The Institute Blog

Inequality – It’s Bad…And It’s About to Get Way Worse

What’s behind rapidly worsening inequality in the United States?

A recent study conducted by Josh Bivens and Lawrence Mishel, “The Pay of Corporate Executives and Financial Professionals as Evidence of Rents in Top 1 Percent Incomes,” takes on this question by discussing the origins of rising trend of inequality and how it could be reversed. And in a study called “Income Inequality, Equality of Opportunity, and Intergenerational Mobility,” Miles Corak examines the impact that high levels of inequality can have on society.

The main focus of Bivens and Mishel is the increase of the incomes at the very top – the so-called top one percent. They argued that the rising incomes of the top one percent over the last thirty years have been driven by rent-seeking (including both increased “opportunities” for rent-reeking and augmented “incentives” for rent-shifting). And this change has come at the expense of middle- and low-income households in the U.S. They conclude that an effective way of reversing the trend of inequality would be changing policy directed at rent-seeking – and they suggest this can be done without creating an adverse impact on the U.S. economy.

There are a number of tools they suggest to achieve this goal, including reducing the incentives for rent-seeking by increasing the marginal rate of taxation on high incomes and getting rid of or limiting the institutions that enable rent-seeking and rent-shifting in its current form.

Some of the income-related statistics in Bivens and Mishel also revealed a shocking truth about corporate governance (or the lack thereof) in the U.S. During the period between 1978 and 2012, CEO compensation grew 876%, or more than double the real growth of the stock market. In comparison, the hourly wage of workers in the private sector grew only 5%.

Often the top one percent justifies their incomes by asserting that they deserve the compensation for the amount of benefit they provide to society, but evidence suggests otherwise. For example, the wider economy has not benefitted from the ascent of large and complex financial institutions. In fact, their risky behavior was what put the general public in a position where it had no choice but to provide a bailout.

This “bankruptcy insurance” that financial institutions enjoy due to their size and importance in the economy has enabled them to engage in reckless behavior. Their size (and power) also has impacted the political landscape of the United States – it has been shown that the rise of the financial sector has “coincided” with a decrease in regulation and legislative controls. The concentration of the sector, and hence the increase in size of individual banks, has had a number of consequences, none of which have proven beneficial to the consumer.

Another justification for the increase in the executive compensation, as well as the increase in inequality, has been the claim that the rich will propel the economy by creating jobs and grow the economy – however, Andrew, Jencks, and Leigh (2011) found that the share of income going to the top one percent has little effect on economic growth. In other words, the increase in the compensation of the one percent may not have negatively impacted the rate of growth, but it certainly did not increase it.

What the income concentration at the very top does impact is the level of inequality, which is most often measured by the Gini coefficient. However, Corak says that while the Gini coefficient captures the level of inequality at a point in time, it does not illustrate the consequences inequality has on future generations. Instead, he uses the “Great Gatsby Curve” to compare the relationship between income inequality and earnings among generations.

Intuitively, it is easy to understand that the social status and income of a family will inevitably impact the future earnings and living standard of their children. But the question is to what extent these factors are able to shape a person’s economic success. Corak compared OECD countries and concluded that, in countries where income inequality was the lowest (Finland, Sweden, Norway and Denmark) the link between the father’s and son’s income was the weakest. In comparison to these countries, where only a fifth of economic disadvantage or advantage was passed down, the sons in the United States inherited about half of their father’s economic standing.

Other factors that influence the earnings capacity of future generations are tied to things like the guidance and value that is placed on higher education, the mother’s level of education, and the stability of the family. These are considered nonmonetary investments and also play an important role in the child’s ability to succeed.

Trends Corak observed in the labor market were also very interesting. His findings show that the social network available to the younger generation through their family is an important factor in finding employment. The effect is intensified in the upper income segments of society, especially if the child works for the same employer as their parent. In Canada for example, 7 out of 10 sons born to the fathers in the top 1 percent worked for the same employer as their father at some point in their lives, whereas the overall statistic is only 4 out of 10.

Corak started his article by asking what the definition of the American Dream was, and according to a poll by the Economic Mobility Project (2009), the answers were rather typical: “Being free to say or do what you want,” “Being free to accomplish almost anything you want with hard work,” and “Being able to succeed regardless of the economic circumstances in which you were born.” It is becoming increasingly more apparent that these ideals are drifting farther from the reality of the American society as time goes by.

Additionally, Corak found that Americans in general were open to the idea of “equality of opportunity” but quite suspicious of the idea of “equality of outcomes.” However, his research has shown that equality of outcomes impacts the equality of opportunity to a great extent, and you can’t have one without the other.

That means that today’s rise in inequality is very likely to increase the level of inequality even further in the future. This continued trend will lower intergenerational mobility and change “opportunities, incentives and institutions that form, develop and transmit characteristics and skills valued in the labor market.”

Simply put, a labor market dominated by connections, not talent, will not translate into an innovative and productive economy.

Will the United States be able to reverse this harmful trend toward income concentration at the top? The answer is still anything but clear. But Bivens, Mishel, and Corak have all made important contributions by providing meaningful context for that conversation.