Scott Winship Reviews “The Upside of Inequality” on Real Clear Politics

“Ed Conard’s voice is a much-needed injection of fresh thinking…”

Scott Winship
February 18, 2017

On the day Facebook went public in 2012, Mark Zuckerberg made $2.3 billion from the exercise of his company stock options. That amount represented the difference between the cost to public investors for 60 million shares in the social media giant and what Zuckerberg had been given the right to pay as part of his compensation package in 2005. Later that year, Zuckerberg sold about half of those shares to pay taxes on the initial windfall. The appreciation in Facebook’s value since the IPO brought him another $1.1 billion in income from the sale.

In 2013, Zuckerberg exercised more options and then later sold shares to pay the tax bill, earning about $4 billion before taxes. That was about 180 times the $22 million Mitt Romney made in 2010, which was, in turn, over 400 times the typical American’s household income. I’ll save you the effort of doing the math—Zuckerberg made roughly 80,000 times the typical household’s income in 2013.

Defending these kinds of disparities is not easy—and even less easy, I would imagine, if you once worked alongside Romney as a titan of private equity at Bain Capital. But that is what Ed Conard set out to do in The Upside of Inequality, a 2016 book that deserves a considered reading from anyone concerned about inequality or the fates of the poor and the middle class. A sequel of sorts to his 2012 debut, Unintended Consequences, Conard’s new book brims with unconventional lessons that, he says, “thirty years in business have taught me.”

The Upside of Inequality is primarily concerned with explaining the rise in income concentration—that is, the rich getting richer—and the disappointing income growth among those below the top brackets in recent decades. While many observers see these two trends as intimately related, Conard argues that they have distinct causes. He makes a largely persuasive case. At points, his conjectures are weakly supported, and his perspective is often idiosyncratic—but invaluably so. Conard’s themes could spawn a dozen dissertation topics.

Income concentration grows, Conard shows, in proportion to the size of the market. Globalization and population growth have dramatically expanded the potential customer base available to businesses. More customers mean more potential profits, which increases the scale of firms, raises the value of successful ones, and increases the importance of top executives. Zuckerberg’s $4 billion would, today, come out to not much more than $2.00 for every Facebook user around the world. Would you pay $2 directly to Mark Zuckerberg one time for the use of Facebook over the rest of your life?

All workers in successful firms—not just executives—are more valuable than they used to be when markets were smaller. A cottage industry has developed in economics looking at the rise in inequality that has occurred between firms, while inequality among workers at the same firm has been relatively flat. That pattern may reflect the expansion of markets that Conard highlights.

But the C-suite remains relatively small as a share of any company’s employees and therefore retains outsize importance. As Conard notes, “It is illogical for a CEO managing five employees to earn the same pay as one managing fifty thousand employees.”

Conard points out that the incomes of the top 1 percent grew much less than the S&P 500 index between 1979 and 2007. That comparison isn’t quite right, though, as the top 500 CEOs did far better than the much bigger group of the top 1 percent of taxpayers. But Conard cites a number of other factors that push up the pay of top earners (including, but not limited to, CEOs). Advancing information technology has doubly helped the highest-skilled workers. It has increased their productivity (relative to that of other workers) while creating new investment opportunities that boost demand for their increasingly valuable skills.

Technology has also allowed innovators to grow massive businesses quickly with much less help from outside investors than past entrepreneurs required. At the extreme, a social media website or app may be created in a dorm room and quickly lead to vast wealth. Mark Zuckerberg did not need to find the money to build a giant factory, hire a massive workforce, pay suppliers, or develop physical distribution networks.

 A lottery-like element works to drive up inequality. Successful innovations produce windfall fortunes for their discoverers. While critics of inequality point to the incomprehensibly large incomes of the winners in this innovation lottery, they ignore the “large pool of very talented failures,” as Conard calls them—all those who tried for windfall fortunes, and lost.

In order to find increasingly hard-to-discover innovations, we need more people looking for them, and if the odds of success are long, the payoff for winning the lottery must be correspondingly large. Conard worries that measures to rein in top incomes will kill the golden-egg-laying goose that is the United States economy. We would be doing a lot worse, he believes, if not for the upside of inequality—the innovation that inequality promotes. And we will not do better by the middle class or the poor if we stifle that innovation through blunt efforts to prevent the rich from getting too rich.

But why haven’t the poor and middle class done better? Conard has an unconventional explanation here, too. He notes that in terms of employment growth, the U.S. actually looks pretty good next to other countries in recent decades. Wage growth has been the real disappointment.

The problem, according to Conard, is twofold. First, demand for lower- and middle-skilled American labor has been weakened by trade with low-wage countries and technology-induced rising productivity in manufacturing, while labor supply has been pushed up by increased immigration. Second, against this backdrop, the American economy has failed to produce enough risk-taking and “properly trained talent”—too few innovators, investors, entrepreneurs, and managers—to create and support the new jobs that might have increased labor demand. This failure prevents an ample supply of savings from being invested in new enterprises.

Conard’s brief (and largely unsourced) discussion of the Golden Age of American economic growth in the mid-twentieth century is the richest I have seen. Lower- and middle-class Americans thrived in this period for various reasons, many impossible or undesirable to replicate. Conard, like many others, cites pent-up demand produced by the Great Depression and World War II, as well as the war’s destructive impact on foreign competition. Labor supply, meanwhile, was diminished from reduced fertility during the Depression, creating upward pressure on wages. Postwar, markets expanded thanks to the interstate highway system and television. Rising college enrollment increased productivity and created shortages of less-skilled labor. Labor shortages in urban manufacturing centers combined with productivity-enhancing agricultural technology to promote migration from low-productivity rural areas to high-productivity cities. Steady economic growth reduced investment risk and the cost of capital.

Since the Golden Age, however, economic changes have tended to be less helpful to lower and middle-skilled American workers. Competition and technological change have driven many manufacturers overseas, where wages are lower, and forced domestic manufacturers to increase productivity, doing more with fewer workers. The capital that would have gone to domestic manufacturing—now less necessary in a service-based, knowledge-intensive economy—is invested offshore. Employment has shifted to the lower-productivity service sector. The baby boom and rising labor force participation among married women, along with increased immigration, expanded the supply of labor, pressuring wages downward.

Conard’s skepticism about trade and immigration captures the Trumpian zeitgeist but is unexpected coming from a conservative capitalist residing squarely in the Boston/Washington corridor. In his account, global trade primarily occurs today between “low-wage, lesser-skilled labor” overseas and high-wage, high-skilled Americans. This trade benefits both parties, as trade tends to do. Less-skilled Americans have not been entirely left out—they benefit from lower prices—but their pay in medium-wage jobs has been pressured downward not just by competition from low-wage workers abroad but by the replenishment of the workforce through lower-skilled immigration.

If those immigrants were contributing proportionally to the stock of “properly trained talent” and to risk-taking innovation, then the additional demand they create might translate into new, higher-wage jobs for native-born, less-skilled workers. But since they do not contribute proportionally to these constrained resources, increased lower-skilled immigration bids down wages. Conard’s lament over the shortage of “properly trained talent” comes from his belief that too many high-skilled people are going into namby-pamby lines of work that do not contribute sufficiently to employment growth and innovation.

Finally, Conard argues that potential investors lack the capacity and willingness to bear greater risk, thwarting the innovation that would lead to stronger growth and higher wages. He cites a variety of factors that have led to a shortage of entrepreneurs willing and able to put sufficient collateral at risk, including slow and unstable growth; the shift to an information- and service-based economy; the revelation during the financial crisis that the banking system is more fragile than realized; increased regulation and higher top marginal tax rates during the Obama years; political polarization; and foreign policy concerns.

Conard’s policy recommendations also include some unconventional ideas. He advocates strengthening the Federal Reserve Board’s role as the lender of last resort to counter risk aversion on the part of investors and lenders. To increase innovation, he wants a corporate tax rate of no higher than 15 percent. For the same reason, Conard would increase “ultra-high-skilled” immigration. He stops short of calling for reduced levels of lower-skilled immigration, proposing to tie its growth to that of high-skilled immigration. He’d also like federal aid to students and institutions of higher education to go toward motivating more people to go into science, technology, engineering, and math—fields that will leave them “properly trained” for jobs that also promote the additional employment of lower-skilled workers.

Otherwise, his support for educational and antipoverty programs is tepid, at best. He’s only lukewarm on charter schools and pre-K. He could live with an expansion of the Earned Income Tax Credit. Mostly, Conard would like to see more experimentation in antipoverty and education policy, with rigorous evaluation.

His two biggest out-of-the-box ideas are to eliminate taxes on working- and middle-class Americans—instead charging them for the government services they consume—and an endorsement of Warren Buffet’s import-license proposal, under which prospective importers to the U.S. would have to purchase American exports first and would receive a license to send imports our way totaling the same amount. These licenses would be tradeable, so China, for example, could purchase licenses from the United Kingdom, with which the U.S. has a trade surplus.

The danger within the policy community in Washington D.C.—among hacks and wonks alike—is that conventional thinking and ideological polarization produce too many stale ideas that don’t reflect perspectives from outside academia and Congressional offices. Ed Conard’s voice is a much-needed injection of fresh thinking. Though not by design—the book was written well before last year’s election—his views and policy agenda are surprisingly Trump-friendly. Here’s hoping that they get a hearing in the new administration.

Scott Winship is a Visiting Fellow at the Foundation for Research on Equal Opportunity.