When well-intentioned government actions increase economic inequality

Joseph Stiglitz, a renowned economist, has just published a book entitled The Price of Inequality, in which he directly tackles the cost and root causes of societal inequality. While I do not agree with his broad recommendations or his overall view of the world, I believe that he correctly identifies inequality of political access and influence as the source of economic inequality.

Based on the experiences of being involved with both government and private sector marketplaces in which individuals have gotten very rich or successful, I would make four broad observations about economic inequality:

  • More complex customer procurement rules or political systems increase inequality;
  • More intensive government regulation to redistribute opportunity increases inequality;
  • “Stimulative” government programs to increase opportunity increase inequality; and
  • Complexity, over-reaching government regulation, stimulus programs and badly designed rating, ranking, and measurement systems benefit people with pre-existing advantages and widen their advantages, and, in some cases, they become obscenely rich.

Increasing system complexity increases inequality.

When I was at Pitney Bowes, we were investigated several times for having achieved leadership positions in mail-related markets. The Justice Department assumed that we must have done something wrong to have a leadership position that spanned several decades. They were wrong, and, eventually, after five investigations in 22 years, they implicitly admitted that something other than bad conduct was behind our leadership position.

The technical and process complexity of how we evidenced and collected postal revenues, both through postage meters and mail service operations, gave us a huge advantage. The postal rate structure for work-sharing discounts was extremely complex. Success depended on successfully making arguments that caused the Postal Service and the Postal Regulatory Commission to approve increases in particular discounts of as little as 1/10 of a cent. Every 1/10 of a cent discount increase we received gave us over $10 million of operating income. To make these arguments required us to hire and educate postal economic specialists, who understood the unique economics of postal mail processing. Without the complexity of postal economics, which few economists could master, we would not have the significant competitive advantage that enabled us to grow and be profitable.

There was nothing sinister about this complexity. It was no different from the economics of other public utility pricing systems, but, because postal mail economics was a smaller perceived business opportunity, few economists attempted to master it, which gave us a big opportunity.

The more complex the discount structures became, the more difficult it became for our smaller competitors, many of whom were anxious to have us acquire them. Our experience is replicated every day as large private sector companies create very complex procurement processes that benefit incumbents or large, resource-rich vendors, at the expense of start-up businesses.

More intrusive government regulation and attempts to redistribute wealth, income, and opportunity have exactly the opposite effect.

This is the point at which I most completely diverge from Stiglitz and others sharing his point of view. When governments try to “level the playing field” between those they believe to be advantaged and disadvantaged, they are more likely to increase inequality.

Complex and comprehensive laws and regulations that attempt to micromanage the economy to redistribute wealth increase inequality in two ways:

  • They give advantages to those with more know how and resources to figure out how to play more effectively within the new rules.

New York City rent control laws have been in place since 1947. They have benefited wealthy people who can maintain a New York apartment and spend their own money for capital improvements, since no honest landlord can afford to invest in upgrading rent-controlled apartments for lower-income tenants. They also benefit unscrupulous landlords, because they are designed to protect absurdly low rents only while the existing tenant is in place. Instead of improving the housing stock to increase the value of the property, landlords finding creative ways to force out or buy out rent-controlled tenants, either by renting adjacent apartments to rock musicians or motorcycle gangs, refusing to make basic repairs, or engaging in noisy construction. The rent control laws induce this dysfunctional behavior because they create a wide gap between the market rate and the rent control rate. Wealthy tenants can fight these abuses, but the lower-income tenants rent control laws are designed to protect cannot fight back easily.

  • They create a new class of people who thrive on being intermediaries, consultants, or other service providers in the marketplace created by these redistribution schemes. Addressing the needs of these various intermediaries adds cost, complexity, and inequality to any marketplace these intermediaries touch.

Public sector labor unions clearly thrive when the government creates more jobs to “redistribute” wealth, since more government employees are needed in such an environment. Civil service professionals do well by “monitoring” the disbursement of funds from government to “disadvantaged” people. Major agricultural corporations benefit from highly profitable food stamp programs. Firms that provide specialized software for managing government social service programs make a lot of money licensing that software to non-profits that have to comply with complex government requirements. Ross Perot became a billionaire because he mastered the intricacies of serving government programs, first at EDS and later at Perot Systems. Not surprisingly, an individual, a small business, or an under-resourced large business will have an even greater disadvantage the more of these intermediaries with which they have to deal.

Title IX has created a whole new cottage industry of parents, coaches, guidance counselors, college counselors, and providers of athletic equipment that benefit from building girl’s sports teams at the K-12 level. Wealthy, resourceful people “game” the college applications process at top-rated schools by getting their daughters into Title IX-induced sports like lacrosse, equestrian sports, squash, and rowing. Greater governmental intervention to redistribute wealth, income, and opportunity simply creates new opportunity for those who are already rich. Title IX has created new opportunity for women, but has significantly skewed all sports toward wealthier women and men. The sports programs that get cut to support a new women’s sports program in lacrosse, squash or equestrian sports are inevitably sports that are more accessible to lower income students, like baseball, track and field, or swimming.

Government “stimulus” programs get burdened by the inevitably costly, onerous and time-consuming audit and compliance programs that accompany them. Wealthy, resourceful people are far smarter in navigating through these expensive requirements.

Elected officials so completely distrust those to whom they give money for stimulus purposes, and are so concerned about failing to catch fraud, waste, and abuse that they insert requirements that slow up the flow of money and siphon off money that should go toward stimulus. This was amply documented in Michael Grabell’s comprehensive analysis of what went right and wrong with the stimulus legislation in Money Well Spent? Many well-intended programs were delayed and costlier because of an excessive preoccupation with government rules and processes.

One example was the weather-stripping program that was going to reduce energy costs for homeowners, reduce environmental pollution, and provide middle-class jobs for people of moderate skills. Despite the program’s obvious merits, it was delayed for several months in communities that did not apply the resources to get the government to define “prevailing wages” for determining compensation. Wealthier communities were far better able to drive the government to act than their economically challenged counterparts.

Major infrastructure programs end up in wealthier states and localities and major government spending programs often are disproportionately spent in wealthier communities, because these communities can marshal the resources to do what it takes to get the money, especially when the program requires matching funds.

My favorite example of this last point (although it did not arise from any stimulus legislation) was the case of Westhampton Dunes, a community formed in the early 1990’s at the western end of a barrier island in a super-wealthy resort area on Long Island. A group of very wealthy real estate speculators bought up beachfront homes that had been severely damaged by ocean wave surges during storms in the late 1980’s, at prices ranging from $50,000 to $100,000 per property. The damage to beaches and homes was caused by a shortsighted county supervisor decision not to fund the construction of protective barriers along several miles of beach (because he thought it only helped wealthy homeowners.) The speculators petitioned the Army Corps of Engineers and the state of New York for 91% of the funds required for beach replenishment and the construction of protective barriers, and then assessed the wealthy owners of the beachfront properties for the remaining 9%.

After the Army Corps of Engineer project was completed, each property was worth millions of dollars. The homeowners got very rich from this well-intentioned government program, because they had the capital and the network to assemble the property, the money and the lobbying strength. The real estate speculators who benefited were far wealthier than those who sold their homes at $50,000 to these speculators.

Many well-intended rating, ranking, and measurement systems have the unintended consequences of increasing inequality.

Given the apparent importance of a college degree from a “good school,” the competition to get into “good schools” is more ferocious than ever. Schools appear to be more exclusive than ever is that schools actually have the incentive to increase the number of applicants they reject. The U.S. News & World Reports college ranking and rating system ranks schools higher, based on their “exclusivity.” As a result, many schools encourage applications from many students who, realistically, have no chance to be admitted.

The flood of applications creates additional complexity and risk for those who actually are qualified, but might be rejected, simply because admissions officers have too many applications to review and have to use shortcuts to screen out applicants. Wealthier people spend a considerable amount of money and time working with college counselors, who help their children “game” the applications process. The ranking system helps create the conditions that make this “gaming” necessary and more effective.

To bring greater “rationality” into the reimbursement system for physicians, Medicare and Medicaid adopted a system developed by a Harvard Medical School professor called the “Relative Value Resource Based System” in the late 1980’s. Payments for clinical encounters were determined by a complex points system, which over-rewards complex procedures undertaken by highly-trained specialists, as opposed to simple cures through consultations by primary care physicians. The end result: American has so lopsided a reimbursement in favor of subspecialists versus primary care physicians that we only see 4% of medical school graduates go into primary care. This is one reason why our healthcare costs are so high relative to other developed countries. We excessively reward skill and inadequately reward cost-effective performance.

Final comments

Stiglitz and others are correct that persistent and widening inequality is dangerous and destructive of the American dream. However, the notion that government intervention is the “cure” for this inequality is misguided. Government has done a great deal, in the interests of eliminating inequality in the past, to create the conditions that have led to the inequality we face now. I do not believe that the future would be any different.