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Politics, the Reorganization of the Economy, and Income Inequality, 1980 2009
Neil Fligstein Politics & Society 2010 38: 233 DOI: 10.1177/0032329210365047 The online version of this article can be found at: http://pas.sagepub.com/content/38/2/233

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Politics, the Reorganization of the Economy, and Income Inequality, 19802009*

Neil Fligstein1

Politics & Society 38(2) 233242 2010 SAGE Publications Reprints and permission: http://www. sagepub.com/journalsPermissions.nav DOI: 10.1177/0032329210365047 http://pas.sagepub.com

Keywords shareholder value, corporate reorganization, income inequality, managerial pay Paul Pierson and Jacob Hackers article Winner-Take-All Politics presents a sophisticated take on exactly how much income inequality has increased in the United States and how political processes were involved in the increasing redistribution of income toward the top 1 percent of the income distribution. They do a great job dissecting the existing statistics and show quite clearly how the real changes in the income distribution took place at the very top, above 1 percent. They also show how the timing of these changes coincided with the early part of the Reagan administration (ca. 198082) and mostly continued unabated for the past thirty years. My comment will focus on two aspects of their argument. First, I consider the degree to which the forces they view as pivotal will remain in play now that Obama is in power and now that we have had a financial meltdown. My basic argument is that their whole article may be fighting the last war. That is, many of the political and economic forces underlying this great run-up in income inequality are about to change. Second, I supplement their story about what happened in order to nail down the role of politics in that process more tightly. Here, they fail because their analysis of the linkages between the changes in the economy and political processes are not developed enough. They make the provocative argument that students of the income distribution have focused too narrowly on policies closely tied to taxation. But as soon as one acknowledges that a diverse set of policies has effects on the income distribution, then

University of California, Berkeley, Berkeley, CA, USA

Corresponding Author: Neil Fligstein, Department of Sociology, University of California, Berkeley, Berkeley, CA 94720, USA Phone: (510) 642-6567 Email: fligst@berkeley.edu *This article is part of a special issue on Winner-Take-All Politics that consists of a substantial article by Jacob Hacker and Paul Pierson, six comments on their piece, and a final rejoinder by Hacker and Pierson.

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one has to specify which policies are relevant and connect their timing to these processes. My argument is that in order to really understand the link between politics, the economy, and the income distribution, one has to understand more clearly what was going on in the economy to change the orientation of Congress and the president for the past thirty years. In essence, one needs to give an account of how top managers and owners changed the way that corporations worked in order to get a larger and larger share of income. Only when one has an understanding of what they did, can we consider the role of politics in this process. My main argument is that the economic crisis of the 1980s produced a new consensus that attaining economic growth without government interference was the be-all and end-all of public policy. Post-1980, Congress and the president gave business whatever they wanted. They did so because they valued economic growth and wanted to reward risk taking. As a corollary, they also supported making such risk taking lucrative and they never were concerned about the distributional consequences of giving business what it wanted.

Fighting the Last War?

I could not help but think as I was reading this article that many of the forces they describe are about to change. Many of these have to do with politics and the policies of the Obama administration. The Bush tax cuts for the wealthy are set to expire in 2010 and the Obama administration has signaled that it will let them lapse. Since these policies were so lopsided in favor of the top 1 percent of the income distribution, it is quite likely that they will affect that distribution. Even more important are changes being made to compensation related to profits from hedge funds. Hedge fund managers have enjoyed having their lavish incomes taxed as if they were capital gains (a marginal tax rate of 15 percent). If the millions of dollars of the leading hedge fund managers are taxed at 3540 percent, this will reduce their distributional distortion as well. Finally, the Obama administration appears dedicated to close offshore banking, which has clearly favored wealthy individuals avoiding tax liabilities. The recent agreement by Swiss banks to reveal the identities of wealthy individuals who are avoiding taxes is a first salvo in increasing the tax bite for the richest Americans. It is not just politics that are working to decrease income (and wealth) inequality in the United States. The current financial meltdown has destroyed at least $6 trillion of value in securities (stocks and bonds) and another $12 billion in real estate values. This devastation has to hit the richest 1 percent the most in the United States. Since the concentration of wealth is even higher than the concentration of income, all of those stock options and stock holdings as well as property holdings have radically changed the share of income going to the richest 1 percent. This decrease in their wealth and nonwage and salary sources of income will surely change the income distribution. Finally, there is a lot of discussion going on in Washington, Wall Street, and boardrooms about how executive compensation and bankers bonuses might be affected by

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the current crisis. There is certainly a lot of concern in corporate boardrooms that boards of directors have been too generous to CEOs. Compensation rules may tighten, and if one set of firms tightens such rules, this will cascade out to other firms. A large part of what has driven the rise in the salaries of the top 1 percent in the past ten years has been bonuses paid to bankers and other people working in the financial sector. The short-run downturn of that sector and the destruction of a large number of highly paid jobs will certainly lower those bonuses. If the sector fails to return to its previous levels of profitability (as many people believe), then the bonuses paid will also not contribute as much to inequality. In sum, the collapse of the financial sector, the ongoing concerns over CEO compensation, and the political actions of the Obama administration will certainly bring down the share of national income going to the top 1 percent of earners. In this way, many of the problems that are identified by the Pierson/Hacker article could lessen.1

Critique of Pierson/Hacker
But this is not my main point. The thrust of the article is that many of the increases in inequality are not tied directly to tax policy, but instead are better understood as the outcome of broader political policies that favor the top 1 percent of earners. This is a provocative argument. The story in the article is totally pitched at the level of business organization in Washington. In essence, the core of their argument is that business became better organized circa 1980 and therefore got on a thirty-year run to dominate legislative processes. But this argument is both ahistorical and astructural. It never asks the question, why does the power of business increase so dramatically circa 1980 and how does that play out, not just in Congress, but in the real economy? Once in play, how does the power of business interact with and help create a new economy, one that benefits the top 1 percent of the income distribution in a systematic fashion? While Pierson and Hacker have bits and pieces of what happened, they do not make much of an attempt to provide the reader with an account that helps us understand how politics came to be controlled by a normative conception of how the economy should work and who the principal beneficiaries of that conception should be. In essence, I document how the top managers and owners under the rubric of maximizing shareholder value worked to reform the economy to get a larger and larger share of income. It is useful to tell that story to fill in the holes in their argument. To begin, the article never asks the question, what was going on circa 1980 in the American economy that would broadly shift the underlying power from labor and progressive redistribution of income to capital and increasing income inequality? The obvious and simple answer is that the U.S. economy was in a crisis almost continuously from 1973 until the election of Ronald Reagan. This crisis had many causes: the oil shocks, the inability of the U.S. government to stay the course with Bretton Woods, and the decline of U.S. leadership in the world economy. But the most important problem was that the 1970s

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produced a prolonged economic slump in the United States, characterized as a period of high inflation and slow economic growth, termed stagflation. This negatively affected everyone in society. Wages did not grow, unemployment was high, interest rates were punishingly high, and inflation threatened everyones standard of living.2 It was this economic crisis that required profound rethinking, not just of government policy, but also of how business was going to operate. For much of the 1970s, CEOs told their boards of directors and shareholders that they were hunkering down to survive the storm of the bad economy. This justified them holding onto cash, and not going into debt for funding their day-to-day activities. It also caused them to not revalue their existing assets even as they were inflating in value. Most of all, with high interest rates, investors left the stock market in droves to bonds and other interestbearing instruments, which caused the market to drop and thereby reducing the book value of corporations.3 This crisis brought forward a whole new set of ways to think about not just public policy, but also the organization of large capitalist firms. At the policy level, the Carter administration began to develop the argument that the problem in the American economy was too much regulation. This regulation stifled competition and helped create inflation because prices remained too high. It also began to argue that too much regulation had entrenched labor as well as producing labor markets where wages and price increases produced inflation. The solutions the Carter administration began to experiment with were deregulation of the airlines, trucking, and the savings and loan industry.4 When Ronald Reagan was elected president, he came in promising to deregulate industry even more. His first legislative act created a huge tax cut for business and individuals. He favored getting government out of regulating and even monitoring the activities of business. He suspended the antitrust laws. During his first year in office, he visibly broke the air traffic control union. His actions left no doubt with business that if they wanted to shed their unionized work forces, the government agencies in charge would not stop them. The Reagan administration also opposed raising the minimum wage, which meant that as inflation raged, the wages that lower-paid workers got were increasingly smaller and smaller.5 In essence, it was the economic crisis of the 1970s that produced the political and economic conditions that lay the ground work for increased income inequality. But the important part of the story that Pierson and Hacker neglect to tell is that the policy response to this crisis dismantled the role of government capability to intervene into product and labor markets. It was this retreat from regulation that came to dominate the way that Congress worked for the next thirty years. These ideas, which we now call neoliberalism, were powerfully embedded not just in policy communities, but also in the popular discussion of the right relationship between government and markets. From 1980 onward, the dominant policy view was that markets were always right and government was always wrong. One could argue that the Reagan administration intentionally set out to increase income inequality in the United States. It cut the high marginal tax rates for the highest

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earners with the argument that such taxes cut off peoples incentives to innovate. The famous Laffer curve suggested that cutting marginal tax rates would eventually increase government revenues because successful entrepreneurs would make so much more money that the tax mans take would go up. It is clear that all of the policies of the Reagan administration favored capital over labor. It is not surprising that during this era, income inequality began to rise. But, the part of the story that was not intentional from the view of policy makers is how the largest American firms were reorganized under the rubric of shareholder-value capitalism during the 1980s and into the 1990s. The increases in income inequality that eventually took hold were certainly related to the promarket orientation of Congress under both Republican and Democratic regimes. This made Congress and the president highly susceptible to whatever business wanted. But, what really drove income inequality was the dynamics of the economy. Corporate America began in the 1980s to deindustrialize, thereby destroying much of the blue-collar male labor forces ability to earn a middle-class income, then moved on to waves of reorganization that reduced the size of corporate bureaucracies, and finally to a finance-driven economy where rewards and bonuses made up a huge percentage of the top 1 percent earners incomes. Congress and the president, under the guise of neoliberal ideas, were always there to support whatever was the leading edge of corporate reorganization. The first wave of corporate reorganization under shareholder value began as early as 1978, but really got going after Reagan took power. From 1978 to 1987, there was a huge merger movement, a merger movement that worked to reorganize American corporations. It is useful to consider the pioneers of the shareholder-value story. It has been documented that the criticism of American managers began in the late 1970s.6 The criticism was that American managers had grown complacent. They had too much capital, they had undervalued assets, and they had low share prices. This meant that they were not making enough money for shareholders and thus they were not maximizing shareholder value. A number of American corporations were so undervalued by the stock market that they held more cash and more assets than they were worth.7 Institutional investors and what came to be called corporate raiders realized that they could buy up entire firms, and then break them up and sell off assets and make a huge profit. Once a few investors began to do this, a feeding frenzy engulfed many of the largest American corporations. Managers had little choice but to take on debt, sell off undervalued assets, and concentrate on raising share prices and profits. The entire relationship between top managers and the investment community began to change.8 If corporations ruled the financial markets before 1980, after 1980, the markets became the most important reference point for firms. Managers either got with the program or found themselves out of a job.9 This created a wave of corporate reorganizations under the rubric of maximizing shareholder value. First, waves of deindustrialization swept through American business. Corporations began to more systematically evaluate their investments according to how much profit they could be expected to return. Industries that were not growing or could not be made more profitable were exited. This meant that highly paid unionized

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manufacturing workers became an endangered species.10 The group most forcefully affected by this was men with just high school educations. Their wages began to stagnate and over time decrease.11 The white working class began to disappear and with them there emerged a more unequal income distribution. Work in general became more insecure for everyone.12 Once firms got rid of unionized workers and businesses that were less profitable, they turned themselves to reorganizing the corporation by downsizing. Downsizing meant removing layers of corporate bureaucracies. It has been estimated that during the recession in 199192, 40 percent of all men aged forty-five to fifty-four who were in managerial occupations lost their jobs.13 How did downsizing affect income inequality? The gains from downsizing management levels went to two groups. First, shareholders got higher dividends and profits. But, for the managers who were left, hours of work increased, but so did pay.14 It was in the late 1980s and early 1990s that top managers began to use the arguments of agency theory to suggest that their pay should be tied to the performance of the firm, in particular, to their ability to raise the share price. The argument was that in order to really align the interest of shareholders and top managers, top managers had to become shareholders. This began the era of paying large bonuses for the firm meeting financial goals and offering stock options to top managers that could be exercised if the stock price went up. During the 1990s, pay packages for top managers grew dramatically. Managers became even more systematic about using financial engineering to adjust their balance sheets in order to look more profitable and raise the share price.15 For example, for a while, all a firm had to do to raise its stock price was to announce a large layoff. Financial markets would treat such an announcement with glee and bid up the stock.16 The final change in the American economy began with the increasing role of the financial sector of the economy as a source of profit particularly after 1992. By the time the current wave of managerial capture of huge wage and salaries began, the idea that top managers should be rewarded primarily for the financial performance of the corporation was firmly in place. Here, Pierson and Hacker capture how large the profits were and how unequally distributed the profits became. Most scholars who have analyzed these changes have concluded that increased managerial power to set their pay increased pay dramatically even under circumstances where the evidence of good financial performance was being manipulated by managers.17 This brief rendition of how American capitalism changed explains how the share of national product going to top managers and owners increased over time and the share going to labor decreased. Institutional investors, top managers, investment banks, and the financial community were the principal beneficiaries of these changes. By the time we got to the subprime mortgage boom of the 200208 period, the Congress, president, and regulators were already used to giving business the leeway it needed to find new ways to make money. Legislation helped Silicon Valley and Wall Street to allow managerial pay to rise as high as it could go in the name of rewarding innovation. Legislation helped the telecommunications companies and later the banks to engage in whatever activities they chose. The exact nature of what sectors of business wanted

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from legislation changed, but the willingness of Congress and the president to accommodate their desires remained constant.

Conclusion
My account of how the American economy has changed to favor top managers and shareholders over workers and communities implies that once Congress began to give business more or less anything they wanted to help in their restructuring their businesses, almost everything Congress did vis--vis the regulation of business probably helped create more income inequality. Since all of this legislation was premised on the idea that whatever business did would increase jobs and the size of the American economy, none of it addressed how the profits from this were going to be distributed. Indeed, Congress implicitly bought into the idea that the main goal of such reorganization should be to reward those who invested and innovated. Implicitly, Congress was okay with the idea that those rewards should be unequally distributed, and it accepted increasing shareholder returns in order to encourage such risk taking. Indeed, no actions that Congress took ever showed that they were worried about the distributional effects of the reorganization of American business. Indeed, when the government did act, it was to try and encourage investment by doing things like cutting capital gains taxes. For example, the government allowed hedge fund managers to treat their salaries and bonuses as long-term capital gains. Executive compensation was viewed as a matter for the market and shareholders to regulate. To the degree that anyone in the government thought about it, they bought the agency theory premise that the attempt to directly tie managerial compensation to increasing shareholder value was an idea that was self-evidently good and not necessary to regulate. If I am right, what is the future of inequality in the United States? This takes us back to the question of the degree to which the current economic crisis is or is not going to be a sea change in how Congress, the president, and business relate. If the 1970s presented a crisis that put business on top, is it possible that the current economic downturn will be severe enough to cause Congress and the president (and the public at large) to be more cynical about the claims of business to serve the public interest and increase economic growth and jobs? Will it make politicians more willing to intervene into business and the processes that have produced so much income inequality? One can construct the scenarios both ways. My argument in the first section of this comment implies two forces that will decrease income inequality. First, the massive destruction of wealth and income earning investments means that inequality will just drop. The decline of banking will mean that the outrageous amounts paid to bankers and hedge fund managers will also lessen. But, equally important, the Obama administration seems to want to attack the problem of income inequality from a number of angles. It will raise taxes on the richest people in the country. It has also worked to lower the bonuses paid to CEOs and bankers. For example, there have been some changes made to rules around corporate governance that will make it easier for shareholders to challenge executive compensation. There

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are many conversations going on about regulation that will change compensation practices in many of the industries most affected by the crisis. I can imagine the Obama administration raising the minimum wage and indexing it to inflation. The Obama health care plan may not change the income distribution, but it certainly might decrease the suffering experienced by low-income people who do not have health insurance. It may also prevent bankruptcy of people who are unfortunate enough to contract a chronic illness. My sense is that these forces may stop income from growing more unequal in the next ten years and maybe even produce a little less income inequality. But I am not convinced that the crisis we have will overcome all of the forces that have led up to the run-up in income inequality. The current crisis, while deep, may not last long enough or produce enough push toward change. There is already evidence that the financial services industry is working to prevent changes in regulation, and in particular, changes that will effect compensation. The team of economic advisers that has the ear of the president in 2010 does not inspire confidence for their concerns about inequality. They seem more concerned with preserving the stability of the banks and bankers and less about unemployment. The American public has never been that concerned about inequality. Most Americans do not begrudge their neighbors very high incomes. They treat the money that is captured by CEOs, bankers, and hedge fund managers as partially about luck and partially about the skill of those who earn it. They also believe that this outcome might happen to them (even in the face of abundant evidence that this is not the case). I am not sanguine that the public mood is really ready to embrace more regulation of the American economy. Such a mood would have to overcome the bias of the past thirty years that instinctively favors business over government. Something will have to persuade a majority of Americans that the government can change business in a positive direction by regulating business activities, including compensation packages, before the income distribution begins to head back to 1970s levels. What that something might be is what political analysts should be trying to figure out. Acknowledgments
I would like to thank Fred Block and the reviewers at Politics & Society for their comments on an earlier draft.

Declaration of Conflicting Interest

The author declared no conflicts of interest with respect to the authorship and/or publication of this article.

Financial Disclosure/Funding
The author received no financial support for the research and/or authorship of this article.

Notes
1. A recent report by the U.S. Census Bureau, Income, Poverty, and Health Insurance Coverage in the United States, 2008 (Washington, DC: Government Printing Office, 2009) shows

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2.

3.

4.

5.

6.

7. 8. 9. 10.

11.

that between 2007 and 2008, the income distribution changed very little. The same is true for most measures since 2000, except for the ninetyten ratio which has increased. See Benjamin Friedman, Corporate Capital Structures in the United States (Chicago: University of Chicago Press, 1985), chap. 1; and Neil Fligstein, The Architecture of Markets: An Economic Sociology of Twenty-First-Century Capitalist Societies (Princeton, NJ: Princeton University Press, 2001), chap. 4. See Neil Fligstein and Linda Markowitz, Financial Reorganization of American Corporations in the 1980s, in Sociology and the Public Agenda, ed. William J. Wilson (Beverly Hills, CA: Sage, 1983), 185206; and Gerald Davis, Kristina Diekmann, and Catherine Tinsley, The Decline and Fall of the Conglomerate Firm in the 1980s: The Deinstitutionalization of an Organizational Form, American Sociological Review 59 (1994): 54770. The deregulation of the trucking and airlines industries led to more competition and lower prices for consumers. The deregulation of the savings and loan industry led to the savings and loan crisis whereby most of the banks went bankrupt. This is relevant to our current financial crisis, but not to the story I want to tell here. See David Card and Joseph DiNardo, Skill Based Technological Change and Rising Wage Inequality: Some Problems and Puzzles (Working Paper 8769, National Bureau of Economic Research, Cambridge, MA, 2002). See Fligstein and Markowitz, Financial Reorganization of American Corporations; Davis, Diekmann, and Tinsley, The Decline and Fall of the Conglomerate Firm; Ellen Appelbaum and Paul Berg, Financial Market Constraints and Business Strategy in the U.S., in Creating Industrial Capacity: Towards Full Employment, ed. James Michael and John Smith (New York: Oxford University Press, 1996), 193221; Gerald Davis and Suzanne Stout, Organization Theory and the Market for Corporate Control, 19801990, Administrative Science Quarterly 37 (1992): 60533; Michael Useem, Executive Defense: Shareholder Power and Corporate Reorganization (Cambridge, MA: Harvard University Press, 1993); and Dirk Zorn, Frank Dobbin, John Dierkes, and Michael Kwok, Managing Investors: How Financial Markets Shaped the American Firm, in The Sociology of Financial Markets, ed. Karin Knorr Cetina and Alex Preda (London: Oxford University Press, 2007), 26989. See Friedman, Corporate Capital Structures in the United States. See Zorn et al., Managing Investors. See Useem, Executive Defense. See Barry Bluestone and Bennett Harrison, The Deindustrialization of America (New York: Basic Books, 1986); David Card, The Effects of Unions on the Structure of Wages: A Longitudinal Analysis, Econometrica 64, no. 4 (1996): 95779; Card and DiNardo, Skill Based Technological Change and Rising Wage Inequality; David Gordon, Fat and Mean: The Corporate Squeeze of Working Americans and the Myth of Downsizing (New York: Free Press, 1996); Bennett Harrison and Barry Bluestone, The Great U-Turn: Corporate Restructuring and the Polarizing of America (New York: Basic Books, 1988). See Henry Farber, The Changing Face of Job Loss in the U.S., 198195 (Brookings Paper on Economic Activity: Microeconomics, Brookings Institution, Washington, DC, 1997), 55142.

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12. See ibid. 13. See ibid. 14. See Neil Fligstein and Taekjin Shin, The Shareholder Value Society: A Review in Changes in Working Conditions in the U.S., 19762000, in The Social Inequalities, ed. Kathy Neckerman (New York: Russell Sage, 2004), pp. 401-432. 15. See Ezra Zuckerman, The Categorical Imperative: Securities Analysts and the Illegitimacy Discount, American Journal of Sociology 104 (1999): 13981438; and Ezra Zuckerman, Focusing the Corporate Product: Securities Analysts and De-Diversification, Administrative Science Quarterly 45 (2000): 591619. 16. See David Blackwell, Wayne Marr, and Michael F. Spivey, Plant-Closing Decisions and the Market Value of the Firm, Journal of Financial Economics 26 (1990): 27788; Henry Farber and Kenneth Hallock, Have Employment Reductions Become Good News for Shareholders? The Effect of Job Loss Announcements on Stock Prices, 19701997 (Working Paper 7295, National Bureau of Economic Research, Cambridge, MA, 1999); and Kenneth Hallock, Layoffs, Top Executive Pay, and Firm Performance, American Economic Review 88, no. 4 (1998): 71123. 17. See Lucien Bebchuk and Jesse Fried, Pay Without Performance (Cambridge, MA: MIT Press, 2004) for a more negative take on executive compensation and Kevin Murphy, Executive Compensation, in The Handbook of Labor Economics, ed. Orley Ashenfelter and David Card (New York: North Holland, 1999), 24852563 for a review with more of efficiency spin.

Bio
Neil Fligstein (fligst@berkeley.edu) is the Class of 1939 Professor in the department of sociology at the University of California. He is the author of numerous books and papers including The Architecture of Markets (Princeton University Press, 2001) and most recently Euroclash: The EU, European Identity, and the Future of Europe (Oxford University Press, 2008). He is currently working on the issue of the causes of the recent financial crisis in America.

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