Why we have income inequality

Photo by freestocks.org on Unsplash

There are two questions regarding income inequality. The first is whether government policy can impact it. I answered that question with a resounding “YES” in a prior post. Evidence for that fact exists in the comparison between inequality in the United States and France. In France, where “yellow vest” protests have erupted as a result of their increasing inequality, inequality is relatively close to that of the United States before taxes and government transfers are factored in. Once those government programs are included, however, inequality in France is far less than that in the United States. Thus, government policy can reduce income inequality and while France has chosen to use the power of government to impact this problem, in the United States, especially with the recent Trump tax cuts, we have implemented a policy aimed at increasing it. That policy continues.

That brings us to our second question, which is why the government chooses to adopt such a policy. After all, one would think that since income inequality means that most people fall into the lower group (the “ninety-nine percent”), government would seek to play to their needs rather than that of the very rich. In fact, the opposite is true.

Furthermore, income inequality is something that is a relatively recent phenomenon. Certainly, back in the “Roaring Twenties” we had serious income inequality, but in the era from the Great Depression on, that had essentially been wiped out. That era continued until the early 1980s — not coincidentally coinciding with the election of Ronald Reagan — when income inequality started to increase again.

So what changed? In 1979, the U.S. Supreme Court decided the case Broadcast Music v. Columbia Broadcasting System v. CBS, 441 U.S. 1 (1979). In that case, the Court put its stamp of approval upon a move by the lower courts to liberalize the enforcement of anti-trust law. No longer could the government or other opponents of mergers point to the fact that an industry was becoming increasingly consolidated as a basis to block it, the so-called per se rule. Instead, courts now had to apply a more permissive “rule of reason,” which required opponents of a merger to show that it would result in some substantive impact upon consumers.

This higher standard was most recently evidenced in the federal court ruling against the government and thus allowing the merger of AT&T with Time Warner. Clearly, this merger will result in a dramatic reduction of competition. However, simply showing that competition will be reduced is no longer enough. Now, the plaintiffs must show that this reduction in competition will directly impact consumers’ pocketbooks. In the absence of such evidence, the court must rule for the defendants, in this case the firms proposing the merger.

The impact of this decision was both immediate and long-term. Companies started merging with higher and higher frequency, rapidly consolidating industries that had once been characterized as highly competitive. The merger frenzy was best illustrated in Oliver Stone’s movie Wall Street, where the character Gordon Gekko, convincingly played by Michael Douglas, memorably stated that “greed, for lack of a better word, is good.”

That movie is ironic on many levels. First, it was meant as a criticism of the contemporary culture on Wall Street. You have to remember that Oliver Stone was no conservative, and that the characters at the end of the movie go to jail. The reaction of many young people, however, was to revere Gordon Gekko and want to become like him. Second, the level of income inequality and industry consolidation at the time was much lower than it is now.

Consider the following data I calculated as I was doing my research the other day. The most widely-used measure of industry concentration is the Herfindahl Index. To assist me in my work, I calculated that index for all 408 industries with publicly-traded companies operating within them. This data, then represents the bulk of the U.S. economy. My findings were striking.

Without getting into the details of how to calculate the index, suffice it to say that the Department of Justice considers an industry with a Herfindahl index of more than 2500 to be uncompetitive. Of the 408 industries, 264 of them have a Herfindahl index of 2500 or more. That represents 65% of the American economy. In fact, only 98 industries have less than 2000 for their index, representing less than a quarter of our economy.

The data are clear. Our economy is dominated by big business who enjoy monopolistic power within their industry. The result is a government focused on the needs of big business rather than the needs of everyone else. If we are to address income inequality, as well as the appearance and reality of a government that does not represent the people, this is where we have to start.

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Mike is an Assistant Professor of Management for Legal and Ethical Studies at Oakland U. Mike combines his scholarship with practical experience in politics.

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