Lecture 13: Explaining Rising Inequality; Winner Takes All Politics?

Introduction

Last week we discussed the rise in income inequality, and its relationship to the financial crisis. We noted that the rise in income inequality has occurred everywhere, but it is particularly pronounced in the USA and the UK, and that this is directly associated with the rise in labour incomes of the top 1 percent.

But what caused this rapid rise in wage inequality?

Most economic explanations tend to emphasise those a-political processes of change: education, skills and technology. These certainly matter in the long run. But most economic accounts on technological change cannot explain:

  1. The extreme concentration of income gains at the very top of the economic ladder.
  2. The role of government policy in creating a winner takes-all pattern.
  3. The change in the collective and organisational landscape of politics.

Winner takes all politics

The concept of “winner-takes-all politics” is a critique of the conception of democratic politics that emphasises the “median voter”. This perspective emphasises the role of “organized interests” in shaping electoral politics and the process of policymaking.

Jacob Hacker and Paul Pierson (2010) have long argued that political scientists are wedded to a conception of public policy that assumes the electorate shape economic policy outcomes. From their perspective, economic policy is predominantly shaped by corporate-business elites (i.e. business interests outside the electoral process).

They start with the question – if electorates determine economic policy, then why don’t the poor soak the rich (given that most people earn below the median wage)?

Hacker and Pierson suggest that to explain the phenomenon of rising economic inequality in the USA we need to analyse politics as “organized combat” between organised interests.

For Hacker & Pierson the winner takes-all dynamic (i.e. where most income gains go to the top 1%) is rooted in how four different institutions shape public policy outcomes:

  • Financial markets,
  • Corporate governance,
  • Workplace relations,
  • Taxation.

I will return to these later.

National models of capitalism 

Piketty also acknowledges the important role of political and economic institutions (chapter 9) in shaping the cross-national variation in patterns of income inequality.  In the end, he gives priority to different ideas of fair compensation.

It is important to note that the explosion in wage inequalities is predominately an Anglo-Saxon phenomenon. In particular, it is a UK and US phenomenon. Why?

Figures 9.2, 9.3 and 9.4 show the share of the top percentile in Anglo-Saxon, Continental and Northern European countries. Note the variations.

This family resemblance in different countries should not obscure important differences between countries. But there is a clear clustering effect. English speaking countries are significantly more unequal than their continental and Scandinavian neighbours.

There are 3 important characteristics of the Anglo-Saxon dynamic of inequality:

  1. Gains have been highly concentrated. The top percentile in the US have seen their share of the income rise from 9 to 23.5 percent.
  2. Gains have been sustained regardless of the partisan nature of government.
    • Figure 1 in Hacker & Pierson (2010) shows that this concentration began with Reagan and continued under every subsequent administration, regardless of whether it was a Democrat or Republican president.
  3. Gains have not resulted in a trickle down effect. Wages at the bottom and middle have stagnated for a long period of time.

Between 1979 and 2005 the average incomes of the poorest fifth of US households increased by 6%. The middle classes saw their incomes rise by 21%, whilst the after-tax income of the top 1 percent rose by 230 percent.

Can different levels of education and skill  explain this outcome?

The macroeconomist, Gregory Mankiw, argues that the “golden ticket”, which grants access to the 1% is meritocratic, and market-driven. But is it? Is it more related to politics?

Compatibility with democracy

How is this rising inequality compatible with democracy?

In most political economy models, median voter theories would suggest that the majority of the electorate should vote for governments who favor redistribution. This, however, is not the case. People don’t just vote in pure economic self-interest.

This is what’s often called the “Robin Hood” paradox.

Median voter models of behavioural science are useful for explaining general trends but they are less capable of explaining the Robin Hood paradox.

But if voters do not run the show, who does?

As mentioned above, answering this question requires going beyond the voter-politician relationship, and analyzing politics as a form of “organised combat” between competing interest groups, particularly the “quiet politics” of corporate influence.

This perspective gives priority to the business-society relationship over electoral politics, and makes three important claims about how economic policy changes:

  1. Government involvement in the economy is broad and deep.
    • Governments do not simply redistribute what markets produce. They actively structure markets in ways that shape economic outcomes. The role of the state in the market varies significantly between countries.
  2. The transformation of policy occurs through drift. Policymakers can effect change by not taking decisions. This suggests that change does not occur primarily because of entrenched interests and political vetoes in the policymaking process. Lobbying results in non-decisions.
  3. Shifts in the balance of organized interests as the driver of policy change. What governments actually do (make policy/legislation) is a long hard battle between competing organised interests that take place outside the media and electoral spotlight. Elections are a spectacle.

Politics as organized combat 

Organised interests influence and build coalitions of interest within and between political parties in government. Political parties are anchored in various interest groups, and agents of societal interests.

The implication of this analysis is that political parties have become responsive to the concerns of interest groups, and less the preference of the median voter. Drift is the cheapest way to abandon the median voter.

Ask yourself, is this true? Whilst recent empirical studies tend to support the hypothesis (Bartels et al 2005, Osberg et al 2006) that national policy generally reflects the preferences of high income over low income voters, surely governments don’t only make policies that benefit the highest earners?

Why?

Another crucial empirical finding in the literature is that voter participation is generally lower when economic inequality is higher (Solt et al 2009). This begs the question: does low voter turn out increase inequality or is the causal mechanism the other way around?

The most important process of collective institutional change from the 1970’s onwards is the rapid rise in corporate-business lobbying and the decline of organized labour.

Declining mass membership

Economists usually focus on how trade union membership contributes to greater equality through their bargaining effect on lower wages. Low to median income earners who are members of a trade union earn more than their equivalent in non-union firms.

Over the past 30 years, mass membership organizations (trade unions, political parties) have atrophied and been replaced by the professional management of advocacy/lobbying groups. The organizational capacity of business has expanded, whereas the organisational capacity of labour has declined.

unions

But can we conclude that this shift led to major changes in the governance of political economy, and rising economic inequality?

Hacker and Pierson (2010) say yes, for the USA. Their empirical research demonstrates that change in the following four policy arenas has contributed toward rising inequality:

  1. Fiscal/Taxes. Most tax cuts for super-high incomes were the outcome of successful lobbying by anti-tax groups and free market think tanks like the Cato Institute.
  2. Industrial relations. Private sector unionization has virtually collapsed in the US. Public policies have never been updated to stem this decline. Governments actively avoided intervening to stem the decline.
  3. Corporate governance and executive compensation. Total compensation for the top three executives in the US has skyrocketed since the 1980’s. There has been no-intervention from government to stem the rising power of managerialism.
  4. Financial de-regulation. The rise of finance is virtually synonymous with the rise of winner takes-all. In 2005, five hedge fund managers made $500m. The average managerial salary of the top 500 S&P is $30 million. FIRE (finance, insurance and real estate) have more lobbying and campaign finance resources, and have actively shaped policies of financial regulation.

Conclusion

Explaining the winner takes-all dynamic (the growth in the share of the top decile/centile in national income) requires a political perspective that sees modern capitalist markets (big firms) and electoral democracies (state/party elites) as deeply interconnected. This is what we call the study political economy.

On the one hand, governments actively shape and influence markets through a range of public policies. On the other hand, economic interests actively shape how political authority is exercised.

Economists generally explain rising wage inequalities as the outcome of impersonal market and technological forces. Recent political science explanations give priority to the median voter. I have suggested it is more related to how corporate-financial interests are capable of shaping public policies (taxes, finance and labor markets) to advance their own economic interests.

The decrease in the top marginal tax rate of very high incomes in the US is a case in point. This is an example of what Pepper Culpepper (2016) calls  ‘quiet politics’, whereby ‘instrumental power (lobbying)’ and ‘structural power’ (capital-resource dependence) influence decision making. This “power” cannot be directly observed in electoral behavior.

In the Irish case – think about the role of the IFSC Clearing House Group (now called the Industry Advisory Group) in shaping the Irish governments policy on whether or not to accept a coordinated financial transaction tax in Europe. Or think about the influence of the private real estate companies/lobby groups in housing policy.

Lecture slides: Lecture 13

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