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Does the increase in income inequality mean market capitalism and the American dream are broken? Should policymakers be in a panic that rich are getting (a lot) richer at the expense of the middle class?

To try and get some of these answers, I talked with Steven Kaplan, the Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business. He is also the director of Booth’s Polsky Center for Entrepreneurship and Innovation, and a co-founder of the New Venture Challenge, ranked in 2015 as the nation’s number one accelerator program. Professor Kaplan earned his PhD in Business Economics from Harvard University, and on top of his work at Booth, he is also a Research Associate at the National Bureau of Economic Research. (Read some of my blog posts and columns using his research here, here, and here.)

Here are some excerpts from our conversation, via a rough transcript of my recent Ricochet Political Economy podcast:

JP: I want to start off with a quote from presidential candidate Bernie Sanders. He gave a big speech recently on democratic socialism and what it means. And here’s just a few sentences of what he said.

Democratic socialism means that in a democratic, civilized society the wealthiest people and the largest corporations must pay their fair share of taxes. Yes, innovation, entrepreneurship, and business success should be rewarded. But greed for the sake of greed is not something that public policy should support. It’s not acceptable that in a rigged economy in the last two years, the wealthiest 15 Americans saw their wealth increase by $170 billion, more wealth than is owned by the bottom 130 million Americans. But let’s not forget what Pope Francis has stated. We have created new idols. The worship of the golden calf of old has found a new and heartless image in the cult of money and the dictatorship of an economy which is faceless and lacking any truly humane goal.

So from your research, what do we really know about income inequality and what’s driving it in the United States today?

SK: There is, I think, some truth in what he’s saying and then some real problems in what he’s saying. So here is my view of what’s happened in the last really 30-35 years. We’ve had a huge amount of technological change. And that has coincided with globalization. And they’re related. Technology allows you to do a lot of things overseas that you couldn’t do before. And so the combination of technological change and globalization has put pressure on the middle class and particularly the less skilled in the developed countries. So it’s the U.S. and Western Europe.

And I think there’s some anxiety and clearly anger about that happening. And at the same time, the people at the top have done very well in the United States. So that’s, I think, the problem that Bernie Sanders has stated. Now what he doesn’t state, and I think is extremely important to recognize is that the world is hugely better off – hugely. And Angus Deaton, who recently won the Nobel Prize in economics and is, you know, archconservative, wrote a book called “The Great Escape.” And that book starts by saying, and I quote, “Life is better now than at almost any time in history. More people are richer and fewer people live in dire poverty. Lives are longer and parents no longer routinely watch a quarter of their children die.”

So the system and capitalism in particular, around the world, has been spectacularly successful over the last 30 or 35 years. The number of people who are living above the poverty level – actually, take the number of people living below the poverty level – has declined in absolute terms and has declined hugely in relative terms.

The world is so much better off. And I think for Sanders and politicians to say that that’s terrible is really just morally abhorrent. … So now the question is, okay, we have this – so it’s great. Around the world, I would not give this up. This has been spectacular. Now, you do have the issue of what do you do in the United States and Western Europe, where you have had – it has been uneven in how the benefits have been distributed.

Folks on the left, they don’t much talk about the role of capitalism bringing hundreds of millions of people in Asia out of really deep, extreme poverty. They focus really more on the U.S. story and they’ll even concede that there’s been economic growth. But they also that it really hasn’t helped the vast majority of the middle class for 30 or 40 years. They talk about stagnant wages. If the median person, the average person, they’re not getting richer, what’s the point of it?

So the median person in the world is much better off. Let’s be clear. So now, let’s go to the median person in the US and try to figure out what to do about him or her.

So first of all, the after-tax numbers are much better than the pre-tax numbers. And this is also, you know, kind of ignored to some extent, is that if you look at – I think these are Congressional Budget Office numbers or they’re not the IRS numbers that are pre-tax that get a lot of play – the increase in inequality, when you include taxes and transfers, is not as high as it is pre-tax. And that’s because there is a safety net. There are transfers.

But even that said, let’s say there has been an increase. Now the question is what do you do about it. And the real issue is you do have this headwind of technological change and globalization. And so now the question is, what do you do about it?

And one set of proposals which I think Bernie Sanders and Hillary Clinton and the Democrats in general push [is] to raise the minimum wage. And that’s precisely the wrong thing to do here because if you’ve got a headwind of technology and globalization, which is making it harder to hire people and it makes jobs more difficult to create, raising the minimum wage exacerbates that. It’s exactly the wrong thing to do.

If you want to encourage job creation, I think job creation is the most important thing. And I know your boss at AEI, Arthur Brooks, is very articulate on this, the way you encourage jobs is, you know, have an Earned Income Tax Credit or something of that nature, rather than raising the minimum wage. Because raising the minimum wage, you just put more headwinds into job creation.

I would say the same thing about mandated leaves, which is also a big campaign plank among the Democrats. Because, again, that makes jobs more expensive. It makes employment more expensive. And what are companies going to do in response to making jobs more expensive? Well, let’s apply more technology. Let’s try to find jobs in places where the costs are lower. So that is – you know – it is a real conundrum what to do with technology and globalization, but the answer is to make it easier to hire, rather than harder.

At the same time, where I think the Republicans sometimes are not quite so sensitive is [that] you do need to have safety net. If you think this is going on, you really want to make sure you have a solid safety net, so that people do not, you know, go too far down.

When you talk about technology, are you just talking about technology in the way it enables very high skilled people — whether they’re CEOs or NBA players — to spread their talents over a larger market, and technology enables to do that? Or to what extent are you talking about technology in the way a lot of people think about now, like the rise of the robots, automation suppressing wages for lower skilled people? Are you using it both ways or just one?

I think both – those are both elements of the same thing. So you know, for example, take someone in finance who’s running a hedge fund. And obviously there’s been a fair amount of wealth created in the financial sector… some of those firms are managing, you know, tens of billions or hundreds of billions of dollars. You couldn’t do that 30 years ago. You didn’t have the technology to do that. Today, with computers and software you can manage much larger sums than you could back then. So that would be one example.

You know, take a law firm. Lawyers now are working… on very large deals and they are getting – you know, their value added applying to larger companies and global companies becomes more valuable when you’re scaling it over larger assets. So that would be, you know, another way where it’s probably globalization and scale, rather than technology per se.

… So some of it is the direct thing, what you’re talking about with robots, but some of it is, call it indirect, that software allows you to do things, you know, with a lot more assets and fewer people. I mean, another thing is managing restaurant chains. Restaurant chains actually are a source of wealth. Starbucks and McDonald’s and the places – Chipotle, you know, you can manage these things and scale it and a lot of it is because you have software that you didn’t have 30 years ago.

Democrats have an alternate theory. I’m not sure if they believe that theory is to the exclusion of yours or is just more important, but their theory is that the reason we’ve seen this rise in inequality is because of CEO pay or executive pay. … They’ll point to CEO pay and say, no, the reason is you have very pliant corporate boards giving very fat pay packages to executives, golden parachutes. And maybe cultural norms have changed [so ] that CEOs don’t feel bad about having an income many hundreds of times [that] of the average worker. Maybe actually because we’ve cut taxes, there’s a greater incentive for these CEOs to try to get big, fat pay packages. Liberals and progressives think it’s really more, I think, an executive pay issue than a technology, globalization issue. How do you address that?

That’s a really hard one to understand for the following reasons. I mean, they’re more or less saying that it’s public company driven. It’s driven by the fact that the boards are not being tough enough on the CEOs. And there, that’s very unpersuasive. I’ll give you a bunch of reasons.

First of all, if you look at the increase in pay for private company executives versus public company executives, the private company executives appear to have done better. And the private company executives are basically running their own companies. So there’s no agency problem or no problem with the board being compliant. They are the owners. And they’ve actually done better over the last 30 years than public company CEOs. And that’s not the prediction you would make if you were, you know, the Bernie Sanders-type story.

Second of all, you have, again, the hedge fund investors, the private equity investors, law partners, partners at places like McKinsey, BCG, Bain, people who are all in business who have also done remarkably well and at least as well as the CEOs over the last 25 years. And again, those people are compensated, you know, clearly, you know, arm’s length market kind of basis. And so if, again, it were compliant boards and sort of this corrupt bargain, it’s very hard to explain why your typical law partner is at a top firm is probably making $3 to $5 million, which is much more than he or she made 25 years ago and is not all that far off from the median pay of an S&P 500 CEO, which is on the order of $10 or $12 million.

So these are all huge numbers. And they’re numbers that get a lot of attention and you know, are just – are big relative to the average person. But what it seems to me is that these are for better or for worse market wages in a world where, because of technology, because of globalization, these people are adding value over larger amounts of assets. And that’s what their time or their participation is worth.

Every year one of the unions trots out the stats saying the average CEO makes, whatever, 400 times the average worker…. [and] CEOs seem to make a lot more versus the workers in this country, than some other advanced economies, like Japan. So why do American executives seem to make so much more than in some other very wealthy advanced countries?

I would say that, number one, Japan is perhaps not the country you want to emulate over the last 20 years. I think if you were to look at the United Kingdom, you would see trends very similar to our own. I think if you were look at Western Europe, you know, there’d be more variation, but you’d see at a number of the larger multinational companies where the executives are mobile, the pay has gone up. And it may not be at US numbers, but it’s getting closer there.

So I think around the world, you’ve seen CEO pay go up and is – may not be, again, equal to the US, but it’s certainly going up because of these same forces. And you also see, particularly in Western Europe you see a lot of the top executives going to work for private equity funded firms, where they are paid more like US executives. And because, again – and that’s actually a very useful example for the private equity firms because the private equity investors are not people who are – tend to overpay people. And the incentives they give to their CEOs, whether they’re in the US or Europe, are pretty much the same.

Do we know — and has your research revealed this — [that] when you talk about really high-end inequality, above the 1%, either the 0.1 or maybe the 00.1 , is it wealthy CEOs, of Wal-Mart or other big companies, driving that very high-end inequality? To what extent is it also entrepreneurs, the Google guys, someone starting up these sharing economy companies like Uber. Is it entrepreneurs, or CEOs?

If you look at the top 1% or the top 0.1%, the CEOs – the public company executives are a modest fraction of those, and they’re not the ones who have done the best over the last 20 or 30 years. The people who have done better are the private company executives, which would be more of the entrepreneurs and some of the finance people. If you go to the billionaire category, the very top, it has been a lot of technology driven people, so you’ve got the Zuckerbergs, the Bezoses, the people like that. You have finance people, so the hedge fund and private equity people have done very well. And then, you have people who’ve done well by using technology of scale. And I think, you know, Starbucks would be a great example of that [because] it’s not a technology company, but they use technology to manage, and they’ve been able to scale, I think, in a way that they probably couldn’t have done 30 years ago.

Do you favor any changes at all in how executives are paid? I’m sure this is going to come up during the campaign, since Democrats are talking a lot about inequality and since they perhaps have not read your research, they really think –

The funny thing – the ironic thing about public company CEOs is that if you look at the average pay of the S&P 500 CEO, it’s down 40% since 2000. So CEO pay for the S&P 500 actually peaked in 2000.

Is that because of the market, because the stock market has sort of been flat –

No, they – the median is flat. What happened in 2000 is some people got outsized pay packages. And those have been pushed down. And so the median has been largely flat since 2000. And what’s also interesting about that is earnings have gone up. So if you look at the ratio of CEO pay to operating income, it’s down since 2000 and it’s actually even flat since the early ’90s. So the CEO pay at… the public companies it’s kind of, it’s high, but it really hasn’t moved or it’s gone down in the last 15 years.

And at the same time, by the way, that job has gotten much tougher because, number one, the amount of time CEOs spend in their jobs is shorter because they’re given – I think the boards have gotten a little tougher. And second of all, you have, you know, this big increase in shareholder activism, which also puts more pressure on the CEOs. So in a period where the job has gotten more difficult, it’s gotten riskier, pay has been flattened down.

And so, again, nobody’s going to cry for the CEOs. It’s a very much more complicated –

I decided to pull up the incomes – the top – you know, the 0.1% income share in the US. And even though there have been ups and downs, it’s the top, the 0.1 %, including capital gains, [who] get about 10.3% of income through last year. That’s actually a bit less than in 2000. So even that high-end inequality – you mentioned CEO pay, but even high-end inequality overall, while it has gone up and down, overall it has been flat for 15 years.

That is another thing that is misreported, and in fact, the people who do some of the inequality research, I don’t want to say misrepresent their results, but they don’t quite explain it the way you just did. But it is exactly true. If you look at the rise in inequality or the rise in the pre-tax income share of the top 1% or the top 0.1 %, it rose a huge amount from 1980 to 2000. And then, since 2000, it’s been up and down. And actually, you know, the most recent numbers, 2014, it’s lower than it was in 2000.

And what that also means, and this is what is completely misreported: there’s this view — and you read it time and again in the press — that in this recovery the top 1% has done much more than everybody else. And what those estimates do, which I believe is disingenuous, is they take as their base year 2009. Well, 2009 was the bottom of the recession. Your base year should be 2007, which was before we went into the recession. And if you look at 2007 to 2014, the top 1% have done quite badly. Their share of GDP has gone down from like 24% [to] 21%, which means everybody else did better.

It really depends on what your base year is. And going back to your earlier comment, it really has been up and down for everybody since 2000.

The new Nobel economics laureate Angus Deaton had something interesting in the Wall Street Journal, in which he talked about the sort of the benefits of inequality. Inequality coming from people capitalizing on the fact they’ve created some great new product or service that’s made them very wealthy. It’s an innovation. It’s also helped everybody else. That kind of inequality is great.

But then there’s like the other kind, which he described as – this is Deaton: “I worry that some of the enormous riches we’re seeing in the United States are coming from activities that are in social doubt. Some of the activities that are going on Wall Street that are occupying some of our smartest young minds, it’s not clear society wants them to be doing that, as opposed to be innovating in the private sector or curing cancer or doing all the various things smart people could do.”

So he differentiates between market-driven capitalism, creating wealthy entrepreneurs, and a sort of crony capitalism, people who are taking advantage of the system. What I wanted to ask you is: let’s say that the first kind is good, the second kind is bad. … Let’s say [high-end inequality is] mostly driven by entrepreneurs creating fabulous new things for us. At some point, do we care about high-end inequality even if that’s the reason? Does it just get too extreme?

So the answer is we don’t know. So let me parse that. So the crony capitalism, I agree, you know, it’s not good. You read Milton Friedman. Milton Friedman, you know, said the same thing way back in “Capitalism and Freedom.” And so to the extent that crony capitalism is operating, whether you call it corruption or favoritism or whatever, you’d like to see less of that. So I agree with that completely.

My view of where the inequality has come from and where the bulk of it is, is that it’s come [from] what you might call good capitalism, which is the technological change and globalization. And there – you know, we have seen this increase. And the income inequality in the US and globally is probably higher, you know, as high as it’s been. It looks like in the US it’s close to where it was in the ’20s. And so your question is, is that bad?

Rightm, is there a level at which it really is worrisome to our democracy? People throw around “plutocracy” – that there’s just too much influence from people who are super wealthy and are rather a narrow sliver of the population.

And my response to that is that it’s a concern, but let’s look at the data. And the data of the last 30 or 35 years is incredibly good around the world. That people have benefited and billions of people are now not starving, who were starving 30 years ago. So it doesn’t seem as if, again, you aggregate around the world that we’ve gotten to the point where you should – where this would be a huge concern.

I think in this day and age, you have so much more transparency and information than you did 100 years ago that it’s just hard to believe that you could go to the other side. And I think I’ll give an example. People were saying pretty much the same thing back in the gilded age of the late 1800s. Remember, you know, back then, you had the huge technological change with oil and steel and manufacturing. And the people who drove that, they were not called heroes. What were they called? They were called robber barons. They were criticized for crony capitalism, exactly what’s going on today. And what happened, well, you’ve saw huge improvements in the overall standard of living, as we’ve seen in the last 30 years globally.

And the other thing that you saw, which is very important to realize, is you saw countervailing political forces emerging. So Teddy Roosevelt shows up and he really fought back on the crony capitalism. Unions emerged. An income tax emerged. The New Deal ultimately emerged. So you have these countervailing forces and they work. And so I think it’s healthy to have this discussion. And these are countervailing forces. And so that’s why, you know, I think it’s – these are very hard issues, particularly in the US, where, again, it’s the middle class and the less skilled have been adversely affected. So it’s a really hard problem… it’s important to talk about, but the real danger is that you focus so much on what I think is a smaller part of the problem, crony capitalism, and you throw out all the benefits that we’ve had in terms of the technological change. And you create a system that’s more, you know, frankly like Western Europe, rather than a vibrant system like the United States.

And I think some of the policy proposals, you know, would turn us into, you know, Italy or France or Spain in terms of how they run their economies. And those have not been good outcomes.

There’s a problem I’ve been writing about and grappling with on my blog and other places. You may have seen this very scary chart showing that over the past 30 years we’ve seen this steady decline in US startups, in entrepreneurship, new businesses as a share of overall businesses. It’s a downward line and it looks like the US just isn’t as entrepreneurial as it used to be, just decade after decade down it goes.

You look at that, and then you look at, not just Silicon Valley in the ’90s, but Silicon Valley today, where it seems to be white hot. Every day there’s a new sharing economy company or somebody making a new app, a new unicorn, these sort of billion-dollar tech firms. And it seems like, wow, we’re extremely innovative. But that decline in startups– also weak official productivity numbers — would seem to suggest that America isn’t very dynamic. Which story should I believe? That we’re very dynamic, as evidenced by sort either the products we’re seeing around us, or what we read in the business pages, or some of these kind of dour productivity and startup statistics?

So, you know, the answer is they’re both right…

Ah, you gave me the economist answer.

You know, now, this is on the one hand or the other hand… I think on the venture, let’s distinguish between venture-backed — very high impact kinds of businesses — versus your mom’s and pop’s dry cleaners, restaurants, things like that. I think [for] the venture-backed kind of startup things are terrific. So there was this wonderful period in the ’90s with the dotcom boom where you had a lot of activity. Then, you had a bust and a kind of slowdown for a while. But the last five or 10 years, venture-backed startups and money going into those kinds of startups have picked up. They’ve been very successful, obviously, on the tech and mobile side.

They’ve also been hugely successful on the biotech side. There’s been a renaissance in biotech-type startups. And you know, there’re several, two have recently gone public, that have some promise to make cancer a chronic disease, rather than the awful killer it’s been. So there’s been, I think, lots of bright spots on the high potential type businesses. The place where there’s been the decline is on the smaller mom-and-pop type businesses. And I cannot – I don’t have data to back this up [but] I’m guessing it’s the regulatory burden.

And so you have an increased regulatory burden on small businesses that everybody talks about – I think is real. And that would be my guess why you see fewer of the kind of mom-and-pop type startups. And you see – but you see no diminution on the high potential startups because they’re high potential enough that regulation doesn’t actually matter.

And if the high impact stuff is doing well, do you then question the official numbers? Again, we’ve seen very slow growth of US productivity really over the past decade and particularly in the recovery from the Great Recession. So do you believe those numbers, or do you think they might be missing something, as some have suggested, in the IT sector broadly?

I – you know – it seems like they miss something and … there a lot of things that are free, for example on the Internet, that you would have had to pay for 15 years ago and that actually GDP goes down rather than up. On the other hand, I have a colleague, Chad Syverson, who did some estimates of that and he was skeptical about how big they are. So I would say the productivity numbers are a bit of a puzzle to me still.