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Alice H. Amsden

Alice H. Amsden, professor of political economy at MIT, is the author
of The Rise of the Rest: Challenges to the West From
Late-Industrializing Countries

  • Inequality August 15, 2002

    Gilded Age II

    How did it all start? What triggered the 1990s political corruption, its inequality in wealth and its stock market bubble? This is the decade that Kevin Phillips rails against in his historical epic of how the rich get richer and the poor get further in debt.

    Arguably it all started in Silicon Valley, with a little help from the Department of Defense (which pioneered the epochal breakthroughs--transistor and Internet--that sparked the electronics revolution). Given the government's basic research, such private companies as Hewlett-Packard, Microsoft, Apple, Intel and Cisco generated creative, profitable products using new technologies. As the intellectual property of these well-managed companies began to rise, their stock prices began to rise, as did those of their suppliers, buyers, competitors, financial consultants, management analysts, lawyers and accountants. Even the stock prices of companies unrelated to high tech began to soar.

    The frenzy struck executive salaries. Top-notch high-tech managers made a lot of money because their pay was tied to stock options. As their company's stock price skyrocketed, so did their salaries. Soon other corporate leaders--good, bad and indifferent--tied their own salaries to the price of their company's stock. The financial markets regarded stock options as a way to make managers more "efficient" using the litmus test of stock-price performance. In practice, some managers cooked the books and inflated stock prices by making risky short-term investments and acquisitions. Long-term investments in new plant, equipment, research and intellectual property, necessary for permanent jobs, became an afterthought.

    As Phillips shows, the greed of corporate America was such that in the 1960s, the pay of corporate CEOs was "only" about twenty-five times that of hourly production workers. In the 1970s, the ratio was around thirty to one. It rose from ninety-three times in 1988 to 419 times in 1999. Between 1990 and 1998, the wages of ordinary workers barely kept pace with inflation or grew at single-digit rates. Meanwhile, top executives of America's biggest corporations enjoyed compensation increases of 481 percent! (Appalled by the eye-popping numbers on executive pay, Paul Krugman referred to Wealth and Democracy in one of his columns in the New York Times.)

    With so much money sloshing around, contributions by business to politicians increased. With more campaign funding, deregulation resumed where Reagan left off, and upper-bracket tax rates mellowed. Phillips shows that the effective federal tax rate (income and FICA, or Social Security and Medicare) for the top 1 percent of families fell from 69 percent in 1970 to about 40 percent in 1993, with plenty of loopholes remaining. Over the same period, the tax rate for the median family increased from 16 percent to 25 percent. Between 1950 and 2000, corporate taxes as a percentage of total tax receipts fell from 27 percent to 10 percent while FICA (mostly paid by the middle class) jumped from 7 percent to 31 percent.

    Regulation was critically lax in the accounting industry's scandals, as we now know. Phillips's book predates news of this disgrace, but he anticipates most of what happened. Deal by deal, the Big Five all began to relax established auditing norms; otherwise they would have lost big customers to one another. When chairman Arthur Levitt Jr. of the Securities and Exchange Commission proposed to investigate, the Big Five went to Washington. The SEC was called off the job; the Clinton Administration caved in. As for the telecommunications sector, now bleeding billions from overcapacity, its relations with the government were similar to those of the railroads in the robber-baron age. In the late nineteenth century, railroad tycoons were given free access to land worth millions of dollars; in the 1990s, the telecommunications industry was given publicly owned electromagnetic spectrum worth billions of dollars. Phillips shows that, among the top thirty billionaires reported by Forbes for 2001, eight were in high-tech electronics, including software, and eight were in media.

    So, starting with Silicon Valley, one can tell a story about the 1990s that may be flat-footed but that at least moves from cause to effect in a linear fashion. This, however, is not the story that Kevin Phillips chooses to tell. Or maybe it is, but his writing style is so roving, rambling and roundabout that it is difficult to find a coherent story anywhere, although the parts are sure to be found somewhere, and are often juicy. He aims a shotgun rather than a rifle at the fin de siècle's cast of cruddy characters.

    Phillips doesn't start in Silicon Valley because, at heart, he is an antitechnologist. For Phillips, technology merely makes mischief. "From early textile machinery to the Internet," he writes, the early stages of major innovations have generated rising social and economic inequality almost as a matter of course." (But how about the millions of jobs created in textiles and the Internet at a slightly later stage?) Elsewhere he states: "We can likewise doubt that technology has outweighed representative government, effective markets, and English-speaking freedoms in achieving the economic leadership of Britain and then the United States." Really? Phillips's dismissal of technology as a major factor in the economic hegemony of first England and then the United States is strange because he shows contempt for the alternative explanation--an obsessive love of market forces and laissez-faire. Technology is bad in Phillips's view simply because it breeds speculation. There are no heroes.

    Notwithstanding Phillips's chaotic style and his neglect of the real economic forces that govern wealth accumulation and distribution (such as technology), he does a big service for his readers by providing them with bytes of information on wealth inequality and democracy's warts.

    Phillips, historically a card-carrying Republican, regards his reformist, liberal politics as nothing strange. It follows in the footsteps of great past Republican reformers like Lincoln and Theodore Roosevelt. Phillips considers Franklin D. Roosevelt one of the team because--his affiliation to the Democratic Party notwithstanding--he was rich but a reformer of radical scope (responding, one might add, not necessarily to his conscience but to social unrest). For most Republicans, Phillips has nothing kind to say. "The Democrats," he writes, "were the more important incubators of the Internet mania, but the underpinning economic spirit was the market-deifying, tax-cutting, and assets-aggrandizing conservatism given its head in the eighties. This part of the framework was more Republican."

    The Republican pedigree lets Phillips get away with murder. He rants and raves in a way that someone on the left would be skewered for. The result, however, is welcome. It is satisfying to read an analysis of the US economy from the standpoint of greed and conservative morality.

    The history lessons Phillips administers range from Aristotle to the Gilded Age of the 1920s, which he contrasts with Gilded Age II of the 1990s. He examines Holland's tulip mania and its economic decline as a world power, comparing its fall with that of Britain and possibly the United States. In one table, culled from the Wall Street Journal, he lists the wealthiest people of the past 1,000 years, starting with Al-Mansur (938-1002), the Moorish regent of Cordoba, who got rich through plunder, moving to Kublai Khan, ruler of China (1215-94), who got rich from inheritance and confiscation, and ending with Bill Gates (1955-), the US software executive, who got rich on stock ownership in Microsoft.

    Other facts and figures are no less interesting, and some of Phillips's charts are ingenious. To show the "giantizing" of wealth enjoyed by the richest person in the realm, Phillips compares the largest fortune at the time to that of the median family or household. In 1790, the ratio of the richest man's wealth, Elias Derby, to the median was 4,000 to 1. By 1868, the ratio of Cornelius Vanderbilt's wealth (in railroads) to the median was 80,000 to 1. For John D. Rockefeller in 1912, the ratio was 1,250,000 to 1 (in 1940, it fell to 850,000 to 1). In 1962, the ratio for Jean Paul Getty was 138,000 to 1. For Sam Walton in 1992, it was 185,000 to 1. For Bill Gates in 1999, it was the blockbuster, 1,416,000 to 1! Presumably, the ratio increased over time as the United States moved from an agrarian economy to one based on modern transportation (railroads), natural resource exploitation (copper, oil) and then manufacturing, where new product innovations could flourish.

    Compared with other wealthy countries, inequality in the United States is extreme. In the 1990s, the income ratio in Japan of the top fifth of households to the bottom fifth was only 4.3 to 1. (A similar ratio exists in Korea and Taiwan, which, like Japan, had a land reform after World War II.) European social democracies tended to have ratios of 6 or 7 to 1 (5.8 in Germany). The US ratio was 11 to 1 or higher, depending on the source. Presumably this reflected the United States' cowboy capitalism, its rich raw materials, its pioneering technologies and its corporations' ability to mass-produce for a vast domestic market.

    Wealth (which Phillips never defines) is essentially the difference between inflows and outflows of income, which is savings in the case of households and profits in the case of firms. Once wealth is attained, its holder has to figure out what to do with it. Thus, the financial services industry usually expands as wealth expands. In the 1990s the finance, insurance and real estate sector (FIRE) overtook manufacturing in US national income, "enabled by a dozen federal rescues and preferences, begun in the eighties and consummated in the nineties." The thirty richest individuals in 2001 also included eight in finance, investments and real estate--including Warren Buffett, George Soros and Ross Perot. As finance grows, Phillips argues, the likelihood of a technobubble grows exponentially.

    What does it all mean, the rising inequality and "financialization" of the economy?

    Business as usual, insofar as Gilded Age II is merely a catch-up with Gilded Age I. Between 1922 and 1997, the share of total wealth of the top 1 percent of households spiked in 1929 at 44.2 percent, tumbled to 33.3 percent in 1933, reached a nadir of 19.9 percent in 1976 (as profits plunged with the energy crisis) and hit 40.1 percent in 1997 (the estimates are from Edward Wolff). As the stock market boomed in 1997-2000, the wealth of the richest rose further, but atomized with the crash of 2000, into the present. Wealth inequality appears to be wired into the American system.

    Relative increases in the wealth of the rich, moreover, are often compatible with increases in real wages and productivity. The average family's real income increased 30 percent between 1960 and 1968 as the ranks of millionaires swelled. Then came the era of stagflation. According to the Council of Economic Advisers, average hourly earnings, adjusted for consumer prices, fell by 0.5 percent a year from 1978 to 1995. They then rose at a piddling 2 percent a year from 1995 to 2000, in tandem with rising productivity and the "irrational exuberance" of the stock market. Thus, wealth inequality does not preclude modest increases in income for other social classes.

    Yet, inequality matters, depending on the use to which wealth is put. And that in turn depends on the economic and social profile of the accumulating classes. Kevin Phillips, however, is not keen on "class analysis." "'Class warfare' a false description," he writes, "a perverse conservative borrowing from Karl Marx," because the United States has had rich reformers and poor Republicans.

    Still, one doesn't have to emulate Karl Marx in the Grundrisse to emphasize that the new American class of rich is different from the railroad barons or the oil money of old. For one, it is extremely well educated. Between 1975 and 1998, the mean annual earnings of US workers with less than four years of high school fell steadily. Those of high school graduates stagnated. Those of college graduates rose slightly. Those of people with advanced degrees soared, particularly after 1990, when the demand for economists, lawyers, accountants and MBAs heated up (as noted by Edward Wolff).

    Investments of the new superrich, therefore, are likely to gravitate toward new technologies in manufacturing and services, and fancy finance. With high educational attainments, the new elite may be expected to command a lot of money and social legitimacy, which the old tycoons never quite managed. A mere college education is no longer a guarantee of upward mobility, as Washington policy-makers still believe. For most ordinary people without a college degree or fancy MBA, the new rich have created a tougher world. Horatio Alger now goes to graduate school.

    The second defining characteristic of the new rich is their internationalism. They hire, produce and market globally, and have mobilized bipartisan political support for operating overseas.

    That all started with strong competition from Japan in the 1980s. Technologically behind the United States, Japan had more government interventions to help business grow (as did Korea, Taiwan, China, India, etc.). The United States regarded this as unfair, and shoved a "level playing field" down everyone's throat--backward and advanced countries have to be equal with open markets, free of government's foul play.

    The financial services sector, with large-scale economies, benefited enormously from Washington's dismantling of developing countries' barriers to foreign banking and regulations of inflows and outflows of "hot," destabilizing money. Deregulation was soon followed by the Asian financial crisis of 1997. The Treasury still publishes a book each year documenting on a country-by-country basis the remaining obstacles abroad to American financial institutions. The pharmaceuticals industry benefited from the extension of patent enforcement to developing countries notwithstanding their need for cheap medicines. The software industry pressed for protection of intellectual property.

    Strangely, Phillips hardly talks about globalization at all. But from stray sentences we can assume he doesn't like it, especially its effect on domestic jobs. Yet lobbying in Washington for protection of jobs that can be provided more efficiently in lower-wage countries is little different in principle from lobbying for tax breaks and deregulation for the rich. They are both a form of political corruption.

    Phillips ends his 470-page book with a tepid recommendation, given the preceding fire and brimstone. It is to end the "democratic deficit," which puts power in the hands of unelected organizations--the judiciary, the Federal Reserve and the WTO. But Washington has a large say in the WTO, controls the World Bank and has a loud voice in the International Monetary Fund. For American business, that deficit is small.

    Is, therefore, American foreign economic policy likely to give the new class of rich the global stability it desperately requires? No, if Kevin Phillips is right and inequality does matter. Internationally, economic inequality among countries has grown like Topsy. As industrialization spread unevenly, the ratio in per capita income of the richest to the poorest regions of the world rose from about 3 to 1 in 1820, to 5 to 1 in 1870, to 9 to 1 in 1913, to 15 to 1 in 1950. Then, as East Asia grew, the ratio fell in 1972 to 13 to 1, but rose steeply to 19 to 1 in 1998, the age of hardball globalism (data are from Angus Maddison, The World Economy). Global distribution of income and wealth is becoming as important to the American rich as domestic distribution, and both are highly skewed.

    Phillips doesn't consider any of this, but that's fine. He makes a real contribution by showing how American politics works, what really goes on behind the fortunes.

    Yech! What a scene!

    Alice H. Amsden