7 Player Piano

PLAYER PIANO WAS the very first novel published by the great American fabulist Kurt Vonnegut.1 It is a dystopia about a world where most jobs have disappeared. Written in 1952 in the wake of the great postwar expansion of jobs, it was either extremely farsighted or astoundingly misguided, but, either way, it’s a perfect novel for our times.

A player piano is a piano that plays itself. In Vonnegut’s world, machines run themselves and people are no longer needed. They are provided for, and get to do various forms of make-work, but there is nothing meaningful or useful they can do. As Mr. Rosewater, a character in a later (1965) novel by Vonnegut puts it: “The problem is this: How to love people who have no use?”2 Or even have them not hate themselves?

The increasing sophistication of robots and the progress of artificial intelligence has generated considerable anxiety about what would happen to our societies if only a few people had interesting jobs and everyone else had either no work or had a horrible job, and inequality ballooned as a result. Especially if this happened because of forces largely out of their control. Tech moguls are getting desperate to find ideas to solve the problems their technologies might cause. But we don’t need to contemplate the future in order to get a sense of what happens when economic growth leaves behind the majority of a country’s citizens. This has already happened—in the United States since 1980.

An increasing number of economists (and of those who comment on economics) worry that new technologies, such as AI, robots, and automation more generally, will destroy more jobs than they create, making many workers obsolete and causing the share of GDP that goes to pay wages to dwindle. In fact, these days growth optimists and labor pessimists are often the same people; they both imagine future growth will be primarily driven by the replacement of human workers by robots.

In their book The Second Machine Age, our MIT colleagues Erik Brynjolfsson and Andrew McAfee offer a bleak view of the impact of digitization on the future of employment in the United States.3 Digitization, they suspect, will make workers with “ordinary” skills increasingly redundant. As tasks from car painting to spreadsheet manipulation are done by computers or robots, highly educated workers who are adaptable and can program and install the robots will become more and more valuable, but other workers who can be replaced will find themselves without jobs unless they accept extremely low salaries. In this view, artificial intelligence will be the final nail in the coffin of these ordinary workers.

In the first IT revolution, as David Autor has shown, jobs involving routine repetitive tasks were the ones that went.4 Jobs that required quick judgment and initiative stayed put. The number of typists and assembly-line workers diminished, but executive assistants and burger flippers kept their jobs. This time, many say, it is different. Artificial intelligence means machines can learn as they go and are therefore able to carry out increasingly nonroutine tasks, such as playing Go or folding laundry. In June 2018, a restaurant offering robot-made burgers opened in San Francisco. Humans are still taking the orders and cooking the sauces, but the robots cook the gourmet burgers, such as the Tumami Burger (“Smoked oyster aioli, shiitake mushroom sauce, black pepper and salt, pickles, onion, butter lettuce—Designed by Chef Tu, Top Chef Season 15”5), in five minutes and for $6. Esther’s sister Annie Duflo, the CEO of a large NGO, does not have a human assistant; she relies exclusively on an AI-powered assistant named Fin. Fin books her hotels and her plane tickets, manages her calendar, and takes care of her travel reimbursements. Annie is, sadly, much happier with Fin than she was with her human assistants. She pays him (her? it?) much less and gets much more reliable service. To be sure, there are some humans behind Fin, but fewer and fewer, and the business model is clearly to move away from them.

The AI revolution is thus poised to hit people across a wide spectrum of jobs. Accountants, mortgage originators, management consultants, financial planners, paralegals, and sports journalists are already competing with some form of artificial intelligence or, if not, will soon. Cynics might say it is precisely because these more high-end jobs are on the line that we are finally talking about this, and they may be right. But AI will also hurt shelf stackers, office cleaners, restaurant workers, and taxi drivers. Based on the tasks they perform, a McKinsey report6 concludes that 45 percent of US jobs are at risk of being automated, and the OECD estimates that 46 percent of the workers in OECD countries are in occupations at high risk of being either replaced or fundamentally transformed.7

Of course, what this calculation misses is that as some tasks get automatized, and the need for humans gets relieved, people can be put to work elsewhere.

So how bad will it be on net? Economists are of course intrigued by this problem, but in this case they have entirely failed to reach a consensus. The IGM Booth panel of experts were asked their opinion of the following statement: “Holding labor market institutions and job training fixed, rising use of robots and artificial intelligence is likely to increase substantially the number of workers in advanced countries who are unemployed for long periods.” Twenty-eight percent of respondents agreed or strongly agreed with it, 20 percent disagreed or strongly disagreed, and 24 percent were uncertain!8

The difficulty is that doomsday (if it is coming) has not arrived. Robert Gordon, whom as we have seen does not think too highly of today’s innovations, likes to play “spot the robot” when he travels.9 For all the talk, he says, it is still a human clerk who checks him in at the hotel, cleans his room, serves his coffee, and so on.

For the time being, humans have not been made redundant. Unemployment in the United States, as we write this book in the first quarter of 2019, is at a historical low and falling.10 With more and more women joining the labor force, the share of the population in the labor force rose substantially until about 2000 (when it started to plateau or reverse).11 Jobs were found for all those who wanted to work, despite rapid labor-saving technological progress.

Of course, it is true we are probably just at the very beginning of the process of AI-fueled automation. The sense that artificial intelligence is a new class of technology makes it hard to predict what it might do. Futurologists talk about a “singularity,” a dramatic acceleration of the rate of productivity growth fueled by infinitely intelligent machines, although most economists are quite skeptical that we are anywhere close to seeing something like that. But it could well be that if Gordon plays spot the robot in a few years, he will have a more exciting time.

On the other hand, while this particular wave of automation is just starting, there have been others in the past. Like AI today, the spinning jenny, the steam engine, electricity, computer chips, and computer-assisted-learning machinery all automatized and relieved the need for humans in the past.12

What happened then is very much what one might have expected: by replacing workers with machines on some tasks, automation has a powerful displacement effect. It makes the workers redundant. This is what happened to the skilled artisans spinning and weaving at the dawn of the industrial revolution. They were replaced by machines. And as is well known, they did not like it one bit. In the early nineteenth century, the Luddites destroyed machines to protest the mechanization of weaving, which was threatening their livelihoods as skilled artisans. The term Luddite is now mostly used pejoratively to describe someone who blindly refuses progress, and their example is often used to dismiss concerns about technology creating unemployment. After all, the Luddites were wrong—jobs did not vanish, and wages and living conditions are much higher today than they were then.

Yet the Luddites were less wrong than we might assume. Their particular jobs did vanish in the industrial revolution, along with the jobs of a whole range of artisans. We are told that in the long run everything was fine, but the long run was very long indeed. Real blue-collar wages in Britain were almost halved between 1755 and 1802. Although 1802 was a particularly low year, they were on a declining trend between 1755 and the turn of the century, and it is only at the turn of the century that they started increasing again. They would recover their 1755 level only in 1820, sixty-five years later.13

This period of intense technological progress in the United Kingdom was also an era of intense deprivation and very difficult living conditions. The economic historian Robert Fogel showed that boys in England during this period were significantly undernourished compared even to slaves in the US South.14 The literature of the time, from Frances Trollope to Charles Dickens, describes what was happening to the economy and society with a certain amount of unmitigated horror. Those were Hard Times indeed.

We know that eventually there was a turnaround in the UK. Even as some workers lost their jobs, the labor-saving innovations raised profitability of other inputs, and hence the demand for workers producing them. Improvements in weaving technology, like John Kay’s flying shuttle, for example, increased demand for yarn, creating jobs for people to produce yarn. And the burgeoning wealth of those profiting from these innovations increased demand for new products and services in a range of sectors (more solicitors, accountants, engineers, bespoke tailors, gardeners, etc.), which created more jobs.

However, nothing tells us the rebound is guaranteed to happen. There may well be no rebound from the fall in demand for labor resulting from this wave of automation and AI. Sectors that become more profitable may invest in new labor-saving technologies instead of hiring more workers. The new wealth may be used to purchase goods made in another country.

We don’t know what will happen this time around, since we haven’t seen the very long run yet, but the impact of the current wave of automation (which started in 1990, giving us a perspective of more than twenty-five years) appears so far to be negative. In a study on the impact of automatization, researchers computed, for each region, a measure of exposure to industrial robots, capturing the spread of robots in the industries in that region.15 They then compared the evolution of employment and wages in the most affected areas to that in the least affected areas. The study found, to the surprise of the authors, who had written a previous paper emphasizing the forces that should lead to a rebound,16 large negative impacts. One more robot in a commuting zone reduces employment by 6.2 workers and also depresses wages. The employment effects are most pronounced in manufacturing and they are particularly strong for workers with lower than a college education, especially those who do routine manual tasks. However, there are no offsetting gains in employment or wages for any other occupation or educational group. These local impacts of robots on employment and wages are reminiscent of the impacts of greater exposure to international trade. They are surprising for the same reasons. As many tasks in a particular industry get automatized, we might have expected displaced workers to find employment in new businesses that would have come to the region to take advantage of the freed-up labor, or to move elsewhere. It is also worrying that the automation of simple tasks did not lead to the hiring of more engineers to supervise the robots. The explanation is probably similar to why competition with China hurt low-skilled workers; in the sticky economy, seamless reallocation is anything but guaranteed.

Even if the total number of jobs does not fall, the current wave of automation tends to displace jobs that require some skills (bookkeepers and accountants) and increase the demand, either for very skilled workers (software programmers for the machines) or for totally unskilled workers (dog walkers, for example), which are both much more difficult to replace with a machine. As software engineers become richer, they have more money to hire dog walkers, who have become relatively cheaper over time, since there is little alternative employment for those with no college education. Even if people remain employed, this leads to an increase in inequality, with higher wages at the top and everyone else pushed to jobs requiring no specific skills; jobs where wages and working conditions can be really bad. This accentuates a trend that has taken place since the 1980s. Workers without a college education have increasingly been pushed out of mid-skill jobs, such as clerical and administrative roles, into low-skill tasks, such as cleaning and security.17

So should we try to stop the push toward automation? There are in fact good reasons to suspect that some of the recent automation is excessive; corporations seem to decide to automate even when robots are less productive than people. Excessive automation reduces GDP instead of contributing to it.

One reason is the bias in the US tax code, which taxes labor at a higher rate than capital. Employers have to pay payroll taxes (used to finance social security and Medicare) on labor, but not on robots. They get an immediate tax rebate when they invest in the robot, since they can often claim “accelerated depreciation” for a capital expenditure, and if they finance it with a loan they also get to deduct the interest from their earnings. This tax advantage gives employers an incentive to automate, even if it would otherwise cost less to keep the workers.18 Moreover, even without subsidies from the tax code, the many frictions in the labor market may make managers dream of factories without workers. Robots won’t demand maternity leave or protest a wage cut in a recession. It is probably not an accident that automation in the retail sector (such as automatic checkout lines) started first in Europe, where the labor unions are stronger.

The increase in industry concentration and monopolies could also reinforce this tendency. A monopolist does not fear competition. It has no reason to constantly reinvent what it is offering its consumers. Therefore, the monopolist will tend to focus more on cost-cutting innovations, which will increase its profit margins. In contrast, a competitive firm might go for a moonshot to try to take over the market.

Now it is true that even if a business adopts a highly productive new technology that displaces labor, the increase in productivity also creates new resources that could be deployed to find new uses for the freed labor. The technologies most dangerous for the workers are what some researchers have described as “so-so” automation technologies; they are just productive enough to be adopted given the distortions in the tax code, and displace workers, but not productive enough to raise overall productivity.19

Unfortunately, notwithstanding the grandiose talk about singularities, the bulk of R&D resources these days is directed toward machine learning and other big data methods designed to automate existing tasks, rather than the invention of new products that would create new roles for workers, and hence new jobs.20 This may make economic sense for the companies, given the financial gains in replacing workers with robots. But it distracts researchers and engineers from working on the truly pathbreaking innovations. For example, inventing new software or hardware health workers could use to assist patients in doing their rehabilitation therapy at home after a surgery rather than in a hospital could potentially save insurance companies lot of money, improve well-being, and create new jobs. But the bulk of the automation effort today in insurance firms goes toward searching for algorithms that automate the approval of insurance claims. This saves money but destroys jobs. This emphasis on the automation of existing jobs increases the potential for the current wave of innovation to be very damaging for workers.

That unregulated automation could be bad for workers is also the instinct of most Americans on the right and the left. One place, remarkably, where Republican and Democrat poll respondents agree is in their opposition to letting companies decide how much to automate. Eighty-five percent of Americans would support limiting automation to “dangerous and dirty jobs,” with no difference between Democrats and Republicans. Even when the question is posed in a more politically pointed way, asking whether “there should be limits on the number of jobs businesses can replace with machines, even if they are better and cheaper than humans,” 58 percent of Americans, including half of Republicans, say yes.21

This specific force of automation is exacerbating what is always a concern. When a worker is fired, the firm is done with him, but society inherits the liability of his continued well-being. Society does not want him to starve or his family to be homeless; it wants him to find another job he likes. We fear his anger, especially if it leads to a vote for the many lurking extremists in today’s world, whereas the firm does not have to pay for the retraining, the welfare payments, or the social costs of the anger.

This kind of argument has traditionally been used to justify making it difficult to fire workers. Some labor laws, like India’s, make it virtually impossible to fire anyone in larger firms. Others, like the French laws, make it difficult and uncertain. The worker can appeal and possibly be reinstated with back pay. The problem with such firing costs is that they can make life very difficult for a manager faced with a nonperforming worker or an urgent need to downsize in order to survive. As a result, firing costs may discourage hiring in the first place, which would exacerbate unemployment.22

The alternative to restricting firing or banning the use of robots in some sectors is a tax on robots, large enough to prevent them from being deployed unless the productivity gains are sufficiently high. This is now the subject of a serious discussion. Bill Gates has recommended it.23 In 2017 the European Parliament considered, but ultimately voted down, a proposed “robot tax,” citing concern over stifling innovation.24 Around the same time, however, South Korea announced the world’s first robot tax. The Korean plan reduces tax subsidies for businesses investing in automation and combines it with a tax on outsourcing, so that the tax on robots does not lead to outsourcing.25

The problem is that while it is easy to ban self-driving cars (whether or not it’s a good idea), most robots do not look like R2-D2 in Star Wars. They are typically embedded inside machines that will still have human operators, just fewer of them; how does the regulator decide where the machine stops and the robot begins? A robot tax would likely lead companies to find new ways around it, further distorting the economy.

For some of these reasons, we suspect the current drive toward replacing human actions with robots cannot be prevented from taking a serious toll on the already dwindling stock of desirable jobs for low-skilled workers, first in the rich countries but very soon everywhere. This will add, to a greater or lesser extent, to what the China shock and the other changes described in previous chapters have done to the working class in much of the developed world. It could lead to a rise in unemployment or a multiplication of poorly paid, unstable jobs.

This perspective deeply worries the elites who feel responsible for, and also threatened by, this state of affairs. This is why the idea of a universal basic income has become so popular in Silicon Valley. Most tend to think, however, that robot-induced despair will become a problem in the future, after technologies have improved even further. But the problem of high and rising inequality has already been staring us in the face in many countries, nowhere more so than in the United States. The last thirty years of US history should convince us that the evolution of inequality is not the by-product of technological changes we do not control: it is the result of policy decisions.

By the 1980s, not only were the United States and the United Kingdom experiencing lower growth than they were accustomed to, but they also felt continental Europe and Japan catching up. Growth became a matter of national pride. It was important not just to grow but to win the “race” with the other rich countries. After decades of fast growth, national pride was defined by the size of GDP, and its continuous expansion.

For both Margaret Thatcher in the UK and Ronald Reagan in the US, what was to blame for the slump in the late-1970s was clear (though we now know they really had no idea). The countries had drifted too far to the left—unions were too strong, the minimum wage was too high, taxes were too onerous, regulation was too overbearing. Restoring growth required treating business owners better through lower tax rates, deregulation, and deunionization, and getting the rest of the country to be less reliant on the government. As mentioned earlier, the idea that tax rates need to be low to avoid disaster is of recent vintage. In the United States, the top marginal tax rate was above 90 percent from 1951 to 1963. It declined afterward, but remained high. Under Presidents Reagan and George H. W. Bush, top tax rates came down from 70 percent to less than 30 percent. Bill Clinton pushed them back up, but only to 40 percent. Since then they have bounced up and down, as the US presidency passes between Democrats and Republicans, but they have never gone much higher than 40 percent. Lower taxes were accompanied, first under Reagan and then even more strongly under Clinton, by “welfare reform” (in other words, gutting welfare), which was justified both on grounds of principle (the poor must be more responsible and therefore welfare must become workfare) and out of budgetary compulsion (resulting from diminished tax collection). Unions were brought to heel, both by changing the laws and by directly using state power against them (Reagan, famously, called out the army to break an air traffic controllers’ strike). Union membership has been in decline ever since.26 Regulations were made less restrictive, and there was a new consensus that a very compelling justification should be required before the “heavy hand of the government” was allowed to intervene in business.

In the UK, something similar happened. The highest tax rate went from 83 percent in 1978 to 60 percent in 1979 and then to 40 percent, and has remained close to that ever since. The very (too?) powerful unions of the postwar era were taken down with a firm hand—the miner’s strike of 1984 was a defining moment of Margaret Thatcher’s rule—and have never recovered. Deregulation became the norm, though the integration with regulation-friendly Europe limited how far it could go. The one difference between the UK and the US is that there was never a major attempt to cut welfare (Mrs. Thatcher apparently wanted to, but her cabinet colleagues dissuaded her). Public spending did fall from 45 percent of GDP to 34 percent during the Thatcher years, but it then partially recovered under subsequent governments.27

The reason why such radical changes were possible probably had a lot to do with the anxiety that came with slowing growth. Despite the fact that there is no evidence massive tax cuts for the rich promote economic growth (we are still waiting for the promised turnaround in growth in both the US and the UK), at the time the evidence was much less clear. Since growth had stopped in 1973, the natural reaction was to turn to the critics of the Keynesian macroeconomic policies of the 1960s and 1970s, such as the (right-leaning) Chicago school of economics professors and Nobel Prize–winners Milton Friedman and Robert Lucas.

Reaganomics, as the dominant economics of this period came to be called, was quite open about the fact that the benefits of growth would come at the cost of some inequality. The idea was that the rich would benefit first but the poor would eventually benefit. This is the famous trickle-down theory, never better described than by Harvard professor John Kenneth Galbraith, who claimed this was what used to be called the “horse and sparrow” theory in the 1890s: “If you feed the horse enough oats, some will pass through to the road for the sparrows.”28

Indeed, the 1980s ushered a dramatic change in the social contract in the US and the UK. Whatever economic growth happened since 1980 has been, for all intents and purposes, siphoned off by the rich. Was Reaganomics or its UK version responsible for it?

In the 1980s, while growth remained sluggish, inequality exploded. Thanks to the outstanding and painstaking work of Thomas Piketty and Emmanuel Saez, the world now knows what happened: 1980 is the year Reagan was elected. It is also almost exactly the year the share of national income that goes to the richest 1 percent reverses fifty years of decline and starts a relentless climb in the United States. In 1928, at the end of the Roaring Twenties, the richest 1 percent captured 24 percent of the income. In 1979, that number was about a third as big. In 2017, the last year to be included at the time of writing, that ratio was almost back where it was in 1929. The increase in income inequality was accompanied by a rise in wealth inequality (income is what people earn every year; wealth is their accumulated fortune), although wealth inequality has not yet reached its early 1920s level. The top 1 percent wealth share in the United States rose from 22 percent in 1980 to 39 percent in 2014.29

The story for the UK is very similar. The turning point, like in the US, is somewhere very close to 1979, the year Mrs. Thatcher took over. Before 1979, the top income share falls steadily from 1920. After 1979, there is a similar rise, interrupted briefly by the global financial crisis of 2009. Unlike in the United States, inequality has not yet reached the 1920s levels, but it does not have that far to go.30

In continental Europe the pattern is strikingly different. Before 1920, the top income share in France or Germany, Switzerland or Sweden, the Netherlands or Denmark was not too different from that in the US or UK. But sometime after 1920, inequality crashed in all of these countries, like in the United States, and stayed down, unlike in the United States. There are small ups and downs, and Sweden actually has a significant upswing starting somewhere in the 1980s, but the levels remain very low by US standards.31

These data are about pre-tax income, before the rich paid taxes and the poor received transfers. Therefore, they do not take into account any attempt to redistribute from the rich to the poor. Since taxes went down in the United States, we might have expected post-tax inequality to increase even more than pre-tax inequality after 1979. One does see a small blip up at the time of the Tax Reform Act of 1986, but for the most part the curves for pre-tax and post-tax income shares track each other.32 Taxes are important for redistribution, but the increase in inequality is a much deeper phenomenon than a mechanical effect of lower redistribution.

At the same time, around 1980, wages stopped increasing, at least for the least educated. The average hourly wage adjusted for inflation for US workers who were not managers rose through the 1960s and 1970s, reached its peak in the mid- to late-1970s, and then drifted down through the Reagan-Bush years, before slowly turning around. As a result, the average real wage in 2014 was no higher than in 1979. Over the same period (from 1979 to today), the real wages of the least educated workers actually fell. Among high school dropouts, high school graduates, and those with some college, real weekly earnings among full-time male workers in 2018 were 10 to 20 percent below their real levels in 1980.33 If there had been any trickle-down effect of lower taxes, as its advocates claimed, one would expect wage growth to have accelerated in the Reagan-Bush years. But the opposite happened. The labor share (the share of revenues used to pay wages) has continuously declined since the 1980s. In manufacturing, almost 50 percent of sales were used to pay workers in 1982; it had fallen to about 10 percent in 2012.34

The fact that this great reversal takes place during the Reagan and Thatcher years is probably not coincidental, but there is no reason to assume Reagan and Thatcher were the reason it happened. Their election was also a symptom of the politics of the time, dominated by anxiety about the end of growth. It is not impossible that if they had lost, whoever won would have gone some distance along the same path.

More importantly, it is not a priori obvious that Reagan-Thatcher policies were the main reason why inequality went up. The diagnosis of what actually happened in this period, with its obvious implications for policy, has been and continues to be an active area of debate within economics, with some, like Thomas Piketty, squarely blaming changes in policies, while most economists emphasize that the structural transformation of the economy, and particular changes in technologies, also had a lot to do with it.35

The reason why this is not an easy question is that this was also a period of momentous changes in the world economy. Starting in 1979, China launched market reforms. In 1984, India started taking baby steps toward liberalization. These countries would eventually become two of the largest markets in the world. Partly as a result, world trade expanded relative to world GDP by about 50 percent over this period,36 with the consequences we discussed in chapter 3.

The advent of computing was the other characteristic feature of the era. Microsoft was founded in 1975; in 1976, the Apple I was released, followed by the much more widely sold Apple II in 1977; IBM released its first personal computer in 1981. Also, in 1979, NTT launched the first widely distributed handheld cell phone system in Japan. Mostly on the strength of selling cell phones, Apple became the first trillion-dollar company in August 2018.

To what extent do technological change and globalization explain the pattern of increase in inequality in the US and the UK? To what extent did policy, tax policy in particular, play a role?

With computerization came other technological change. This may not have been a revolution in the sense that the steam engine brought in a revolution, as Robert Gordon argued, but like the steam engine and its love child, the internal combustion engine, it killed a lot of jobs. No one probably makes a living by being a typist now, except the three lone men of uncertain age who sit under a tree near where Abhijit grew up in Kolkata, who for a small fee will type in your name and address into government-issued documents. There are few stenographers left. Even in the White House, their days appear to be numbered. And this technological progress was to a large extent skewed against the less qualified.

This skill-biased technological change clearly explains the increase in the return to college education.37 But it cannot explain what happened at the very top of the income distribution, unless we think skills were suddenly transmogrified just for the very richest. We usually think of skills increasing relatively continuously with education and wage levels. So, if the explosion of top income inequality was just due to technological progress, the widening of the distribution of wages should have been not just for the ultra-rich but also for the merely rich. But, in fact, those making, say, between $100,000 and $200,000 a year have seen their pay increase only slightly more rapidly than the average, while those who are making more than $500,000 have seen their incomes explode.38

This suggests that plausible changes in technology are unlikely to explain the stratospheric increase in incomes at the very top. Nor, for that matter, can they explain the difference between United States and continental Europe; technological change has been similar in all rich countries.

However, technology has also changed the organization of the economy. A lot of the most successful inventions that came out of the high-tech revolution were “winner take all” products; there was no point in being on Myspace when the whole world was on Facebook, and Twitter is meaningless unless someone is retweeting your tweets. Technological innovations have also transformed existing industries, and created large benefits from being connected to industries where they used to be largely absent, like hospitality or transportation. For example, if drivers know that all passengers use a particular ride-sharing platform, they will choose to stay on that one. Conversely, if passengers know that all drivers use a particular platform, that is where they will go. These network effects explain in part the dominance of giant tech companies like Google, Facebook, Apple, Amazon, Uber, and Airbnb, but also of “old economy” behemoths, such as Walmart and Federal Express. In addition, the globalization of demand has increased the value of brands, as rich Chinese and Indian customers can now aspire to the same goods. And the ability to browse, compare, and boast on Facebook has made consumers more aware of differences in prices and quality, but also more sensitive to fads.

The result is a winner-take-all (or if not all, most) economy, in which a few firms capture a large part of the market. As we saw in the chapter on growth, in many sectors sales have become more concentrated, and we see the increasing dominance of “superstar firms.” And in sectors that have become more concentrated, the share of revenues going to pay wages has gone down more. This is because those firms, which are monopolies or near monopolies, make more profits, and those tend to be distributed to shareholders. The increase in concentration thus helps explain a part of why wages are not keeping pace with GDP.39

The rise of the superstar firms also offers an explanation for why overall wage inequality has been rising: some firms are now much more profitable than others and they pay higher wages. It is also true that profitability is more variable than it used to be, with more clear winners and clear losers, even outside the set of superstars.40 In fact, in the United States, the increase in inequality between the average salaries at different companies can explain two-thirds of the overall rise in inequality (increase in inequality between workers within the same company explains the rest). A lot of this increase in inequality between firms seems due to changes in who works where; the highest-paid workers in low-paying firms are moving to those that pay more. If one assumes that higher earnings reflect higher productivity (which is probably true on average), then the more productive workers are increasingly working with other high-productivity workers.41

This is consistent with a theory in which superstar firms attract both capital and good workers.42 If more productive people benefit more from being paired with other productive people, then the market should drive such people to come together to form high-productivity firms that would, as a result, have higher wages and salaries than other firms. Moreover, once a firm has invested in a galaxy of talents, the CEO of such a firm is in a position to make a big difference; if he pushes them down the wrong path, he would waste a whole lot of productive capacity. Therefore, such firms should strive to get the best CEO possible even if that requires paying him or her what some may feel is an obscene salary.43 The rise in top incomes, in this view, is just the flip side of the rise of superstar firms that value getting the best top management and are willing to pay a lot for them.

That the economy is sticky also contributes to the rise in inequality between firms. As production in some sectors gets concentrated in superstar firms, other firms in those sectors all over the country are shutting down (think the local department store versus Amazon), in addition to those that shut down because of the effect of new technology or trade. Since workers do not move out, wage growth in the affected area flattens or gets reversed, and rents do the same. This is good news for the surviving firms in those pockets, especially if their clients are elsewhere. The resulting windfall in profits may lead to greater investment in these companies, but probably not enough to halt the overall decline of the area. In other words, part of the distinction between good firms and bad firms may be purely happenstance. If you are a firm in a failing local economy lucky enough to be able to continue to sell to the national or world economy, you can do very well, at least for a while, until the overall drain in talent from these places, as the young and the ambitious move out, starts to hurt.

In other words, globalization and the rise of the infotech industry, combined with the sticky economy, and no doubt with other important but perhaps more local changes, created a world of good and bad firms, which in turn contributed to an increase in inequality. In this view, what happened may have been unfortunate, but it probably could not have been stopped.

But the winner-take-all explanation for the rise in inequality cannot be the whole story either.

The reason is that, like skill-biased technological progress, the explanation ought to apply to Denmark just as much as the United States. But it does not. Denmark is a capitalist country where the share of income going to the top 1 percent was more than 20 percent in the 1920s, just like in the United States. But when it went down it stayed low, and now hovers around 5 percent.44 Denmark is a small country but it has a number of large and well-known companies, including the shipping giant Maersk; Bang & Olufsen, maker of beautiful consumer electronics products; and the Tuborg Brewery. But its top incomes never went sky high. The same is true of many very different countries in Western Europe and also of Japan.45 What’s different between these countries and the United States?

A part of the answer is finance. The US and UK dominate the “high end” of finance—the investment banks, junk bonds, hedge funds, mortgage-backed securities, private equity, quants, etc.—and this is where many of the astronomical earnings have shown up in recent years. Two finance professors at Harvard Business School (of all places) estimate that investors who use financial market intermediaries pay 1.3 percent of their total investment to their fund manager every year, which over the thirty-year horizon of an investor saving for retirement amounts to handing the manager a third of the assets initially invested.46 A chunk of change, but nothing compared to those who manage the hedge funds, private equity funds, and venture capital funds that epitomize high-end finance, where, at least until recently, you had to pay the managers between 3 percent and 5 percent of the amount invested every year. Given that the amount invested is growing steadily, it is no wonder some of these managers are becoming very, very rich.

Financial sector employees are now paid 50–60 percent more than other workers with comparable skills. This was not true in the 1950s, 1960s, or 1970s.47 This rise in earnings is a big piece of the overall shift in top incomes. In the UK, which is the most finance-dominated large economy, between 1998 and 2007, employees in the financial sector, who represented only about one-fifth of those in the top 1 percent, swallowed 60 percent of the rise in earnings in this group.48 In the United States, from 1979 to 2005, the share of top incomes going to finance professionals almost doubled.49 In France, where finance still mostly means banking and insurance, the change in inequality was much smaller in absolute terms. Between 1996 and 2007, the share of national income going to the richest one-tenth of one percent of the population went up from 1.2 percent to 2 percent (it then went down during the financial crisis, but had recovered partly by 201450), but about half of that increase, it is estimated, is due to increasing earnings in finance.51

The superstar narrative does not fit finance very well. Finance is not a team sport. It is an industry marked, supposedly, by individual geniuses, people who can spot the particular irrationalities currently infecting the markets or identify the next Google or Facebook before anybody else. But it is hard to see how that explains why an ordinary manager in the financial sector is nonetheless paid extraordinary fees, year after year. In fact, most years, actively managed funds do not do any better than “passive funds” that simply replicate the stock market index. In fact, the average US mutual funds underperform the US stock market52—they seem to have borrowed the language of individual talent but not the talent itself. A large part of the premiums paid to financial sector employees are almost surely pure rents; that is, rewards not for talent or hard work but for nothing more than having lucked out in landing that particular job.53

These rents, much like the rents from government jobs in poor countries discussed in chapter 5, distort the entire functioning of the labor market. As the 2008 global crisis unfolded, caused in large part by a combination of irresponsibility and incompetence on the part of the masters of finance, a study reported that 28 percent of Harvard college graduates of recent cohorts opted for jobs in finance.54 That ratio was 6 percent in 1969 and 1973.55 The reason to be concerned about this is that if some job pays a premium unrelated to its usefulness, like the fund managers earning a fat fee for doing nothing, or the many talented MIT engineers and scientists hired to write software that allows stock trading at millisecond frequencies, then talented people are lost to firms that might do something more socially useful. Faster trading may be profitable because it allows the trader to react more quickly to new information, but given that the reaction time is already seconds or less, it seems implausible that it improves the allocation of resources in the economy in any meaningful way. And hiring the brightest of the bright may be an effective tool for a financial firm to market itself, but if the firm does nothing useful those talents are lost to the world. Maybe in a saner world they would have been writing the next great symphony or curing pancreatic cancer.

There is another problem. The salaries and bonuses of CEOs of the larger corporations are set by board of directors compensation committees, and these committees use the salaries of CEOs at comparable firms as a benchmark. This creates a contagion; if one company (say, in finance) starts to pay its CEO more, others not necessarily in finance feel they have to as well, to keep getting the best. Their CEOs feel undervalued compared to CEOs they play golf with. Consultants who help the CEOs compile a list of what happens in “comparable” firms are very skilled at selecting a sample of particularly high salaries; the high finance salaries tend to infect the rest of the economy as well. The practice of using salary comparisons to negotiate increased compensation has spread far beyond the largest firms, and even beyond the for-profit sector.

This is not helped by the fact that CEOs, everywhere and not just in finance, try very hard to pack boards of directors with people they feel they can control (or people who are only interested in getting paid their director’s fees). The result is that CEOs are often rewarded for pure luck; when the stock market valuation of the firm goes up, even if it is due to pure chance (e.g., world crude oil prices went up, the exchange rate moved in the firm’s favor), their salary increases. The one exception, which in some ways proves the rule, is that CEOs of companies where there is a single large shareholder who sits on the board (and is vigilant because it is his own money on the line) get paid significantly less for luck than for genuinely productive management.56

Stock options probably contributed to the skyrocketing CEO salaries, by normalizing the idea that CEO pay was directly linked to shareholder value and nothing else. In addition, linking managerial pay to the stock market meant that managers’ pay was no longer linked to a salary scale within the enterprise. When everyone was on the same scale, CEOs had to grow salaries at the bottom to increase their own. With stock options, they had no reason to increase wages at the bottom, and in fact every reason to squeeze costs. Paternalism, once a feature of the large corporations that demanded loyalty but took care of their own, is now restricted to elite workers in software companies, and is expressed in the form of free food and dry cleaning in exchange for long hours.

One solution to the puzzle posed by Denmark might be that finance is much more dominant in the UK and the US than in continental Europe,57 and perhaps a more attractive option for those countries’ elite graduates. Relatedly, stock options (and stock market–linked compensation more generally) are much more likely to get used in the Anglo-Saxon world, where more people are familiar with the stock market and where most reasonable-sized companies are traded.

Low taxes probably played a role as well, as argued by Thomas Piketty. When tax rates on the very top income are 70 percent or more, firms are more likely to decide that paying stratospheric wages is a waste of their money and cut back the top salaries. With these tax rates, the board faces a stark trade-off: at a 70 percent marginal tax rate, a dollar in salary is only thirty cents in the pocket for the manager, versus a whole dollar for the firm. It makes salary less valuable for the CEO, and it becomes cheaper for the board to pay the CEO in other “currencies,” such as allowing him to pursue his dream projects. This might not always be what the shareholders want (they want higher profits, not size per se)—economists in the 1960s and 1970s were concerned with empire-building by managers—but could be better for the workers, or the world. For example, the CEO could prioritize growing the firm, being popular with the workers, or pursuing some new product because it is good for the world, even if it is not the best for share value. The shareholders may tolerate this to keep their CEO happy. It might even be part of the reason why workers’ salaries were rising when top tax rates were high.

So the point of the very high top tax rates of the 1950s and 1960s, which applied only to extremely high incomes, was not so much to “soak the rich” as to eliminate them. Almost nobody ended up paying the top rates, because those very high incomes had all but disappeared.58 When the top tax rates went down to 30 percent, ultra-high salaries became attractive again.

In other words, high top tax rates may actually lead to a reduction not just in inequality after taxes, but also in inequality before taxes. This is important because, as already discussed, a large part of the reason for the divergence in inequality between Europe and the United States in recent decades comes from pre-tax inequality. And some evidence hints at the possibility that the decline in top tax rates may have something to do with it: at the country level, there is a strong correlation between the size in the cuts in top tax rates between 1970 and today, and the increase in inequality. Germany, Sweden, Spain, Denmark, and Switzerland, where top marginal tax rates stayed high, did not experience sharp increases in top income shares. In contrast, the United States, Ireland, Canada, the UK, Norway, and Portugal cut the top tax rates significantly and experienced large increases in top income shares.59

However, beyond tax rates, in the United States it is also likely there was a cultural change that created a social environment in which high salaries were acceptable. After all, how did people in finance manage to convince their shareholders and the world they could be paid that much for their services, if we are correct that they are mostly earning rents?

In our view, beyond the tax cuts, the narrative of incentives that underpinned the Reagan-Thatcher revolution convinced a substantial fraction of the non-rich (and most of the rich who had any doubts about it) that those sky-high salaries were legitimate. Low taxes were a symptom of it, but the ideological shift was even deeper. The rich could go ahead and pay themselves more money than they could ever spend, without raising any hackles, as long as they had “earned” this money. Many economists, with their unconditional love for incentives, played a key role in spreading and legitimizing this narrative. As we saw, many economists remain in favor of high CEO pay today even though they are not opposed to higher taxation across the board. The narrative has spread: even today, while many in the US and the UK clearly resent their own economic situation, they tend to blame immigration and trade liberalization rather than the increasing vacuuming of resources toward the very rich.

Was the basic presumption, that high take-home salaries were essential to encourage the most productive people to do their best and create prosperity for the rest of us, correct? What do we know about the effect of taxes on the effort of the rich?

Europe is a more equal society than the United States, with much lower inequality in pre-tax income, a higher tax burden, and highly progressive taxation. There is one interesting exception to that: payments to top athletes. Major League Baseball in the United States implements a luxury tax, wherein teams are fined if their combined payroll exceeds some amount. A team that goes over the luxury tax threshold for the first time in a five-year period pays a penalty of 22.5 percent of the amount they were over the threshold, and the maximum fine for repeat offenders is 50 percent of the excess. Most other major sports leagues in the United States (the NFL, the NBA, Major League Soccer, etc.) have salary caps. The maximum that could be paid in total for a team in the NBA in 2018 was $177 million. Not a trifle, but in 2018 the Argentine soccer player Lionel Messi was paid a yearly total of $84 million by his club, Barcelona, way above what would be possible in the US.

Salary caps in professional sports are hardly the product of some Nordic idealism. Clearly, the main rationale of the salary caps is to control costs. It is what a cartel of team owners does to limit how much of the proceeds go to players and, by implication, increase the amount that goes to them. But it has the virtue, and this is the stated reason for the caps, that it ensures some degree of equity between the teams, making the season much more interesting to watch. Unlimited money creates too much inequality, with the result that within a league only a few teams ever have a real chance of winning. In Europe, where Major League Soccer does not have salary caps, some teams (such as Manchester City, Manchester United, Liverpool, Arsenal, and Chelsea in England) spend vastly more than others and enjoy an uncontested domination. So much so that in 2016 the odds against the team of Leicester winning the Premier League championship was five thousand to one, lower than the probability of spotting Elvis alive. Bookmakers lost a combined 25 million pounds when the team, to everyone’s surprise, actually won.

There is plenty of opposition to the salary cap in the United States. A Forbes article described it as “Un-American,” arguing that “based on the capitalist system, spending money on employees (and that’s what athletes are in professional sports) should be based on performance and not encumbered by system.”60 Players naturally hate it, resent it as deeply unfair, and have staged multiple strikes to oppose it. Interestingly, the one argument no one makes is that players would play harder if only they were paid a little (or a lot) more. Everybody agrees that the drive to be the best is sufficient.

What is true of professional athletes seems to be true of rich people in general.

The question of taxes on rich people took center stage in the political discourse in the United States at the end of 2018. With Alexandria Ocasio-Cortez’s proposal of a top marginal income tax above 70 percent and Elizabeth Warren’s call to establish a progressive wealth tax, tax policy became one of the core issues at stake for the 2020 presidential election.

Given the longstanding importance of income taxation as a policy issue, it is no surprise there are many studies that look at whether people stop working when their income taxes increase. The authoritative review of the literature by Emmanuel Saez and his colleagues concludes that real work effort does not respond to top tax rates, although effort to evade or avoid taxes does.62 For example, the Reagan tax cut of 1986 led to a large onetime increase in personal taxable income, which faded quickly. This suggests the increase in taxable income was mainly people bringing their previously hidden incomes into the (now friendlier) tax net rather than an increase in earnings and hence effort. In countries where there are no easy loopholes because taxes apply to all income (with no differential treatment for investment income, labor income, or “fees for being a real estate agent”), taxable income (and therefore the underlying real effort) is insensitive to taxation.

This should make sense. For top athletes, as Vince Lombardi is reputed to have said, “Winning isn’t everything, it’s the only thing.” They are not going to do less than their best because the tax rate just went up. The same probably goes for top CEOs and aspiring top CEOs.

What about the idea that the best firms want the best managers and are willing to pay top dollar for them? Would they be able to do that if taxes were high? The answer is yes. The argument that the best CEO will go wherever he makes the most money works no differently when the government takes 70 percent of the money. The highest-paid job is still the highest-paid job, as long as the tax rate is the same in all firms.

However, high top marginal tax rates may also reduce the lure of the most lucrative, but not necessarily the most socially useful, professions, such as finance. Without the attraction of huge take-home pay, aspiring top managers may prefer to go where they will be the most productive, not where they will make the most money. A silver lining of the 2008 crisis is that it reduced the appeal of the financial sector for the brightest minds; a study of career choices of MIT graduates found those who graduated in 2009 were 45 percent less likely to choose finance than those who graduated between 2006 and 2008.63 This may lead to a better allocation of talent, and to the extent finance’s salary levels infect every other sector, it could further reduce income inequality.

All in all, therefore, it seems to us that high marginal income tax rates, applied only to very high incomes, are a perfectly sensible way to limit the explosion of top income inequality. They would not be extortionary, since very few people will end up paying them; top managers will simply not get these kinds of income anymore. And from all we see, they won’t discourage anybody to work as hard as they can. To the extent they affect people’s choice of career, it will likely be in a positive direction. This is not to deny the importance of structural economic changes, which have made it increasingly difficult for those with low education to succeed, generating an increase in inequality even within the remaining 99 percent.64 Addressing this issue will call for other complementary approaches. But we might as well begin by eliminating the ur-super-rich (which really means, in case you feel sorry for them, turning them to merely super rich).

The other way the rich will surely try to react to a tax rise, however, is by finding ways to not pay taxes.

One thing the absence of caps in European soccer and the resulting astronomical salaries does is encourage players to evade taxes. In 2016, Lionel Messi (who made more than €100 million in 2017) was found guilty on three counts of defrauding tax authorities of €4.1 million and given a suspended jail sentence. In July 2018, the Spanish government and Cristiano Ronaldo signed a deal in which he agreed to pay a fine of €19 million and receive a suspended prison sentence. He was accused of four counts of tax fraud worth €14.7 million, resulting from the use of shell companies outside Spain to hide income made from image rights from 2011 to 2014. Moreover, many of those who do not actually cheat shop around for lower taxes. Comparing countries in Europe that raised or lowered taxes at different points in time, a study found that when the tax rate in a country increases by 10 percent, the number of foreign players goes down by 10 percent.65 In 2018, Ronaldo left Spain for Italy to lower his tax bill.

The exposé of the so-called Panama papers, which revealed the efforts of Panamanian law firm Mossack Fonseca on behalf of the global plutocracy in setting up hundreds of thousands of shell companies for them to evade taxes, showed just how pervasive tax evasion had become. The list of names included former prime ministers of Iceland, Pakistan, and the UK. Even in famously honest Scandinavia, only 3 percent of personal taxes are evaded on average, but the very rich are much more serious offenders. A study estimated that those in the top 0.01 percent in the wealth distribution of Norway, Sweden, and Denmark evade 25–30 percent of personal taxes they owe.66

If taxes go up a lot, so will tax evasion. The question is, by how much? In the short run, the response will surely be substantial. We already mentioned this in the context of the Reagan tax cuts. When taxes go up, we expect to see the reverse: a sharp drop in taxable income as those who can hide their incomes do so right away, but a smaller effect afterward.

In part for this reason, a small number of politicians in the United States and some economists67 are pushing for a progressive wealth tax applicable on worldwide wealth (in 2019, Elizabeth Warren proposed a 2 percent wealth tax on Americans with assets above $50 million, and a 3 percent wealth tax on those who have more than $1 billion). The idea is not new. After all, most Americans who own a home already pay a tax on the value of their home: the real estate tax they pay to their municipal government. But this tax is regressive. Suppose you own a house worth $300,000 and pay 1 percent property tax ($3,000). Then you will effectively pay 10 percent of your net wealth if you have a mortgage of $270,000 (since your net wealth is then $30,000) but 0.1 percent of your net wealth if you have financial assets of $2.7 million and no mortgage (since your net wealth is then $3 million).

The wealth tax would be progressive and apply to all forms of wealth, not just real estate. The advantage of a tax applied on very high wealth, from the point of view of fighting inequality, is that very wealthy people do not consume the vast majority of the income they derive from their wealth. Instead, they take a small fraction of the wealth income in the form of a dividend, and they plow the rest back into their family trust or whatever structure has allowed their wealth to accumulate. In the current tax codes in most countries, they do not pay any taxes on the amount that goes back into the trust.68 This is part of the reason why Warren Buffet, as he likes to remind us, pays very little in income taxes.69 It is difficult to have a redistributive income tax if most of the top incomes are effectively (and legally) shielded from taxation in this way. Moreover the tax advantage gets compounded. The new wealth generates new investment income, most of which is again untaxed for the same reasons, making the rich even richer. A wealth tax on very high fortunes solves this problem. The best way to think about it is not, as the economic press and the politicians try to explain it, as a way for the wealthy to make a special effort to “give back” (though if that makes them feel better maybe it’s okay). Instead, it is simply a convenient and administratively (relatively) simple way to ensure they pay a tax on all their income, regardless of what they chose to do with it: someone whose $50 million in wealth makes at least $2.5 million in investment income in the average year. A 2 percent tax on wealth ($1 million) amounts to a 40 percent tax on this income, which is not outrageous.

Unlike estate tax, which got a bad rap after being called the “death tax,” the idea of wealth tax is very popular. In 2018, 61 percent of respondents to a poll conducted by the New York Times were in favor, including 50 percent of Republicans.70 So it even may be politically feasible. Yet in recent decades many countries got rid of their wealth tax if they had one, and few countries have put one in place (Colombia is an exception). In France, getting rid of the wealth tax was one of the first actions of the centrist Macron government after his election in 2017. As we saw, this was a very dangerous political move; the abolition of the wealth tax and the attempt to put in place a surcharge on fuel was the original motivation for the Yellow Vest protest movement. In an attempt to quell it, Macron promised a number of giveaways, but did not reinstate the wealth tax.

There are two reasons why wealth taxes are so politically difficult. First, because of effective lobbying. High-net-worth individuals finance the campaigns of politicians on the left and on the right, and few are in favor of wealth taxation, even when they are otherwise quite liberal. Second, it is easy to avoid the taxes, legally or not, particularly in small European countries where people can move or park their wealth abroad. This gives rise to a race to the bottom on tax rates.

We should not lose sight of the fact, however, that all of this happens in part because the world tolerates tax evasion: most tax codes have loopholes galore and the penalties for parking money abroad are ineffective. As we saw, countries with a simple tax code with few loopholes lose less from evasion when taxes go up than the United States.71 Gabriel Zucman has convincingly argued that there are many relatively straightforward things that would help a lot in limiting tax evasion and tax avoidance. Among his ideas are to create a global financial registry that would keep track of wealth no matter where it is (making it possible to tax wealth no matter where it is parked), to reform the corporate tax system such that the global profits of multinational firms are apportioned to where they make their sales, and to more strongly regulate banks and law firms that help people evade taxes through tax havens.72

Identifying a set of steps is of course not sufficient. There needs to be the political will to implement them. The three steps Zucman recommends may be particularly tricky since they involve international cooperation, and the men (yes, almost always men) at the top right now do not seem to be all that able to join together to get things done. Without that, countries may be tempted to engage in a race to the bottom in taxation in the hope of attracting talent and capital. Preferential tax schemes for high-skilled foreign workers have been introduced in Belgium, Denmark, Finland, the Netherlands, Portugal, Spain, Sweden, and Switzerland. In Denmark, for example, high-earning foreigners pay only a 30 percent flat tax for three years (against a top rate of 62 percent for the Danish). This was very effective in attracting high-income foreigners to Denmark, which may be good for Denmark, but bad for other countries. Now they have the choice between taxing their top earners less or pushing them to leave.73 This tension between country welfare and global welfare in the design of individual income tax policy has loomed large in the debate about tax competition.

But the point is that these are political problems, not economics impossibilities. The spirit of this book is to emphasize that there are no iron laws of economics keeping us from building a more humane world, but there are many people whose blind faith, self-interest, or simple lack of understanding of economics makes them claim this is the case.

From the strict point of view of economic efficiency, therefore, the evidence suggests that nothing stops a government from having a very progressive tax schedule with extremely high top marginal rates. If Denmark can have high taxes on top incomes without all the capital decamping to some neighboring less-taxed country, and all its rich moving to Ireland (or Panama), then for a large and much less globally integrated economy like the United States, from a strictly economic point of view, there is nothing to prevent it from doing the same.

The difficulty of raising top tax rates is a political one. Indeed, we seem to be in the midst of a vicious cycle of concentration of political and economic power. As the rich become richer, they have more interest and more resources to organize society to stay that way, including financing the campaigns of legislators willing to lower taxes at the top. The “Citizens United” decision of the US Supreme Court, which ruled as unconstitutional legislative limits on corporations’ ability to fund electoral campaigns, has formally legitimized the unlimited power of money in influencing elections.

But it seems unlikely that this state of affairs can continue unfettered without generating a massive backlash. High tax rates on the top earners are already quite popular. Polling data suggest that 51 percent of voters support a marginal tax rate of 70 percent on income above $10 million.74 In our survey, more than two-thirds of respondents, who were otherwise not particularly liberal, thought entrepreneurs making more than $430,600 annually (which puts them in the top 1 percent) paid too little in taxes.75

To some extent, the recent populist uprising in the United States is the beginning of this backlash. Behind it is a profound sense of disempowerment, a feeling, right or wrong, that the elites always decide, and in any case what they decide makes no difference for the average Joe or Jean. In the United States, Trump, for all his wealth and elite connections, was elected on his promise to undermine business as usual, but the Republicans lined up behind him because they were confident he was as pro-rich as any of them. Indeed he did deliver the tax cut. But it is not clear how long this game of bait and switch can continue without it all exploding. The rich may eventually see that it is in their self-interest to argue for a radical shift toward real sharing of prosperity, or it may end up being imposed on them in even less favorable ways. The reason is that the increase in inequality has been at the root of a deep increase in social anxiety and unhappiness.

Social scientists have long suspected that people’s sense of self-worth is related to their position in the groups they see themselves as part of—their neighborhoods, their peers, their country. If this were true, inequality would of course directly affect well-being. Given how plausible this seems to us, it has been surprisingly difficult to prove beyond doubt. For example, evidence suggests that, at any given income level, people tend to be less happy when the average income in their locality is higher than their own.76 But it could be because they live in an expensive neighborhood where everything, from housing to cups of coffee, costs more. In other words, the facts can be explained without reference to inequality per se.

A recent study from Norway shows that increased awareness about one’s place in the distribution of income increases the extent to which a person’s happiness depends on their income.77 In Norway, tax data has been publicly available many years, but the records were kept as hard copies and were therefore hard to access. This changed in 2001, when they were put online, and it became possible to snoop on your neighbors or your friends with just a few clicks of your mouse. This was very popular, to the point it was dubbed “tax porn,” and everyone seemed to know exactly where they stood. What we saw right after the data went online was that the poor were sadder and the rich happier. The awareness of one’s place on the totem pole does seem to affect well-being.

In a way, we are all living in some version of the Norway experiment. Bombarded as we are by images of the lives of others on the internet and in the media, it is impossible for those who are stuck to not be aware that the rest of the world looks like it is moving ahead. The flip side of this is the impulse to show the world that we too are able to “keep up with the Joneses” and, if possible, do better than them. This is the logic behind “bling” purchases, designed to show off status. In a recent experiment, an Indonesian bank offered some of its higher-income customers (largely urban and upper middle class) a new platinum credit card.78 In the control group, customers received an offer upgrade of their existing credit card, with all the benefits of a platinum card except the platinum look. Customers understood the cards had exactly the same benefits, but that did not stop them from liking the platinum card more; 21 percent of those offered the platinum card went for it compared to 14 percent of those offered the nondescript alternative.

Interestingly, the urge to show off is less strong when people feel good about themselves. The experimenters found that simply writing a short essay describing a moment when the person did something she or he was proud of reduced the demand for platinum cards. This creates a vicious cycle, with people who feel economically vulnerable being particularly eager to demonstrate their worth through useless purchases they can ill-afford, and an industry all too ready to provide these services for a handsome fee.

Americans have another peculiar problem of their own. Fed a steady diet of the “American dream” along with their breakfast cereals, Americans tend to believe, in spite of everything, that although their society is unequal, it rewards industry and effort. In a recent study, researchers asked people in the United States and in several European countries their views of social mobility.79 When asked, “Out of 500 families divided in 5 groups of 100, how many of the children born of parents in the poorest group will stay in the poorest group, move one group up, two groups up, or make it to the richest group?” Americans are more optimistic than Europeans. They believe, for example, that out of one hundred poor children, twelve will make it to the richest quintile and only thirty-two will be stuck in poverty. In contrast, the French believe that out of one hundred, nine poor children will make it to the top, and thirty-five will be stuck in poverty.

The rosy American view does not reflect reality today in the United States. Along with the general stagnation at the bottom, intergenerational mobility has declined sharply in the US. Mobility is now substantially lower in the United States than it is in Europe. Within the OECD, the child from the bottom quintile most likely to remain stuck in the bottom quintile is from the US (33.1 percent), while the least likely is from Sweden (26.7 percent). The average for continental Europe is below 30 percent. The probability of moving to the top quintile is 7.8 percent in the US, but close to 11 percent on average in Europe.80

The places within the United States most likely to cling to the outdated notion of American social mobility, a.k.a. the dream, are actually those least likely to experience it. Americans also generally believe effort is rewarded (with the corollary that the poor must be in part responsible for their own plight), and probably for this reason, those who believe mobility is high also tend to be suspicious of any government effort to address the problems faced by the poor.81

When overoptimistic perceptions of mobility clash with reality, there is a strong urge to avoid the awkward truth. The majority of Americans whose wages and income have stagnated, and who confront an ever-widening gap between the wealth they see around them and the financial woes they are experiencing, face a choice between blaming themselves for not benefitting from the opportunities they believe their society offers and finding someone to blame for stealing their jobs. That way lies despair and anger.

By all measures, despair is on the rise in today’s America, and it has become deadly. There has been an unprecedented increase in mortality among less-educated whites in middle age and a decrease in life expectancy. Life expectancy declined in 2015, 2016, and 2017 for all Americans. This grim trend is specific to US whites, and in particular to US whites without college degrees: in all racial groups in the US except the whites, mortality is falling. Other English-speaking countries that have pursued a broadly similar social model to the US, namely the UK, Australia, Ireland, and Canada, are also going through a similar change, albeit in slow motion. In all the other wealthy countries, on the other hand, mortality is going down, and going down faster for the uneducated (who had higher mortality to start with) than for the educated. In other words, when the rest of the world saw convergence between mortality levels of the college educated and the rest, the United States went the other way. Anne Case and Angus Deaton have shown that the increase in mortality is due to a steady rise of “deaths of despair” (such as deaths from alcohol and drug poisoning, suicide, alcoholic liver disease, and cirrhosis) among white middle-aged men and women in America, combined with a slowdown in the progress against other causes of mortality (including heart disease). Self-reported health and mental health follow a similar pattern. Since the 1990s, middle-aged whites with low education are increasingly likely to report themselves in poor health, and they are more likely to complain of various pains and aches. They are also more likely to report symptoms of depression.82

This is probably not so much a result of low (or unequal) incomes per se. After all, blacks did not fare any better economically over the period, and they are not affected by this trend. And there was no uptick of mortality in Western Europe, even after incomes stagnated during the Great Recession. On the other hand, Russia’s mortality exploded after the breakup of the Soviet Union in 1991, and like in the United States, most of the increase was due to changes in mortality from vascular disease and violent deaths (mainly suicides, homicides, unintentional poisoning, and traffic incidents) among young and middle-aged adults.83

Case and Deaton also point out that although the increase in mortality in the United States started in the 1990s, it capped a trend that had begun long before that. After the cohort that entered the labor market in the late 1970s, each subsequent cohort fared worse than the preceding one in many different ways.84 At every age, among less-educated white Americans, each subsequent cohort was more likely to have difficulty socializing, to be overweight, to experience mental distress and symptoms of depression, and to have chronic pain. They were also more likely to kill themselves or die of a drug overdose. It is the accumulated weight of these deprivations that eventually led to the increase in mortality.

Any number of slow-moving factors could have caused this erosion of the well-being of less-educated Americans. Every single one of these cohorts was also less likely than the preceding one to be in the labor force. For those who worked, their real wages were no higher than those of previous cohorts, and sometimes lower, and they were less likely to have a strong attachment to a particular job or company. They were less likely to be married or in stable relationships. All in all, the white non-college-educated working class collapsed after the 1970s, and this was probably a product of the specific kind of unequal economic growth the country experienced.

The alternative to despair is anger.

Becoming aware of the lack of social mobility does not necessarily make people more willing to support redistribution. In the study we discussed above, after eliciting the views of Americans, the researchers presented some of them with an infographic suggesting mobility was much lower than they thought (and the others with another infographic showing the same data, but with a rosier angle). For respondents who originally identified with the Republican Party, this made them even less likely to agree that the government could be part of the solution.85

An alternative is to rebel against the system, potentially at great personal cost. In an experiment in Odisha, India, when employees in a firm felt the pay varied arbitrarily, they rebelled by working less hard, and being absent more often, than in comparable firms where the wage was kept constant, and since they were paid a fixed salary for every day they came to work, they hurt themselves by doing so. Workers in firms with unequal pay were also less likely to cooperate to achieve a collective goal tied to a reward. Workers were willing to tolerate pay inequality, but only when it was clearly tied to performance.86

In the United States, there is another possible reaction. Because many believe the American market system is fundamentally fair, they must then find something else to blame. If they don’t get that job, it must be because the elites have somehow conspired to give it to an African American, a Hispanic, or at one remove, to a Chinese worker. Why would I trust the government of those elites to redistribute to me? More money for the government is more money for “those other guys.”

Therefore, when growth either fails or fails to benefit the average guy, a scapegoat is needed. This is particularly true in the United States, but is happening in Europe as well. The natural foils are immigrants and trade. Behind the anti-immigrant views, as we argued in chapter 2, are two misconceptions: an exaggeration of how many migrants are coming in, or about to come in, and a belief in the nonfact that low-skilled immigrants depress wages.

More international trade, as we saw in chapter 3, hurts the poor in rich countries. This has provoked a backlash not only against trade, but also against the existing “system” and the elites. Autor, Dorn, and Hanson found that in US electoral districts more affected by the China shock, moderate politicians were replaced by more extreme ones. In counties originally leaning Democratic, centrist Democrats were replaced by more liberal ones. In counties originally leaning Republican, moderate Republicans were replaced by conservative Republicans. Counties highly affected by trade tended to be in traditionally Republican states, and therefore the overall effect of this was to push many districts toward more conservative candidates. This trend started well before the 2016 elections.87 The problem of course is that since conservative candidates tend to be against any form of government intervention (and redistribution in particular), they then exacerbated the problem that little was done to compensate those hurt by trade. For example, many trade-affected states governed by conservative Republicans refused federal funds to expand Medicare expansion. And this in turn fueled the resentment against trade.

A similar negative cycle may emerge as people gradually understand that they live in a society that has much more inequality and much fewer opportunities than they previous believed. As in the study mentioned above, they may become even more upset with the government and even less likely to believe it can do something to help them.

This has two implications. First, the obsession with growth at the root of the Reagan-Thatcher revolution, and that no subsequent president has taken issue with, has caused lasting damage. When the benefits of economic growth are largely captured by a small elite, growth can be a recipe for a social disaster (like the one we are currently experiencing). We argued before that we should be wary of any policy sold in the name of growth because it is likely to be bogus. Perhaps we should be even more scared if we think that such a policy might work, because growth will benefit only the happy few.

The second implication is that if collectively we as a society do not manage to act now to design policies that will help people survive and hold on to their dignity in this world of high inequality, citizens’ confidence in society’s ability to deal with this issue might be permanently undermined. This underscores the urgency of designing, and adequately funding, an effective social policy.