Who, or What, is to Blame for Inequality?

Over at the Washington Post, columnist Matt O’Brian reveals how inequality has less to do with a small class of super wealthy elites, and more to do with the structure and culture of many big U.S. companies

The easiest way to think about this is to think about the different types of inequality. There isn’t just inequality between everyone, but also between everyone at a single company. Why does this matter? Well, if CEOs really are gobbling up a bigger and bigger slice of the profit pie, then inequality within society at large should have increased because inequality within companies increased. But that’s not what happened. The research team of Jae Song of the Social Security Administration, Fatih Guvenen of the University of Minnesota, and David Price and Nicholas Bloom of Stanford were able to look at what had previously between private earnings data for every company between 1978 and 2012—the best data we have so far—and found that the pay gap between executives and their own workers had barely changed during this time. What had changed, though, was the pay gap between every worker at the highest-paid firms and everyone else. In other words, inequality exploded because the top 1 percent of companies were making more and paying all their employees more. This was true across the country and across industries.

It is not entirely clear why this is the case, but one hypothesis is that technological innovation has made every industry “winner-take-all”, meaning it is easier than ever for the most ruthless and resourceful companies to dominate a particular market. This explains the rise of global behemoths like Google, Amazon, Apple, and Facebook, all of which lack any true competitors in their respective industries. 

But one thing that has changed is the center of gravity in the economy. Workers have traded in their blue collars for white ones, and the top 1 percent overall have become much more finance-focused. Indeed, according to one estimate, Wall Street and corporate executives explain as much as 60 percent of the increasing share of income going to the top 1 percent the past 30 years. Why? It’s probably that deregulation has freed the banks to not only get into new businesses, but also take bigger risks, which has supercharged their bottom lines and bonuses (but made them blow up when those bets have gone bad). So inequality between industries—or at least between finance and everything else—has all but certainly increased. That’s why, even though Wall Street firms still share the spoils just as much as they ever did come bonus time, it’s not misguided to pay particular attention to them when we talk about the pay gap.

This “financialization” of the U.S. economy — wherein the finance sector grows at the expense of the rest of the economy — is not only draining talent and resources from other industries, but corrupting business culture into becoming more obsessed with unsustainable short-term gain. Even Forbes pointed out this growing issue:

Wall Street followed their capitalist instincts and saw that there was more profit in making money from money rather than in engineered products. They wanted quick returns of financial instruments and software rather than investing in the brick and mortar of expensive factories. They were also supportive of products that could be sold at Wal-Mart and manufactured overseas.

In an article in Industry Week, Susan Berger a professor at MIT makes the assertion that, “Since the 1980s, financial market pressures have driven companies to hive off activities that sustained manufacturing.” She gives the example of The Timken Company that was forced to split into two companies by the board of directors. The Chairman argued that the company should stay together because that is how it has been able to offer high quality products with good service support. The board overruled him based on the potential of better short term profits.

This stripping down the company to their core competencies has been forced on most of the large publicly held corporations to some degree. But in stripping them down, many critical functions are lost. For instance, apprentice type training has been lost in many American corporations because it is long term training and doesn’t have a good enough ROI. Basic research, funding to bring innovation to scale, and diffusion of new technologies to suppliers, have also been dropped or reduced because they are seen by the shareholders as being peripheral to the core competencies.

The articles goes on to list a host of troubling trends in finance, such as the advent of “corporate raiding”:

Corporate raiders contributed to inequality as they dismembered firms, laid off workers, auctioned off the assets and destroyed entire communities to reap huge rewards for a few stake holders. If the company had a chance to survive, raiders would demand wage concessions, eliminate collective bargaining agreements, dissolve pension agreements, and sometimes the company would be driven into bankruptcy despite the concessions.

The corporate raider approach to making huge returns in a short period of time was very popular with the wealthy and was viewed as necessary part of free market capitalism (the elimination of the weak). However some economists believe that every point gained in financialization leads to deeper inequality, slower growth and higher unemployment.

…Shady credit and lending practices, and the subsequent housing bubble collapse…

As regulations slowly collapsed along with oversight of consumer and mortgage lending, Wall Street introduced predatory lending in the form of high interest rate credit cards with fees and penalties, pay day loans and subprime mortgages. They conducted massive promotions to scrape more borrowers from the bottom of the barrel. The predatory lending practices “preyed on the poor and made them poorer”.

…It is true that government regulations were loosened to get more people into homes, but the finance industry took advantage of this new open gate. Instead of examining the loans to make sure the people could handle the debt, the big banks began issuing subprime mortgages to people who they knew were not qualified for the loan. Then they packaged the junk loans into toxic securities to be sold all over the world. When the bubble burst and prices collapsed, lower income home owners found themselves underwater and the foreclosures began. The bubble bursting forced the economy off the cliff and into the great recession but nobody went to jail, the shareholders paid the government fines, and the taxpayers were forced to bail them out. The big banks are still too big to fail and with tax payer support they will do it again.

…and the starving of well needed public funds and projects…

One study suggests we need $3.6 trillion to finance the repair or replacement of highways, bridges, sewer, water, and electrical transmission systems, but very little outside of emergency repairs has been done on these massive projects.

The Financial Times reports that government investment in research has plummeted to its lowest point since the end of World War II. This basic research has led to a long list of technologies and breakthroughs like the internet and human genome project. Private investment can’t fill the gap in basic research because this investment must compete with the short term returns from capital investment in trading.

In short, inequality is built into the upper echelons of American business culture, especially in the realm of finance. But even among non-financial industries, and small to medium-size business, there has emerged this perverse idea that the only way to get ahead is to beggar your employees and cut corners.  Many small-time employers sees themselves as a future big-wigs, and subsequently allow their egos and greed to drive their business choices — often at their employees’ expenses.

Granted, I cannot say that this is a scientific assessment; I am just speaking from personal and secondhand experience. But given the example set by the titans of industry, both within and beyond their particular companies and markets, it is safe to say the America’s elites are having a perverse impact on the larger economic and political spheres. Cut-throat competition in the service of one’s insatiable greed — without taking into account social responsibility, environmental sustainability, and so on — will lead to disaster. Absent any values, virtue, or rational long-term thinking, inequality and environmental degradation will worsen despite the unprecedented amount of capital and resources at our disposal.

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