As James Surowiecki explains in his review of Joseph Stiglitz’s most recent books, “the fundamental truth about American economic growth today is that while the work is done by many, the real rewards largely go to the few.”
Economic inequality is clearly back on the agenda in the United States, in political discourse as well as in the discipline of economics.
Historically, inequality was not something that academic economists, at least in the dominant neoclassical tradition, worried much about. Economics was about production and allocation, and the efficient use of scarce resources. It was about increasing the size of the pie, not figuring out how it should be divided. Indeed, for many economists, discussions of equity were seen as perilous, because there was assumed to be a necessary “tradeoff” between efficiency and equity: tinkering with the way the market divided the pie would end up making the pie smaller. As the University of Chicago economist Robert Lucas put it, in an oft-cited quote: “Of the tendencies that are harmful to sound economics, the most seductive, and…the most poisonous, is to focus on questions of distribution.”
Today, the landscape of economic debate has changed. Inequality was at the heart of the most popular economics book in recent memory, the economist Thomas Piketty’s Capital. The work of Piketty and his colleague Emmanuel Saez has been instrumental in documenting the rise of income inequality, not just in the US but around the world. Major economic institutions, like the IMF and the OECD, have published studies arguing that inequality, far from enhancing economic growth, actually damages it. And it’s now easy to find discussions of the subject in academic journals.
First, after decades of simply ignoring the problem, mainstream economists tried to make sense of growing inequality in terms of “earnings inequality,” that is payments to different amounts of human capital (measured, for example, in terms of years of education). But that couldn’t account for huge differences within the top 10 percent, most of whom have college degrees. A second, more recent attempt has focused on the “rent-seeking” behavior of individuals (like CEOs) and sectors (such as pharmaceuticals and finance). The idea is that a small group of individuals and industries at the top are able to capture excess payments—”rents”—because they’re able to keep competitive forces from driving returns down. From Stiglitz’s perspective, the issue is
the economy suffers when “more efforts go into ‘rent seeking’—getting a larger slice of the country’s economic pie—than into enlarging the size of the pie.”
As I’ve explained before, the idea of rent-seeking behavior puts the final nail in the coffin of neoclassical marginal productivity theory, that is, the idea that “everybody gets what they deserve, according to their marginal contributions to production.”
But rent-seeking theory fails to account for where the extra value that takes the form of rents comes from, that is, it doesn’t offer an explanation of how a surplus is created, which can then be captured—in competitive situations (so-called normal profits) as well as in noncompetitive situations (which give rise to rents).
The fact is those at the top, in the immediate postwar period (when income inequality was much less than it is today), were left with both the incentive and the means to remake the circumstances to capture the surplus that was being created. And, of course, they eventually did so, beginning in the 1970s—allowing them both to make sure more surplus was pumped out of the workers (by paying wages that remained stagnant) and to capture more of that surplus (by funneling it into areas like finance and pharmaceuticals and by paying CEOs higher and higher salaries).
That, in my view, is the “fundamental truth about American economic growth.”