The Price of Inequality: How Today's Divided Society Endangers Our Future (24 page)

We should be concerned about the risk of this diminished influence. Even if things had been going better in the United States, the growth of the emerging markets would necessitate a new global order. There was just a short period, between the fall of the Berlin Wall and the collapse of Lehman Brothers, when the United States dominated in virtually every realm. Now the emerging markets are demanding a larger voice in international forums. We moved from the G-8, where the richest industrial countries tried to determine global economic policy, to the G-20, because we had to: the global recession provided the impetus, but one could not deal with global issues, like global warming or global trade, without bringing others in. China is already the second-largest global economy, the second-largest trading economy, the largest manufacturing economy, the largest saver, and the largest contributor to greenhouse gas emissions.

America has been extraordinarily influential in spreading ideas—of equality, of human rights, of democracy, of the market. Having a world that shares these values has been part of the country’s mission. But it is also in our self-interest. I observed earlier that our real source of power is our soft power; but that power arises only because others see things through lenses that are not too dissimilar from ours. We may try to enforce a pax Americana
,
but we have seen how difficult and costly that is. Far better for others to see their interests as coincident with ours, in creating democratic and prosperous societies. The management of globalization requires global agreements, in trade, finance, investment, the environment, health, and the management of knowledge. In the past the United States had enormous influence in shaping these agreements. We have not always used that influence well; we have often used it to advance some of our special interests, aiding and abetting the rent-seeking activities that play such a large role in the creation of inequalities. Although in the early days of modern globalization, that was not fully grasped, today it is. There is a demand for a change in the governance of the global economic institutions and arrangements, and, combined with the new balance of global economic power, changes are inevitable. Even then, our influence is likely to remain large, almost surely disproportionate to our population or our economy. But the extent to which the global economy and polity can be shaped in accord with our values and interests will depend, to a large extent, on how well our economic and political system is performing
for most citizens.
As democracies grow in many other parts of the world, an economic and political system that leaves most citizens behind—as ours has been doing—will not be seen as a system to be emulated, and the rules of the game that such a country advocates will be approached with jaundiced eyes.

C
ONCLUDING
C
OMMENTS

The United States played a central role in creating the current rules of the game and the United States, still the world’s largest economy, can use its economic power and influence to shape new rules that create a fairer global economy. It may or may not be in the interests of the 1 percent to do so,
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but it is in our broader national interests. As we saw earlier, current rules of globalization are contributing to our growing inequality. Someday, perhaps soon, we too will see how globalization
as currently managed
promotes neither global efficiency nor equity; even more importantly, it puts our democracy in peril.
Another world is possible
: there are alternative ways of managing globalization that are better for both our economy and our democracy; but they do not entail
unfettered
globalization. We have learned the risks of unfettered markets for our economy and how to temper capitalism so that it serves
the majority
of citizens, not a tiny, powerful fraction. So too, we can temper globalization; indeed, we must if we want to preserve our democracy, prevent our rampant inequality from growing worse, and maintain our influence around the world.

C
HAPTER
S
IX

1984 IS UPON US

T
HE BIG PUZZLE WE PRESENTED IN THE LAST CHAPTER
was how, in a democracy supposedly based on one person one vote, the 1 percent could have been so victorious in shaping policies in its interests. We described a process of disempowerment, disillusionment, and disenfranchisement that produces low voter turnout, a system in which electoral success requires heavy investments, and in which those with money have made political investments that have reaped large rewards—often greater than the returns they have reaped on their other investments.

There is another way for moneyed interests to get what they want out of government: convince the 99 percent that they have shared interests. This strategy requires an impressive sleight of hand; in many respects the interests of the 1 percent and the 99 percent differ markedly.

The fact that the 1 percent has so successfully shaped public perception testifies to the malleability of beliefs. When others engage in it, we call it “brainwashing” and “propaganda.”
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We look askance at these attempts to shape public views, because they are often seen as unbalanced and manipulative, without realizing that there is something akin going on in democracies, too. What is different today is that we have far greater understanding of how to shape perceptions and beliefs—thanks to the advances in research in the social sciences.

In contradistinction to the reality that perceptions and preferences can be shaped, mainstream economics assumes that individuals have well-defined preferences and fully rational expectations and perceptions. Individuals know what they want. But in this respect, traditional economics is wrong. If it were true, there would be little scope for advertising.
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Corporations use recent advances in psychology and economics that extend our understanding of how preferences and beliefs can be shaped to induce people to buy their products. In this chapter we’ll see how those in the 1 percent have shaped beliefs about what is fair and efficient, about the strengths and weaknesses of government and the market, and even about the extent of inequality in America today.

It is clear that many, if not most, Americans possess a limited understanding of the nature of the inequality in our society: They believe that there is less inequality than there is, they underestimate its adverse economic effects,
3
they underestimate the ability of government to do anything about it, and they overestimate the costs of taking action. They even fail to understand what the government is doing—many who value highly government programs like Medicare don’t realize that they are in the public sector.
4

In a recent study respondents on average thought that the top fifth of the population had just short of 60 percent of the wealth, when in truth that group holds approximately 85 percent of the wealth. (Interestingly, respondents described an ideal wealth distribution as one in which the top 20 percent hold just over 30 percent of the wealth. Americans recognize that some inequality is inevitable, and perhaps even desirable if one is to provide incentives; but the level of inequality in American society is well beyond that level.)
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Not only do Americans misperceive the level of inequality; they underestimate the changes that have been going on. Only 42 percent of Americans believe that inequality has increased in the past ten years, when in fact the increase has been tectonic.
6
Misperceptions are evident, too, in views about social mobility. Several studies have confirmed that perceptions of social mobility are overly optimistic.
7

Americans are not alone in their misperceptions of the degree of inequality. Looking across countries, it appears that there is an inverse correlation between trends in inequality and perceptions of inequality and fairness. One suggested explanation is that when inequality is as large as it is in the United States, it becomes less noticeable—perhaps because people with different incomes and wealth don’t even mix.
8

These mistaken beliefs, whatever their origins, are having an important effect on politics and economic policy.

Perceptions have always shaped reality, and understanding how beliefs evolve has been a central focus of intellectual history. Much as those in power might like to shape beliefs, and much as they do shape beliefs, they do not have full control: ideas have a life of their own, and changes in the world—in our economy and technology—impact ideas (just as ideas have an enormous effect in shaping our economy). What is different today is that the 1 percent now has
more
knowledge about how to shape preferences and beliefs in ways that enable the wealthy to better advance their cause, and more tools and more resources to do so.

In this chapter, I describe some of the research in economics and psychology that extends our understanding of the links between perceptions and reality. I show how the 1 percent has used these advances to alter perceptions and achieve its aims—to make our inequality seem less than it is and more acceptable than it should be.

S
OME
B
ASICS OF
M
ODERN
P
SYCHOLOGY AND
E
CONOMICS

Understanding how people actually behave—rather than how they would behave if, for instance, they had access to perfect information and made efficient use of it in their attempts to reach their goals, which they themselves understood well—is the subject of an important branch of modern economics called behavioral economics
.
This school holds that even if behavior is not consistent with the standard tenets of
rationality
, it still may be predictable. And if we can understand what determines behavior, we can shape it.
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Work in modern psychology and behavioral economics has observed that, in certain arenas, there are systematic misperceptions. There are consistent biases in judgments. And the work has set out to explain what determines those biases and misperceptions.

Framing and misperceptions

This research has emphasized how much our perceptions are affected by “framing,” for instance, the context in which the analysis is posed. Police lineups are notorious: even if none of the accused could have been at the scene of the crime, eyewitnesses will identify one of them as the culprit, with conviction. Much of the battle in politics today is over framing. The frames that different parts of our society bring to bear affect their judgments.

One can manipulate frames and thus perceptions and behavior. These frames and perceptions can be self-reinforcing.
10

One set of experiments shows how “fragile” and easily affected our beliefs can be. Individuals are asked to draw a number out of a hat. They are then asked a question about which they have relatively little information, such as the number of ships that passed through the Panama Canal last year. The answer, it turns out, is systematically related to the random number they previously pulled out of the hat—those who pulled out a larger number
systematically
respond with a higher number.
11

Standard economic theory begins, as we have noted, with the presumption that individuals have well-defined preferences and beliefs. They make decisions about how much to save on the basis of a careful evaluation of the benefits of consuming today versus consuming in the future. The reality is otherwise. When employers ask individuals how much of their income they would like to put into their retirement accounts, the answer depends heavily on how the employer “frames” the question. If she says, for instance, that 10 percent will be deducted from income and put into a retirement account unless the employee elects to save more (15 percent) or less (5 percent), overwhelmingly the worker chooses 10 percent. But if the employer says that 15 percent will be deducted unless the employee chooses a smaller number (5 percent or 10 percent), the number 15 percent is chosen much more frequently. If she poses the question still differently, giving additional options of 20 percent or 25 percent, these options—irrelevant for most individuals, because they wouldn’t, in any case, be chosen—still affect the employee’s choice.
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Such behavior should not come as a surprise (at least not to someone who is not an economist). Individuals don’t really know what life will be like forty years from now and therefore have little basis for making a judgment about how much to save now. The standard model in economics has individuals making choices repeatedly—say, between red lettuce and green lettuce, experimenting and discovering what they truly like. But unless there is reincarnation, there is no way that an individual can repeatedly go through the savings experiment over time: if he saves too little, he may live to regret it, but he won’t be able to live his life over again; the same applies if he saves too much. And today’s world is so different from yesterday’s that there is little that he can learn from his parents about life cycle savings and little that his children can learn from him.

Equilibrium fictions

There is a second important proposition from psychological research: individuals process information that is consistent with their prior beliefs differently from how they process information that is inconsistent.
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Information that is consistent is remembered, seen as relevant, and reinforces beliefs. Information that is inconsistent is more likely to be ignored, discounted, or forgotten. This distortion is called “confirmatory bias.”
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The “equilibrium fictions” that can result from this process are beliefs that are maintained strongly because the evidence that people see—as they perceive and process it—is fully consistent with those beliefs.
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Behavioral economics and modern marketing

Shaping behavior is a central goal of marketing. Over the years, firms have worked hard to understand what determines consumers’ buying decisions; for if they understand that, they can induce people to buy more of their products. Thus, the major objective of advertising is not to convey information, but to shape perceptions. The best-known examples conjure a lifestyle—which may even be at odds with that of the real users of the product—that consumers aspire to. The Marlboro Man offers an egregious example of this strategy.
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Perceptions affect behavior
and market equilibrium

Beliefs
and
perceptions
, whether they are grounded in reality or not, affect behavior. If people see the “Marlboro man” as the type of person they aspire to be, they may choose that cigarette over others. If individuals overestimate some risk, they may take excessive precautions.

But important as perceptions and beliefs are in shaping individual behavior, they are even more important in shaping
collective
behavior, including political decisions affecting economics. Economists have long recognized the influence of ideas in shaping policies. As Keynes famously put it,

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.
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Social sciences like economics differ from the hard sciences in that beliefs affect reality: beliefs about how atoms behave don’t affect how atoms actually behave, but beliefs about how the economic system functions affect how it actually functions. George Soros, the great financier, has referred to this phenomenon as reflexivity,
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and his understanding of it may have contributed to his success. Keynes, who was famous not just as a great economist but also as a great investor, described markets as a beauty contest where the winner is the one who assessed correctly what the other judges would judge to be the most beautiful.

Markets can sometimes create their own reality. If there is widespread belief that markets are efficient and that government regulations only interfere with efficiency, then it is more likely that government will strip away regulations, and this will affect how markets actually behave. In the most recent crisis what followed from deregulation was far from efficient, but even here a battle of interpretation rages
.
Members of the Right tried to blame the seeming market failures on government; in their mind the government effort to push people with low incomes into homeownership was the source of the problem. Widespread as this belief has become in conservative circles, virtually all serious attempts to evaluate the evidence have concluded that there is little merit in this view. But the little merit that it had was enough to convince those who believed that markets could do no evil and governments could do no good that their views were valid, another example of “confirmatory bias.”
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