In his new documentary, Inequality for All, Robert Reich, who is no relation of mine by the way, is trying to match the success of Al Gore’s 2006 documentary An Inconvenient Truth. The documentaries are similar in important ways. Growing income inequality, like global climate change, is undisputable and both are clearly problems, by which I mean outcomes that policymakers should strive to mitigate rationally. The magnitude of both problems, however, remains unclear and, more importantly, the causes of both problems remain contested. The causes are the crucial thing because they lead to policy recommendations and possibly to actual policies with real world repercussions. Policymaking is tricky business even when the causes of a problem are clear. When policymakers have the causes wrong they are almost certain to develop the wrong prescriptions. I think Reich’s analysis is off the mark because instead of following the evidence in a nonpartisan manner, as he promises early in the film, he leans heavily on liberal causes. That was a double entendre by the way.
Please allow me to provide an exaggerated example so there is no mistake here. Reich is doing the equivalent of pointing out that sometimes grain mills explode. Sure enough, that is the case, though he exaggerates the extent of the problem by not dropping mills destroyed by military action or other external causes from the data. Then, Reich ascribes grain mill explosions to an excess of bilious humors that increase the amount of phlogiston to the point that an explosion is inevitable. If you have never heard of bilious humors or phlogiston, good for you as they were concepts long ago abandoned by scientists because they were nothing more than conceptual black boxes that could not predict when grain mills would explode or anything else for that matter. Reich has done something analogous here by pointing to a real problem, income inequality, but exaggerating it somewhat and, more importantly, attributing the wrong causes to it.
First, the exaggeration. Reich uses data on Real Wages, which have indeed stagnated since the 1970s. Real total compensation, however, has continued to increase. The difference is fringe benefits, especially healthcare. Here is the chart, right from the St. Louis Federal Reserve’s FRED data system:
The core problem on the bottom end of the distribution, then, is not the demise of labor unions or low marginal tax rates on the rich but rising healthcare costs. Reich probably blames healthcare costs on quote unquote markets but in fact the core problem is a hybrid of government and market failures, of which the most important are government tax rules, first implemented during World War II, that encouraged the development of health insurance provided via employers. That led to a whole host of problems, including runaway costs and large numbers of uninsured individuals. I analyze the healthcare crisis more fully and offer solutions in two books, Mutually Beneficial and Fubarnomics.
Real wages have stagnated and real compensation increases have slowed because of globalization, which is just jargon for competition. The 1940s, 50s, and 60s were so sweet because the U.S. emerged from World War II not only unscathed but with tremendous productive capacity and hence was able to extract monopoly rents from the rest of the free world and even from the Soviet bloc to some extent. Unions waxed over that period because there was plenty of free money to go around. By the 1970s, however, the monopoly was gone as evidenced by the disintegration of the Bretton Woods system of fixed exchange rates, and Americans had to compete against Europeans and East Asians at both home and abroad. That competition was a good thing for the U.S. economy as it forced Americans to work harder and smarter but it also meant that the expectations of many Americans, especially those who assumed, for reasons that I’ll never quite understand, that an easy life was their birthright, were more Dickensian than Great. (I sincerely hope that you are enjoying the delectable word stew I have created for you today.)
Of course the disappointment of poorer Americans is relative: better to be in the bottom quintile of incomes in the U.S. than in the middle class, even the upper middle class, in most of Latin America, Africa, Central Asia, or Micronesia. But Reich doesn’t want to consider world income distributions even though there is a wonderful little book out about it, The Haves and the Have Notes, by Branko Milanovic, who points out that the global Gini coefficient, a widely used measure of inequality, is 70, far higher than the 45 that the U.S. currently registers.
The Gini coefficient in South Dakota, by the way, is 33, tied for the lowest in the entire nation and similar to that of the western European democracies that left leaners so love. Clearly, there is more to income distribution than just politics but you don’t hear that from Reich, who wants to concentrate on real wages in the U.S. because that allows him to pull out his Keynesian jargon about consumption and the need for a strong middle class, whatever that is. It’s all as much economic voodoo as trickle down economics ever was. Producers have a good idea what the income distribution in their markets is like and respond accordingly. Where income inequality is high, for example, they target a high margin luxury niche and/or make their wares as affordable as possible in a low margin mass niche. Check out C. K. Prahalad’s The Fortune at the Bottom of the Pyramid for details.
Another inconvenient truth, unitalicized and uncapitalized of course, about Inequality for All is that Reich also fails to adequately explain the movement at the top of the distribution, to wit why the rich are getting richer. Globalization is at play here, too, at least when it comes to top actors and athletes, who now reach audiences that number in the billions. That is just market forces at work and taking Reich at his word that he is not a socialist there is nothing to be done there. Of course the title of the documentary, Inequality for All, belies Reich’s real views. The Pledge of Allegiance reads “with liberty and justice for all” and says nothing about equality. Reich can’t mention liberty, however, because his policies restrict it and he can’t rely on justice because we can’t agree on what it means.
In any event, when it comes to CEOs, market forces are not at play. Reich can’t see that because he conflates markets with corporations, a mistake that many left-of-center thinkers make. Corporations interact with other corporations and with consumers in markets but within themselves corporations are essentially governments and hence subject to politics and power plays. Due to a combination of market and government failures that I explain in detail in my new book, Corporation Nation, the ability of stockholders to minimize managerial rent seeking has waxed and waned over time. Most importantly, it waned after the Great War and after the Fall of the Wall, leading to increased rent seeking by CEOs and other top executives, variables that Reich is completely oblivious to in his infamous bridge graphic. Let me be perfectly clear here: inequality in the U.S. is rising in part because stockholders and governments have, once again, allowed CEOs to determine their own compensation without effective checks or balances.
The same loss of checks and balances has made Washington rich as it sucks resources from the rest of the nation into its gaping maw. Suburban Washington now boasts several of the counties with the highest per capita incomes in the nation because they are chock full of high level government officials and government contractors. Reich claims that Americans at all income levels don’t want to pay taxes. I counter that Americans happily pay taxes when they know it is going to provide services that they actually need and in a relatively efficient way. Reich wants to restart his so-called virtuous cycle, which by the way is full of non sequiturs and other half truths, by taxing the rich instead of by trimming back government spending. We don’t need to throw more cash into DC, we need a government that uses what it already has more effectively. That means reforming education, including higher education, and not just shoveling more money at the problem. America already spends more per student than most of its peer nations do, it just doesn’t get as much bang for the buck because its schools and colleges don’t teach independent thinking as well as they could. For details, see my Fubarnomics or my Higher Education and the Common Weal: Protecting Economic Growth and Political Stability with Professional Partnerships, which was so radical that it was only published in India.
In conclusion, Robert Reich is right when he says that income inequality is increasing. He is also right that inequality is problematic but due to its negative effect on incentives to work hard and smart not due to kooky Keynesian concepts. Reich’s analysis of causes and hence his policy suggestions are way off base. If we fix corporate governance, healthcare, higher education, and the social safety net, inequality as measured by the Gini coefficient will decrease to the mid-30s of its own accord. If resorting economic freedom doesn’t work, then, and only then, we can think about increasing tax rates, keeping in mind, however, the inconvenient truth that with the free flow of capital globally actually collecting anything over 50 percent is highly unlikely, which is why the marginal rates were reduced in the first place. Thank you and God bless.