An important new paper shows us what’s driving economic inequality — and how we can stop it

Earlier, today, in my Larry Summers post, I wrote this:

Given what we know about the relationship between the growth in economic inequality and rents accruing to finance professionals (of which more later), Larry agreeing to investigate the causes of stagnating wages is something akin to O.J.’s vow to “find the real killers.”

Consider this post to be the “more later” referred to above. The new issue of the Journal of Economic Perspectives (one of the premier, peer-reviewed journals of the economics profession) is now online, and, like the JEP archive, it’s free and available to all. The theme of the issue, “The Top 1 Percent,” is could hardly be important. It includes several fascinating articles, but for now I want to focus on this paper by Josh Bivens and Larry Mishel, “The Pay of Corporate Executives and Financial Professionals as Evidence of Rents in Top 1 Percent Incomes.” The authors look at how the rise in rents to the richest 1 percent is driving inequality and slowing down economic growth among low- and middle-income households.

Let’s begin by looking at how the authors define “rent.” As Bivens and Mishel observe, rent-seeking can mean a lot of things. For the purposes of this paper, they define it as income received “in excess of what was needed to induce the person to supply labor and capital to these respective markets.” It’s important to note that they do not argue, as Joseph Stiglitz does, that inequality has led to a decrease in overall economic growth. What they are saying is that: 1) economic growth for the top 1 percent and economic growth overall are not strongly associated, and 2) that low- and middle-income households have been hurt by the income shift to the top 1 percent. Income growth at the lower and middle rungs of the economic ladder have lagged behind growth in the economy as a whole.

The authors make a strong case that the engine driving the rise in income in the top 1 percent has been the financial sector. Among other things, the financial sector has enjoyed both increased opportunities and increased incentives for rent-seeking. Rent-seeking in finance has had spillover effects to other sectors of the economy and driven up wages in the top 1 percent in those occupations as well. Crucially, the authors argue that the rise in rent-driven incomes among the top 1 percent has been “the primary impediment to having growth in living standards for low- and moderate-income households approach the growth rate of economy-wide productivity.” I’m summarizing here, but it’s well worth reading the entire article and working through the details of the full argument.

What, then, must be done? It’s worth emphasizing that since, according to Bivens and Mishel, the gains to the 1 percent have been rent-driven, by definition, the 1 percent are being rewarded on a scale that is disproportionate to their economic performance. In other words, relative to their compensation, the 1 percent are not engaged in productive activity, and are not adding value to their firms or to the economy as a whole. Therefore, we have the ability to apply policy fixes to stop or even reverse gains to the 1 percent, without hurting economic growth.

The authors discuss a host of policy fixes. First, they say, we must directly attack the ability of the one percenters to extract rents. Some ways to to do this include:

— Reforming corporate governance to give shareholders and other stakeholders much more power over executive pay decisions;

— Discouraging rent-seeking shenanigans in the financial sector by instituting stricter regulations there;

— Increasing the bargaining power of low- and middle-income workers by significantly raising the minimum wage and reforming labor law to make it easier for workers to form labor unions;

— Vigorously pursuing full employment policies throughout the economy; and

— Reforming intellectual property law to eliminate rent-seeking monopolies in the pharmaceutical industry, entertainment, and the like.

Secondly, the authors say, we must reduce the one percenters’ incentives for rent-seeking. The way to do this, they argue, is simple: by significantly raising marginal tax rates for high incomes, and by eliminating corporate tax loopholes (such as the provision that allows firms to deduct “performance-based” pay) that encourage rent-seeking behavior.

It will be very difficult, politically, to bring about these reforms, and to make sure they have teeth. But the main takeaway is that we are not helpless here. Contrary to conservative propaganda, inequality and stagnating wages are not things that “just happened” because of impersonal processes over which we’ve allegedly had little or no control, such as “technology” or “globalization.” They occurred because of political decisions that increased opportunities and rewards for rent-seeking at the top, and eroded worker bargaining power at the middle and bottom. Bivens and Mishel make this abundantly clear. The next step is organizing politically and pressuring electedofficials to start making very different political choices. As is often the case, the answers are relatively simple — but not easy.

Kathleen Geier

Kathleen Geier is a writer and public policy researcher who lives in Chicago. She blogs at Inequality Matters. Find her on Twitter: @Kathy_Gee