The Left and Right Are Wrong About Inequality

The problem isn’t trade or corporations—it’s the monopolization by professional groups of high-profit services.

By Jonathan Rothwell

Businesspeople and shoppers walk along Madison Avenue in New York City on Nov. 1, 2011.

January 17, 2020, 11:13 AM

Over the last decade, right-wing and left-wing populism have gained traction in the United States—and, arguably, in many other rich democracies as well.

The right’s version of populism has taken a variety of forms: the pro-tariff and anti-immigration agendas of U.S. President Donald Trump, anti-corporatism as expressed by the former Trump advisor and Breitbart co-founder Steve Bannon, and greater skepticism toward markets more generally among many conservative intellectuals.

Meanwhile, on the left, an anti-corporate agenda has gone mainstream. Two of the leading Democratic candidates for 2020’s presidential election—Sens. Bernie Sanders and Elizabeth Warren—routinely discuss their plans to reduce the power of U.S. corporations. For example, Sanders would compel publicly traded companies to redistribute ownership, while Warren would force them to appoint board members based on worker preferences. For several years, Democrats have expressed more favorable views toward socialism than capitalism.

It’s likely the 2007-2008 financial crisis, recession, and federal government bailouts of big banks and automakers elevated the popularity of these views, but even setting that aside, the last 40 years have been characterized by slow economic growth; low personal savings rates; soaring costs for health care, education, and housing; and falling labor force participation rates of prime-aged men—and later women.

The last four decades have also been characterized by rising income inequality. This is true using pretax market data from the Congressional Budget Office, IRS data, or household survey data from the Census Bureau. To take the Congressional Budget Office numbers, the top 1 percent of earners saw their share of market income increase from 10 percent in 1980 to 18 percent in 2016. Estimates based of the IRS data, including by the economists Thomas Piketty, Emmanuel Saez, and Gabriel Zucman, put the share at around 20 percent. Whatever the method of calculation, the United States is one of the most unequal democracies in the world. The share of income going to the top in the United States is roughly three times higher than rates found in several Northern European countries.

Income inequality, as I argue in my new book from Princeton University Press, A Republic of Equals: A Manifesto for a Just Society, is not inherently bad. But it is a political problem when it is unfair. Unfair inequality occurs when rich people earn well beyond what they contribute. Excessive inequality, in that sense, is bound to be unfair.

Citizens, of course, pick up on that unfairness and look to leaders for explanations and remedies. During the 2016 Republican Party presidential primary, for example, Trump emerged as the leading candidate not among high-income earners—who supported more moderate Republicans like Jeb Bush and Sen. Marco Rubio, but rather among middle- and lower-income-earning Republicans, even though their exposure to trade competition and immigration was no higher than among those who do not support Trump.

Yet the diagnoses offered by populists on the right and left are based on fundamental misunderstandings of the reasons for inequality, and their remedies would fail to reduce it in any meaningful way.

The idea that corporations are the driving force behind income inequality is perhaps best understood in the theory that executives, board members, and shareholders successfully conspire to reward each other at the expense of rank-and-file employees, who are powerless to prevent it from happening. In this view, inequality is growing because the balance of power within firms has shifted toward executives, who are paid increasingly well compared to workers.

That theory doesn’t align with the facts. Research published in the Quarterly Journal of Economics last year examined U.S. tax data to see how pay inequality in firms has changed over the years. The authors of the article find that almost all of the overall increase in U.S. income inequality since 1980 has come from growing gaps between firms—not between workers within the same firm. Though there are certainly exceptions, the highest-paid workers in firms are not generally pulling away from the typical worker, rather, as the authors state, “workers’ earnings in almost all percentiles have evolved in line with those of their coworkers.”

Still, even if rising inequality between executives and workers at large corporations can’t explain the overall rise, it could be the case that corporations are driving inequality because of growing corporate control over the economy.

That also is not case. Corporations are not nearly as important economically as they used to be. From 1979 to 2018, the share of U.S. national income going to revenue from C corporations—which are taxed separately from their owners and can be publicly traded on stock exchanges—fell from 62 percent to 42 percent. Their profits as a share of national income fell by half over the period. Businesses are increasingly organizing as S corporations, which are usually very small, with one or two owners, and not publicly traded. In fact, scholars who study tax records have found that today’s rich are much more likely to own S corporations than be executives of traditional C corporations.

Going beyond the United States, it becomes clear that corporate economic influence can be compatible with an egalitarian society. Compared with the United States, corporate compensation is higher as a share of GDP in many countries that are seen as more egalitarian.

Corporate Share of Compensation and Income Inequality

Note: Data are from 2016 or closest year available. Source: European Commission and LIS Inequality and Poverty Key Figures

Another variant of the anti-corporate narrative is that inequality has increased as trade barriers have fallen, leading to offshoring that enriches executives in trade-oriented industries at the expense of workers. If this is true, then countries with the lowest trade barriers should have the highest levels of inequality. This too is not the case, nor is it true that manufacturing executives and workers more generally are increasingly top income earners. Their presence among top income earners has fallen in the United States and is generally low in most countries in the Organization for Economic Cooperation and Development (OECD). Certainly, some workers have suffered income losses as a result of displacement from trade competition, but layoffs are even more common in sectors that are sheltered from overseas competition. As recent academic work has shown, moreover, only a small fraction of workers experience long-term earnings losses as a result of import competition.

The populists are wrong about inequality, but another group—call them the anti-populists—are just as wrong. They claim that inequality is simply the price of prosperity. The basic argument is that markets create inequality because some people are simply better at making money. The upshot is that any policy agenda meant to curb inequality will harm efficiency and economic growth by preventing star entrepreneurs from realizing their potential.

One fundamental error they make is failing to distinguish among different causes of inequality. Certainly, highly successful entrepreneurship plays a role in inequality and also leads to economic growth. But unequal access to political power is perhaps a more important cause of both inequality in skill-generation and inequality in pay.

One indication that rising inequality in the United States and most other advanced countries has not purely resulted from entrepreneurship is that entrepreneurship has ground down over the last 40 years. Start-ups and young companies more generally are increasingly rare in the United States. Further, looking across countries, innovation and inequality are negatively correlated. The number of patent applications per capita is highest in egalitarian Japan and Northern and Western European countries, such as Switzerland and Sweden. Meanwhile, other than the United States, the most unequal OECD countries, such as Chile and Mexico, tend to generate very few patents.

Patents Per Capita and Income Inequality

Note: Inequality data are most recent available. Patent data are from 2000-2014. Source: OECD, Patent Corporation treaty applications, and LIS Inequality and Poverty Key Figures

Along these lines, innovative productivity growth has slowed across OECD countries. As the economist Robert Gordon has argued, 1870 to 1970 was a far more innovative era in the United States than 1970 to 2016—and that era was characterized by falling income inequality toward the end of the period. Rising inequality has coincided with an unmistakable slowdown in productivity growth.

Across rich democracies, the economy has shifted massively from goods production to service production. That is not an inherent problem, but service production brings challenges: The services provided by highly educated professionals (including financial services, legal, medical, education, and others) are expensive and, most importantly, subject to stringent regulations that are typically created by the insiders themselves. These regulations allow certain types of professionals to monopolize the provision of high-profit services.

Thus, in 2017, 43 percent of the top 1 percent of income earners working in the United States worked in medical, legal, or financial services, up from 30 percent in 1980. Another significant portion of top earners come from various other professional service industries as well, putting the 2017 total around 50 percent. In other words, essentially half of elite income earners in the United States either directly provide highly regulated services that require a license—such as doctors or lawyers—or work in a regulated skilled-service industry, such as finance, real estate, or health care. These industries are all largely domestic—and they are politically powerful.

Top 1 Percent of Income Earners by Industry-Occupation Categories

UNITED STATES, 1980-2017

Source: IPUMS USA, University of Minnesota

The American Medical Association, for example, has prompted the massively inefficient insurance company model of health care, as the historian Christy Ford Chapin has shown, and has carved out special privileges for doctors, helping them maintain their independence from potential cost-cutting bureaucracies, while allowing them to charge on a fee-for-service basis. Through the American Medical Association and its control over state licensing laws, doctors in the United States also hold a monopoly on valuable services. Hospitals enjoy the same, which gives them the power to charge absurd and arbitrary prices for basic services. The resulting model has made U.S. doctors, hospital owners, and insurance company executives abnormally rich at great expense to U.S. citizens.

Likewise, the American Bar Association has blocked efforts to allow alternative licensed professionals—like quasi-paralegals—from selling legal advice of any kind. Hedge funds, for their part, have managed to charge extraordinary fees by exploiting rules that forbid mutual funds from providing hedge fund-like investment strategies to their retail investors. The anti-populists fail to acknowledge how these political advantages consistently translate into gratuitous economic power, acting like a regressive tax on Americans.

As markets for professional services have been rigged to favor elite insiders, neither right-wing populism nor inequality can be fully explained without understanding the role of race and the way racial differences in political power have limited access to markets and stymied competition for elite professional jobs.

Internationally, racial diversity is highly correlated with inequality. Through a series of historical developments in the early 20th century, Northern and Western Europeans and their descendants in former British colonies found themselves in a position of economic and political power relative to the rest of the world. With an ideology of white supremacy already firmly in place, the Great Migration of African Americans out of the U.S. South and the large-scale immigration of Eastern and Southern Europeans motivated white Americans to set up formal institutions to segregate themselves from other groups and sharply curtail the ability of black people to participate in markets.

As a consequence of these institutions, racial and economic segregation remain extraordinarily high in the United States, and the upward mobility of African American children remains much lower than that of whites. Meanwhile, professional whites continue to benefit from limited competition from African Americans, who were explicitly denied membership in the most prestigious professional associations into the 1960s. Even today, U.S.-born white Americans under the age of 65 are three times more likely to be working as doctors or lawyers than U.S.-born black Americans.

Enduring patterns of racial inequality in social status, combined with racist ideology, have convinced a subset of populists—particularly whites who are not professional elites and not among the top 1 percent of earners—that new nonwhite migrants with low levels of formal education would be a permanent multigenerational drag on society, even as intergenerational data says otherwise.

In this way, the ideology of racial differences provides soil for right-wing populism to grow, drawing fertilizer from excessive income inequality.

A just society would likely still have moderate levels of income disparity, but nothing like what is found in the United States. But to get to that future, politicians will need to move on from their flawed emphasis on corporations and globalization. Cutting down extreme inequality in incomes will require equalizing political power. That means providing not just equal voting rights and access to public services, but also access to markets for housing, financial, and professional services. Granting that access would work as a powerful decentralized force for curbing inequality.

If this doesn’t happen, the unfairness of the economy will continue to damage the financial and political health of the country. The fruitless back-and-forth between populists and anti-populists will continue, with both groups arguing past one another with the wrong solutions.

Jonathan Rothwell is the principal economist at Gallup, a nonresident senior fellow at the Brookings Institution, and a visiting scholar at George Washington University. Twitter: @jtrothwell