What caused the mess we are in, and how do we get out of it?

By Peter Winsley

16 January, 2017

Inequality, social malaise, and identity-based extremism result from productivity trends, technological change, globalisation, and business models.  These sit within tax, labour market, competition, trade, intellectual property and other policy settings that governments can change.  Policy makers must find ways to drive inclusive growth with widely-shared benefits that restore self-worth and open society.

Globally, wealth has never been more evenly spread (Heise, 2016).  However in some developed countries inequality has risen.  Since the early 1970s incomes in the US for the top 1% rose by around 300%, while incomes for those below the top 10% stagnated.  The real median income of US households was less in 2016 than in 1999 (Cowen, 2016).

In the US, rates of “absolute income mobility” – the fraction of children who earn more than their parents – have fallen from around 90% for children born in 1940 to 50% for children born in the 1980s (Chetty et al, 2016).  Some communities have seen rises in drug abuse and morbidity (Case & Deaton, 2015), and reduced life expectancy (NCHS, 2016).

Divergence has grown between the most profitable businesses and those in the mainstream.  This divergence reflects a mix of frontier firms with exceptional innovative capabilities, network effects, and mergers and acquisitions that create market power and monopolistic pricing (Barth et al, 2014; Furman & Orszag, 2015).  This has led to higher economic rents

Productivity and median incomes have diverged.  For example, in the US from 1948 to 1973 productivity grew by 96.7% and hourly compensation by 91.3%.  From 1973-2014 productivity grew by 72.2% and hourly compensation by only 9.2% (Bivens & Mishel, 2015).

Technological change in the manufacturing and IT industries has reduced material goods and IT costs.  It has also destroyed many jobs, with employment growth largely being in ill-paid service sectors.  Productivity gains have therefore not translated into well-rewarded jobs.  Identity as well as skill mismatches have occurred as self-worth and pride disappeared with the jobs that gave rise to them.

Globalisation is associated with manufacturing sector job losses.  However, Helpman (2016) concludes that while trade has played a role in increasing wage inequality, its cumulative effect has been modest, and globalization does not explain most of the rise in wage inequality within countries.

Malaise comes when businesses lose sight of external customers and focus on management and shareholder interests.  Examples include the finance sector model leading to the 2008 Global Financial Crisis (GFC), and the Maximising Shareholder Value (MSV) model.

In the lead up to the GFC, banks went from financing economies’ capital needs to financing themselves.  Even as local, community banks declined, finance expanded as a proportion of the economy.  The GFC lowered the path of GDP in advanced economies (Fatas & Summers, 2015).  It caused enduring negative impacts on future output (Ball, 2015).  Post-GFC attempts to reduce government debt have likely resulted in a higher debt to GDP ratio associated with negative output effects.

The GFC saw lower income people lose jobs and incomes, and then bail out finance companies “too big to fail”.  Gains were privatised and losses socialised.  This corporate welfare helped give rise to the Tea Party movement and subsequent American and European populism.

In the post-World War Two period in the developed world, a “retain and invest” business model drove innovation, productivity, social mobility and real income advances.  Shareholders were rewarded with dividends from patient capital and long-term productivity growth.  Stable employment helped workplace learning translate into sustained productivity and job security.

William Lazonik (2014; 2015, 2016) documents how, from around the 1980s, many corporations moved to an MSV model.  This created incentives for share price manipulation, insider trading, and share buy-back schemes.  These diverted finance away from innovation and other productive investment towards short-term management and shareholder interests (Kozul-Wright, 2016).

Over 2003 to 2012 the largest 500 US companies returned more than US$2.4 trillion to shareholders through share buy-back and other arrangements.  US public corporations now have record cash holdings, and total pay-outs to shareholders as a percentage of net income are at record levels (Kahle & Stulz, 2016).

Both the financial conduct associated with the GFC, and the MSV model diverted resources from innovation and productivity growth into short-term gains for the privileged few.

Policy levers are needed to address problems that policy makers have allowed to happen.  However, options are limited.  Monetary policy has little traction at low interest rates.  There is scepticism about how big the Keynesian multiplier is now in many economies.  Infrastructure spending may not be effective (Glaesar, 2016).  Many countries face environmental limits, debt burdens, unfunded entitlements and ageing populations.

Crony capitalism and corporate welfare in western countries do not deliver widely-shared benefits.  State capitalism degrades people’s rights and freedoms.  Populist movements are shallow, divisive and capricious.  Social welfare transfers cannot compensate for labour market income losses.  People want jobs for meaning, standing and social connections, not just money.  A dollar earned is worth more than a dollar paid as a benefit.

However there are opportunities, and cues on where to focus.  Middle class spending power is rising within growing and better connected world populations. Climate change and resource depletion creates demand for technological and investment responses.  Businesses are cash-rich and interest rates are low.

Never before have so many scientists and technologists been active in so many different fields and countries.  Physical communication has never been cheaper, nor idea exchanges greater, more diverse, faster, or more stimulating.

My next paper will argue for an inclusive innovation strategy to lift productivity and deliver broadly-shared benefits.

References

Ball, L. 2014: Long-term damage from the Great Recession in OECD countries.  NBER Working Paper 20185.

Barth, E. et al 2014: It’s where you work: Increases in earnings dispersion across establishments and individuals in the US.  IZA DP No. 8432.

Bivens, J.; Mishel, L. 2015: Understanding the historical divergence between productivity and a typical worker’s pay. Economic Policy Institute Briefing Paper No. 406.  2 September 2015.

Case, A.; Deaton, A. 2015: Rising morbidity and mortality in midlife among white non-Hispanic Americans in the 21^st century.  Proceedings of the National Academy of the Sciences of the United States of America 112(49).

Chetty, R. et al 2016: The fading American dream: trends in absolute income mobility since 1940: NBER Working Paper No. 22910.

Cowen, T. 2016: Is Innovation Over? The Case Against Pessimism.  Foreign Affairs March/April 2016 Issue.

Fatas, A.; Summers, L. 2015: The permanent effects of fiscal consolidations.  CEPR Discussion Paper No. DP10902.

Furman, J.; Orszag, P. 2015: A firm-level perspective on the role of rents in the rise of inequality.  Presentation at ‘A Just Society’ Centennial Event in Honor of Joseph Stiglitz.  Columbia University.

Glaeser, E. 2016: If you build it…Myths and realities about America’s infrastructure spending.  City Journal, Summer 2016.

Heise, M 2016: The Complexity of Inequality.  Project Syndicate 9 December, 2016.

Helpman, E. 2016: Globalisation and wage inequality.  NBER Working Paper No. 22994.

Khale, K.; Stulz, R. 2016: Is the American Public Corporation in Trouble?  NBER Working Paper No. 22857.

Kozul-Wright, R. 2016: Returning to investment.  Project Syndicate 6 October 2016.

Lazonick, W. 2016: The Value-Extracting CEO: How executive stock-based pay undermines investment in productive capabilities.  Institute for New Economic Thinking.  Working Paper No. 54.

Lazonick, W. 2015: Stock buybacks: From retain and reinvest to downsize-and-distribute.  Centre for Effective Public Management at Brookings.

Lazonick, W. 2014: Profits without prosperity.  Harvard Business Review September 2014 Issue.

NCHS 2016: Mortality in the United States 2015.  NCHS Data Brief No. 267.