Friday, May 30, 2014

Piketty: U.S. sold its middle class birthright for a mess of Reaganite pottage

The main thesis of Thomas Piketty's Capital in the Twenty-First Century is that the accumulation of wealth in the hands of a few is subject to a kind of gravitational pull. That's what the long-term data tells Piketty. But there's a second core thesis: that graviational pull can be countered by social policy. Markets, he asserts, are a social construct: prices and wages do not magically align themselves with intrinsic worth.
In practice, the invisible hand does not exist, any more than “pure and perfect” competition does, and the market is always embodied in specific institutions such as corporate hierarchies and compensation committees (p. 332).
In Chapter 8, Piketty traces "the explosion of inequality in the U.S. after 1980." In Chapter 9, he homes in on the explosion in compensation of top exectuives in the U.S. -- mirrored to a somewhat lesser extent, throughout the Anglosphere, and to a lesser but still pronounced degree, through Continental Europe, Japan, and emerging economies:
The central fact is that in all the wealthy countries, including continental Europe and Japan, the top thousandth enjoyed spectacular increases in purchasing power in 1990– 2010, while the average person’s purchasing power stagnated (p. 320).
This astronomic rise in compensation at the very top is the chief driver of the recent surge in equality: "In all the English-speaking countries, the primary reason for increased income inequality in recent decades is the rise of the supermanager in both the financial and nonfinancial sectors" (p. 315).

Piketty dismisses arguments that the astronomical pay of "supermanagers" is due to pure market forces or "technological forces" that put a super-premium on the skills of a very few. If that were so, U.S. managers would not be paid vastly more than Continental European or Japanese ones.  Moreover, the "real" value of managers of large companies is impossible to quantify. Generally, he claims, incentive pay rewards corporate performance based on factors outside the execs' control. The alleged "indvidual marginal productivity" of a supermanager is "something close to a pure ideological construct on the basis of which a justification for higher status can be elaborated" (p. 331).

How did that ideological construct get built post-1980?  Wherein lies the cultural shift that justifies executive pay at 300 times that of the average worker, rather than the roughly 30-to-1 ratio that was the norm into the 1970s?  Piketty lays the blame squarely at the feet of the Reagan (and Thatcher) revolution:
Of course changes in tax laws are themselves linked to changes in social norms pertaining to inequality, but once set in motion they proceed according to a logic of their own . Specifically, the very large decrease in the top marginal income tax rate in the English-speaking countries after 1980 (despite the fact that Britain and the United States had pioneered nearly confiscatory taxes on incomes deemed to be indecent in earlier decades) seems to have totally transformed the way top executive pay is set, since top executives now had much stronger incentives than in the past to seek large raises. I also analyze the way this amplifying mechanism can give rise to another force for divergence that is more political in nature: the decrease in the top marginal income tax rate led to an explosion of very high incomes, which then increased the political influence of the beneficiaries of the change in the tax laws, who had an interest in keeping top tax rates low or even decreasing them further and who could use their windfall to finance political parties, pressure groups, and think tanks (p. 335).
This is an inversion of the economic theory that's become Republican dogma: that tax cuts always spur productive economic growth. According to Piketty, low taxes at the top not only contribute directly to inequality by enabling the rich to keep more of their pay (and later, in the U.S., of their income derived from capital) -- they also provided a massive incentive for an unprecdented wealth grab. In that context, here is a fuller version of Piketty's counterpoint to Adam Smith quoted above:
It may be excessive to accuse senior executives of having their “hands in the till,” but the metaphor is probably more apt than Adam Smith’s metaphor of the market’s “invisible hand.” In practice, the invisible hand does not exist, any more than “pure and perfect” competition does, and the market is always embodied in specific institutions such as corporate hierarchies and compensation committees.
If Piketty is right as to cause and effect, Americans since 1980 have become history's greatest victims of trickle-down economic theory.The premise not only that low taxes spur growth, but that fostering unbridled opportunities in a variety of fields to obtain the wealth of Croesus stimulates growth, is not just Republican dogma: with the rise of third way Democrats, it became consensus. The notions that capital gains cuts spur productive investment, that marginal income tax rates topping out at 60 or 70 percent inhibit growth, that debt-fueled private equity makes the economy more efficient, that financial deregulation aids the efficient allocation of capital, and that international competition is a Darwinian smithy for supermanagers really worth ten times their last-gen predecessors were all pretty much accepted by Clinton-era Democrats -- and really, too, by Obama Democrats

In the giddy late nineties, as an accidental businessman of sorts earning far more than I ever expected to (my standards were low..), I pretty much bought this bill of goods myself. So did Obama. In The Audacity of Hope he avers that Reagan effected a necessary correction -- in effect, that he put liberalism on a saltuary diet and purged some of its excesses:
In his rhetoric, Reagan tended to exaggerate the degree to which the welfare state had grown over the previous twenty five years. At its peak, the federal budget as a total share of the U.S. economy remained far below the comparable figures in Western Europe, even when you factored in the enormous U.S. defense budget. Still, the conservative revolution that Reagan helped usher in gained traction because Reagan's central insight--that the liberal welfare state had grown complacent and overly bureaucratic, with Democratic policy makers more obsessed with slicing the economic pie than with growing the pie--contained a good deal of truth. Just as too many corporate managers, shielded from competition, had stopped delivering value, too many government bureaucracies had stopped asking whether their shareholders (the American taxpayer) and their consumers (the users of government services) were getting their money's worth (Audacity, 156-157).
It's true that some liberal programs and transfers were inefficient and produced skewed incentives. But the perception that Reagan's tax cuts grew the pie was probably an accident of correlation: Paul Volcker's breaking of the country's inflation fever probably had more to do with the strong rebound from the terrible recession of the early 1980s.

Piketty's statistical research highlighting the disproportionate gains of the top 1% and the top .1% has filtered into the mainstream in the last few years, in the wake of the financial crisis. His book, putting the master narrative together, is crystalizing a growing perception that we in the U.S. have sold our middle class birthright for a mass of supply-side pottage. And the rest of the world has to varying degrees followed suit.

P.S. I haven't finished Piketty's Capital.  There are pitfalls to commenting on a book in midstream. But I've always taken blogger's license in that regard.

Related: Political polarization correlates with rising inequality

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