How the 1% Became So Wealthy and Why We Should Care About Growing Inequality

One important statement by the Occupy Wall Street movement has been the condemnation of the 1%. They depicted a struggle between the 99%, the vast majority of the lower, middle and working class, against the richest 1%, consisting of bankers, executives of major firms, and hedge fund managers, who have reaped most of the gains of economic growth in the last three decades. Can this contention be justified? In number terms, it can. The share of income going to the richest 1% increased from 9% in 1976 to 24% in 2011, and has reached the highest level since the 1920s (Jilani 2011, cf. Figure 1 and 2). The wealth of the 1% increased from 33% in 1986 to 40% in 2011 (Stiglitz 2011). As of 2007, the bottom 50% only holds 2.5% of the national wealth (cf. Figure 3). Much of the income gains derived from capital gains, which are taxed at a lower rate than regular income. In 2007, the top 1% owned 50.9% of the shares, while the bottom 50% owned 0.5% of the shares (cf. Figure 4). Between 1990 and 2006, CEO pay had increased by 298.2%, but production workers’ pay only went up by 4.3%, while minimum wage workers have lost -9.3% in income (Lubin 2010). Research by Picketty and Saez (2012) finds that 15% of the national income had shifted from the bottom 90% of the population to the top 10% over the last 30 years. The top 1% has absorbed 60% of US income growth between 1976 and 2007. This is a redistribution of wealth from the bottom to the top, i.e. socialism for the rich. The most recent economic recovery has further exacerbated the trends in inequality: The top 1% captured 121% of the income gains between 2007 and 2009. In other words, the 1% gained more in income than the growth of national income would have permitted. How is that possible? It is because the bottom 99% has lost income in that time period. The bottom 99% saw their income decline by -0.4%, while the top 1% saw an increase of 11.4% (Saez 2013).

Figure 1


Figure 2

Share of National Income

Figure 3

Financial wealth distribution

Figure 4

Distribution of stock ownership

So income and wealth inequality has been on the increase, and the contention of the Occupy Wall Street movement is largely vindicated. How did we get to this point? One account of inequality especially popular in the economics literature, claims that skill-biased technological change is responsible for the growth in inequality (e.g. Bekman, Bound and Machin 1998; Siegel 1999; Moore and Ranjan 2005; Goldin and Katz 2008; Violante 2008). In this account, new technological innovations require workers to upgrade their skills through training and education in order to retain their jobs and receive higher incomes. The skilled workers have seen their incomes go up, while the less skilled workers are facing unemployment or low-wage jobs. The Harvard economist, Greg Mankiw (2013), even went one step further and claimed that the top 1% saw their incomes rise, because their contribution to productivity had increased correspondingly. In Mankiw’s words, “My own reading of the evidence is that most of the very wealthy get that way by making substantial economic contributions, not by gaming the system or taking advantage of some market failure or the political process” (ibid., p.17). This account builds on Sherwin Rosen’s (1981) theory that technology and globalization allow a small group of individuals, superstars, to capture all the gains of income growth.

While the explanation of skill-biased technological change may be able to account for wage inequality among workers, it can not account for the income inequality between workers and capital owners (shareholders and corporate management). Wall Street bankers, who have gambled the savings of the American people, while enriching themselves from government bailouts and consumer/investor scams have appropriated a large part of the national income gains. Capital owners have captured basically all of the income gains in the last few decades. The growth of financial sector and executive incomes account for 70% of the income growth of the top 0.1% (Bakija, Cole and Heim 2012). And this group has consisted of rent-seekers, who don’t produce much of anything of value (consider Stiglitz 2012; Hudson 2013; Mischel 2013). In the words of Bivens and Mischel (2013),”the increase in the incomes and wages of the top 1 percent over the last three decades should largely be interpreted as driven by the creation and/or redistribution of economic rents, and not simply as the outcome of well-functioning competitive markets rewarding skills or productivity based on marginal differences.” Another flaw in Mankiw’s argument about the productivity of corporate executives is that most of the value that is produced still derives from two sources: workers and machines. The six members of the Walton family had $102.7 billion in net worth, while their Walmart employees earn an average of $8.81 an hour (Walmart 1% 2012). Can it be proven that the Walmart employee’s contribution is 100,000 times lower than the Walmart owners’? This argument of economic superstars collapses upon close consideration of these figures. Wealth inequality does not derive from productivity differences between executives and workers, but from the appropriation (i.e. theft) of the latter by the former. (No reading of Marx is required, though it would be helpful.) And if we want to apply the metric of productivity, it should be noted that the minimum wage for the poorest workers today should be $21.72/hour, and not $7.25 (Schmitt 2012).

So are there other, more viable explanations, for inequality in the US? The general narrative has been that the forces of globalization of the workforce (outsourcing) and automation have consistently shifted power and wealth from the working and middle class to the very rich. Since corporations face no more capital restrictions, they can invest their capital anywhere in the world, where the rate of return is the highest. Cheap labor in China and other emerging countries has proven to be a boon for many corporations. Since 2001, the US has lost 2.8 million manufacturing jobs to China, essentially because the average Chinese worker is getting paid less than one tenth of a US worker (Kavoussi 2012). US labor loses out, China’s workers gain low-income jobs, and corporate executives and shareholders in the US celebrate higher profits and share prices. Another factor has been the increasing automation of work. Many factories, that used to have hundreds and thousands of factory workers, are operating mostly with highly productive machines that only require a few maintenance workers and engineers, who push buttons. Machines have the nice feature that they don’t go on strike, don’t ask for pay raises, and make very few mistakes. (This argument actually corresponds with the skill-biased technological change hypothesis.) The combined pressure of the globalization of the workforce and automation of work has consistently weakened union power in the US. Unions which used to cover about 35% of the workforce in 1945, now only cover 11.3% of the workforce (BLS 2013). Weaker unions imply a weaker middle class, because the bargaining power of the working class has been effectively reduced (Walter and Madland 2011, cf. figure 5). Many workers want to be part of a union, but have not found organizational strength to get it. While the few existing unions are granting concession after concession to capitalists, who make their workers tremble with the threat of outsourcing and automation (which occurs sooner or later anyway, regardless of the magnitude of worker concessions).

Figure 5

Union and middle class income

While these two explanations are very much accurate with regard to growing inequality, it has an important limitation. While income inequality, globalization and automation fit together in the US, it does not apply to Europe, where the same forces of globalization and automation are in effect, but have not led to a rampant increase in inequality (perhaps with the exception of the UK, which closely follows US trends; consider Tyler 2013). Given this limitation one more factor needs to be analyzed. The United States has implemented tax and regulatory policies that strongly benefit the rich. The US used to tax its richest residents with a  91% marginal tax rate between World War II and the early 1960s. It was an anomaly in US history, because the US has much experience with serious wealth and income inequality. One glance into the robber baron era of the late 19th century dominated by Rockefeller, Vanderbilt, Carnegie and Morgan, makes this picture fairly clear. But the necessity of World War II (requiring huge defense expenditures and tax revenues), and the memory of the Great Depression (which was also accompanied by huge wealth inequality) have wrought concessions from the 1% in the form of higher taxes on the rich. But beginning in the early 1970s, capitalists fought back in a major way. The Powell memo had warned of the “assault on the enterprise system” which has been “broadly based and consistently pursued” by “Communists, new leftists and revolutionaries”, who are “far more numerous, better financed and increasingly are more welcomed and encouraged by other elements of society, than ever before in our history” (Powell 1971). The ideological battle took up steam with the stagflation period of the 1970s, which the capitalists used as an excuse to attack the state apparatus that works on behalf of the working and middle class. Capitalist interests founded and funded conservative think tanks, such as the American Enterprise Institute, the Cato Institute and the Heritage Foundation, that called for a scaling back in the welfare state (that benefits poor and middle class people) to fund tax cuts for the rich and corporations. Business interests also founded the Business Roundtable in 1972 to advocate for business interests in Congress (demanding less regulation and less taxes) (Reuss 2009). In 1973, ALEC, the American Legislative Exchange Council, was founded, which is a business organization that drafts model legislation for state legislatures and successfully advances pro-business, anti-labor, and anti-environmental laws, such as cuts to social programs or school/prison privatization (Fisher 2013).

These business efforts were a success: During the Reagan administration in the 1980s, marginal income taxes were cut from 70% to 34%, estate and corporate taxes were reduced (cf. figure 6). Telecommunication, transportation and finance were deregulated. Clinton completely repealed financial regulation in the late 1990s, leading to speculation and crisis of the late 2000s and more inequality as Wall Street bankers siphoned off wealth from the rest of society (Reuss 2009). An estimated $5.8 to $6.6 trillion in wealth have been transferred to the financial sector since 1980 (Tomaskovic-Devy and Lin 2011). The latest tax breaks for the rich occurred under the George W. Bush presidency, which was faithfully continued by President Obama. The recent rate increases will hardly put a dent on the inequality statistic. Wealth inequality escalated with government policies to exclusively benefit the rich (Bartels 2008; Hacker and Pierson 2010; Tyler 2013).

Figure 6

Marginal income tax rates

But why should we care about more inequality? Because the greatest threat to social mobility and social coherence is inequality itself (cf. figure 7). With more inequality, the poor and the middle class have less power to get their political desires achieved (Gilens 2012). The bottom third of society has virtually no say in the political process, as their opinions have no impact on US senators’ voting behavior in Congress (Bartels 2005). One of the central tenets of US ideology is equality of opportunity. Everyone may not have equal income, but at least by acquiring education and hard work one should be able to advance and improve materially. But this prospect has become increasingly unlikely with the increase in inequality. While some inequality may encourage effort and innovation, too much inequality poses a significant barrier to people in the bottom rung of the economic ladder, because the very rich, who feel insulated from the needs of the rest of society and control a majority of the resources, prefer to keep their income in their own hands, and attack government social and education programs that allow people from the lower classes to advance socio-economically. Many poor school districts in the US are facing severe budget cuts, which inevitably reduces social mobility for the poor. The rich also have more income to support their own children in reproducing their class rank, which children from poor families do not have (Economist 2013). The rich have also done their best to bid up the prices for important commodities for personal advancement, such as a college education. College tuition fees have outpaced inflation 2 to 1, and created a $1 trillion student loan bubble, which places the majority of college graduates in long-term debt servitude to wealthy bankers, creating even more inequality. Inequality produces more inequality, and weakens the institutional basis for redressing inequality.

Figure 7

Inequality and social mobility

If income inequality reduces social mobility it is at least hoped that it can produce more efficient and better economic results. After all, if the rich have most of the income they can allocate more of their savings to new investments and jobs. If the workers have too much income, they squander it in personal consumption while saving almost nothing. This is also part of standard economic theory, which assumes that there is always a trade-off between saving (and, therefore, future consumption) and current consumption. You have more of the one, and less of the other and vice versa. But I don’t find much validity in the argument. First, it is questionable how much efficiency we have produced by having much talent in the lower and middle class wasted, which the US trend to inequality has implied (given the stagnant incomes, the rise of low-wage jobs and the downward social mobility). With regard to the saving and consumption trade-off, there has not been much evidence for it. An increase in the saving rate among the wealthy resulting from their income gains and tax breaks has not resulted in an increase in the investment rate or in the GDP. Research confirms that there is no correlation between tax cuts for the rich and economic growth (OCPP 2013; cf. figure 8). If the US investment rate were so high, we would have had no unemployment by now. The problem in the logic is that US companies and elites, who control most of the resources, do not have to invest their capital in the US, and can do so abroad. The 1% is also free to invest their capital in non-productive areas, such as share buybacks or asset bubbles, especially if overall demand remains weak due to the weak purchasing power of the 99% that consume most of their income. (A standard Keynesian lesson, which has been grossly ignored.) In the words of the Economist (2012), “inequality has reached a stage where it can be inefficient and bad for growth”.

Figure 8

Correlation Tax Cuts and GDP Growth

Finally, inequality also produces bad social effects. Sociological research by Wilkinson and Pickett (2009) finds that more unequal societies have a population with worse physical health, mental health, education, communal life, child well-being; more drug abuse, imprisonment, obesity, violence, teenage pregnancy; and less social mobility, and trust. The authors explain that more inequality implies less social trust, more anxiety and illness, and more excessive consumption, which have disastrous social and health impacts. At the same time, social institutions, which maintain social coherence, such as a strong welfare state, public infrastructure such as hospitals or schools, or robust labor organizations, are undermined with more inequality and concentration of wealth. (A similar argument was made by Durkheim, who argued that less social coherence and solidarity in Protestant comunities compared to Catholic communities explained higher suicide rates in the former.) In conclusion, the contention of the Occupy Wall Street movement that heavily attacked inequality is largely justified, and more social discontent will likely have to build up in order to promote political alternatives that are more favorable to the bottom 99%.


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Source of Figures

Figure on income share of top 1%, 1913-2008.

Figure on changes in income distribution, 1979-2007.

Figure on stock, bond and mutual fund ownership.

Figure on middle class and unions:

Figure on social mobility and income inequality.

Figure on marginal income tax rates, 1913-2008.

Figure on correlation between tax cuts and economic growth.

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4 Responses to How the 1% Became So Wealthy and Why We Should Care About Growing Inequality

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