America then exhibits in her social state a most extraordinary phenomenon. Men are there seen on a greater equality in point of fortune and intellect, or, in other words, more equal in their strength than in any other country of the world, or in any age of which history has preserved the remembrance. —Alexis de Tocqueville, Democracy in America, 1835
Many of Tocqueville's trenchant observations about early 19th-century American society still resonate. It's one of the pleasures of reading his writings. But his famous comment about equality seems increasingly anachronistic. Over the past three decades, the U.S. has steadily become a society defined by inequality in income and inequity in opportunity.
Economic inequality is a hot topic. A populist campaign against widening inequality helped propel Democrats to power in Washington in the last election. The nation's chief economist, Federal Reserve Board Chairman Ben Bernanke, highlighted the troubling distribution of income and opportunity in a Feb. 6 speech before the Greater Omaha Chamber of Commerce.
A week earlier, seemingly for the first time in his Administration, President Bush remarked on the trend. "The fact is that income inequality is real," the President said in a talk before business leaders in the heart of Wall Street. "It has been rising for more than 25 years." Yet the discussion never really seemed to gain traction. Until now.
Why the sudden surge in attention? One reason is that the men and women who occupy the commanding heights of society and the economy worry that a political backlash against economic inequality and economic insecurity is brewing. Political pressures could force leaders to embrace protectionist policies that restrain creative destruction, economist Joseph Schumpeter's famous metaphor for the wellspring of economic growth in a capitalist economy. "But hindering the adoption of new technologies or inhibiting trade flows would do far more harm than good, as technology and trade are critical sources of overall economic growth and increases in living standards," said Bernanke.
Another reason is that, after decades of dispute, few doubt the evidence of widening inequality. For example, between 1970 and 2006, real weekly earnings of the median worker rose by about 11.5%, according to Bernanke. But wages among those in the 90th percentile jumped 34%. Even more striking are the results of a paper by Northwestern University economists Ian Dew-Becker and Robert Gordon. The scholars found that real wages and salaries for the median worker had risen by only 11%, or at an average annual rate of 0.3% a year, from 1966 to 2001. In sharp contrast, wages and salaries for the 99th percentile jumped 121% (2.26% a year), and the 99.9th percentile profited from a 236% gain (3.48% annual average). America's top earners are enjoying riches worthy "of the Robber Barons of the 1890s or the Gilded Age of the 1920s," wrote Gordon and Dew-Becker.
What's more, the traditional promise that the rising tide of a strong economy and rapid productivity growth will lift all boats isn't proving true. Throughout much of American history, citizens didn't concern themselves if the rich got richer so long as most everyone else prospered, too. The building block for raising the living standard of the mass of Americans has always been higher productivity. And for the past decade, productivity growth has been robust.
Rising Economic Insecurity
Yet waiting for the income payoff has been like waiting for Godot. For example, between 2001 and 2005, productivity expanded at a strong 3.1% average annual rate while real compensation per hour rose at a pace of just 1.4%, calculates Stephen Roach, chief economist at Morgan Stanley (MS). And Gordon and Dew-Becker found that only the top 10% of workers saw their wages and salaries grow along with productivity since 1966.
These figures are disturbing on their own. Their social and economic impact is magnified by another trend: the rise in economic insecurity. Who doesn't shudder at Eastman Kodak's (EK) recently announced plans to eliminate as many as 30,000 jobs? Who doesn't know a smart, savvy 50-something who has lost her job and can't find decent employment? Who doesn't worry that the pincer of technology and globalization will squeeze them out of a job? Who isn't afraid that, if they lose their job, their family will join the swelling ranks of those without health insurance? These are the kinds of issues that worry Americans.
They're right to be worried, too. The adverse consequences of losing a job are mounting, according to data gathered by Peter Orszag, head of the Congressional Budget Office. Among the evidence he cites is a study by economist Henry Farber of Princeton University that found, on average, workers who lost a full-time job between 2001 and 2003 and landed a new job in 2004 earned about 17% less than at their old job. That's roughly double the average loss in earnings incurred by displaced workers in the late 1990s. A CBO study of workers who lost their jobs during the 2001 recession and got a job within three months of their unemployment benefits' expiring earned about 15% less than before. As for their health insurance, 20% of them had been uninsured before losing their job. That figure climbed to 30% in their new jobs.
It's a High-Tech World
Is it any wonder evidence is mounting that more and more workers are frustrated about the economy, worried about their prospects and their children, fearful that the workplace and the economy are evolving in directions that will make life increasingly capricious and unfair, leaving the mass of Americans behind no matter how hard they toil? "An unequal society cannot help but be an unjust society," wrote University of California, Berkeley, economist Bradford Delong on his daily blog.
What accounts for the rise in inequality? Most everyone agrees that the powerful combination of growing globalization and technological change is, in complex ways, the prime culprit. The main evidence for that point of view is the difference in pay for well-educated and less well-educated workers. In 1979, median compensation for college graduates was 38% higher than for high school graduates. Last year, that difference was 75%. The demand for skilled, educated workers who can adapt to technological upheaval and respond to international competition has been greater than the supply. Nevertheless, there are many remaining puzzles to the inequality trend. For instance, CEO pay has escalated far beyond any notion of reasonable economic returns on brainpower or pay-for-performance.
That said, a set of policy prescriptions is getting attention, because the rise in inequality is accompanied by rising insecurity. Education reform is of paramount importance. Too many schools, especially in the nation's inner cities, are failing to prepare their students for a college education, the ticket to a good job in our intensely competitive economy. Of course, the idea of investing in human capital is hardly new. But the sense of urgency and impatience surrounding the idea seems to be growing. Equally important is creating a social safety net in an economy where job stability has declined, with the top priority in this area being health-care reform. The social contract between employers and employees has been shredded, and workers now need a health-insurance system that protects families from the destructive side of creative destruction.
Toward a Functioning Economy
To be sure, inequality has narrowed in many ways for significant segments of society. It's a lot easier for men and women to compete on an equal footing when they're working with high-tech equipment such as computers than, say, toiling on an auto assembly line or in a taconite mine. Women now earn a majority of all college degrees. Similarly, skilled immigrants are vital workers in Silicon Valley, Austin, Tex., Route 128, the Beltway, and other high-tech centers. Immigrant entrepreneurs are opening stores, delis, restaurants, and other services in many urban and metropolitan communities.
Still, if policymakers don't address inequality and insecurity, the risk is that the U.S. economy will lose its flexibility, dynamism, and openness. In his new textbook, Michael Mandel, chief economist at BusinessWeek, has proposed this definition of economics: "the study of the functioning—and malfunctioning—of the economy, with the aim of improving living standards." It's clear the economy is malfunctioning now, because the fruits of productivity aren't being broadly shared. And that's not the American way.