America's prosperity requires a level playing field
Joseph E. Stiglitz

This article first appeared in the Los Angeles Times on July 22, 2012.

To fix the economy, we must boost demand. To do that, we have to address inequality. Despite what the debt and deficit hawks would have you believe, we can't cut our way back to prosperity. No large economy has ever recovered from serious recession through austerity, but there is another factor holding our economy back: inequality.

Any solution to today's problems requires addressing the economy's underlying weakness: a deficiency in aggregate demand. Firms won't invest if there is no demand for their products, and one of the key reasons for lack of demand is America's level of inequality, the highest in the advanced countries.

Because those at the top spend a much smaller portion of their income than those in the bottom and middle, when money moves from the bottom and middle to the top (as has been happening in America in the last dozen years), demand drops. The best way to promote employment today and sustained economic growth for the future, therefore, is to focus on the underlying problem of inequality. In turn, this better economic performance will generate more tax revenue, improving the country's fiscal position.

Even supply-side economists, who emphasize the importance of increasing productivity, should understand the benefits of attacking inequality. America's inequality does not come solely from market forces; those are at play in all advanced countries. Rather, much of the growth of income and wealth at the
top in recent decades has come from what economists call rent-seeking:
activities directed more at increasing the share of the pie they get rather than increasing the size of the pie itself.

Some examples: Corporate executives in the US take advantage of deficiencies in our corporate governance laws to seize an increasing share of corporate revenue, enriching themselves at the expense of other stakeholders. Pharmaceutical companies successfully lobbied to prohibit the federal government — the largest buyer of drugs — from bargaining over drug prices, resulting in taxpayers’ overpaying by an estimated half a trillion dollars in about a decade. Mineral companies get resources at below competitive prices. Oil companies and other corporations get "gifts" in the hundreds of billions of dollars a year in corporate welfare, through special benefits hidden in the tax code. Some of this rent-seeking is very subtle; our bankruptcy laws give priority to derivatives (such as those risky products that led to the $150-billion AIG bailout), but dictate that student debt can't be discharged even in bankruptcy.

Rent-seeking distorts the economy and makes it less efficient. When, for instance, speculation gains get taxed at a lower rate than true innovation, resources that could support productivity-enhancing activities get diverted to gambling in the stock market and other financial markets. So too, much of the income in the financial sector (including that derived from predatory lending and abusive credit card practices) derives not from making our economy more efficient, but from rent-seeking.

If we curbed these abuses by the financial sector, more resources — especially the scarce talent of some of our brightest young people — might well be devoted to making a stronger economy rather than to exploiting the financially unsophisticated. The banks might actually go back to the boring business of lending rather than high-risk and often opaque speculation.

Curbing rent-seeking is not that complicated, aside from the politics. It would require better financial regulations; fairer and better-designed bankruptcy laws; stronger and better-enforced antitrust laws; corporate governance laws that limit the power of CEOs to effectively set their own pay; and, in all of these areas, more transparency. Because so much of the income at the top is from rent-seeking, more progressive taxation (of capital gains, in particular) is necessary to discourage it. If the additional revenue is used by the government for high-return public investments, there are double benefits.

Joseph E. Stiglitz is University Professor at Columbia University; Co-Chair of the Committee on Global Thought; and co-founder and Co-President of the Initiative for Policy Dialogue. In 2001, he was awarded the Nobel Prize in economics for his analyses of markets with asymmetric information. He has written textbooks that have been translated into more than a dozen languages, and is a Trustee of EPS.