This week, the Washington Monthly is featuring a conversation about economic inequality, prompted by Timothy Noah’s new book, The Great Divergence: America’s Growing Inequality Crisis and What We Can Do about It. Participants are Mark Schmitt, director of the fellows program at the Roosevelt Institute, and Brink Lindsey, senior scholar at the Kauffman Foundation.

From: Brink Lindsey

To: Mark Schmitt

I want to go back and talk about the causes of rising inequality that are (or at least may be) problematic.

First, let’s look at runaway gains at the very top of the income scale. Some portion of that is due to the “financialization” of the U.S. economy during recent decades as the share of GDP and profits going to finance shot up thanks to financial “innovation.” In retrospect, a lot of that innovation looks misconceived and, thus, a lot of that financialization looks more malignant than benign. So there’s a real problem, and unfortunately, the major legislative response to the financial crisis, the Dodd-Frank bill, doesn’t even begin to tackle it. The problem, though, is that a twisted tangle of perverse incentives has created a system that badly misallocates capital – not that some people made a bunch of money. If financial innovation had actually been as productive as technological innovation, the fact that financial barons along with tech entrepreneurs had shifted the Gini coefficient a bit higher shouldn’t concern us at all.

CEO compensation is another driver of ballooning incomes at the top, and there are legitimate questions about how it is set. There are studies on both sides of the question, and I haven’t resolved my own thoughts about the matter, but I’ll certainly accept that there are plausible arguments that CEOs in cahoots with compliant boards are looting their shareholders. Again, though, the problem is bad corporate governance and abuse of shareholders, not the effect on inequality.

The most important problem signaled by rising inequality, in my estimation, is the growing divide between the highly skilled (or, to use a crude but effective proxy, college grads) and everybody else. Over the past generation there has been a big increase in the pay gap between college grads and others, and it’s happened because of supply and demand: the demand for highly skilled workers continues to grow, but the new supply has bogged down as growth in college grads has slowed to a crawl. In particular, the college graduation rate for men is pretty much the same as it was 30 years ago. The problem here isn’t the unfairness of capitalism: capitalism is doing exactly what we want it to do, creating more room at the top because of the rising demand for skills. The problem, I believe, is that class-based culture is trumping economic incentives, so that people born into the working class or underclass aren’t receiving the upbringing necessary to enable to develop valuable marketplace skills. We have a social institution that should compensate for not winning the parent lottery: it’s called K-12 education. Unfortunately, at present it serves to perpetuate class differences, not mitigate them.

The mediocrity of the American educational system and a number of other policies I identify in Human Capitalism amount to structural barriers against upward mobility. Reducing those barriers ought to be, in my view, a major reform priority. And not just because bad policies lie at the root of the problem. Regardless of the causes, the consequences of a system in which large numbers of people fall farther and farther behind because of accidents of birth are profoundly unhealthy. Avoiding those consequences lends even greater urgency to reform.

Noah sees this too, to be sure. But because he seems to think inequality per se is an evil, he too often takes his eye off the ball. See, in particular, the lead item in his policy agenda: soak the rich by jacking up the top tax rate to 70 percent again. I’m convinced that the economic consequences of such a steep tax hike would be severely negative. Tanking the economy isn’t g0ing to expand opportunity for anybody, and I doubt that workers and their families would take much solace in the fact that their narrowed prospects had purchased a downward nudge of the Gini coefficient.

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