Stiglitz - The Price of Inequality - Chapter 1 and 2 - Summary PDF

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America's 1 percent Problem und Rent seeking...

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America’s 1% problem Situation Families had to leave homes Graduates can’t find jobs People forced to early retirement High unemployment in general o Great inequality exposed by crisis that couldn’t be longer ignored: top 1% earn 1/5 of national income, owning 1/3 of national wealth After crisis: o ‘recovery’ was rather advantageous for wealthier people o Middle & lower class grew worse as their wealth lay in houses but with falling house prices their houses had no value anymore > ‘phantom value’ (bubble house prices)  Top could recover from losses faster Problems of countries with high inequality: o Gated rich communities with low-income workers o Unstable political system: populists promises fail o No hope of lower class to benefit anymore > absence of opportunities    

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The Rising Tide that didn’t lift all boats 

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After WW2 the bottom grew faster than the top, there was growth in every segment o Reasons: strong developments in markets & gov. policies  Access to higher education, progressive tax system Last 30 years the top grew faster than the bottom, the bottom even declined o Reasons: gov. initiatives to temper inequities in market were dismantled, taxes for top were lowered, social programs were cut back Doing something against inequality means o High investments which are too costly o Reversion of policies need that benefit America’s economy o Change impacts of market forces (supply – demand) Trickle-down economy o Idea: giving more money to the top will benefit everyone because it would lead to more growth (pie example) o BUT: the opposite of it happened Polarization of labor force o Former: low class required few skills, middle class required medium level and top class required top skills o But polarization of labour occurred: while more money is going to the top, more of the people go toward the bottom > middle class diminishes

The Great Recession makes hard lives even harder 

Family with medium income has normally no buffer o When crisis arose:  People lost their jobs and thus also their health insurance  Due to the missing income, people lost their home  The loss lead to personal bankruptcy which causes psychological illness (depression)  In addition to lost job also gov. revenues fell  People received less social protection  no money for child care

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Labour market without safety net o Unemployment insurance system couldn’t provide adequate support  Normally insurance extends for 6 months  But millions were still unemployed after 6 months  Only 38% received unemployment benefits  44% had never received any o Unemployment people could not get treatment in case of health problems, as they had no health insurance coverage o People enter the labour market after long unemployment show less lifetime earnings Economic insecurity o Americans have to manage their retirement accounts on their own, normally by investments in stocks o In addition also houses were bought as retirement income and to finance education of children o BUT suddenly jobs were lost and houses lost value -> loss of retirement security A standard of living in decline o Less economic, health and physical security o More women joined workforce > family quality declined o More young adults live at parents houses o Less marriages o Due to long-term poverty and underinvestment in education:  Increase in crime > more prisoners > expensive to keep prisoners Poverty o Poverty = family living with $2 or less per day o After crisis: poverty rate at 15% (now slowly declining to 13%) o 1 in 7 depends on gov. to meet basic food needs

Opportunity      

‘America – a land of opportunities’ = a myth It is not possible for low class children to become a part of high class There is a stronger link between parental education & children’s economic situation o Devil’s circle: less opportunity, more inequality, less opportunity etc. Education = key to success, but average American only receives average education Poor people face poverty trap: can’t escape poverty No hope > less motivation > low productivity

International comparisons    

Gini coefficient = standard measurement of inequality Gini coefficient 0 = income is shared equally: bottom 10% receive 10% of income etc. Gini coefficient 1 = perfect inequality: top 1% receive 100% More equal societies have Gini 0.3 or below; America has 0.47

Conclusion   

Growing inequality: top grows, middle and bottom decline No opportunities for low class to go up > poverty trap > no American dream Counter arguments of American Right: o Lifetime inequality matters & it’s better than actual inequality o Poverty is not real poverty > people receive subsidies, public education o Income statements do not take into account inflation (living standards and social securities are not in an income statement) o To do s.th. against poverty will harm the economy, thus everyone

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Rent seeking Rent-seeking involves seeking to increase one's share of existing wealth without creating new wealth. Situation  

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America’s inequality was created and self-reinforcing -> result of economic and political forces In modern economy: Government policies shape market forces -> market forces shape degree of inequality o Gov. has power to move money from top to bottom or vice versa o Gov. sets and enforces rules: what is fair competition? What is illegal? What happens in case of bankruptcy? Taxes & social expenditures? Strong increase in inequality is unusual, compared with other countries and past of the US o Normally: if economy weakens -> sales fall -> profits fall -> wages and employment adjust slowly o What happened: share of wages has fallen BUT firms are making good profits Different justifications for inequality existed (religion, military etc.), today the justification of inequality: marginal productivity theory: those with higher productivities earned higher incomes that reflect their greater contribution to society, technology determines the productivity in modern hi-tech economies: brainpower is more relevant (than physical strength) Economists say that inequality depends on the distribution of endowments, of financial and human capital (e.g. access to public education) o The way gov. performs these functions determines the extent of inequality in our society o Competitive forces should limit outsize profits which could lead to monopoly and limit outsize executive compensations (CEOs can pay bonuses to themselves) BUT reality looks like this: political system has changed rules of the game in favour of those at the top and they have used this power o Rent seeking: (the top) gets income not as a reward to creating wealth but by grabbing a larger share of the wealth that would otherwise have been produced without their effort o Those at the top learned how to suck out money from the rest o There a two ways to become wealthy: to create wealth or to take wealth away from others o People are not trying to be innovative anymore rather America’s society tries to protect their land and have privileges

Possible Actions of Government to stop rent seeking activities and decrease inequality      

progressive tax expenditure policies enforcement of competition laws to limit monopoly profits laws on predatory lending and credit card abuses to limit extent of bank exploitation laws that limit the extent to which CEOs appropriate for themselves firm revenues reduce power of financial sector

Why didn’t the gov. put an end to this? Financial sector had invested heavily in lobbying and campaign contribution and the investments had paid off -> political power very strong General Principles 1. Adam Smith’s Invisible Hand and inequality  Adam Smith’s idea: the private pursuit of self-interest would lead, as if by an invisible hand, to the well-being of all; needed for efficient and desirable outcomes of the market: private returns and social benefits are well aligned -> government is responsible to correct market failures (by taxes and regulations) that bring private incentives and social returns into alignment

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After financial crisis: negative-sum game: gains to winners (bankers) are less than the losses to the losers (society) (see moving money from the bottom to the top) o government actions to align private returns and social benefits failed o financial sector used political muscle to make sure these failures are not corrected o thus market failed to produce efficient outcomes Private reward and social returns are not well aligned in case of (forms of rent seeking) o Imperfect competition (impact of companies actions strongly negative or positive) o Imperfect or asymmetric information o Absence of risk markets

2. Shaping markets (how private financial firms act to ensure that markets don’t work well)  There are incentives for firms to work to reduce market competition  Firms also strive to make sure there are no strong laws prohibiting them from engaging in anticompetitive behaviour ( or not effectively enforced)  Objective: make markets work for them, to make them more profitable which results in inefficient economy and greater inequality  When markets are competitive, profits above the normal return to capital cannot be sustained. Because if a firm makes greater profits than that on a sale, rivals will attempt to steal customer by lowering prices. Firms compete vigorously, prices fall to the point that profits are driven down to zero, a disaster for those seeking big profits o Some of the most important innovations in business have centred not on making the economy more efficient but on how better to ensure monopoly power or how better to circumvent government regulation intended to align social returns and private rewards  Making market less transparent is a favourite tool  Since the sellers are trading constantly and buyers enter only episodically, sellers have more information than buyers, and they use it to their advantage. This means that sellers can extract more money out of their customers  Lack of transparency results in more profits for the bankers, leads to lower economic performance 3. Moving Money From the Bottom of the Pyramid to the Top One of the ways that those at the top make money is by taking advantage of their market and political power to favour themselves. 

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Forms of rent seeking (developed by financial sector) o Imperfect or asymmetric information o Taking excessive risk o getting money from the FED at a low interest rate, now almost zero o take advantage of the poor and uninformed by preying upon them with predatory lending and abusive credit card practices In addition to rent seeking: the rich have managed to design a regressive tax system, thus the pay a lower fraction of their income than do those who are much poorer

Regressive taxes and rent seeking are the core of growing inequality Rent Seeking 

Forms of rent seeking (established by government and used by private sector) o Laws that make markets less competitive o Laws that allow companies to pass costs on the rest of society o Subsidies for companies from government

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Hidden (e.g. trade restrictions) and open (subsidies for industries) transfers to companies from government o Flip-side: selling to the government products at above market prices (non competitive procurement) e.g. by drug companies and military contractors o Monopolistic practices o CEO’s control of her/his compensation  Countries with the greatest inequality are those with the most natural resources o Easy to get rich in these countries by gaining access to resources, country sells $1 bio mine for $500 mio, individual or company makes profit with it with a monopoly status 1. Monopoly rents: creating sustainable monopolies Monopolies seek rents  Monopolies can be created by o Governments: grant someone the right for an activity o Entry barriers: have excess of capacity o Patent law: patents used as entry barrier, monopoly over innovation o

Some factors contributed to this increased monopolization of markets 1. There was a battle over ideas about the role that the government should take in ensuring competition. There should be no intervention in the free market – even when the outcome is anticompetitive like predatory pricing: Where a firm lower its price to force out a competitor and then uses its monopoly power to raise prices 2. Giving rise to increased monopoly is related to changes in our economy, creation of monopoly was easier in new growth industries 3. Businesses found new ways of resisting entry, of reducing competition pressure o e.g. computer operating system, Microsoft deployed a strategy known as FUD –fear, uncertainty and doubt – creating concerns about compatibility among users by programming error messages that would randomly appear if Netscape was installed on a Windows computer 4. Politics: getting to set the rules and pick the referee Leaders of regulatory agencies help to write the complex laws with loopholes which are beneficial for companies through the help of their political influences. o “regulatory capture”: capture is associated with pecuniary incentives; those on regulatory commission come from and return to the sector that they are supposed to regulate o ‘’cognitive capture’’: capture is associated with whom they regulate 5. Government munificence There is another way to get rich. You can simply arrange for the government to hand you cash. A provision in the law that prohibited government from bargain for prices on drugs was, in effect, a gift of some 50 billion or more per year to the pharmaceutical companies. Tariffs put foreign producers at a disadvantage, they enable domestic firms to raise their prices and increase their profits. In some cases, there may be some incidental benefits such as higher domestic employment and the opportunity for companies to invest in R&D that will increase productivity and competitiveness.

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