The Price of Inequality: How Today's Divided Society Endangers Our Future (30 page)

When I was chairman of the Council of Economic Advisers, I tried to encourage the United States to address some of these problems, for instance, by constructing “Green GDP” accounts, which would take into consideration the depletion of natural resources and the degradation of the environment. I knew that I had hit on something important when the coal industry responded with vehemence, and when congressional representatives of the coal states even threatened to cut off funding for work on this area. The coal industry realized that perceptions mattered: if it became widely recognized that, correctly measured, the coal industry might have been making a negative contribution to the nation’s output, that would have had significant policy implications.

Today there is almost universal recognition that we have to change our metrics. President Sarkozy of France set up the International Commission on the Measurement of Economic Performance and Social Progress, which I chaired.
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Experts were drawn from statistics, economics, political science, and psychology, and the group included three Nobel Prize winners. We unanimously agreed not only that GDP was a bad, and potentially badly misleading, measure but that it could be improved upon.
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I cannot say, at this point, that we have fully won this battle, but the tide has turned. Even the United States has begun work in broadening its measures. The G-20 endorsed work to find better metrics. The OECD, the organization of the advanced industrial countries, has undertaken a large project following up on our work. And countries around the world—Australia, New Zealand, Scotland, the UK, Germany, France, Korea, Italy, and many others—have begun initiatives along these lines.

In democratic societies, even given the power of the wealthy to control the media and shape perceptions, it is impossible to completely suppress ideas. And when these ideas resonate with so many citizens, they can take on a life of their own.

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ONCLUDING
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OMMENTS

In politics, perceptions are crucial. Devoted ideologues on each side will cherry-pick examples and draw from them broad generalizations. As we’ve tried to argue, many individuals will perceive or remember only the evidence that is consistent with their initial beliefs. This is so perhaps especially in ideologically charged issues, such as the role of government, particularly in dealing with inequality. That itself may be a reflection of the high inequality in the United States. A great deal of money is at stake for the 1 percent in winning this debate. Given that, it becomes harder, not easier, to weigh all considerations in a balanced way.

In this chapter, I’ve tried to present a case for a nuanced and balanced approach to the proper role of the market and the government. We don’t decide whether a given medical intervention is good or bad by considering only the successes or only the horror stories. Instead, we try to understand the conditions under which a medical intervention is likely to work or not. What are the risks of doing nothing? What are the limitations of intervening? The same care should be taken with both the “big” ideas we have been discussing and the more specific policy interventions.

The powerful try to frame the discussion in a way that benefits their interests, realizing that, in a democracy, they cannot simply impose their rule on others. In one way or another, they have to “co-opt” the rest of society to advance their agenda.

Here again the wealthy have an advantage. Perceptions and beliefs are malleable. This chapter has shown that the wealthy have the instruments, resources, and incentives to shape beliefs in ways that serve their interests. They don’t always win—but it’s far from an even battle.

We’ve seen how the powerful manipulate public perception by appeals to fairness and efficiency, while the real outcomes benefit only them. In the next chapter, we’ll see how they achieve this not only in the court of public opinion but also in America’s courts.

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HAPTER
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EVEN

JUSTICE FOR ALL? HOW INEQUALITY IS ERODING THE RULE OF LAW

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VERY MORNING, STUDENTS THROUGHOUT AMERICA
pledge their allegiance to the flag of the United States and “to the Republic for which it stands, one nation, under God, with liberty and justice for all.” That implicit promise, liberty and justice for all, captures one of the essential values that help define America’s sense of identity. At our best, we are a country where the rule of law prevails, where an individual is innocent until proven guilty, and where all people stand equal before the law. These values also are central to our understanding of America’s place in the world. We have championed them to other countries. Yet what the pledge really means is seldom taken up. Nor is a still larger question broached: whether America has really delivered on its promises.

This chapter explores one of three crucial battlefields upon which the fight to create a more equal, or more unequal, society is fought—the battle over the laws and regulations that govern our economy and how they are enforced. The next chapter considers the battle of the budget, and chapter 9 examines the conduct of monetary policy and macroeconomics.

The chapter begins by asking a rather abstract, but key, set of questions: What is the purpose of the laws and regulations that are central to the functioning of our economy? Why do we need a rule of law? Is there more than one possible “rule of law,” and, if so, what differences do the choices make? The central message echoes that of earlier chapters: There are alternative legal frameworks. Each has consequences for efficiency and distribution. The
wrong
kind of rule of law can help preserve and extend inequities.

While a good “rule of law” is supposed to protect the weak against the powerful, we’ll see how these legal frameworks have sometimes done just the opposite, and the effect has been a large transfer of wealth from the bottom and middle to the top.
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Ironically, while the advocates of these legal frameworks argued for them as promoting an efficient economy, they have actually led to a distorted economy.

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ULE OF
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As the old poem goes, “No man is an island.” In any society what one person does may hurt, or benefit, others. Economists refer to these effects as externalities. When those who injure others don’t have to bear the full consequences of their actions, they will have inadequate incentives not to injure them, and to take precautions to avoid risks of injury. We have laws to provide incentives for each of us to avoid injuries to others—to their property, their heath, and the public goods (such as nature) that they enjoy.

Economists have focused on how best to provide incentives so that individuals and firms take into account their externalities: steel producers should be forced to pay for their pollution, and those who cause accidents should pay for the consequences. We embody these ideas, for instance, in the “polluter pays principle,” which says that polluters should pay for the full consequences of their actions. Not paying the full consequences of one’s action—for instance, for the pollution caused by production—is a subsidy. It is equivalent to not paying the full cost of labor or capital. Some corporations that resist paying for the pollution that they create talk about the possible loss of jobs. No economist would suggest that distortionary subsidies to labor or capital should be preserved to save jobs. Not paying the costs imposed on the environment is a form of subsidy that should be no more acceptable. The responsibility for maintaining the economy at full employment lies elsewhere—with monetary and fiscal policy.

The success corporations often have had in avoiding the full consequences of their actions is an example of how they shape the rules of the economic game in their favor. As a result of laws that limit the extent of their liabilities, nuclear power plants and offshore oil rigs are shielded from bearing the full costs should they explode.
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The consequence is that we have more nuclear power plants and offshore rigs than we would otherwise—in fact, it’s questionable whether, without a whole set of government subsidies, there would be any nuclear power plants at all.
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Sometimes, the costs that firms impose on others aren’t apparent right away. Corporations often take big risks, and nothing may go wrong for years and years. But when something does go wrong (as with the TEPCO nuclear power plant in Japan or with the Union Carbide plant in Bhopal, India), thousands can suffer. Forcing corporations to compensate those injured doesn’t really undo the harm. Even if the family of someone who dies because of unsafe work conditions is compensated, the person isn’t brought back to life. That’s why we can’t rely just on incentives. Some people are risk takers—especially when others bear most of the risk. The explosion aboard the Deepwater Horizon in April 2010 began a spill that spewed millions of barrels of British Petroleum oil into the Gulf of Mexico. BP executives had gambled: skimping on safety increased immediate profits. In this case, they gambled and lost—but the environment and residents of Louisiana and the other Gulf states lost even more.

In the resulting litigation, corporations that do cause damage may have a stronger hand than the people who are hurt. They may be in a position to nickel-and-dime those who suffer damage, since many people cannot hold out for adequate compensation, nor can they afford lawyers to match those of the company. One role of government is to rebalance the scales of justice—and in the case of the BP disaster, it did, but very gently, and in the end, it became clear that many of the victims were likely to receive compensation that was but a fraction of what they suffered.
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Ronald Coase, a Chicago Nobel Prize–winning economist, explained how different ways of assigning property rights were equally efficient for addressing externalities, or at least would be in a hypothetical world with no transactions costs.
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In a room with smokers and nonsmokers, one could assign the “air rights” to the smokers, and if the nonsmokers valued clean air more than the smokers valued smoking, they could bribe the smokers not to smoke. But one could alternatively assign the air rights to the nonsmokers. In that case, smokers could bribe the nonsmokers to allow them to smoke so long as they valued the right to smoke more than the nonsmokers valued clean air. In a world of transactions costs—the real world, where, for instance, it costs money to collect money from one group to pay another—one assignment can be much more efficient than the other.
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But more to the point, there can be large distributive consequences of alternative assignments. Giving nonsmokers the air rights benefits them at the expense of the smokers.

Try as one might, one cannot escape issues of distribution, even when it comes to the simplest problems in organizing an economy.
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The flip side of the intertwining of these “property rights”/externalities issues and distribution is that notions of “liberty” and “justice” cannot be separated. Each individual’s liberties have to be curtailed when they impose harms on others. One person’s liberty to pollute deprives another of her health. One person’s liberty to drive fast deprives another of his right not to be injured.
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But whose liberties are paramount? To answer this fundamental question, societies develop rules and regulations. These rules and regulations both affect the efficiency of the system and distribution: some gain at the expense of others.

That’s why “power”—political power—matters so much. If economic power in a country becomes too unevenly distributed, political consequences will follow. While we typically think of the rule of law as being designed to protect the weak against the strong, and ordinary citizens against the privileged, those with wealth will use their political power to shape the rule of law to provide a framework within which they can exploit others.
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They will use their political power, too, to ensure the preservation of inequalities rather than the attainment of a more egalitarian and more just economy and society. If certain groups control the political process, they will use it to design an economic system that favors them: through laws and regulations that apply specifically to an industry, through those that govern bankruptcy, competition, intellectual property or taxation, or, indirectly, through costs of accessing the court system. Corporations will argue, in effect, that they have the right to pollute—and they will ask for subsidies not to pollute; or that they have the right to impose the risk of nuclear contamination on others—and they will ask for, in effect, hidden subsidies, limitations in liability to protect themselves against being sued if their plant explodes.

My experience in government suggests that those who hold positions of power want to believe that they are doing the right thing—that they are pursuing the public interest. But their beliefs are at least malleable enough for them to be convinced by “special interests” that what they want is in the public interest, when it is in fact in
their own
interests to so believe. In the rest of this chapter, we examine this theme in three contexts where rules and regulations play a central role in determining how America’s market economy has been working in recent years: predatory lending, bankruptcy law, and the foreclosure process.

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REDATORY
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ENDING

Early on in the housing bubble, it became clear that the banks were engaged not only in reckless lending—so reckless that it would endanger the entire economic system—but also in predatory lending, taking advantage of the least educated and financially unsophisticated in our society by selling them costly mortgages and hiding details of the fees in fine print incomprehensible to most people. Some states tried to do something about it. For instance, in October 2002 the Georgia legislature, after observing that mortgage lending in the state was riddled with fraud and predation, tried to call a halt to it with a consumer protection law. The response from the financial markets was quick and furious.

The ratings agencies, today best known for their role in calling pools of F-rated mortgages A-rated securities, also had a hand in sustaining fraudulent lending practices. They should have welcomed the actions of states like Georgia: the law meant that the agencies would not need to assess whether mortgages in a given pool were fraudulent or inappropriate. Instead, Standard & Poor’s, one of the leading rating agencies, threatened not to rate any of Georgia’s mortgages. Without these ratings, the mortgages would have been hard to securitize and without securitization (in the business model of the day) mortgage lending in the state might dry up. Evidently, the rating agencies were worried that if the practice spread to other states, the flow of bad mortgages from which they made so much money “rating” would be greatly diminished. S&P’s threat was effective: the state quickly reversed the law.
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In some other states, too, there were attempts to stop predatory lending, and in each of these instances banks used all their political muscle to stop states from enacting laws aimed at curtailing predatory lending.
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The result, as we know now, was not only massive fraud but also bad lending: too much indebtedness, with financial products that could explode with a change in interest rates or in the broader economic conditions, and indeed many did explode.
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In a simpler world, the adage caveat emptor (“let the buyer beware”) might have been appropriate; but not in today’s complex world. A regulatory agency for financial products is needed to prevent not just fraud but also abusive, deceptive, and inappropriate products.
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Even many financial institutions recognized that
some
regulation was needed: without bank and insurance regulations ensuring the soundness of these institutions, individuals would be reluctant to turn over their money to banks and insurance companies, lest they never get it back. Individuals on their own would never be able to assess the financial conditions of these large and complex institutions; it has proven hard enough for experienced government regulators to do so.
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But the U.S. banking sector resisted the suggestion that regulation be extended to protect consumers, in spite of its terrible record of bad lending and poor credit practices before the crisis, which had led to widespread public support for an agency to do so. And when a provision creating such an agency was included in the Dodd-Frank bill, financial institutions campaigned to make sure that Elizabeth Warren, a Harvard law professor with all the credentials necessary to run such an agency, including the expertise and commitment to protect consumers, was not chosen to head it. The banks won. (She was in, in fact, widely cited as the originator of the idea of such an agency, and a tireless campaigner for it, a sin for which the financial community could not forgive her. Even worse, she served as chair of the Congressional Oversight Panel, overseeing the government’s bailout program. The panel revealed that the administration was giving the banks a great deal—getting back from the banks preferred shares worth about half of what the government was giving them.)
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