialist country.

Why the generational disparity? Is it because many of these folks reached adulthood in a dismal job market with crippling student loans caused by the brutal 2007-2009 recession that left them with less disposable income than their predecessors? They end up hating their own culture, even as millions around the world dream of coming to the land of milk and honey. Many agree with Governor Cuomo’s comment that “America was never that great.”

But these proposals also create agita for many politicians. That is why House Speaker Nancy Pelosi, in a recent interview with CBS’s “60 Minutes,” said socialism is “not the view” of the Democratic Party,” and that lawmakers on her side of the aisle “know that we have to hold the center.” The Republicans are trying to paint Democrats with the socialism brush, using accusations of rampant amnesia about the failures of socialism as a 2020 campaign weapon.

Former President Ronald Reagan once mocked Fidel Castro’s brand of socialism with a clever joke. He said Castro was immersed in one of his long speeches when a person in the crowd was heard shouting, “Peanuts, popcorn, Cracker Jacks.” Castro continued on with his speech when a second voice was heard shouting the same thing. This time Castro became angry and screamed, “We will kick the tush of the next person I hear say that all the way to Miami Beach.” At which point the whole crowd yelled, “Peanuts, popcorn, Cracker Jacks.”

 Originally Published: April 27, 2019

Concentration of power benefits the haves

In the continuing controversy over economic inequality in the United States, the focus is on such factors as the decline of organized labor, tax cuts for the well off, outsourcing of American manufacturing jobs overseas, and the substitution of capital for labor. But the lack of competition in many sectors of the economy is also a powerful driver of disparity, redistributing income and wealth from consumers generally to the affluent.

As with lengths of skirts, lapels on men’s suits, and other more or less important customs, there are also fashions in markets. Over the last two decades, many firms have been consolidated across the U.S. economy. Oligopolies are common and concentration is increasing in numerous industries.

Many markets are now oligopolies, in which a small number of companies account for most sales. In major industries from telecoms, social media and internet search to retail, airlines, beer, pharmaceuticals, hospitals, banks, the American public has seen a few giants come to dominate. What competition does exist is among just a few participants, not exactly the type described in textbooks.

These firms use their market power to increase prices, drive down wages and assert greater authority over workers. They find ways to deter new firms by creating and maintaining barriers to entering the market, and use economies of scale to exercise strong leverage over suppliers. In addition to raising prices relative to what they would charge in a competitive market, these powerful companies may also reduce quality or convenience, modifying product features and reducing customer discounts. All this leads to a transfer of wealth from buyers to sellers.

It should not be overlooked that consolidation of market power also concentrates political power, thanks to the lobbying muscle of oligopolistic companies. Economic and political power can be mutually reinforcing. As things stand, market power gives these companies the resources to protect their competitive advantages and leverage their advantages through the political process buying the all-important access.

Take the $2.5 trillion health care industry, where rising prices are partially driven by increased consolidation. Consider the large number of hospital mergers that limit competition among hospitals. Today, many Americans today live in areas where there is little such competition.

The same is true in other economic sectors. Merger mania in the airline industry has resulted in eight majors combining to create four giant carriers over the past decade. Not to be ignored is the fact that a handful of large institutional investors such as BlackRock, Vanguard, Fidelity, and State Street are among the top shareholders for all four major airlines. Given the huge extent of common ownership in the U.S. airline industry, it is not surprising that the price wars of the 1990s have ended and profits are on the rise as companies may refrain from competing aggressively when their competitors have the same large shareholders.

Consider the drastic increase in banking industry concentration, where too big to fail banks, instead of getting smaller, are pretty much taking over the financial universe. The five largest banks in the U.S. – JPMorgan Chase, Bank of America, Wells Fargo, Citigroup and US Bancorp – have about $7 trillion in assets. That’s nearly 45 percent of the industry’s total. The other 55 percent of assets are divided among 6,000 institutions, according to the Federal Reserve. The top-10 banks’ share of the deposit market has increased from about 20 percent to 50 percent from 1980 to 2010.

Looking beyond individual industries affected by excessive market power, the bad news is that this concentrated power leads to concentration of wealth and income, and contributes to increasing economic inequality because the returns from market power go disproportionately to the wealthy, like company shareholders and senior executives.

God love them, for they are reaping rewards to which ordinary Americans have no access. Amen.

Originally Published: October 13, 2018

Hero CEOs need to look in the mirror about economic inequality

In a strong rebuke to President Trump’s response to the recent violence in Charlottesville, Virginia, a chorus of masters of the universe, titans of industry, and corporate rock stars lined up like soldiers to take head shots at the president, criticizing him by name for his handling of the violence.

Many were so appalled by what the president did and did not say that they resigned from his business advisory councils. The media certainly milked it for all it was worth, some characterizing senior executives as heroes for speaking truth to power.

Nothing stokes cable ratings like a sustained campaign of outrage that feeds into the attention deficit disorder of the American news cycle. But perhaps some of that outrage should be directed at the crusading corporate giants themselves.

Perhaps it is only a matter of time before chief executive officers show the same passion and anger when it comes to speaking out against the economic inequality that has risen so sharply since the mid-1970s. For example, CEOs could voluntarily take less compensation and use their concentrated political and economic power to support a national living wage.

After all, the Gods of Fortune have continued to smile down upon corporate executives with outsized payoffs. The average CEO earns something close to 300 times the pay of the median American worker, whose real wages have been stagnant for decades. This ratio is up from roughly 40 to 1 in 1980. In contrast to this growing gulf between the haves and the have-nots, the ratio of CEO to average worker pay in Japan is 16 to 1. In Denmark, it is 48 to 1 and in the United Kingdom 84 to 1.

CEOs do not have to worry about saving for retirement or their children’s college education as they enjoy expensive perquisites from country club membership to second homes a little smaller than Rhode Island, to the personal use of corporate jets.

Is it any wonder that the public is mad as hell? They make the connection between business executive pay and growing economic inequality.

A few decades ago, executives were paid mostly in cash. Much of the story of executive compensation in recent decades comes down to two words: stock options.

To align incentives between shareholders and management, boards of directors use equity compensation by granting stock options. Today, they comprise two thirds of the typical executive’s pay.

Stock options give the executive the right to buy a company’s stock at a predetermined price sometime in the future. If share prices rise above the negotiated strike price, the executive stands to reap significant gains. If the options become worthless, the CEO breaks even, having paid nothing for them.

The result is a win-win for executives, especially when supplemented through the use of stock buy backs and the labyrinthine of accounting shenanigans such as excluding depreciation and amortization in calculating earnings for performance based compensation.

The stock buyback binge of $4 trillion since 2008, much of it with borrowed money thanks to low interest rates since the Great Recession, has resulted in firms reducing the number of outstanding shares by which profits have to be divided. So the share repurchases lift per-share earnings, improving a key metric for determining CEO compensation.

Solutions to the CEO compensation issue include tightening the cap on tax deductibility of CEO pay and disallowing deductions for excess salary, stock options, and perks. Fat chance, these reforms will happen when the positions of too many politicians closely reflect those of their big money donors.

Cynicism about those in positions of power seems to be confirmed afresh each day by the latest tweets, pandering, and headlines. As a general rule, assume the worst about elected officials and the thinly veiled plutocracy. That way you will not be disappointed.

Originally published: September 12, 2017

Rich getting richer is no accident

The upward redistribution of income in the United States over the last four decades has been well documented. Many argue there is little we can do about forces like globalization, accelerating technological change, the transformation to a service economy, taxes and government programs that have put downward pressure on wages for the ordinary American worker, but there are steps government could take to address these changes.

Economic inequality is the result of conscious policy choices. This issue is especially relevant in light of President Trump’s new tax blueprint and the health care overhaul recently passed by the House of Representatives.

From the 1950s to the mid-1980s, the richest 1 percent of Americans earned a touch under a 10 percent share of the national income. By 2012, that number was about 20 percent.

Overall wealth is even more concentrated than income. In 2012, the top 1 percent of the population controlled about 42 percent of the wealth.

The promises many politicians make about material comforts are duplicitous, since only a small minority have access to such comforts and they come at great expense to the majority. Working-class Americans feel left behind, stewing in their resentment of economic hardships and being forced to make daily choices between things like buying gas or putting food on the table.

They have come to believe government is run by and for the rich, who are used to getting their own way and face none of the daily struggles they do. Much of the American working class lives in a provisional world where making it to the next day is a victory.

Average Americans were cut adrift from their former lives, given little help to build new ones and disparaged as a basket of deplorables. All this was largely happening outside the view of the media and the political class.

You don’t have to have the psychological acuity of a self-important academic to understand the ironclad rage of the working class, which is proving to have the shelf life of radioactive waste. Is it any surprise that when powerless to determine their own destinies and achieve the American Dream, they backslide into anger and resentment?

This was not supposed to happen. In the optimistic period after the fall of the Berlin Wall in 1989 and the collapse of the Soviet Union in 1992, free-market capitalism, with its invisible hand miraculously transforming selfishness into common good, was seen as the way to usher in a period of prosperity and peace.

More recently, one event after another has exposed this utopian narrative. The 2008 financial earthquake revealed fault lines running through the economic system that cost millions of Americans their jobs, homes, life savings and hopes for decent retirements. It unraveled communities, especially those where manufacturing jobs have disappeared and the well being of the working class has been marginalized by circumstances beyond their control. It was a cataclysm far worse than any natural disaster.

Troubling results from growing inequality include dampened economic growth, reduced social mobility, and a corrosive impact on democratic institutions. Another important consequence is weak consumer demand to support the economy.

It would be wise to recall how Henry Ford simultaneously created transportation for the masses and drove economic growth. He furnished consumers with reasonably priced cars while raising wages for his own workers to make the car affordable to them.

Rather than raising the federal minimum wage, a modern version of Ford’s approach would be to expand the earned income tax credit to supplement low-wage workers’ incomes, which would mean the government paying Americans whose earnings are below a certain level. The program was started under President Ford in 1975, expanded once by President Reagan and again by President Clinton.

President Trump has proposed expanding the earned income tax credit beyond the 27 million working families who currently benefit from it. Such a move would increase demand and economic growth by providing working class Americans with the living wage they deserve.

Originally Published: May 13, 2017

Widening gap between rich and poor a challenge for capitalism

Capitalism is a well-known paradigm that attempts to answer the question of what constitutes an economically just society through the production and distribution of economic goods. It is a classic example of a paradigm that was developed by studying what was going on in the real world and reducing it to abstract theory.

As practiced in most societies, capitalism is an inevitable outgrowth of the human instinct to trade goods with each other. This instinct seems to be as strongly hard-wired into the DNA of our species as the instinct to reproduce and has defied all attempts to suppress it. Various forms of capitalism have, over time and across countries, improved the lives of billions of people, especially since the collapse of the Soviet Union and China’s adoption of a form of state capitalism in 1976. But how effective is it when it comes to the just distribution of goods among members of society?

A late-night television wag once quipped that paradigms were the last refuge of the intellectually challenged. Preconceptions can be a useful starting point for organizing great masses of empirical evidence, but it is prudent not to edit the evidence to fit our normative theories about what the real world ought to look like.

This was the mistake made by the Medieval European philosophers who based their cosmology of an earth-centered universe on accepted Christian myths carefully propped up with Aristotelian logic. The result was the need for constant tinkering with their theoretical models to accommodate a growing body of astronomical evidence about how the known planets actually moved.

Not to mention centuries of embarrassment for the Roman Catholic Church after it forced Galileo to recant the evidence of his own eyes that supported the “heretical” sun-centered cosmology of Copernicus.

As capitalism matured and came to dominate western societies during the last two centuries, it attracted the attention of various writers who developed paradigms to explain it. Beginning with Adam Smith and proceeding through John Stewart Mill to today’s stained glass theorists of the Austrian and Chicago schools, these writers with the regularity of Swiss trains sought to purify their paradigms and give them a hard core of academic logic.

In Smith’s world, competition among those who pursue their own interest promotes the general welfare of society more effectively than the efforts of any individual who might deliberately set out to promote it. As he simply put it: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”

Critics argue that, as currently structured, capitalism disproportionately benefits the wealthy and powerful. They say it exacerbates both economic inequality and other pressing societal problems, such as environmental issues.

Stated differently, one downside of capitalism as currently practiced is that it results in the rich getting richer and the poor getting poorer. This has led to unprecedented stagnation in American social mobility and been a major factor in the anger many Americans are expressing.

This condition is a real challenge in a country where, just this past November, we learned just how deeply economic and demographic factors has divided the electorate. To paraphrase Florida Sen. Marco Rubio, it is a country in which half the people absolutely hate the other half. The relationship between the haves and have-nots is dramatized by the media and by politicians firing up their base.

In any case, the practical test of a vision’s standing in the real world is whether it can consistently pass the French Revolution Test. That is, whether it can win acceptance by a sufficiently large majority of a society’s members to withstand the inevitable assaults from those who find it objectionable and seek to replace it with their own visions – by force, if other means fail.

Originally Published: February 18, 2017

Stock buybacks do nothing for most of us

Economic inequality in the United States is at historic levels. In the wake of the Great Recession, the issue has captured the attention of the American public, but there is little consensus about its causes. One of the causes is clearly the rise in corporate stock buybacks and short-term thinking.

In the 1980s, the top 1 percent of Americans accounted for 10 percent of the income generated in the economy; by 2012 it was approaching 20 percent. The top 1 percent controlled nearly 42 percent of the wealth, a level not seen since the roaring ’20s.

This increased inequality does not support, and even inhibits, the consumer spending that drives economic growth in the United States because it leaves the middle class with less buying power.

Those who are supposedly smart on the issue point to a range of reasons for economic inequality, such as technological change, the decline of unions, globalization and trade agreements. Often overlooked is the expansion of the financial sector and corporate America’s Ahab-like obsession with short-term thinking.

According to the Bureau of Economic Analysis, in 1970 the finance and insurance industries accounted for 4.2 percent of gross domestic product, up from 2.8 percent in 1950. By 2012, the sector represented 6.6 percent.

The story with profits is similar: In 1970, finance and insurance industry profits made up about one quarter of the profits of all sectors, up from 8 percent in 1950. Despite the after effects of the financial crisis, that number had grown to 37 percent by 2013. Yet these industries create only 4 percent of all jobs, so profits go to a small minority.

The increase in the influence of financial sector extends to public corporations that face increased pressure to make immediate investor payouts through stock buybacks. According to Research Affiliates, S&P 500 companies spent $521 billion on stock buybacks in 2013 and $634 billion in 2014. More than

$6.9 trillion has been spent on share buybacks since 2004. Not one dime of this money has gone into expanding operations, hiring more employees, increasing wages, research and development, enhancing productivity, and improving the customer experience.

An important part of the appeal of stock buybacks is their ability to increase earnings per share. In theory, buybacks tend to jack up the share price, at least in the short term, by decreasing the number of shares outstanding while increasing earnings per share. Corporations frequently finance these buy backs by issuing debt, taking advantage of the Federal Reserve holding interest rates underwater and the fact that interest expense on the debt is tax deductible.

Underlying all this are two notions. First, the only responsibility of the corporation is to maximize shareholder value as reflected in the stock price, as opposed to getting sidetracked by talk about multiple stakeholders such as employees, customers and the community.

The second is that corporate management should be compensated in stock to align their interest with those of shareholders. Since managers’ pay is tied to the firm’s stock performance even at the expense of long-term shareholder wealth, the temptation to manage earnings to meet short-term investor expectations instead of long-term shareholder value is quite strong. For example, if the choice is between repairing the roof on the factory in Toledo this quarter or missing the quarterly earnings figure, which could cause earnings per share to tumble, corporate management might decide not to make the capital investment.

Stock-based compensation has also contributed to the sharp rise in CEO compensation. Between 1978 and 2013, CEO compensation increased by nearly 10-fold while workers experienced stagnant wages and increasing job insecurity.

While corporate and finance executives live in a second gilded age, stock buybacks and short-term thinking contribute to under investing in innovation and skilled workers, and ultimately to more economic inequality. But none of this troubles the 1 percenters, and they appear to be the only ones who really matter.

Originally Published: Jul 23, 2016

Extreme wealth inequality threatens the nation

One of the salient characteristics of the last 20 years has been the unprecedented growth in income and wealth inequality, and the extent to which both have flowed to the proverbial1-percenters.

Market capitalism has generated enormous wealth, but the distribution of the spoils of capitalism has gone awry. While there are many ways to measure inequality, consider that in today’ s Gilded Age, the wealthiest 1 percent of American households enjoy a higher total net worth than the bottom 90 percent and the top 1 percent of income earners receive more pretax income than the entire bottom half.

Since 1979, 36 percent of all after-tax gains went to the 1-percenters; over 20 percent of those gains went to the top one-tenth of 1 percent of the income distribution.

The increasingly unequal distribution of income and wealth threatens not only the social fabric of American society but the economy as well. The mega-rich cannot spend enough to offset the lost demand that results from a shrinking middle class, which slows economic growth.

Growing inequality is making a lie of the American promise that this is a country where if you work hard, you can make it into the middle class. We are witnessing the hollowing out of the middle class; it is being mothballed like an old Navy ship. The last time that income inequality in the land of plenty was as profound as it is now was immediately before the 1929 stock market crash.

Right now, more than 8.4 million Americans are collecting either state or federal unemployment benefits and one out of every seven depend on food stamps, the highest share of the population ever to do so. A shrinking few claim a disproportionate share of the nation’s wealth at the expense of everyone else.

If we could identify a single culprit to blame for this mess, it would make for a good television drama. But the story of rising income inequality is more complex. None of the major explanations are exhaustive or definitive, and making sense of them is no easy task.

Some blame globalization, a process of closer integration between different countries and peoples made possible by falling trade and investment barriers, tremendous advances in telecommunications and  drastic reductions in transportation costs that have forced American workers to compete against the huge supply of low-cost labor in the developing world and contributed to the declining influence of labor unwns.

Others point to new labor-replacing technologies that threaten both unskilled and skilled workers, while they increase demand for a select few with highly specialized skills. They argue that American public education does not provide children with the advanced skills they need to compete in this new world.

Stated differently, the pace of technological advance has outstripped the educational system’s ability to supply students with the skills they need to utilize this technology, leading to outsized earnings gains for those who have such skill. This is the so-called college wage premium.

Over the past few decades, people in developed economies who were educated enough to take advantage of the technological advances won higher wages. Others got left behind.

Finally, there are those who contend that immigration policy worsens inequality. The mass influx of low-wage workers probably reduces global inequality at the same time it increases inequality within America by reducing the wages of hard-working, semi-skilled Americans.

Many pundits contend that we can reverse the deterioration of the middle class with a series of policies such as revising the tax code, making free trade fair, investing in America’s infrastructure, rethinking training and education and strengthening labor unions.

Perhaps America can deal finally with the divisive issue of inequality after having spent decades ignoring it, but hope is not a strategy. The only thing we can be certain of is that there are no quick fixes or easy solutions, and the longer it takes to address the problem, the more painful the cure will be.

originally published: November 30, 2013