<jnmorgan@umich.edu> F=inqlty.doc Version of 2/10/05

**BEHIND MANY OTHER PROBLEMS LURKS ECONOMIC INEQUALITY**

There is a set of attitudes in the United States dramatically different
from those of Europe. We firmly believe that mobility is easy and that
the poor have themselves to blame. 60% of Americans believe the poor are
lazy, versus 26% of people in the European Union. 60% of Europeans
believe that the poor are trapped in poverty, versus 29% of Americans.
30% of Americans believe that luck determines income, versus 54% of
Europeans. (Alberto Alesina and Edward L. Glaeser, [Fighting Poverty in
the US and Europe: a World of Difference]{.underline}. 2004, Oxford
Press. p 184[)]{.underline} The truth could not possibly be that
different. Hence it is crucially important that we do the research to
find out the truth about opportunity structures. Actual mobility is
quite similar here and in Europe. But simply comparing mobility will not
suffice, since it is crucial whether the mobility was purposeful or
inadvertent, in either direction. Forty years ago Michael Harrington and
Charles Murray took sides on opportunity in this country. Early findings
from the Michigan Panel Study of Income Dynamics were summarized in the
press as: "Horatio Alger was a myth!" (Duncan and Morgan, 1981) However,
after many more years, there was some effect of motivation on labor
market success. (Dunifon and Duncan, 1998).

Alesina and Glaeser believe that lack of proportional representation,
dispersion of political power to the states, and ethnic and racial
diversity in the United States all make it difficult to have an adequate
redistribution system and representation of minorities, and have shaped
our attitudes. They report that the United States spends less than 15%
of its GDP on social programs, compared with 25% or more in European
countries. (p19), consistent the differences in attitudes. But even if
our national attitudes were shaped by past political structures and
ethnic divisions, correcting false justifications for continuing
inequality might help. And it might point to the need for improving
opportunities and reducing unemployment as well as reducing inequality.

> Free market capitalism provides incentives by rewarding productivity.
> Differential rewards are justified as incentives to work hard, and
> create wealth. But in a free competitive system, the result is an
> increasing concentration of income and then of wealth which can cause
> whole series of problems, even apart from concerns of compassion.
> Evidence on inequality is in Sheldon Danziger (2004), and perversions
> of our tax system that exacerbate it are exhaustively documented in
> Johnston (2003). An extensive coverage of many of the effects of
> increased inequality appears in a recent volume from the Russell Sage
> Foundation entitled [Social Inequality]{.underline}, (Kathryn
> Neckerman, editor[,]{.underline} 2004[)]{.underline} Here is a list
> with a few important additions:

1\. Combined with the uncertainty of a market system, extreme inequality
creates stress, which leads to health problems, and to fear which leads
to mistreatment of minorities and immigrants. Much obesity and drug use
probably comes from stress and leads to more health problems. Unequal
access to medical care at low incomes also affects health and
productivity. And unequal ability to invest in children's health and
education transmits the problems to the next generation. Happiness has
been shown to be impaired when income is less than others'.(Layard,
2005) Vast inequality can mean that two thirds of the population can be
below average, even if only half are below the median, of course.
Poverty and instability induce resort to high-cost loans and gambling.

2\. Inequality of purchasing power violates one of the crucial
assumptions that justify free market capitalism, i.e. that market demand
is a good guide as to what to produce and how to produce it. We clearly
have too little prenatal care and infant nutrition relative to our
yachts and cosmetic surgeries. And many remedies for external costs or
benefits that disrupt optimal resource use get stopped because of their
distributional effects, or lead to proposals that also help a few poor,
but very inefficiently, like \"affordable housing\".

3\. Unequal economic power allows perversion of democracy in various
ways, and it is exacerbated by treating corporations and other
agglomerations of economic power as though they democratically
represented individuals with rights of free speech. Campaign finance
reform would not be an issue if only individuals could support
candidates, and individual wealth was not too disparate. Corruption has
been found to be high in countries with high tariff barriers, as
businesses seek protection. And there is a steady flow of government
officials who then work for companies they once regulated. Income
differences among racial or ethnic groups foster stereotyping and
prejudice. In Africa and elsewhere, massive corruption bvenefits a few
politicians, but here increasingly it benefits the wealthy who "support"
friendly legislators, and we don't call it corruption.

4\. Natural market forces, combined with differences in natural
resources and governments and restrictions on free trade, lead to vast
inequalities between countries, resulting in immigration pressures and
even military conflicts. Economists realize that free trade is a
substitute for migration of workers. Free trade provides permanently
better employment in poor countries, permanently low prices for
consumers in all countries, and temporary unemployment and suffering
among a minority of workers in affluent countries. We have a program
funded at several billions to help those who lose their jobs because of
foreign competition.

5\. Finally, when the masses face low incomes, aggregate demand may fall
short of what is needed for full employment, while at the same time the
savings of the affluent find no productive real investments and simply
bid up the prices of existing assets. The effects are clear in many
underdeveloped countries. The reckoning here is being postponed by
massive military expenditures and massive borrowing by consumers. The
latter must end, and the former should. At home our federal deficits and
adverse trade balance lead to calls for more saving, but it is possible
that the real causation might go from adequate demand to investment
which is then financed by reinvesting profits or borrowing, and the
resulting prosperity produces saving. We have spent so long fighting
inflation, fueled by military expenditures, that it is difficult to
think about unemployment and recession again. The
[Economist]{.underline} worries about excess liquidity without asking
why.

What might we propose in addition to research on actual mobility and
opportunities available? We should reintroduce progressivity into the
tax structure, including the estate tax. This can be done without
eliminating incentives. (Marginal income tax rates on the last dollar
earned have been reduced from 91% to 34%, and could easily return to 50%
without increasing the average tax burden). A comprehensive reform would
go to a progressive consumption tax. (See Seidman, 1997) We could
declare aggregations of economic power like corporations, foundations,
non-profits, unions, and churches not to be individuals with rights of
free speech. Stockholders, employees, and members can exercise that
right. We must continue to free up international trade while increasing
the appropriation to help those who lose jobs, not requiring proof that
it was outsourcing that did it. In order to reduce fear and uncertainty
further, Congress should declare that the Federal government is
responsible for meeting the legitimate obligations of the Social
Security system. A universal compulsory insurance program covering long
term care and major medical expenses would ease not only our fears but
the budgets of Medicaid and Medicare. (About half the Medicaid budget
goes for long-term care.) If we want more private saving, providing a
voluntary supplemental saving program with the same safeguards as Social
Security would work.

Seldom has a good motive, compassion, been so well aligned with a
program for reducing inequality where the program has so many other
benefits. In the words of Alan Blinder, we can be soft hearted and hard
headed simultaneously.

References:

Alesina, Albert, and Edward Glaeser, 2004, [Fighting Poverty in the US
and Europe;A world of Difference]{.underline}. Oxford Press.

Danziger, Sheldon, 2004, [Diverging Fortunes: Trends in Poverty and
Inequality]{.underline}, New York, Russell Sage

Duncan, Greg J. and James Morgan, 1981, "Sense of Efficacy and Changes
in Economic Status---A Replication", [Journal of Human Resources,
16(4):649-657.]{.underline}

Dunifon, Rachel, and Greg J. Duncan,1998, "Long-Run Effects of
Motivation on Labor Market Success", [Social Psychology
Quarterly]{.underline} 61(1):33-48.

Johnston, David Cay, 2003, [Perfectly Legal]{.underline}, Penguin, New
York.

Layard, Richard, 2005, [Happiness:Lessons from a New
Science]{.underline}, Penguin.

Neckerman, Kathryn, 2004, [Social Inequality]{.underline}, New York,
Russell Sage.

Seidman, Laurence, 1997,[The USA Tax: a Progressive Consumption Tax, MIT
Press.]{.underline}