The Chronicle Review

Economics Is Too Important to Be Left to Economists

Natalya Balnova for The Chronicle Review

September 23, 2015

The cartoon version of our economy contains a private sector and a public sector. The private sector, the so-called free market, is the domain of economics. The public sector, the government, is the domain of political science.

But that cartoon version masks an important reality. There can be no market without rules. Even the basic building blocks of the market — property, acceptable monopoly power, contract, liability, and bankruptcy — depend on rules and how they’re enforced. And those rules are the products of government. Legislators, administrative officials, and judges are continuously engaged in readjusting, resetting, or reinventing them. Without government there can be no free market.

Economic analysts and advisers play a significant role in the making and changing of rules. The field of public policy, largely the handiwork of economists, is important and valuable to the extent it helps the public and public officials anticipate the outcomes of various alternative rules. But the field can go awry when it takes a further step and presumes to advise officials and the public about what is in the public interest.

For that, we need political scientists, because the central economic challenges of our era are less about economics and finance than about politics and power.

The shift from economists’ prediction to prescription is often hidden within a search for the most "efficient" outcomes or the fastest economic growth. These twin goals, efficiency and growth, have become the talismans of economic and policy analysis, but they fail to deal with at least three critical issues.

One is distributional — that is, outcomes the public might consider to be fair or unfair in terms of who gets what. If a policy option is technically efficient because it makes some people better off without making anyone else worse off, a so-called Pareto improvement, it may nonetheless worsen inequality if its beneficiaries are already better off than most. Another way of putting it is that when the benefits of a policy substantially exceed its costs, inequality may worsen if those costs fall disproportionately on those at the lower end of the distributional ladder and they are not compensated by the winners. And even if compensated so they are actually no worse off, they may still feel worse off relative to those who have received most of the gains from growth.

The second issue unaddressed by an exclusive focus on efficiency and growth is democracy — the accountability of government officials to the public. I have known economic policy analysts and advisers who, after finding what they believe to be the best or most efficient outcome, then seek to discover how best to do end runs around the democratic process to implement it. To them, politics is a constraint on rational policy making rather than a source of wisdom about what should be done.

Power is exercised far more often by keeping issues off the political agenda.

Finally, and perhaps most significantly, a focus on efficiency and growth disregards the allocation of power in a political-economic system and the role of political power in determining what the economic rules will be. It fails to examine whether that allocation of power is likely to result in a stream of future decisions that further entrench the powerful and add to their winnings. And it doesn’t ask whether a different balance of power might be preferable.

In practice, economic policy analysis itself is often at the service of powerful interests. Economists and policy experts are routinely hired to participate in agency rule-making proceedings, or provide testimony in court, or appear before legislative committees, or back a particular political candidate’s positions — all in order to justify or legitimate policies that those powerful interests seek. In this way, economic analysis as actually practiced within politics actively masks the issues of distribution, democracy, and power.

These three issues are interrelated. The problem we face today of widening inequality is in many respects a political problem — reflecting both the failure of democracy and the strategic use of political power by large corporations, Wall Street banks, and some of the richest people in the nation to alter the rules of the game in their favor. This should be the domain of political science.

Consider the looming presidential election. At this moment Bernie Sanders and Donald Trump are confounding Washington insiders. Both may be washed away in the riptides of next year’s caucuses and primaries. But each in his own way draws on deep public anger toward and distrust of American politics and the congeries of political and corporate leaders that have dominated politics for the last three decades. To be sure, Sanders and Trump draw from different strains of that anger — Sanders from the rebuild-the-system sentiments that propelled the Occupy movement several years ago, Trump from the wreck-the-system sentiments that have animated much of the Tea Party. But the anger they both represent in their different ways will not recede any time soon.

Put simply, Americans are angry because they feel they are on the losing end of a political-economic system that seems to be rigged against them. They’re working harder than ever but are not getting ahead, and they fear their children will have an even harder time making it. In 2001 a Gallup poll found 77 percent of Americans satisfied with opportunities to get ahead by working hard and 22 percent dissatisfied. By 2014, only 54 percent were satisfied and 45 percent dissatisfied.

The American economy is twice as large as it was four decades ago, but the median wage has barely risen, adjusted for inflation. Almost all the gains have gone to the top. Corporate profits before taxes have reached their highest share of the total U.S. economy since 1942 when World War II artificially boosted profits (and much of those profits were then taxed away). Between 2000 and 2014, quarterly corporate after-tax profits rose from $529 billion to $1.6 trillion. Meanwhile, labor’s share of the economy has dropped, representing a shift from labor to capital of about $750 billion a year. Importantly, much of the increase in income inequality, as opposed to wealth inequality, has occurred within labor’s share — as the paychecks of high earners continue to diverge from those of low earners. CEO pay in large corporations relative to the pay of average workers has gone from 20 to 1 in 1965 to 123 to 1 in 1995 to around 300 to 1 today.

Some of this shift has been due to globalization and technological change — but not all of it. Other nations have experienced the same forces but not grown nearly as unequal. The median income in Germany has risen over the last 15 years, and Germany’s richest 1 percent take home about 11 percent of total income, before taxes, while America’s richest 1 percent take home more, almost 20 percent.

Moreover, if it were just globalization and technological change, we’d expect college graduates to command higher wages in line with their greater productivity. After all, a college education was supposed to boost personal incomes and maintain American prosperity. Although young people with college degrees have continued to do better than people without them, since 2000 the real average hourly wages of young college graduates have failed to grow — largely because the middle class’s share of the total economic pie continues to shrink while the share going to the top continues to grow.

Something else has happened, and it has to do with economic power. One expression of that power is found in the financial sector. Over the last three decades, laws and regulations instituted in the wake of the Great Crash of 1929 to constrain finance and prevent a recurrence were abandoned — restrictions on interstate banking, on the intermingling of investment and commercial banking, and on banks becoming publicly held corporations, for example — thereby allowing the largest Wall Street banks to acquire unprecedented influence over the economy. In the crisis of 2008, big Wall Street banks and their executives and shareholders were bailed out when they couldn’t pay what they owed, but homeowners who couldn’t meet their mortgage payments were not.

The reorganization of the financial sector over the past three decades is only the tip of a vast iceberg of market reorganization taking place over the last few decades across the economy. Intellectual property rights — patents, trademarks, and copyrights — have been enlarged and extended, creating windfalls for high tech, biotechnology, and pharmaceuticals, but higher prices for average consumers, including the highest pharmaceutical costs of any advanced nation.

Antitrust has become far more lenient, allowing vast segments of American industry — including big cable, high tech, airlines, health insurers, hospitals, and giant retailers to consolidate and gain market power. Meanwhile, government has shown less tolerance toward another form of economic collusion — that of workers seeking to combine forces to gain greater bargaining leverage. Nowadays, workers trying to form unions are fired with impunity, and more states are adopting so-called right-to-work laws that further undermine unions.

Bankruptcy laws have been loosened for large corporations — notably airlines and automobile manufacturers — allowing them to abrogate labor contracts and threaten closures unless they receive wage concessions. But college graduates overburdened with student debts are denied bankruptcy protection. Contract laws now allow corporations to insist on mandatory arbitration of any contractual disputes before private judges selected by those corporations.

Securities laws have been relaxed to allow insider trading of confidential information, as long as investors who get tipped off don’t know who the original tip came from. CEOs are now allowed to use stock buybacks to boost share prices when they cash in their own stock options, without shareholders knowing. Special tax loopholes allow the partners of hedge funds and private-equity funds to treat their income as capital gains, even though they didn’t invest their own money. Estate taxes on the wealthy have been reduced. High earners are now subject to just half the tax rates they paid in the first three decades after World War II.

In recent years, half of retiring senators and 42 percent of retiring reps have turned to lobbying.

I could go on, but you get the point. Most Americans don’t know the details but they know that the market is now rigged in ways that leave them at a disadvantage and that government has enabled the rigging to occur. In 1964, according to polls, Americans agreed by 64 percent to 29 percent that government was run for the benefit of all the people. By 2012, the response had reversed, with voters saying by 79 percent to 19 percent that government was "run by a few big interests looking after themselves." In Rasmussen polls undertaken in the fall of 2014, 63 percent thought most members of Congress were willing to sell their vote for either cash or a campaign contribution, and 59 percent thought it likely their own representative already had. Sixty-six percent believed most members of Congress didn’t care what their constituents thought, and 51 percent said even their own representative did not care what they thought. This degree of cynicism about government has no parallel in modern American history.

Big corporations and Wall Street banks are now trusted almost as little as government. In a CNBC/Burson-Marsteller international survey, released in September 2014, more than half (51 percent) of the respondents agreed with the statement "strong and influential corporations are bad, even if they promote innovation and growth."

Which may be why the Republican right is sounding almost as populist as the Democratic left these days. We "cannot be the party of fat cats, rich people, and Wall Street," said the Republican senator Rand Paul, soon before announcing his 2016 presidential run. Sen. Ted Cruz, another Republican presidential aspirant, has accused the "rich and powerful, those who walk the corridors of power" of "getting fat and happy." David Brat, a Republican who, in June 2014, beat Eric Cantor, the majority leader of the House of Representatives, in the Republican primary in Virginia’s Seventh Congressional District, had accused Cantor of "crony capitalism," and charged big corporations with wanting only "cheap labor … that’s going to lower wages for everybody else." Donald Trump, seeking the Republican presidential nomination, excoriated "these hedge-fund guys" who are "getting away with murder."

The sincerity behind these statements might be questioned but sincerity is not the point. Such statements are uttered because those who make them know they are being received enthusiastically. Pollsters and campaign consultants who advise Republican candidates have picked up the voter anger toward the "rich and powerful" who are "getting fat and happy" by "lowering the wages for everyone else."

Americans no longer believe that those in charge are looking out for them. A study published in the fall of 2014 by Martin Gilens, of Princeton University, and Benjamin Page, of Northwestern University, appears to justify this view. Gilens and Page analyzed 1,799 policy issues in detail, determining the relative influence on them of economic elites, business groups, mass-interest groups, and average citizens. Their conclusion: "The preferences of the average American appear to have only a minuscule, near-zero, statistically nonsignificant impact upon public policy."

It is sobering that Gilens and Page’s data come from the period 1981 to 2002, before the Supreme Court opened the floodgates to big money in its Citizens United and McCutcheon decisions. The study also preceded the advent of super PACs and "dark money" (unlimited political contributions via nonprofits, which don’t have to disclose the sources), and even before the Wall Street bailout. Presumably their results would be even more skewed toward the moneyed interests if their sample were extended to today.

I’m aware of skepticism in some quarters of political science about any direct relationship between political contributions and political results, but that may because political scientists have looked in the wrong places, as my Berkeley colleague Paul Pierson suggests. They have looked at money’s relation to particular votes over visible contests. But power is exercised far more often by keeping issues off the political agenda. It is precisely because the distribution of power has become so unequal that there are so few votes over basic distributive issues. The powerful set the agenda by not allowing this underlying contest to become openly contestable.

Moreover, when you look at regulatory proceedings and courtrooms where laws are interpreted and enforced, you see some of this power exercised indirectly through platoons of lawyers and economic experts — so ubiquitous and well staffed, armed with so many studies and so much data, that they’re able to completely dominate the proceedings. For weaker players and interests, the costs of entering the fray are far too expensive. Sometimes weaker players refrain from participating because they fear retaliation.

Look also at how power is exercised in setting the public agenda — instructing the public as to what is important, what facts should be considered, indeed, even what is scientific truth. Coca-Cola wants you to believe sugary soft drinks and an unhealthy diet are not as responsible for obesity, diabetes, and heart disease as is lack of exercise. Koch Industries wants you to view climate change skeptically. Large Wall Street banks would have you believe the Dodd-Frank law and attendant regulations — far easier on the banks than a resurrection of the Glass-Steagall Act would be — are harming their international competitiveness. The National Restaurant Association wants you to believe an increase in the minimum wage will throw millions out of work. Monsanto wants you to believe that genetically modified foods are perfectly safe.

And so on. All hire experts — scientists and economists — who dutifully write op-eds and articles, appear on television and radio, and testify before Congress and in regulatory proceedings. They rarely if ever mention in their op-eds, broadcasts, or testimony that they’re fronting for an economic interest that has paid them for their expertise. Such "experts" are also remunerated indirectly through institutes and centers with anodyne names financed by the very same interests for the very same purposes.

As moneyed interests gained dominance over market rules, countervailing forces declined.

Look also at tacit promises to public officials of lucrative future employment, if the public official tacitly cooperates by doing what the private interest wants done. The revolving door between Wall Street and the Treasury Departments and White Houses of both Republican and Democratic administrations has spun so fast in recent years that it’s hard to tell at any given time who’s in office and who’s back on the Street. So, too, with members of Congress and major lobbying firms.

In the 1970s, only about 3 percent of retiring members of Congress went on to become Washington lobbyists. In recent years, fully half of all retiring senators and 42 percent of retiring representatives have turned to lobbying, regardless of party affiliation. This is not because more recent retirees have had fewer qualms than their predecessors about making money off their contacts and experience gained during government service, but because the financial rewards from corporate lobbying have grown considerably larger. As Kay Lehman Schlozman, Sidney Verba, and Henry Brady have found, business groups spend 72 percent of all lobbying dollars and hire 64 percent of outside lobbyists.

Look also at the quiet silencing of views unpopular with the economically powerful. Not long ago I was asked to speak to a religious congregation about widening inequality. Shortly before I began, the head of the congregation asked that I not advocate raising taxes on the wealthy. He said he didn’t want to antagonize certain wealthy congregants on whose generosity the congregation depended. I had a similar exchange last year with the president of a small college who had invited me to give a lecture attended by his board of trustees. "I’d appreciate it if you didn’t criticize Wall Street," he said, explaining that several of the trustees were investment bankers.

The fear of alienating wealthy donors dissuades a nonprofit devoted to voting rights from launching a campaign against big money in politics. A Washington think tank’s study on inequality omits mention of the role big corporations and Wall Street have played in weakening the nation’s labor and antitrust laws. A public broadcasting station decides not to air a program critical of a major supporter. A university shapes research and courses around economic topics of interest to its biggest donors, avoiding mention of the increasing power over the economy of large corporations and Wall Street.

The nonprofits say they have no alternative. Other sources of funding are drying up; research grants are waning; funds for social services of churches and community groups are growing scarce; university funding, and appropriations for public television, the arts, museums, and libraries are being slashed by legislatures. What are they to do? "There’s really no choice," a university dean told me. "We’ve got to go where the money is." And more than at any time since the Gilded Age of the late 19th century, the money is now in the pockets of big corporations, Wall Street banks, and the super wealthy. So the presidents of universities, congregations, think tanks, and other nonprofits are kissing wealthy posteriors as never before.

That money often comes with strings.

When Comcast, for example, finances a nonprofit like the International Center for Law and Economics, the Center supports Comcast’s proposed merger with Time Warner. When the Charles Koch Foundation pledges $1.5 million to Florida State University’s economics department, it stipulates that a Koch-appointed advisory committee will select professors and undertake annual evaluations.

The Koch brothers now fund 350 programs at over 250 colleges and universities across America. You can bet that support doesn’t underwrite research on inequality and environmental justice. David Koch’s $23 million of donations to public television earned him positions on the boards of two prominent public-broadcasting stations; it also guaranteed that a documentary critical of the Kochs didn’t air. As Ruby Lerner, president and founding director of Creative Capital, a grant making institution for the arts, told The New Yorker’s Jane Mayer, self-censorship practiced by public television "raises issues about what public television means. They are in the middle of so much funding pressure."

Our democracy is directly threatened when the rich buy off politicians. But no less dangerous is the quieter and more insidious buyoff of institutions democracy depends on to research, investigate, expose, and mobilize action in support of the public interest.

Another reason for the lopsidedness of political power at the top of the economy is the decline in countervailing power. In 1952, the economist John Kenneth Galbraith wrote that "the support of countervailing power has become in the last two decades perhaps the major peacetime function of the federal government." That created counterweights to the centralized power of big corporations and Wall Street. "Given the existence of private market power in the economy," Galbraith continued, "the growth of countervailing power strengthens the capacity of the economy for autonomous self-regulation and thereby lessens the amount of over-all government control or planning that is required or sought." These alternative power centers ensured that America’s vast middle and working classes received a significant share of the gains from economic growth.

Unions pushed for and won legislation in 1935 that legitimized collective bargaining, and then, in subsequent decades, built economic and political strength on that foundation. Unorganized workers gained economic power in the form of minimum-wage legislation. Small farmers got federal price supports, as well as a voice in setting agricultural policy. Farm cooperatives won exemption from federal antitrust laws. Small retailers obtained protection against retail chains through state "fair trade" laws, requiring wholesalers to charge all retailers the same price and preventing chains from cutting prices. Small investors gained protection under the Securities and Exchange acts against the power of big investors and top corporate executives. Small banks were protected against Wall Street by regulations that barred interstate banking, and that separated commercial from investment banking. And so it went, across the economy.

Starting in the 1980s, however, something profoundly changed. It wasn’t just that big corporations, Wall Street, and the wealthy were becoming more politically potent, as Gilens and Page’s research clearly shows. It was also that the centers of countervailing economic power were withering. Just as the large moneyed interests gained increasing dominance over the rules by which the market runs, countervailing centers of economic power declined, as did their voices in helping set the rules.

Grass-roots membership organizations shrank, largely because Americans had less time for them. As wages stagnated, most people had to devote more time to work in order to makes ends meet. That included the time of wives and mothers who began streaming into the paid work force in the late 1970s to prop up family incomes threatened by the new fragility of male wages. As Harvard’s Robert Putnam has documented, Americans stopped being a nation of "joiners." By the first decades of the 21st century, many of these organizations had all but disappeared, as had their collective voices. They had been replaced by national advocacy organizations, typically headquartered in Washington. "Membership" no longer means active engagement at the local and state levels, whose affiliates and chapters communicate their members’ preferences upward to national leaders. It means little more than an individual’s willingness to send money in response to mass solicitations flowing downward.

At the same time, union membership began dropping, as corporations began sending jobs abroad and threatened to send more unless unionized workers agreed to wage and benefit concessions, moved to non-union "right to work" states, and fought attempts of nonunionized workers to form unions. President Ronald Reagan helped legitimize these moves when he fired striking air-traffic controllers but competitive pressures were already pushing CEOs in that direction.

The unfriendly takeovers and leveraged buyouts of the 1980s put ever-greater pressure on top executives to cut labor costs by fighting unions. The decline of unions not only reduced the bargaining power of average workers to obtain a share of corporate profits. It also reduced the political power of average working people to negotiate laws and rules that would help maintain their incomes — labor laws that preserved and enlarged upon their contractual rights to collectively bargain, trade agreements that protected their jobs (or adequately compensated them for jobs lost), corporate laws that gave them something of a voice in corporate governance, bankruptcy laws that gave union agreements a high priority.

Unions have continued to lobby and make campaign contributions, but their political and economic clout has waned, especially when compared with that of big corporations, trade associations, Wall Street, and wealthy individuals. In the 2012 elections, for example, the Koch brothers’ political network alone spent more than $400 million. That sum was more than twice the political spending of the 10 largest labor unions put together. That same year, corporations spent $56 on lobbying for every dollar spent by labor unions. Democratic candidates no longer rely nearly as much on labor unions to finance their campaigns as they do on the wealthy. In 2012, the richest .01 percent of households gave Democratic candidates more than four times what unions contributed to their campaigns. The loss of American workers’ collective economic power has compounded the loss of their political power, which in turn has accelerated the loss of their economic power.

Other centers of countervailing power — small retail businesses, farm cooperatives, and local and regional banks — have also lost ground. Many small retailers went under due to repeals of state "fair trade" laws and of court decisions finding resale price maintenance to violate antitrust laws. The large chains that spearheaded such moves argued that consumers would get better deals as a result. But the moves also opened the way to giant big-box retailers, such as Walmart, that siphoned away so much business from the Main Streets of America that many became ghost towns. The changes also led to the closings of millions of locally owned businesses that had provided their communities with diverse products and services, some produced locally or regionally, and many jobs. Likewise, the deregulation of financial markets — demanded by Wall Street — allowed the street’s biggest banks to become far bigger, taking over markets that state and local banks had previously served and cutting off financing for many small local and regional enterprises.

It is possible that in coming years the major fault line in American politics will shift from Democrat versus Republican to anti-establishment versus establishment — that is, to the middle class, working class, and poor who see the game as rigged versus the executives of large corporations, the inhabitants of Wall Street, and the multimillionaires and billionaires who do the rigging.

By late 2014, big business and Wall Street Republicans were already signaling their preference for a Democratic establishment candidate over a Republican anti-establishment one. Dozens of major GOP donors, Wall Street Republicans, and corporate lobbyists told the Washington journal Politico that if the Republican Party did not put forward a candidate supportive of big business and Wall Street — Jeb Bush, Chris Christie, or Mitt Romney — they would support Hillary Clinton.

"The darkest secret in the big-money world of the Republican coastal elite is that the most palatable alternative to a nominee such as Sen. Ted Cruz of Texas or Senator Rand Paul of Kentucky would be Clinton," concluded Politico’s analyst. A top Republican-leaning Wall Street lawyer told the paper, "if it’s Rand Paul or Ted Cruz versus someone like Elizabeth Warren that would be everybody’s worst nightmare."

Everybody on Wall Street and in corporate suites, that is. And even if the "nightmare" does not occur in 2016, some such nightmare is likely within the following decade if economic and political trends don’t change. There is simply no way the American economy can be sustained if the richest 10 percent continue to reap all the economic gains while the poorest 90 percent grow poorer. There is no way American democracy can be maintained if the voices of the vast majority continue to be ignored.

For political scientists especially, attention must be paid. No other academic and intellectual field has such a direct stake, and so much expertise. Do not leave economic and public policy to economists. Economics did not even exist separately from political science until the great Alfred Marshall wrote his Principles of Economics in 1890. Adam Smith never called himself an economist because in the 18th century his field was known as "moral philosophy" — the study of what is best for a society. Now, in 21st-century America — in an era of wider inequality, a less functional democracy, and more concentrated political power at the top than in living memory — you have your work cut out for you.

Robert B. Reich is Chancellor’s Professor of Public Policy at the University of California at Berkeley and was secretary of labor under President Bill Clinton. His new book, Saving Capitalism for the Many, Not the Few, is just out from Knopf. This essay is adapted from a plenary address he delivered recently at the annual meeting of the American Political Science Association.