Economic Inequality, Part 1: Where We Are and Why

For three years, Darden Professors Jim Freeland and Ed Freeman, initially with the help of Professor Ed Hess, have taught a popular course titled “Economic Inequality and Social Mobility” to help students become more aware of what may be one of the defining challenges of their lifetime — economic inequality — and to focus on what business can do to help address the challenge.

The challenges posed by increasing economic inequality and how technology may exacerbate them is a matter being raised by a wide spectrum of leaders, including business heavyweights like Paul Tudor Jones (celebrated hedge fund manager), Bill Gates (principal founder of Microsoft) and Warren Buffett (CEO of Berkshire Hathaway). Nobel Prize-winning economists like Yale Professor Robert Shiller and Columbia Professor Joseph Stiglitz are sounding the alarm that it may be the most important problem the world is facing. Former President Obama has called it the defining challenge of our time. 

Increasing Economic Inequality

Addressing the issue of income inequality is not an argument that it is desirable that income and wealth should be equal across individuals or households. Capitalism allows those who work harder and/or smarter to do well economically. But since 1979, income and wealth inequality have been growing significantly, having recently reached levels not seen since the Great Gatsby era of the 1920s. While people across class boundaries have benefited from what Erik Brynjolfsson and Andrew McAfee, authors of The Second Machine Age, call the bounty — the increase in volume, variety and quality and the decrease in cost of many products and services — there has not been shared economic prosperity. 

For example, in the post-World War II period from 1946 to 1980, the bottom 90 percent of pretax income levels showed a cumulative growth rate of 68 percent while the top 10 percent had a 31 percent growth in income. However, since 1980 (through 2014) these percentages reversed so that the top 10 percent had a growth of 121 percent while the bottom 90 percent had a growth of 30 percent. Those in the bottom 50 percent showed almost no growth while those at higher income levels grew even more: the top 1 percent by 205 percent and the top 0.01 percent by 434 percent.

Wealth inequality — beyond income, the distance between people’s net worth — is even greater: Three individuals in the United States have combined wealth equivalent to the combined wealth of the bottom 50 percent of the U.S. population, and eight of the wealthiest men in the world have the combined equivalent of 50 percent of the wealth in the bottom 50 percent of the world’s population.

Even when there is a growth in the average or median income or wealth level, the growth is far from uniform: Those in the higher income or wealth levels have grown disproportionally compared to lower levels.

What’s Caused These Increases?

The root causes for the increase in economic inequality since 1980 can be argued, but the two major reasons usually given are globalization (particularly outsourcing) and skill-based technology changes — in which technology eliminates labor and creates some higher-skilled and higher-paying jobs and some lower-skilled and lower-paying jobs. 

• Other plausible contributors — that are more controversial for some — include:
• Managers in business believing their goal is to maximize value to the shareholders
• Adoption of financial incentives for CEOs to maximize shareholder value (implementing principal-agent theory) that has resulted in the average CEO compensation rising to 270 times average worker pay in 2016, up from a ratio of 27 to 1 in 1980
• Government policies involving taxation and market consolidation
• A booming stock market (only 16 percent of stock is owned by the bottom 90 percent of the income level, and the rest is held by those in the top income brackets)
• Growth of financial services focusing on financial engineering
• A weakening of labor unions

For a discussion of what economic inequality may bring in the future, please see “Economic Inequality, Part 2: Where We’re Going and Why It Matters."