The Great Divide

By Joseph Stiglitz

This book is mostly about the economics of inequality. But as I have just suggested, one cannot neatly separate out politics and economics.

I describe the nexus between politics and economics: the vicious circle by which more economic inequality gets translated into political inequality, especially in America’s political system, which gives such unbridled power to money. *

During the past decade, four of the central issues facing our society have been the great divide—the huge inequality that is emerging in the United States and many other advanced countries—economic mismanagement, globalization, and the role of the state and the market.

But while politics has been part of the cause of our current troubles, it will only be through politics that we will find solutions: the market by itself won't do it. Unfettered markets will lead to more monopoly power, more abuses of the financial sector, more unbalanced trade relations. It will only be through reform of our democracy—making our government more accountable to all of the people, more reflective of their interests—that we will be able to heal the great divide and restore the country to shared prosperity.

This is a theme I return to frequently in this book. Inequality weakens aggregate demand and the economy.

The articles included in this first section describe the policies that laid the groundwork for the Great Recession: What did we do wrong? Who is to blame? While those in the financial market, at the Fed, and at Treasury would like to pretend it was just something that happened—an unpreventable, once-in-a-hundred-years flood—I believed then, and believe even more strongly now, that the crisis was man-made. It was something that the 1 percent (indeed, a sliver of that 1 percent) did to the rest of us.

It is policies and politics that matter. The United States could have responded to the weakened economy by investing in America, or by undertaking policies that reduce inequality. Both of these would have led to a stronger economy and a fairer society. But economic inequality inevitably leads to political inequality.

Rather than regulations that would stabilize the economy and protect ordinary citizens, we got deregulation that led to instability and left Americans prey to the bankers.

Proponents of a strong financial sector were right about one thing: it is hard to have a well-performing economy without a well-performing financial sector. But, as we have seen repeatedly, the financial sector doesn't perform well on its own; it requires strong regulations, effectively enforced, both to prevent it from imposing harm on the rest of the society and to make sure that it actually performs the functions it is supposed to perform.

Even though the crisis had long been in the making, and even though there had been ample warnings, those in charge, both at the Fed and in the administration, seemed surprised, and I believe genuinely were—a remarkable testament to the ability to close one’s senses to information that one finds unpleasant and contradicts one’s preconceptions.

Virtually any economist who did not blindly believe in the virtues of the free and unregulated markets, their efficiency and stability, saw the writing on the wall.

The precipitating event that plunged the country from the recession into a deep recession, the worst since the Great Depression, was the collapse of Lehman Brothers on September 15, 2008.

After confidently asserting that letting it collapse would have only a limited effect on the economy, the Fed and Treasury took a 180-degree turn and bailed out AIG, the most expensive bailout in human history, an amount of corporate welfare to one firm that exceeded that given to the millions of poor Americans over years and years. Later we were to learn why—and why they did everything they could to hide what they were doing from the American people: the money passed quickly from AIG to Goldman Sachs and other banks.

The Obama administration may claim that it stopped the economy from falling into another Great Depression.

The recovery was designed by the 1 percent, for the 1 percent. Trillions have been unnecessarily lost by following the 1 percent’s agenda.

Doing so redistributed money from ordinary citizens to the wealthy bankers. Had the banks been charged what they should have been, our national debt would be lower and we would have more money to invest in education, technology, infrastructure—investments that would have led to a stronger economy with more shared prosperity.

When there is a crisis, it is always ordinary citizens who bear the brunt—workers who lose their jobs, homeowners who lose their homes, ordinary citizens who see their retirement accounts vanish, who are unable to send their children to college, and who cannot live out their dreams. Small businesses go into bankruptcy in droves.

By contrast, big businesses not only survive; some even prosper as wages are forced down and they maintain sales abroad. The bankers who caused the crisis also manage to do quite well, thank you.

The need for regulation should have been particularly clear because the banks and others in the financial sector have a long-established proclivity for exploitation.

When banks focus on exploitation, they increase inequality; when they focus on job creation, they promote equality, both by reducing unemployment and by leading to higher wages, which naturally follow from lowered unemployment. Thus, bank regulations that restrict their bad behavior can help doubly: they inhibit their ability to exploit, and encourage them to do what they should be doing—simply by reducing the profits to be made in alternative ways.

Even as growth is restored, it will be years and years, if ever, before the damage of the Great Recession is repaired,before incomes are back to where they would have been without the crisis. Indeed, the damage appears to be long-lasting.

Looked at another way, Bush’s own fiscal irresponsibility fostered irresponsibility in everyone else. Credit was shoveled out the door, and subprime mortgages were made available to anyone this side of life support.

U.S. aid to all of Africa has been hovering around $5 billion a year, the equivalent of less than two weeks of direct Iraq-war expenditures. The president made a big deal out of the financial problems facing Social Security, but the system could have been repaired for a century with what we have bled into the sands of Iraq.

In retrospect, the only big winners from the war have been the oil companies, the defense contractors, and al-Qaeda.

President Bush worked to undermine multilateralism—the notion that countries around the world need to cooperate—and to replace it with an America-dominated system. In the end, he failed to impose American dominance—but did succeed in weakening cooperation.

What is required is in some ways simple to describe: it amounts to ceasing our current behavior and doing exactly the opposite. It means not spending money that we don't have, increasing taxes on the rich, reducing corporate welfare, strengthening the safety net for the less well off, and making greater investment in education, technology, and infrastructure.

The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, “I have found a flaw.” Congressman Henry Waxman pushed him, responding, “In other words, you found that your view of the world, your ideology, was not right; it wasn't working.” “Absolutely, precisely,” Greenspan said. The embrace by America—and much of the rest of the world—of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.

There is one more important culprit, which, in fact, has played a key behind-the-scenes role in many various parts of this story: America’s political system, and especially its dependence on campaign contributions. This allowed Wall Street to exercise the enormous influence that it has had, to push for the stripping of regulations and to the appointment of regulators who didn't believe in regulations—with the predictable and predicted consequences that we have seen.

There are those who now would like to reconstruct the system as it was prior to 2008. They will push for regulatory reform, but it will be more cosmetic than real.

Little will be done about incentive structures or even risky practices. If so, then, another crisis is sure to follow.

Capitalism may be the best economic system that man has come up with, but no one ever said it would create stability. In fact, over the past 30 years, market economies have faced more than 100 crises. That is why I and many other economists believe that government regulation and oversight are an essential part of a functioning market economy.

The market on its own is not enough. Government must play a role.

Democracy, we now know, is more than periodic elections: in some countries, such elections have been used to legitimize essentially authoritarian regimes and deprive large parts of the citizenry of basic rights.

Perhaps the most important aspect of inequality is inequality of political rights.

Some countries try to make it easy for the working poor to vote, by having elections on Sunday. Other countries (like Australia) have actively sought to make sure that the voices of all citizens are heard with of mandatory voting—charging a penalty on everyone who does not show up at the voting booth.

Voice is even more important: the ability to influence the political process, either by affecting voting patterns or, more directly, by affecting the actions of key decision makers. If the rich can use their money to control the press or to influence (a gentler, but perhaps less accurate word than “buy”) politicians, then their voice will be heard far more loudly.

It is a corruption that occurs not via cash-stuffed envelopes handed to politicians, but via an equally invidious process, using campaign contributions to buy “policies” that bring riches to a few.

Economic inequality is not just or even so much the result of inexorable laws of economics, as it is of our policies and politics. It is, in this sense, a matter of choice. But here we have a vicious circle, as economic inequality leads to and reinforces political inequality, which simply reinforces our economic inequality.

We know what to do to achieve a more egalitarian society. Inequality is a matter not so much of capitalism in the 20th century as of democracy in the 20th century. The worry is that our ersatz capitalism—socializing losses while we privatize gains—and our imperfect democracy—closer to a system of one dollar one vote than to one person one vote—will interact to produce disappointment in both the economic and the political spheres.

Those who have contributed great positive innovations to our society, from the pioneers of genetic understanding to the pioneers of the Information Age, have received a pittance compared with those responsible for the financial innovations that brought our global economy to the brink of ruin.

The more divided a society becomes in terms of wealth, the more reluctant the wealthy become to spend money on common needs. The rich don't need to rely on government for parks or education or medical care or personal security—they can buy all these things for themselves. In the process, they become more distant from ordinary people, losing whatever empathy they may once have had.

In a broad sense, “rent seeking” defines many of the ways by which our current political process helps the rich at the expense of everyone else, including transfers and subsidies from the government, laws that make the marketplace less competitive, laws that allow CEOs to take a disproportionate share of corporate revenue and laws that permit corporations to make profits as they degrade the environment. The magnitude of rent seeking in our economy, while hard to quantify, is clearly enormous.

The financial industry, which now largely functions as a market in speculation rather than a tool for promoting true economic productivity, is the rent-seeking sector par excellence. Rent seeking goes beyond speculation. The financial sector also gets rents out of its domination of the means of payment—the exorbitant credit and debit card fees and also the less well-known fees charged to merchants and passed on, eventually, to consumers.

In recent years, the financial sector has accounted some 40 percent of all corporate profits. This does not mean that its social contribution sneaks into the plus column, or comes even close.

Much of the inequality in our economy has been the result of rent seeking, because, to a significant degree, rent seeking redistributes money from those at the bottom to those at the top.

Many, if not most, Americans possess a limited understanding of the nature of the inequality in our society. They know that something has gone wrong, but they underestimate the harm that inequality does even as they overestimate the cost of taking action. These mistaken beliefs, which have been reinforced by ideological rhetoric, are having a catastrophic effect on politics and economic policy.

Franklin D. Roosevelt, a purebred patrician, understood that the only way to save an essentially capitalist America was not only to spread the wealth, through taxation and social programs, but to put restraints on capitalism itself, through regulation. Roosevelt and the economist John Maynard Keynes, while reviled by the capitalists, succeeded in saving capitalism from the capitalists.

he children of the poor can afford neither the advanced degrees that are increasingly required for employment nor the unpaid internships that provide the alternative route to “good” jobs.

“Loopholes” does not adequately describe the flaws in our tax system; “gaps” might be better. Closing them might end the specter of the very rich almost proudly disclosing that they pay a tax rate on their disclosed income at half the rate of those with less income, and that they keep their money in tax havens like the Cayman Islands.

Two basic principles of taxation are that it is better to tax bad things than good; and it is better to tax factors in what economists call “inelastic supply”—meaning that the amounts produced and sold won't change when taxes are imposed on them. Thus, if we taxed pollution in all of its forms—including carbon emissions— we could raise hundreds of billions of dollars every year, and have a better environment.

Similarly, appropriately designed taxes on the financial sector would not only raise considerable amounts of money but also discourage banks from imposing costs on others— as when they polluted the global economy with toxic mortgages.

If we required the banks to pay but a fraction of the costs they have imposed on others, we would then have further funds to undo some of the damage that they caused by their discriminatory and predatory lending practices, which moved money from the bottom of the economic pyramid to the top.

Similarly, by taxing land, oil, and minerals more, and forcing those who extract resources from public land to pay the full values of these resources, which rightly belong to all the people, we could then spend those proceeds for public investments—for instance, in education, technology, and infrastructure—without resulting in less land, less oil, fewer minerals. *

On both sides of the Atlantic, the austerity fanatics say, march on: these are the bitter pills that we need to take to achieve prosperity. But prosperity for whom?

Excessive financialization—which helps explain Britain’s dubious status as the second-most-unequal country, after the United States, among the world’s most advanced economies—also helps explain the soaring inequality.

Inequality and poverty among children are a special moral disgrace. They flout right-wing suggestions that poverty is a result of laziness and poor choices; children can't choose their parents.

see us entering a world divided not just between the haves and have-nots, but also between those countries that do nothing about it, and those that do. *

The problem may not be with how markets should work, but with our political system, which has failed to ensure that markets are competitive, and has designed rules that sustain distorted markets in which corporations and the rich can (and unfortunately do) exploit everyone else.

The main question confronting us today is not really about capitalism in the 21st century. It is about democracy in the 21st century.

This is less about economics than it is about politics. We don't have to choose between capitalism and fairness. We must choose both.

Today, inequality is growing dramatically again, and the past three decades or so have proved conclusively that one of the major culprits is trickle-down economics—the idea that the government can just step back and if the rich get richer and use their talents and resources to create jobs, everyone will benefit. It just doesn't work; the historical data now prove that. *

If those who are in charge of making the critical decisions are so “cognitively captured” by the 1 percent, by the bankers, that they see that the only alternative is to give those who caused the crisis hundreds of billions of dollars while leaving workers and homeowners in the lurch, the system is unfair.

None of this is the outcome of inexorable economic forces, either; it’s the result of policies and politics—what we did and didn't do.

And if these policies continue, these conditions will grow even worse.

Everyone recognizes that education is the only way up, but as a college degree becomes increasingly essential to making one’s way in a 21st-century economy, education for those not to the manner born is increasingly unaffordable.

Of the harm that inequality inflicts on our economies, politics, and societies, the damage done to children demands special concern. Whatever responsibility poor adults may bear for their lot in life— they may not have worked hard enough, saved enough, or made good decisions—children’s circumstances are thrust upon them without any sort of choice. Children, perhaps more than anyone else, need the protection that rights afford.

There has always been inequality. There always will be. The question posed by these articles is why inequality—in virtually all of its dimensions—has increased so much in the last 35 years. *

Financialization—the increased importance of the financial sector in the economy—has been central, not only in the increased instability of the economy, evidenced by the Great Recession, but in the increased inequality.

Inequalities of opportunity are both cause and consequence of inequalities in incomes.

Every law and regulation, every government expenditure, every policy, can have an effect on inequality.

We need to break up the too-big-to-fail banks; there is no evidence that these behemoths deliver societal benefits that are commensurate with the costs they have imposed on others. And, if we don't break them up, then we have to severely limit what they do. They can't be allowed to do what they did in the past—gamble at others’ expenses.

Their lobbying efforts worked well, first to deregulate, and then to have taxpayers pay for the cleanup. Their hope is that it will work once again to keep them free to do as they please, regardless of the risks for taxpayers and the economy. We cannot afford to let that happen. *

No one enjoys paying taxes, and yet all but the extreme libertarians agree, that taxes are the price we pay for civilized society. But in recent decades, the burden for paying that price has been distributed in increasingly unfair ways.

Economists—even at traditional, conservative international institutions like the International Monetary Fund—have come to realize that excessive inequality is bad for growth and stability. The tax system can play an important role in moderating the degree of inequality. Ours, however, does remarkably little about it.

We could have a tax system that encourages good things like hard work and thrift and discourages bad things, like rent seeking, gambling, financial speculation, and pollution.

It is time the international community faced the reality: we have an unmanageable, unfair, distortionary global tax regime. It is a tax system that is pivotal in creating the increasing inequality that marks most advanced countries today—with America standing out in the forefront and the UK not far behind.

We do not measure trust in our national income accounts, but investments in trust are no less important than those in human capital or machines. Unfortunately, however, trust is becoming yet another casualty of our country’s staggering inequality:

When 1 percent of the population takes home more than 22 percent of the country’s income—and 95 percent of the increase in income in the post-crisis recovery—some pretty basic things are at stake. Reasonable people, even those ignorant of the maze of unfair policies that created this reality, can look at this absurd distribution and be pretty certain that the game is rigged.

It’s hard to know just how far we’ve gone down the path toward complete trust disintegration, but the evidence is not encouraging.

As always, it is the poor and the unconnected who suffer most from this, and who are the most repeatedly deceived.

A central message of this book is that inequality is affected by virtually every policy that the government undertakes.

Trade agreements have always been sold on the grounds that they create jobs—and if that were true, workers should be among the loudest champions of these agreements. *

Dishonesty is never the best policy, and the dishonest selling of trade agreements stands as a low point in public policy.

nequality prolongs the downturn, and the downturn exacerbates inequality. Unfortunately, the austerity agenda advocated by conservatives will make matters worse on both counts.

If we go down the path of austerity,our country will increasingly become divided, and we will pay a high economic price for our growing inequality and declining opportunity. The consequences will be even harder on our democracy, our identity as a nation of opportunity and fair play, and our society.

Just look at what havoc this crisis wrought: median wealth fell by 40 percent, those in the middle still have not seen their incomes recover to precrisis levels, and those in the upper 1 percent enjoyed all the fruits of the recovery (and then some). It is ordinary workers who have suffered most: they are the ones who face high unemployment, who see their wages cut, and who bear the brunt of cutbacks in public services as a result of the budget austerity.

‘Trade agreements’ new boosters euphemistically claim that they are simply after regulatory harmonization, a clean-sounding phrase that implies an innocent plan to promote efficiency.

But when corporations call for harmonization, what they really mean is a race to the bottom.

Corporations everywhere may well agree that getting rid of regulations would be good for corporate profits. But there would be some big losers—namely, the rest of us.

In this series, I have repeatedly made two points: The first is that the high level of inequality in the United States today, and its enormous increase during the past 30 years, is the cumulative result of an array of policies, programs, and laws.

And this brings me to the second point that I have repeatedly emphasized: Trickle-down economics is a myth.

What are being sold as “free-trade agreements” include IP provisions that could stifle access to affordable medicines, with a potentially significant impact on economic growth and development.

Every country has a distinct political economy that shapes the extent and effects of inequalities; each requires separate assessment. The marked differences in the extent and nature of inequality across countries demonstrate that inequality is not just determined by economic forces; it is shaped by politics and policies.

Economists of widely differing philosophical outlooks agree that inequalities of incomes and assets have harmful economic effects. *

The more that wealth is allowed unrestricted roles in funding elections, the more likely it is that economic inequality will get translated into political inequality.

One of the most pernicious forms of inequality relates to inequality of opportunity, reflected in a lack of socioeconomic mobility, condemning those born into the bottom of the economic pyramid to almost surely remain there.

There are many dimentions to inequality - some with more invidious effects than others—and many ways to measure these inequalities. One thing is certain, however: sustainable development cannot be achieved while ignoring extreme disparities.

An economic and political system that does not deliver for most citizens is one that is not sustainable in the long run. Eventually, faith in democracy and the market economy will erode, and the legitimacy of existing institutions and arrangements will be called into question.

Our divisions are deep. Economic and geographic segregation have immunized those at the top from the problems of those down below. *

Our economy, our democracy, and our society have paid for these gross inequities. The true test of an economy is not how much wealth its princes can accumulate in tax havens, but how well off the typical citizen is.

Money that was meant to have trickled down has instead evaporated in the balmy climate of the Cayman Islands.

We need not just a new war on poverty but a war to protect the middle class. *

We must end the rent-seeking society we have gravitated toward, in which the wealthy obtain profits by manipulating the system. The problem of inequality is not so much a matter of technical economics. It’s really a problem of practical politics.

Inequality is not just about the top marginal tax rate but also about our children’s access to food and the right to justice for all.

Widening and deepening inequality is not driven by immutable economic laws, but by laws we have written ourselves.

Thus the UK, which has followed the U.S. model most closely has, not surprisingly, the highest level of inequality among the advanced countries, next to that of the United States. Countries pay a high price for this inequality; at stake is not just inequality of incomes but also inequality of opportunity.

Democracy, we now recognize, involves more than periodic voting. Societies with a high level of economic inequality inevitably wind up with a high level of political inequality: the elites run the political system for their own interests, pursuing what economists call rent-seeking behavior, rather than the general public interest. The result is a most imperfect democracy.

Another world is possible; we need only the political will to pursue it.

If the UK continues on its current course, imitating the American model, it is likely that the results will be like those of the U.S.—where the typical family has seen its income stagnate for a quarter-century, even as the rich get richer.

No large economy—and Europe is a large economy—has ever emerged from a crisis at the same time that it has imposed austerity. Austerity always, inevitably, and predictably makes matters worse.

Society’s most valuable asset, the talents of its people, is being wasted and even destroyed.

The pain that Europe is experiencing, especially its poor and its young people, is so unnecessary.

But austerity provides no promise of a better world anytime in the foreseeable future.

And if the depression does continue, it is those at the bottom and in the middle who will suffer the most

It is simply a matter of politics whether we choose to take the steps we need to take to restore our economy to prosperity.

Even were we able to ignore the economic imperative of fixing our inequality problem, the damage it is doing to our social fabric and political life should prompt us to worry. Economic inequality leads to political inequality and a broken decision-making process.

There are all kinds of excuses for inequality. Some say it’s beyond our control, pointing to market forces like globalization, trade liberalization, the technological revolution, the “rise of the rest.” Others assert that doing anything about it would make us all worse off, by stifling our already sputtering economic engine. These are self-serving, ignorant falsehoods. Market forces don't exist in a vacuum—we shape them.

Now we realize that we are paying a high price for our inequality and that alleviating it and promoting growth are intertwined, complementary goals. It will be up to all of us—our leaders included—to muster the courage and foresight to finally treat this beleaguering malady.

But anyone who believes that monetary policy is going to resuscitate the economy will be sorely disappointed. That idea is a distraction, and a dangerous one.

What we need to do instead is embark on a massive investment program—as * will increase our productivity for years to come, and will also increase employment now.

The only way it will happen is through a government stimulus designed not to preserve the old economy but to focus instead on creating a new one.

Growth is not just a matter of increasing GDP. It must be sustainable: growth based on environmental degradation, a debt-financed consumption binge, or the exploitation of scarce natural resources, without reinvesting the proceeds, is not sustainable. *

Growth also must be inclusive; at least a majority of citizens must benefit. Trickle-down economics does not work: an increase in GDP can actually leave most citizens worse off.

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