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Joseph Stiglitz, the 2001 Nobel Memorial Prize in Economic laureate.

INEQUALITY, , AND

Inequality has become one of the major debating points among economists—not a surprise given the large increase in inequality over the past 35 years. What are the reasons that the rich are getting richer and what impact does this have on the rest of ? What can we do about the growing inequality?

by Joseph Stiglitz

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“WORKERS’ BARGAINING POWER HAS BEEN FURTHER WEAKENED BY THE ASYMMETRIC RULES GOVERNING : CAPITAL AND MOVE FREELY BUT LABOUR DOES NOT.”

he enormous increase for which they are justly rewarded, this alter- increase in wealth is an increase in the in inequality in many native theory suggests that what has been of , or the capitalized value of other advanced countries going on is worse than a zero sum game: rents, not in the amount of capital goods. over the past third of a their gains have come at the of the Such increases in “wealth” do not in general century has been exten- rest—and of overall economic performance. lead to an increase in of the T sively documented, This is a somewhat different view of ine- economy nor increases in wages. Indeed, including most recently by Thomas quality than that which is at the centre of they may have just the opposite effect. Piketty in his justly celebrated book, Piketty’s recent book. He argues that the By “land”, I am referring primarily to the value Capital in the Twenty-First Century. He main driver of inequality is the tendency of of urban land, rather than agricultural land. focuses on the growth of and returns on capital to exceed the rate of Broadly, rents associated with natural wealth at the top. Others (including me, in . are also included. For example, The Price of Inequality, and more recently, suppose that valuable is owned in The Great Divide) have noted the many THE DIFFERENCE BETWEEN mostly by the rich. If this real estate becomes other dimensions of inequality—including WEALTH AND CAPITAL more valuable, the wealth of the country the increase in in the bottom and Most readers of Piketty’s book get the increases, but wealth also becomes more the evisceration of the middle. And there impression that the accumulation of wealth unequally distributed. Moreover, more une- are many other aspects of inequality, for through is almost entirely respon- qual wealth spills into a more instance, in health, access to , and sible for the rise in inequality and that there unequal income distribution because exposure to environmental hazards. is, therefore, a link between growth of the income includes higher imputed rent for the There is a growing understanding that ine- economy—the accumulation of capital—on real estate owners whose housing has gone qualities in income and wealth cannot sim- the one hand and inequality and wealth on up in price and who have not sold it. But ply be explained by the standard economists’ the other. Piketty tends to use wealth and simply because the price of land in the Rivi- competitive equilibrium model. As I wrote in capital interchangeably. But wealth and era or Southampton has gone up does not a recent Roosevelt Institute report (co-au- capital are two distinct concepts; the for- mean that the French or US economies have thored by Nell Abernathy, Adam Hersh, mer refl ects control over resources, the become more “productive.” Susan Holmberg, and Mike Konczal) Rewrit- latter is a key input into pro- The capitalisation of the increase in other ing the Rules, “Inequality is not inevitable: cesses. Much of the increase in wealth that kinds of rents also increases the wealth/ it is a choice we make with the rules we can be observed from the 1990s onwards income ratio. Such rents include monopoly create to structure our economy…” These does not correspond to a rise in productive rents of fi rms or the “exploitation” rents of choices have resulted in economies marked capital. More and more was lent to the banks. If, for example, the fi nancial sec- by greater divisions and poorer perfor- investors who mainly did not use it to cre- tor convinces Congress that it is a idea mance. There is more rent-seeking and less ate new or make productive to bailout too-big-to-fail banks and repeal productive investment. Firms behave in a investments in existing businesses, but to the Glass-Steagall Act which then makes short-sighted way. While trickle down eco- speculate in already existing , it easier for banks to become too big, then nomics argued that everyone gains from thereby pushing up prices. the implicit rents that are associated with the productive efforts of those at the top More generally, a large fraction of the the bailout get capitalised in the banks, and

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28-79-D150035-Mag7-FOCUS.indd 57 03/06/2015 12:22 INSIGHT © Seth Wenig/AP/SIPA People listen to an Occupy Wall Street anniversary concert in Foley Square in New York.

show up as an increase in wealth in the Thus, the real capital has not of credit expansion. Similarly, quantitative stockmarket. But there are negative increased as much as wealth; in some easing led to high stock prices — benefi t- effects—the implicit liability to the govern- cases, the two variables (especially when ing the owners of equity, disproportionately ment and the public, and the higher measured relative to income) have moved the very rich — but the low interest rate on that may have to be levied to fund the bail- in different directions. government bonds hurt the elderly who out. But these changes in the wealth of This has repercussions on income inequal- had invested (they thought) prudently in taxpayers do not show up on the national ity: if more of the savings of the economy government bonds. balance sheet; all that is recorded is the lead to an increase in the value of land rather Indeed, with life cycle savers holding their increase in the value of bank . Thus, than the stock of capital goods, then worker assets in different forms than capitalists this change in banking has a productivity and wages stagnate and might who pass on wealth from one generation negative effect on the economy, and yet it even go down. Equally important, however, to another, the old distinction between “cap- appears as if the wealth of the economy is how changes in fi nancial and italists” and “workers,” or even creditors and has increased. monetary policy can lead to more wealth debtors, may be less relevant in analysing In recent years, monetary and fi nancial inequality. For instance, an increased fl ow the impact on inequality of different policies authorities allowed—through of credit combined with a change in regu- than that between “holders of equity-assets” and lax standards—banks to lend more, but lation that allows more lending against col- and “holders of debt instruments.” much of that money did not go for creating lateral will lead to an increase in asset prices new businesses or increasing the stock of that can be used for collateral, such as land; WHAT CAN BE DONE? capital goods. The effect of the expansion those who hold wealth become wealthier. How can we prevent inequality from getting of credit has actually been an increase in Those who have little or no wealth do not worse? What can we do to reduce inequal- the value of land and other fi xed assets. benefi t (or benefi t very little) from that kind ity? The question can be divided into three

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parts: What can we do to reduce inequality “GOOD PUBLIC of before- and transfers income? What can we do to improve the after-tax and SYSTEMS IS A STRONG CENTRIPETAL transfers income distribution? What can we FORCE, BRINGING SOCIETY TOGETHER do to increase equality of opportunity? There is some evidence that the power of AND REDUCING INEQUALITY.” the 1 per cent to exploit the rest seems to be increasing. This is partly the result of changes in technology and globalization; but the rules governing the economy and the policies adopted by governments (often famously pointed out, he was paying a lower is a strong centripetal force, bringing soci- under the infl uence of the ) have played tax rate (on his reported income) than his ety together and reducing inequality. In equal or more important roles. Markets do secretary. He was right to suggest that this many countries, however, the education not exist in a vacuum, and we have shaped was wrong. And, unfortunately, his experi- system is one of the important mechanisms markets in ways that often do not promote ence is typical of the very rich. for the intergenerational transmission of effi ciency but do increase inequality. When thinking about policies that are advantages. For instance, in the United The ratio of wages to productivity is going intended to reduce inequality of wealth, it States more is spent publicly on the edu- down and the ratio of CEO pay to worker is important to bear in mind what econo- cation of the children of the rich than on pay has gone up. The bargaining power of mists call “incidence” of taxes and expend- that of the poor, the result of a largely workers declined as unions got weaker. iture. There are often indirect effects of such locally funded and managed elementary Workers’ bargaining power has been further policies, and sometimes these can undo the and secondary school system. Similarly, a weakened by the asymmetric rules govern- direct effects. For instance, if most of the strong system of taxation is ing globalization: capital and goods move savings is being done by capitalists, and the important for the prevention of the creation freely but labour does not. Corporate gov- return on capital is taxed, then investment of an inherited . ernance laws provide relatively little check could decline. That could mean, over the Such policies have the further advantage that on abuses of corporate power by CEOs. In long run, that the rate of interest would go they not only lead to equilibrium with lower some critical sectors of the “new economy” up and wages might decrease, undermining inequality, but they increase equality of oppor- monopoly power increased because of net- the intent of the tax to reduce inequality. If, tunity—strengthening what should be a fun- work . however, the government invested some of damental value in a progressive society. There are numerous policies that could help the tax revenue itself, these adverse effects reduce before tax and transfer inequality: might not occur: the rate of return on capi- higher minimum wages, stronger unions, tal might not rise and wages might not fall. ABOUT better education, and better anti-trust and We can think of the degree of inequality in corporate governance laws and stronger the economy as resulting from a balance of Joseph Stiglitz is University enforcement of the laws we already have. centrifugal and centripetal forces—of forces Professor at Columbia University in Progressive tax and expenditure policies that lead to a more equal distribution and New York and the winner of the 2001 can help undo the effects of the increase forces that lead to a more unequal distribu- Nobel Prize for Economics. He was in market income inequality. Unfortunately, tion. Preventing an increase in centrifugal chairman of the U.S. Council of in some countries, such as the United forces and strengthening centripetal ones Economic Advisors under President States, rather than “leaning against the provides a framework for policy prescriptions. Clinton, and then joined the World wind,” just as market became more For instance, good public education sys- Bank as chief economist and senior unequal, the tax system became less pro- tems—with strong pre-school programs vice president. He’s cooperating with gressive. Indeed, at the very top the tax and good access to university education, FEPS since 2007 through the system is regressive: as regardless of the income of one’s parents— Initiative for Policy Dialogue (IPD).

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