Sunday, June 29, 2014

The Myth of America’s Golden Age

I hadn’t realized when I was growing up in Gary, Indiana, an industrial town on the southern shore of Lake Michigan plagued by discrimination, poverty and bouts of high unemployment, that I was living in the golden era of capitalism. It was a company town, named after the chairman of the board of U.S. Steel. It had the world’s largest integrated steel mill and a progressive school system designed to turn Gary into a melting pot fed by migrants from all over Europe. But by the time I was born in 1943, cracks in the pot were already appearing. To break strikes—to ensure that workers did not fully share in the productivity gains being driven by modern technology—the big steel companies brought African-American workers up from the South who lived in impoverished, separate neighborhoods.
Smokestacks poured poisons into the air. Periodic layoffs left many families living hand to mouth. Even as a kid, it seemed clear to me that the free market as we knew it was hardly a formula for sustaining a prosperous, happy and healthy society.
So when I went off to college to study economics, I was astonished by what I read. The standard economic texts of the time seemed to be unrelated to the reality I had witnessed growing up in Gary. They said that unemployment shouldn’t exist and that the market led to the best of all possible worlds. But if that were the case, I decided, I wanted to live in a different world. While other economists were obsessed with extolling the virtues of the market economy, I focused a lot of my work on why markets fail, and I devoted much of my Ph.D. thesis at MIT to understanding the causes of inequality.
Nearly half a century later, the problem of inequality has reached crisis proportions. John F. Kennedy, in the spirit of optimism that prevailed at the time I was a college student, once declared that a rising tide lifts all boats. It turns out today that almost all of us now are in the same boat—the one that holds the bottom 99 percent. It is a far different boat, one marked by more poverty at the bottom and a hollowing out of the middle class, than the one occupied by the top 1 percent.

Most disturbing is the realization that the American dream—the notion that we are living in the land of opportunity—is a myth. The life chances of a young American today are more dependent on the income and education of his parents than in many other advanced countries, including “old Europe.”
Now comes Thomas Piketty, who warns us in his justly celebrated new book, Capital in the 21st Century, that matters are only likely to get worse. Above all, he argues that the natural state of capitalism seems to be one of great inequality. When I was a graduate student, we were taught the opposite. The economist Simon Kuznets optimistically wrote that after an initial period of development in which inequality grew, it would begin to decline. Although data at the time were scarce, it might have been true when he wrote it: The inequalities of the 19th and early 20th centuries seemed to be diminishing. This conclusion appeared to be vindicated during the period from World War II to 1980, when the fortunes of the wealthy and the middle class rose together.

But the evidence of the last third of a century suggests this period was an aberration. It was a time of war-induced solidarity when the government kept the playing field level, and the GI Bill of Rights and subsequent civil rights advances meant that there was something to the American dream. Today, inequality is growing dramatically again, and the past three decades or so have proved conclusively that one of the major culprits is trickle-down economics—the idea that the government can just step back and if the rich get richer and use their talents and resources to create jobs, everyone will benefit.

It just doesn’t work; the historical data now prove that.

But it has taken us far too long as a country to understand this danger. Changes in the distribution of income and wealth occur slowly, which is why it requires a grand historical perspective of the kind that Piketty provides to get a feel for what is happening.

Ironically enough, the final proof debunking this very Republican idea of trickle-down economics has come from a Democratic administration. President Barack Obama’s banks-first approach to saving the nation from another Great Depression held that by giving money to the banks (rather than to homeowners who had been preyed upon by the banks), the economy would be saved. The administration poured billions into the banks that had brought the country to the brink of ruin, without setting conditions in return. When the International Monetary Fund and the World Bank engage in a rescue, they virtually always impose requirements to ensure the money is used in the way intended. But here, the government merely expressed the hope that the banks would keep credit, the lifeblood of the economy, flowing. And so the banks shrank lending, and paid their executives megabonuses, even though they had almost destroyed their businesses. Even then, we knew that much of the banks’ profits had been earned not by increasing the efficiency of the economy but by exploitation—through predatory lending, abusive credit-card practices and monopolistic pricing. The full extent of their misdeeds—for instance, the illegal manipulation of key interest rates and foreign exchange, affecting derivatives and mortgages in the amount of hundreds of trillions of dollars—was only just beginning to be fathomed.

Obama promised to stop these abuses, but so far only a single senior banker has gone to jail (along with a very few mid- and low-level employees). The president’s former Treasury secretary, Timothy Geithner, in his recent book, Stress Test, made a valiant but unsuccessful attempt to defend the administration’s actions, suggesting that there were no alternatives. But Geithner clearly worried excessively about the “moral hazard” of helping underwater homeowners—in other words, encouraging lax borrowing habits—while seeming to care far less about the moral hazard of helping banks, or the culpability of the banks in encouraging excessive indebtedness and in marketing mortgages that put unbearable risks on the poor and middle classes.

In fact, Geithner’s attempts to justify what the administration did only reinforce my belief that the system is rigged. If those who are in charge of making the critical decisions are so “cognitively captured” by the 1 percent, by the bankers, that they see that the only alternative is to give those who caused the crisis hundreds of billions of dollars while leaving workers and homeowners in the lurch, the system is unfair.

This approach also exacerbated one of the country’s most pressing problems: its growing inequality. Only with a vibrant middle class can the economy fully recover and grow faster. The more inequality, the slower the growth—a conclusion now endorsed even by the IMF. Because the less wealthy consume a greater share of their income than do the rich, they expand demand when they have more income. When demand is expanded, jobs are created: In this sense, it is ordinary Americans who are the real job creators. So inequality commands a high price: a weaker economy, marked by lower growth and more instability. It is not very complicated.

None of this is the outcome of inexorable economic forces, either; it’s the result of policies and politics—what we did and didn’t do. If our politics leads to preferential taxation of those who earn income from capital; to an education system in which the children of the rich have access to the best schools, but the children of the poor go to mediocre ones; to exclusive access by the wealthy to talented tax lawyers and offshore banking centers to avoid paying a fair share of taxes—then it is not surprising that there will be a high level of inequality and a low level of opportunity. And that these conditions will grow even worse.   


Cautiously and belatedly, some six years after the fact, the Obama administration has now begun to revise its views about the Great Recession. Even Geithner, in his book, agrees that more should have been done. But hey, resources were scarce, and one had to make bets where they would be most effective. That’s the point: Listening to the bankers, it’s not a surprise that he placed his money on the bankers. Even before Obama took office, I urged a greater emphasis on homeowners: that we should combine at least a little trickle-up economics with trickle-down economics. But those of my persuasion were given short shrift, as the administration sought counsel from the vested interests in the financial sector.

The Obamians seem bewildered that the country is not more thankful to its government for having prevented another Great Depression. They saved the banks, and in doing so, they saved the economy from a once-in-a-hundred-year storm. And they proudly point out that all the money given to the financial sector has been more than repaid. But in making such claims, they ignore some critical realities: It was not something that just happened. It was the result of reckless behavior, the predictable and predicted consequences of deregulation and the inadequate enforcement of the regulations that remained, of buying into the mind-set of the 1 percent and the bankers—for which Geithner and his mentor, former White House economic adviser Larry Summers, had more than a little culpability. It was as if, after an accident caused by drunk driving, in which the last drink was served by the police officer on duty, the drunk driver was put back into the driver’s seat, his car rushed to the repair shop, while the victim was left to languish at the scene of the crime.

The repayment itself is, at least in part, the result of a game that would do any con man proud. The government, under the auspices of the Federal Reserve, lends money to the bank at a near-zero interest rate. The bank then lends it back to the government at 2 or 3 percent, and the “profit” is paid back to the government in repayment of the “investment” the government made. Bank officials, meanwhile, get a bonus for the hefty returns they have “earned” for the bank—something a 12-year-old could have done. This is capitalism? In a true rule-of-law world, a drunk driver would have to pay for not only his own repair costs but also the damage he has inflicted—in this case, the cumulative loss of GDP, which now amounts to more than $8 trillion, and which is mounting at the rate of $2 trillion a year. The banks recover, while the typical American’s income plummets to levels not seen in two decades. It is understandable why there might be some anger in the body politic.

What we have here is not, as administration officials would have it, a failure to communicate. The problem was that Americans saw what they were doing. There was a healthy debate in the country about alternative courses of action—before, during and after the bailouts. The reason critics like Sheila Bair, Elizabeth Warren, Neil Barofsky, Simon Johnson, Paul Krugman and others (left, right and center) won the day—at least the intellectual debate and the war over public perceptions—was not that they were better communicators. It was that they had a more convincing message: There were alternative ways of rescuing the economy that were fairer and that would have resulted in a stronger economy. Instead, our politics and economics are now locked into a vicious circle: Economic inequality leads to political inequality, and this political inequality then leads to rewriting the rules to increase the level of economic inequality even further, and so on. The result? Ever greater disillusionment with our democracy.

Meanwhile, lower taxes on capital and lower inheritance taxes are allowing the accumulation of inherited wealth—in effect, the creation of a new American plutocracy. It is even possible, as I pointed out long ago in my Ph.D. thesis and as Piketty has emphasized, that wealth will be increasingly concentrated among a select few. The shared prosperity that marked the country in that golden age of my youth—in which every group saw its income growing but those at the bottom saw it rise the fastest—is long gone.

When I was growing up in Gary during its own smog-choked “golden age,” it was impossible to see where the city was going. We didn’t know, or talk, about the deindustrialization of America, which was about to occur. I didn’t realize, in other words, that the rather grim reality I was leaving behind was actually as good as Gary was ever going to get.
I fear America could be at the same place today.
Joseph Stiglitz, a Nobel laureate, is University professor of finance and economics at Columbia University.

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