Reflection 87: Economic Inequality, Part 1 — How We Got Here

From time to time, I am exposed to a thinker who reminds me, once again, that ideas matter – at lot. A recent example: Robert Reich whose latest book, Saving Capitalism: For the Many, Not the Few (Alfred A. Knopf 2015), is the subject of this Reflection and the inspiration for the one I’ll be sharing next week.

Saving Capitalism begins with an anecdote.

Reich, a well-known economics professor and former Secretary of Labor, regularly speaks to a wide variety of audiences about economic inequality, the book’s subject. To his great frustration, the first question with which he must deal, almost invariably, is this: Do you favor the free market or greater governmental regulation?

Since this question has, for decades, framed our left/right, conservative/liberal political debate, why (you might ask) does Reich find it so frustrating? Because, in his view – far from being THE key issue of our times – it is, instead, a chillingly effective distraction from a far more pertinent debate about the policy choices that so deeply affect our economic future.

Transfixed by this issue, people on the right passionately argue that the free market’s competitive efficiencies allow everyone to prosper and that, conversely, most all governmental intervention inhibits this process. Those on the left argue, with equal fervor, that the free market produces far too many distortions, resulting in unacceptable levels of suffering and that, as a result, governmental intervention is essential.

Reich, however, stands entirely apart from this standard liberal/conservative debate, premising all that follows on these essential points:

  • There is no such thing as a “free market;” that is, a mechanism that un-interfered with can – for better (the conservative view) – or worse (the liberal view) – be relied upon to regulate our economic activities.

To the contrary,

  • All that exists is an intricate, ever evolving web of rules that determine how we interact with one another as economic entities; rules that, always and inevitably, are created, enforced and, as circumstances change, modified and further elaborated by public/governmental institutions – legislators, public executives, courts, and agencies.

In other words, “the market” and “government” are thoroughly and completely symbiotic – and always have been. The market, as it exists at any point in time, is the result of an accumulated set of choices, made over time, by our governing institutions.


When it comes to defining the challenges we face, and crafting strategies to deal with them, Reich’s perspective dictates a dramatic shift in focus. Instead of arguing for more government or less, Reich begins his analysis with a detailed discussion of the policy choices, made over the last 40 years, that have had the greatest effect on the economy’s operative rules.

His conclusion: The dominant economic theme, in this period of our history, is the effectiveness with which people at the top have been able to change these rules in ways that have dramatically increased their ability to add to their wealth. And, he is at pains to point out, most of these changes have had very little to do with rewarding productivity. To the contrary, they reflect instead the ever-increasing ability of the extremely wealthy to use their power to “fix” key aspects of the game in ways that allow them expand their wealth even further.


Reich’s narrative is far-reaching and filled with examples that give vital specificity to this overarching narrative. One particularly stunning example is the massive shift in CEO and senior management compensation, in the last 15 years, from salary to stock options and, with it, an equally massive increase in stock buy backs.

If income maximization is a CEO’s goal, using these two strategies in tandem is an obvious move. The reason: The increase in the company’s stock price that a buy back predictably provokes will – if timed to coincide with the cash-in date for CEO’s option – result in a far more lucrative payday. So, you might ask, why did massive adoption of this strategy only occur in the last 15 years? The answer – fully in line with Reich’s thesis – is that before it could be effectively implemented key rule changes, sought by big business, had to be put in place.

And that is exactly what happened.

In 1982, the SEC (1) removed all limitations on the size and timing of stock buy backs, even as it (2) ensured CEO anonymity by keeping in place (anemic) disclosure rules that require public announcement of a buy back, but not of the date on which it occurs or the date on which the CEO and other executives cash in their stock options.

Then, in 1993, the Clinton administration dramatically incentivized these transactions by allowing, for the first time, tax deductions by companies for executive pay in excess of $1 million – so long as it was linked to corporate performance; in other words, if it came in the form of stock options and awards that, in theory, are linked to performance.

With these changes in place, the stage was set for a massive money grab by some of the richest among us – and, with dismal predictability, CEOs have done exactly that.

Indeed, the figures are just stunning. Between 2001 and 2013, stock buy-backs accounted for $3.6 TRILLION in outlays by companies in the Standard and Poor’s 500 index – and, in 2013 alone, for $500 million in outlays by those companies; fully a third of their cash flow – money that could otherwise have been spent on research and development, price reductions, new jobs, additional pay for workers, or other more productive activities.


Unfortunately, but predictably, Reich has many other stories to tell – stories that persuasively support his thesis – including the following:

  • The enormous economic benefit, bestowed on the very rich, when the recent rise in the estate tax exemption (from $2 to $10 million), is combined with the little known fact that – in contrast, say, to the taxes paid by middle class folks who sell their houses at a profit – people who inherit stocks, bonds and other capital assets do not pay any capital gains tax at all on the increase in asset value that occurred during the decedent’s life.
  • The fact that each Princeton student (by way of illustrative example) effectively receives a public subsidy of $54,000 – as compared to just $6,000 for the average public university student – a result explained by fact that: (1) A third of every dollar donated to nonprofit universities, such as Princeton, comes from the government, in the form of donor tax deductions; and (2) the massive amounts of money, earned by these university’s endowments, that are exempt from taxation.
  • Bankruptcy code revisions that: (1) allow companies in Chapter 11 to the re-write union contracts and, with bankruptcy court approval, to impose them unions; and, by way of stark contrast, (2) exempt student loans from bankruptcy relief (even as colleges – the direct beneficiaries of these loans – enjoy the enormous hidden subsidies described in the last bullet point).
  • The massive increase in mandatory arbitration clauses, that severely limit consumer companies’ liability and require the use of biased arbitrators; a movement made possible by Supreme Court decisions that make escape or, even appeal from, these tribunals a practical impossibility.

A final example, too important to omit, is in the area of patents and intellectual property. In the last few years, in response to pressure from pharmaceutical companies:

  1. Patent rights have been expanded to include processes used to manufacture vaccines and other products from nature; an expansion that allowed Pfizer (for example), as the sole manufacturer of the now-patentable Prevnar 13 vaccine, to earn nearly $4 billion in 2013, alone.
  1. Patents are now being renewed on the basis of insignificant product changes; a shift that allowed Forest Laboratories, by substituting Namenda XR (extended release) for Namenda, to maintain monopoly control over this widely used Alzheimer drug for an additional 14 years.

To the same point is the repeated expansion, in recent years, of intellectual property rights (11 times since 1960 vs. 2 times in the preceding 160 years). Not coincidentally, this dramatic expansion has occurred precisely at a time when our exploding digital economy has made these rights exponentially more valuable.


Reich’s analysis is remarkable in this breadth and specificity – and vitally important. If we don’t understand what’s going on, our chances of changing it will be very small indeed.

In the end, however, the really important question is this: What do we do about it? And in this area Reich makes an important, analytic contribution as well.

Most attempts to deal with this “what to do about it” issue are, unfortunately, hamstrung by a (typically unawares) mindset – a by-product of the free market/ government dichotomy – that goes like this:

When it comes to making things better, the free market will, inevitably, do its own thing. Thus, the events described by Reich must, however reluctantly, be accepted as “free market” maneuvers by “private parties;” unavoidable by-products of our otherwise treasured, and highly functional, free market system.

Given this reality, our only viable reform option is to move in, after the fact, with governmental programs that, funded by our tax dollars, patch up, as best they can, the many and varied economic wounds that are caused by the inevitable excesses of the free market.

Locked into this perspective, the hard truth about our reform efforts is this: They will never work. Despite the governments’ best efforts, the current system will create more and more inequality – which will require more and more tax dollars – to fund more and more, after the fact, “patch up the wounds” governmental programs.

But because inequality is growing at an ever-accelerating rate, these programs will inevitably fall further and further behind, failing ultimately in their purposes. And this, in turn, will lend further credence to the belief that “government is the problem and not the solution” – the mindset that perversely, ironically, is the precise political cover the current system needs, and uses so effectively, to defeat reform efforts!!

Recognizing this, Reich offers an expanded, and far more helpful, frame of reference within which to understand how the economy operates and where we need to intervene – if we hope to effectively deal with our growing inequality.

In his view, most all of the processes he describes – the shifts in CEO compensation strategies, the tax avoiding maneuvers of the rich, the patent and copyright extending moves of pharmaceutical and internet companies – are all manifestations of a phenomenon he calls “upward pre-distributions.”

As Reich explains it, upward pre-distributions are processes that, preceding any governmental activity, shifts wealth “upward” to the rich. In his view, these “pre” distributions stand side by side with the “post” distributions that governments make when they use tax money, after the fact, to re-allocate wealth downward (social security disability and retirement payments, unemployment insurance, etc.).

Needless to say, Reich advocates a shift in emphasis away from our (deeply flawed) efforts to relieve inequality through “post” distributions and toward efforts to curb and reverse upward pre-distributions. We vitally need laws and regulations that, instead of enabling these maneuvers – the current norm – discourage and prevent them.


The subtle and varied changes to our economic/political the system that Reich describes – so instrumental in the massive shift in wealth to the rich – are also a suggestive and useful summary of the laws and regulations we need change if we hope to undo the effects of the last 40 years.

But how to we get from “here” to “there”?

Addressing this issue, Reich brings us back to the concept of “countervailing power,” described by John Kenneth Galbraith in the 1950s. This is the process through which institutions such as unions, farms cooperatives, local and regional banks, and local (small business oriented) chambers of commerce pushed against Wall Street, big business and the wealthy, limiting in this way their ability to fix the game.

In that era, as Galbraith describes it, people with diverse economic interests – operating, crucially, through entities with the organizational and political muscle to promote their interests – balanced each other out, producing a more equitable economic system in the process.

The last 50 years have witnessed a dramatic decline in the power of the countervailing institutions that Galbraith described. Reich, while acknowledging this, argues nevertheless that “the only way back toward a democracy and economy that work for the majority is for the majority to become politically active once again, establishing a new countervailing power.” Saving Capitalism, at 182.

I am sympathetic with Reich’s argument. Millions of good-hearted people, acting alone, will never magically coalesce into a movement for meaningful change. What we need instead are robust institutions and communities who, through their cumulative choices, create a larger movement that leads the way in creating the change we seek. And, a 21st century version of the kinds of countervailing institutions that existed on the 1950s may well be among the most viable communal building blocks from which such a movement could emerge.

But, for me, a deeper question remains unanswered: Where will the motive force to create these countervailing institutions come from? As I see it, the answer to this question points directly to the underlying values issues that Radical Decency seeks to highlight and address. That will be the subject of next week’s Reflection. I hope you find it interesting and helpful.