How, in a democracy supposedly based on one person one vote, could the 1 percent could have been so victorious in shaping policies in its interests? It is part of 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.

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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.” 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.

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, 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.

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. Misperceptions are evident, too, in views about social mobility. Several studies have confirmed that perceptions of social mobility are overly optimistic.

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.

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

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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.

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.

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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.

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, 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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If individuals believe that they are being treated unfairly by their employer, they are more likely to shirk on the job. If individuals from some minority are paid lower wages than other equally qualified individuals, they will and should feel that they are being treated unfairly—but the lower productivity that results can, and likely will, lead employers to pay lower wages. There can be a “discriminatory equilibrium.”

Even perceptions of race, caste, and gender identities can have significant effects on productivity. In a brilliant set of experiments in India, low- and high-caste children were asked to solve puzzles, with monetary rewards for success. When they were asked to do so anonymously, there was no caste difference in performance. But when the low caste and high caste were in a mixed group where the low-caste individuals were known to be low caste (they knew it, and they knew that others knew it), low-caste performance was much lower than that of the high caste. The experiment highlighted the importance of social perceptions: low-caste individuals somehow absorbed into their own reality the belief that lower-caste individuals were inferior—but only so in the presence of those who held that belief.

Fairness, like beauty, is at least partly in the eyes of the beholder, and those at the top want to be sure that the inequality in the United States today is framed in ways that make it seem fair, or at least acceptable. If it is perceived to be unfair, not only may that hurt productivity in the workplace but it might lead to legislation that would attempt to temper it.

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In the battle over public policy, whatever the realpolitik of special interests, public discourse focuses on efficiency and fairness. In my years in government, I never heard an industry supplicant looking for a subsidy ask for it simply because it would enrich his coffers. Instead, the supplicants expressed their requests in the language of fairness—and the benefits that would be conferred on others (more jobs, high tax payments).

The same goes for the policies that have shaped the growing inequality in the United States—both those that have contributed to the inequality in market incomes and those that have weakened the role of government in bringing down the level of inequality. The battle about “framing” first centers on how we see the level of inequality—how large is it, what are its causes, how can it be justified?

Corporate CEOs, especially those in the financial sector, have thus tried to persuade others (and themselves) that high pay can be justified as a result of an individual’s larger contribution to society, and that it is necessary to motivate him to continue making those contributions. That is why it is called incentive pay. But the crisis showed to everyone what economic research had long revealed—the argument was a sham. What was called incentive pay was anything but that: pay was high when performance was high, but pay was still high when performance was low. Only the name changed. When performance was low, the name changed to “retention pay.”

If the problems of those at the bottom are mainly of their own making and if those collecting welfare checks were really living high on the rest of society (as the “welfare deadbeats” and “welfare queen” campaign in the 1980s and 1990s suggested), then there is little compunction in not providing assistance to them. If those at the top receive high incomes because they have contributed so much to our society—in fact, their pay is but a fraction of their social contribution—then their pay seems justified, especially if their contributions were the result of hard work rather than just luck. Other ideas (the importance of incentives and incentive pay) suggest that there would be a high price to reducing inequality. Still others (trickle-down economics) suggest that high inequality is not really that bad, since all are better off than they would be in a world without such a high level of inequality.

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On the other side of this battle are countering beliefs: fundamental beliefs in the value of equality, and analyses such as those presented in earlier chapters that find that the high level of inequality in the United States today increases instability, reduces productivity, and undermines democracy, and that much of it arises in ways that are unrelated to social contributions, that it comes, rather, from the ability to exercise market power—the ability to exploit consumers through monopoly power or to exploit poor and uneducated borrowers through practices that, if not illegal, ought to be.

The intellectual battle is often fought over particular policies, such as whether taxes should be raised on capital gains. But behind these disputes lies this bigger battle over perceptions and over big ideas—like the role of the market, the state, and civil society. This is not just a philosophical debate but a battle over shaping perceptions about the competencies of these different institutions. Those who don’t want the state to stop the rent seeking from which they benefit so much, and don’t want it to engage in redistribution or to increase economic opportunity and mobility, emphasize the state’s failings. (Remarkably, this is true even when they are in office and could and should do something to correct any problem of which they are aware.) They emphasize that the state interferes with the workings of the markets. At the same time that they exaggerate the failures of government, they exaggerate the strengths of markets. Most importantly for our purposes, they strive to make sure that these perceptions become part of the common perspective, that money spent by private individuals (presumably, even on gambling) is better spent than money entrusted to the government, and that any government attempts to correct market failures—such as the proclivity of firms to pollute excessively—cause more harm than good.

This big battle is crucial for understanding the evolution of inequality in America. The success of the Right in this battle during the past thirty years has shaped our government. We haven’t achieved the minimalist state that libertarians advocate. What we’ve achieved is a state too constrained to provide the public goods—investments in infrastructure, technology, and education—that would make for a vibrant economy and too weak to engage in the redistribution that is needed to create a fair society. But we have a state that is still large enough and distorted enough that it can provide a bounty of gifts to the wealthy. The advocates of a small state in the financial sector were happy that the government had the money to rescue them in 2008—and bailouts have in fact been part of capitalism for centuries.

These political battles, in turn, rest on broader ideas about human rights, human nature, and the meaning of democracy and equality. Debates and perspectives on these issues have taken a different course in the United States in recent years than in much of the rest of the world, especially in other advanced industrial countries. Two controversies—the death penalty (which is anathema in Europe) and the right to access to medicine (which in most countries is taken as a basic human right)—are emblematic of these differences. It may be difficult to ascertain the role the greater economic and social divides in our society has played in creating these differences in beliefs; but what is clear is that if American values and perceptions are seen to be out of line with those in the rest of the world, our global influence will be diminished.

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Reprinted from The Price of Inequalityby Joseph Stiglitz. Copyright © 2012 by Joseph Stiglitz. With the permission of the publisher, W.W. Norton & Company, Inc.