As Income Gap Balloons, Is It Holding Back Growth?

Originally published on July 10, 2011 8:16 pm

Members of the Federal Reserve Board of Governors tend to speak cautiously: Their words can move markets. Yet last month, Fed governor Sarah Bloom Raskin was remarkably candid about the growing gap between America's rich and poor.

"This inequality is destabilizing and undermines the ability of the economy to grow sustainably and efficiently," she said. Income inequality, she continued, "is "anathema to the social progress that is part and parcel of such growth."

The income gap in the United States has ballooned: It's wider than any time since 1928, in the days before the stock market crash triggered the Great Depression.

The numbers are startling: Top CEO salaries were up 23 percent last year, according to the New York Times; the average worker's pay was up only .5 percent. Meanwhile, the top 0.1 percent of American earners now take in more than 10 percent of the nation's collective income. That puts the U.S. in the same inequality ballpark as developing countries like Cameroon and Ivory Coast.

This degree of income inequality has produced plenty of outrage — most of it about the moral implications of the gap.

But is income inequality putting the brakes on the stalling economy? And how did the gap between the wealthy and the middle class get so big?

A dairy business in Illinois may hold some answers.

From Cadillac To Corporate Jet

Kenneth Douglas had the good life. He had a three-bedroom house in the Chicago suburbs. He drove a Cadillac to work. He belonged to a country club.

Douglas was the CEO of Dean Foods, a dairy company. During his tenure from 1970 to 1987, Dean increased its yearly sales from $165 million to $1.4 billion. Yet his annual salary never topped $1 million.

According to Peter Whoriskey of The Washington Post, "The board said, 'We want to give you some more money' " as a reward for the company's success. "And he would say repeatedly, 'No.' He was making enough."

Whoriskey reports that the culture of corporate modesty at Dean Foods is a relic. The current CEO, Gregg Engles, lives a much different life.

"He has averaged about $10 million a year," Whoriskey tells weekends on All Things Considered host Guy Raz. "He's got a $6 million house in Dallas. He's got property in Vale. He's got membership at four different golf clubs. He's got a corporate jet."

"It's a whole new level of executive grandeur that we see today."

But while the current CEO of Dean Foods makes 10 times the amount the company's CEO did 30 years ago, the rest of the employees make on average 9 percent less than they would have in the 1970s, after you adjust for inflation.

So how do the employees feel about executive pay?

"They were resentful of it," says Whoriskey. "But for the most part, they were just trying to figure out how to get by. They honestly said they were just happy to have jobs."

Wage Stagnation Nation

Economists disagree widely about how the U.S. has gotten to this point. Some blame globalization and technology for eliminating manufacturing jobs. Others say our education system hasn't done enough to keep America competitive. Some argue the power of unions has gradually declined.

Jeff Madrick, the author of Age of Greed: The Triumph of Finance and the Decline of America, traces U.S. inequality to changes in U.S. economic policy several decades ago.

"In the 1970s, there was an assault on government oversight and regulation," Madrick tells Raz. "And eventually, the financial community stopped playing by the rules. There was an economic theory that kept justifying what they were doing. And the American public was not fully aware of what was going on."

The traditional argument for deregulation states that those policies make America richer, and that a rising tide lifts all boats.

But Madrick says that for the typical American worker, the wage tide has gone out since 1969.

"The typical male worker makes less today, discounted for inflation, than the typical median worker made in 1969," says Madrick. "The idea that people make the same or less today than they made 40 years ago is a stunning historical fact."

Financial Failure: Inequality's Dance Partner?

David Moss is a professor of economics at Harvard Business School. Back in 2008, he was researching U.S. bank failures from the 19th century to the present. He charted those failures over time and found an interesting pattern.

"They peak up in crisis years. They peak in the 1920s," Moss tells Raz. "But then most striking, after 1933, when we saw the introduction of federal banking and financial regulation, these banking crises disappear almost completely. And then it continues very, very low until the 1980s, then they pick back up again."

Moss found it striking that banking failures go down after financial regulation and start rising after the introduction of deregulation.

Then, one of Moss' colleagues showed him a chart of income inequality over the same period. Moss took that curve and plotted it on the same page as his bank failure curve.

"And lo and behold, it was a striking, striking connection," Moss says.

As bank failures went up in the 1920s, so did income inequality. As inequality came down in the 1930s, bank failures stayed down. They stayed down together until the advent of deregulation in the 1980s.

For Moss, this coincidence raises more questions than it provides answers. He isn't sure what exactly the correlation between income inequality and financial failure means.

"Is there a connection especially between extreme inequality and economic growth?" Moss asks. "Does it cut down on demand? Spending not as vibrant? Do we see more borrowing? Do we see more risk taking at excessive levels? Deregulation feedback loops?"

These are questions Moss hopes he can answer with future research.

Sarah Bloom Raskin, the Federal Reserve governor, points to studies that suggest income inequality could cause economic turmoil.

Raskin tells Raz that "growing levels of income inequality are associated with increases in crime, profound strains on households, lower savings rates, poorer health outcomes, diminished levels of trust and people and institutions — those are all forces that have the potential to drag down economic growth."

If income inequality can negatively affect the whole economy, then what can be done to combat it?

Social Solutions To An Economic Problem

One year ago this month, Congress passed the Dodd-Frank financial reform bill, designed to increase oversight and regulation of the financial markets.

But so far, unlike the regulations put in place after the Great Depression, Dodd-Frank hasn't done much to shrink the inequality gap. Regulators say they've struggled to implement the bill's many rules. Many are being rolled out well behind schedule.

In the meantime, Moss suggests more social-oriented solutions.

He says that World War II had a profound effect on how executives saw themselves in American society.

"I think that probably led many executives to not even think about asking for the kind of salaries that are now typical," he says. "It wouldn't have seemed right."

Moss wonders what sort of programs could foster that same feeling in the CEOs of today.

"Could there be some kind of compulsory or voluntary public service at a young age, where people come together across groups that don't normally come together?" Moss asks.

"It seems to me that trying to build communities, bring people together from different parts of the spectrum and different parts of the country, probably has, long term, the best likelihood of bringing down inequality."

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GUY RAZ, host: From NPR News, this is WEEKENDS on ALL THINGS CONSIDERED. I'm Guy Raz.

A couple weeks ago, Sarah Bloom Raskin, a member of the Board of the Governors of the Federal Reserve, gave a speech here in Washington. And the topic was the growing gap between rich and poor in America. And in that speech, she said something striking.

SARAH BLOOM RASKIN: This inequality is destabilizing and undermines the ability of the economy to grow sustainably and efficiently. It is so...

(SOUNDBITE OF MUSIC)

RAZ: We'll hear more from Raskin in a moment. Now, when Federal Reserve governors speak, they speak cautiously. Their words can move markets. But what Sarah Bloom Raskin was essentially saying was this: The economic recovery might be slow going for a long, long time if the income gap continues to grow.

And how big is it? Well, the latest statistics show that right now, the wealthiest 1 percent of Americans earn more than 20 percent of all the money generated in this country each year. And the last time the gap was so wide, 1928, right before the stock market crashed, leading to the Great Depression. That's our cover story today: the growing income gap, why it might be making the economy worse.

(SOUNDBITE OF MUSIC)

RAZ: In a recent issue of The Washington Post, reporter Peter Whoriskey wrote about a man named Kenneth Douglas, who was a corporate executive back in the mid-1970s.

PETER WHORISKEY: He is the CEO of Dean Foods, which is a dairy company that has become one of the largest dairy companies in the U.S.

RAZ: Kenneth Douglas was, by all accounts, a talented CEO.

WHORISKEY: The company is doing great. Profits are going up very quickly. Revenues are going up very quickly. All of these good things are happening to the company. And a board - his board of directors said, Ken, we want to give you some more money. And he would say, repeatedly, no. He was making enough.

RAZ: Douglas thought it would be bad for morale. Besides, he was happy with his pay. His compensation package, in today's dollars, was a million bucks a year. Douglas had a nice three-bedroom home in the Chicago suburbs. He had access to a company car, membership in a country club. But that was the 1970s.

Today, things at Dean Foods are a lot different, especially for the current CEO, a man named Gregg Engles.

WHORISKEY: He had averaged about $10 million a year, 10 times as much as Ken Douglas, and he lives a much different life.

RAZ: How so?

WHORISKEY: Well, he's got a $6 million house in Dallas. He's got property in Vale. He's got membership in four different golf clubs. He's got a corporate jet. Ken Douglas, back in the '70s, had a Cadillac. But it's a whole new level of executive grandeur that we see today.

RAZ: Gregg Engles is hardly an extreme case. Last year, top CEOs saw their pay rise by 23 percent, according to a recent New York Times study. The average worker? A pay increase of just half a percent. And corporate executives now account for most of the very richest Americans. Peter Whoriskey found that executive pay has gone up 400 percent since the 1970s.

And at Dean Foods, after you adjust for inflation, the average employee actually makes 9 percent less than they would have in the 1970s.

WHORISKEY: They honestly said they were just happy to have jobs.

RAZ: Whoriskey actually traveled to a Dean Foods milk plant to speak with some of those workers.

WHORISKEY: They said they thought about how much the new CEO, Mr. Engles, makes. They were resentful of it. But for the most part, they were just trying to figure out how to get by, and a lot of them have second jobs.

(SOUNDBITE OF MUSIC)

RAZ: According to the Federal Reserve, over the past two years, middle incomers, these are families earning around $50,000 a year, saw their net worth drop by 20 percent. The numbers are even worse for the poorest fifth of Americans. But for the top 1 percent, it's almost the reverse. They're earning more, a lot more. And economists have different theories as to the economic consequences of this gap.

Here's one of them: America's economy has long depended on middle class consumer spending. It's the engine of our economy. So if 90 percent of Americans are either seeing their wages stagnate or worse, what happens when the engine starts to sputter, when people can't spend money?

That's a question I put to Sarah Bloom Raskin, a Federal Reserve governor we heard from earlier.

RASKIN: Combine with widespread unemployment, you know, housing and stock market declines, increasing rates of mortgage defaults, foreclosures and bankruptcies, the assets of many American families have been significantly eroding. One consequence of this is we want to understand better how inequality is growing through both a fall in the bottom as well as a rise in the top.

RAZ: If this gap continues to grow, could you conceive a future where there is a relatively small middle class in America? A middle class that is not necessarily able to sort of drive the engine of the U.S. economy, which traditionally, of course, has been consumption.

RASKIN: I think that that's something that needs to be looked at carefully. I mean, clearly, there have been studies showing that growing levels of income inequality are associated with increases in crime, profound strains on households, lower savings rates, poorer health outcomes, diminished levels of trust in people and institutions. And those are all trends that I think are forces that have the potential to drag down maximum economic growth.

RAZ: That's Sarah Bloom Raskin. She serves on the Board of Governors of the Federal Reserve, and she spoke to me from her office here in Washington. Governor Raskin, thank you.

RASKIN: Thank you.

RAZ: A Harvard economist named David Moss studies income inequality. Then three years ago, he had a breakthrough.

DAVID MOSS: Well, there is a chart that I had created back in late 2008, looking at bank failures from the 19th century up to the present. And an interesting pattern emerged, which was they peak up in crisis years, which occurred fairly often. And then they peak up especially in the 1920s.

But then most striking, after 1933, when we saw the introduction of federal financial regulation and banking regulation, these banking crises disappear almost completely. So close to zero, you can almost not tell the difference. And then it continues very, very low until the early 1980s, then they peak back up again.

Anyway, so I made that chart and...

RAZ: So, he had this chart of bank failures. And, of course, the 1980s marks a point of a return to deregulation. A few months after making this chart, one of David Moss' colleagues mentioned a similar chart, except one that looked at income inequality. And he asked Moss...

MOSS: Have you ever thought about how that curve looks almost exactly like this chart on bank failures? And so, we took that curve and we plotted it on the same page with bank failures. And lo and behold, it was a striking connection. So as bank failures started to go up in the 1920s, inequality was going up in the 1920s. And as inequality came down in the 1930s, bank failures came down and stayed down.

They both stayed down together through the '40s, '50s, '60s, '70s, just about the time we see financial deregulation, off they both go. Inequality goes up and bank failures go up together. Who knows exactly what's causing what there, if anything. But there was certainly quite a remarkable coincidence.

RAZ: So there is, in your view, a correlation between income inequality and financial failure, economic failure.

MOSS: I think there's probably some connection, although again I wish we knew for sure. But there are a lot of hypotheses, and some of them may well turn out to be true. There are a lot of people looking at it, is there a connection between especially extreme inequality and economic growth? Does it cut down on demand? Do we see spending not as vibrant? Especially coming out of a recession when inequality is high, do we see more borrowing? Do we see more risk taking?

Some people suggests, I think there might be something to this, that as you get higher inequality, up at the top, there is more and more resources in order to lobby Congress and so on and you get more deregulation of key sectors, including the financial sector. The more you do that, the more inequality rises and on and on. And so, those are, I think, some of the things that we should be looking at in trying to understand.

RAZ: How would you suggest narrowing that gap? I mean, is it just a matter of getting the economy back up and running as it once was?

MOSS: Well, getting the economy up and running is a big part of it. As many people say, we need to think about education. How do we make sure that we're doing a good job of education all across the spectrum? But then there are some things that aren't talked about too much.

My guess is if you say why did inequality come down so much after the '30s, a very large role was the war. The war brought people together across every income, ethnic, other class. I think that probably led many executives, for example, at leading corporations just to not even think about asking for the kind of salaries that are now typical.

I think that gradually, that sense of cohesion has begun to atrophy. It's begun to break. And now people feel much more comfortable asking for the kind of salaries that they're getting at the very, very top end.

RAZ: Harvard economist David Moss.

Writer and historian Jeff Madrick recently wrote a book about how we got here and where we might be headed. It's called "The Age of Greed."

JEFF MADRICK: In the 1970s, there was an assault on government oversight and regulation. It was followed through time and again over the ensuing years. And eventually, the financial community stopped playing by the rules. They - there was an economic theory that kept justifying what they were doing. And the American public were not fully aware of what was going on.

RAZ: Why is the income inequality gap a problem, in your view? I mean, what does it matter if there's a gap? I mean, does it affect everybody?

MADRICK: Well, you know, we should think of it not only as a gap. In fact, we should think of it more as stagnation of wages. And stagnation of wages really bothers me. The typical male worker today in the middle of the pack, the median, makes less today, less discounted for inflation, than the typical median worker made in 1969. The idea that people make the same or less today than they made 40 years ago is a stunning historical fact.

RAZ: Has the idea of greed, has it become a patriotic idea in the minds of most Americans?

MADRICK: I think it's become acceptable. It's become even something to be proud of. I doubt it's a patriotic or American thing. But I suppose you're getting to an interesting point. Do we think it's part of our heritage? It would be dead wrong to think so. Self-interest is central to a free enterprise system.

But greed implies something else. Greed implies making so much money you're willing to violate the rules. And that begins to undermine the economy, undermine prosperity and, most important, undermine the potential for economic growth.

(SOUNDBITE OF MUSIC)

MADRICK: Economic historian Jeff Madrick, author of "The Age of Greed." He also notes that the gap between rich and poor in America is now wider than Cameroon, Nigeria, India and even Egypt. Transcript provided by NPR, Copyright NPR.