the policy relevance of institutional economics

jei JOURNAL OF ECONOMIC ISSUESVol. XXXV No. 1 March 2001Notes and Communications

The Policy Relevance of Institutional Economics

In March 1984, the Journal of Economic Issues published a special national economicpolicy issue titled "Economic Policy for the 1980s and Beyond: An InstitutionalistAgenda," In the editor's introduction Marc Tool wrote:

Presumably it is always "the best of times" for some, perhaps a few, and "theworst of times" for others, often the many. Economic policy is, and always hasbeen, addressed to economic problems characterizing "the worst of times," asexperienced by those adversely affected and as perceived by those with under-standing, position, or voice, whether the many or the few.

Although the economy of today is in many ways very different than that of 1984,it is hard to imagine a better way to think about the recent performance ofthe US econ-omyand the economic policy challenges this performance gives rise tothan interms ofthe "best of times" and the "worst of times,"

In the popular press, the last decade is typically presented as a period of greatprosperity for the United States, and in a recent poll over 70 percent of respondentsidentified 1999 as "the best economic time oftheir lives" (Leone 1999), Almost daily,we are reminded that the United States is enjoying low unemployment, low inflation,and a "booming" stock market. Last fall, the US Census Bureau reported that in 1998the median real income for households had reached an "all-time high" of $38,855. Inaddition, it reported that the overall poverty rate had declined to 12,7 percent, the low-est level since 1979, and that the child poverty rate had declined to 18,9 percent, thefirst time it was below 19 percent since 1980 (Wall Street Joumal 1999; Greenstein etal, 1999). It has also been widely noted that in 1998 the "percentage ofAmerican fami-lies holding stockeither directly or indirectly as part of a mutual fund or retirementaccounthit an all-time high of 48,8 percent" (Crutsinger 2000),

Another recent poll, however, found that 75 percent of Americans believe that thebenefits ofthe "new economy" are being distributed unequally (Stevenson 2000), andmany ofthe economic trends ofthe last decade support this perception. In particular, alook beyond median income to the distribution of income reveals that, in the words ofthe Wall Street Joumal (1999), "the fruits of prosperity in this decade have been more

173

/ 74 Notes and Communications

heavily skewed to the rich than in prior booms" and "life is still a struggle for millionsof Americans."

Inequality: Recent Trends

Although the statistics on recent trends in the distribution of income in the UnitedStates are well known, a few key points are worth emphasizing.

Income Distribution

According to recent reports by the Center on Budget and Policy Priorities and theEconomic Policy Institute, US Census data for 1998 indicate that income disparitiesbetween the rich and poor in that year were at "their widest point since the CensusBureau began collecting these data several decades ago" (Greenstein et al. 1999).They also report that nationwide, income inequality increased significantly duringboth the 1980s and 1990s, with the gaps in income between high-income families andpoor families, and between high-income families and middle-income families,becoming wider across the United States, in every region, and in virtually every state(Bernstein et al. 2000).

For example, from the late 1980s to the late 1990s, the average real income ofthelowest-income families grew by less than 1 percent and the average real income ofmiddle-income families grew by less than 2 percent, while the average real income ofhigh-income families grew by 15 percent. This small growth in the incomes oflow-income families in the 1990s was not enough to make up for the decline inincomes during the 1980s: from the late 1970s to the late 1990s, the average realincome of the lowest-income families fell by over 6 percent and the average realincome of middle-income families grew by about 5 percent. In contrast, the averagereal income ofthe highest-income of families increased by over 30 percent (Bernsteinet al. 2000).

The resulting income disparities are substantial. Nationwide, in the late 1990s, theaverage income of families in the top 20 percent ofthe income distribution was morethan 10 times as large as that ofthe poorest 20 percent. At the state level, in the late1970s there were no states where high income families had an average income thatwas as much as 9.5 times larger than the average income of low-income families; bythe late 1990s, the "top-to-bottom" income ratio was 9.5 or greater in 24 states(Bernstein et al. 2000).

The trends in income inequality and the resulting income disparities become evenmore pronounced when race is taken into account. For example, in their recent bookPersistent Disparity, William Darity and Samuel Meyers (1998) illustrate that "simul-taneous with the rise in general inequality has been a worsening ofthe relative income

Notes and Communications 175

position of black families in America." That is, there has been a "widening ofthe gapbetween whites and blacks," even as "some blacks are doing well fmancially." Theyargue that "it is not just an issue ofthe rich getting richer and the poor getting poorer,but that while both affluent blacks and whites got richer, it was the black poor that gotpoorer."

Poverty

These trends in income inequalityparticularly the lack of progress at the bottomof the income distributionhave obvious and important implications for poverty.Although the United States did see a reduction in the incidence of poverty in 1998, thepoverty rate was still higher than it was in "nearly all years ofthe 1970s, even thoughthe unemployment rate was considerably lower" in 1998 than it was during the 1970s.Child poverty also remains considerably higher than it was in the late 1960s and dur-ing the 1970s, and continues to be "higher than in most other industrialized nations."In addition, "more than one in every three hlack and Hispanic children in the UnitedStates remain poor" (Greenstein et al. 1999).

There have also been increases in the depth of povertythat is, poor families arepoorer, on average, now than they were a few years ago. The Center on Budget andPriorities reports that even when food stamps, housing subsidies, and the earnedincome tax credit are counted as income, "the average amount by which the incomesof poor families fall below the poverty line was $245 greater per family member in1998 than in 1995" (Greenstein et al. 1999). In addition, the number of extreme poor(i.e., people trying to survive on less than half of the poverty line income) went upbetween 1995 and 1997, including an increase in the numher of children living inextreme poverty (Edleman 1999).

Wealth

While the income distribution data are startling, the increase in inequality in fam-ily income during the 1990s was "surpassed by the growing imbalance in the accumu-lated wealth of families" during that time period. Due in part to the well-publicizedgains in the stock market, the United States has seen a tremendous increase in thevalue of certain assets, and most of the increases in this wealth were concentratedamong the richest families (Larin 1998). In fact, the median value of assets owned byfamilies with incomes less than $25,000 annually (including everything from bankaccounts and stocks to homes and cars) actually fell during the mid to late 1990s, whilefamilies with higher incomes saw the value of these assets increase (Stevenson 2000).

This disparity is reflected in recent data on the net worth of US families. In Janu-ary 2000, newspaper articles around the country celebrated the increase in the net

176 Notes and Communications

worth ofthe "typical" American family, based on a report by the Federal Reserve thatindicated a 17,6 percent increase in the median net worth of families between 1995and 1998, In the same report, however, the Fed indicated that "families eaming lessthan $ 10,000 annually actually saw their median net worth fall by 25 percent,,, whilethe median net worth of families eaming between $10,000 and $24,999 was down 20percent,,, The median net worth of families eaming $25,000 to $49,000 was up 6,3percent , , , while families eaming $50,000 to $99,000 enjoyed , , , a 20 percentincrease," Families with income over $100,000 saw their median net worth remainroughly the same (at about $511,000), but the average net worth for this groupameasure that "captures the gains by the wealthiest Americansrose 22,4 percent to$1,73 million" (Cmtsinger 2000), Other research indicates that the wealth gap is evenmore stark for blacks and Hispanics, In 1995, for example, "nearly one in three blackhouseholds had zero or negative net worth," and half the Hispanic population in theUnited States had "more debts than assets" (Collins 1999).

Some "good news" is reported from the most recent income data, which indicatethat the income distribution remained roughly the same in the final years ofthe 1990s,suggesting that income inequality may, perhaps, have stabilized (Stevenson 2000),This may also suggest, however, that "disparity has locked in at a historically highlevel" (Wall Street Joumal 1999), Thus, the causes and consequences of inequalityremain a critically important issue for research and policy agendas in this new century.

Inequality: Causes

The causes of recent increases in inequality in the United States are many. Threeareas of concem that appear to be particularly important are changes in labor markets,the concentration of asset ownership and investment income, and govemmentpolicies.

Labor Markets

Wages are, of course, a key factor in the distribution of income, since they consti-tute about three-fourths of total family income. Despite the economic expansion andlow unemployment rates through much of the last decade, average wage increaseshave been muted and wage inequality has increased. Over the course of the last twodecades, wages at the bottom and middle of the wage scale have "been stagnant orhave declined," while the wages ofthe very highest paid employees have "grown sig-nificantly," And, although real wages did begin to rise for many workers at the end ofthe 1990s, this recent wage growth has not been sufficient to counteract two decadesof "stagnant or declining wages" (Bemstein et al, 2000),


In addition, the growing gap between high and low income workers is even moredramatic when total compensation (wages plus fringe benefits) is considered.Although the average amount employers have spent on fringe benefits has increasedover the last two decades, the benefits of these increases have been concentratedamong high-income workers. A particulariy striking comparison reveals that while theaverage total compensation of "top executives at major U.S. companies nearly tripledduring the last two decades, average total compensation actually has fallen for the 80percent of the workforce who are production and nonsupervisory workers" (Larin1998).

Analysts have identified a number of broad factors contributing to rising labormarket inequality, including globalization, the decline in manufacturing jobs and theexpansion of low wage service jobs, and the weakening of key labor market institu-tions. These factors have been particularly significant in leading to "an erosion ofwages for workers with less than a college educationapproximately the lowest earn-ing four-fifths of the workforce" (Bernstein et al. 2000). These changes have beenaccompanied by fundamental changes in the structure of employment and in the rela-tionship between labor and management, illustrated, for example, by the "increasedwillingness of companies to lay-off large numbers of workers even during profitableperiods" and the "growing use of labor on a 'contingent' basis" (Leone 1999).

In his recent book Securing Prosperity, Paul Osterman (1999) attributes what hecalls the "good news/bad news" character ofthe "new labor market" to changes takingplace both within the firm and in the external labor market. Inside firms, employers arereorganizing work into new systems that, for some workers, "bring more interestingand more highly skilled employment." At the same time, however, these new systemsweaken "the ties that bind the workforce to the firm," thus reducing employment secu-rity and increasing the number of lay-offs.

The external labor market is seen to have the same "two-faced nature." Osterman(1999) argues that on one hand.

It is undeniable that many people find the new labor market a congenial place.These people, roughly 20 percent of the working population, have experi-enced considerable wage gains. They have the good fortune to have high-levelskills that are in strong demand. They believe that they indeed can managetheir own careers, and high rates of job changing and weak attachments toemployers pose no threat and may even be valued.

For those who do not share in this good fortune, however, Osterman (1999)argues that the external labor market is "treacherous." In particular, "employmentsecurity is declining, and the consequences of being dislocated are severe"; the situa-tion for those at the bottom of the labor market, including both wages and mobility,has deteriorated; and new forms of employment, such as the rise of contingent work,leave "many people in jobs whose quality . . . is clearly substandard." He concludes


that "[tjhese are some ofthe characteristics of a 'successful economy.' One can easilyimagine that the inevitable downturn will yield even more troubling outcomes."

Investment Income

Besides wages, the other major source of income is investment income (such asdividends, rent, interest, and capital gains) and since investment income primarilyaccrues to those at the top ofthe income distributionfor example, "eighty percent ofcapital gains income goes to the richest 20 percent of the population" (Larin1998)recent expansions of this type of income have led to greater income inequality(Bemstein et al. 2000).

Despite the growing popularity of mutual funds among families of many incomelevels and the fact that nearly half the population now owns some stocks, "very fewhave sizeable stock holdings." For example, in 1995 "nearly three-quarters of stock-holders held less than $5,000 worth, including stock in retirement plans and muUialfunds.... Financial assets like stocks and bonds remain concentrated in relatively fewhands, with the richest 10 percent ofthe population owning 88% of stocks and 90% ofhonds." It is interesting to note that even among the richest 10 percent, wealth is highlyconcentrated. For example, one percent of households, "each with at least $2.4 millionin net worth... now own 40% ofthe nation's wealth, twice the share they claimed twodecades ago" (Collins 1999).

Government Policy

Federal and state govemment policiesboth in they "have done and what theyhave not done"also contributed to the increase in income inequality over the pasttwo decades. Policies and policy changes in virtually every sector ofthe economy mayhe of relevance here. For example, "deregulation and trade liberalization, the weaken-ing ofthe social safety net, the failure to have effective labor laws regulating the rightto collective bargaining, and a minimum wage" that was allowed to decline in realterms are all seen to have contributed to growing wage inequality. In addition,"changes in federal, state, and local tax structures and benefit programs have, in manycases, accelerated rather than moderated the trend toward growing inequality" emerg-ing from labor and fmancial markets (Bemstein et al. 2000)].

From the perspective of those at the bottom ofthe income distribution, changes inprograms that provide public assistance to low-income families have been particularlysignificant. For example, in "the typical state, cash assistance benefits for a family ofthree with no other income fell 40 percent between 1975 and 1996, after adjusting forinflation." In addition, in every state the receipt of cash assistance has declined dra-matically with the implementation of welfare reform in 1996. While various studies


indicate that between one-half and three-quarters of former welfare recipients areemployed shortly after they leave the program, it is also the case that this employmentoften fails to provide steady work at above-poverty level wages or to provide basichealth, family, or pension benefits (Bemstein et al. 2000),

The Center on Budget and Policy Priorities also reports that a significant part ofthe increase in the depth of poverty that has occurred among poor families with chil-dren in the mid to late 1990s also "appears to reflect sharp decreases in the proportionsof poor children and families that receive cash assistance and food stamp benefits. Thepercentage of poor children whose families receive cash assistance benefits fell from62 percent in 1994 to 43 percent in 1998, The percentage of poor children whose fami-lies receive food stamp benefits dropped from 94 percent to 75 percent during thesame period" (Greenstein et al,1999).

Inequality: Consequences

The consequences of these trends in inequality are extensive and varied, rangingfrom the economic to the social and political. In terms of the long-run economicimpact, Jared Bemstein has cautioned that the under-investment in the "lives of thehave-nots" that typically accompanies inequality can ultimately defeat economicgrowth (Stevenson 2000), And, because income disparities are hitting families withchildren the hardest, the long-mn impacts may be particularly severe: "Recentresearch on the effect of poverty on children has shown that when all other factors arecontrolled for, poverty can have a substantial effect on child and adolescentwell-being," negatively impacting their health, educational achievement, and futureemployment prospects (Larin 1998),

Socially and politically, the consequences may be equally dire, James K.,Galbraith (1998), for example, argues that contemporary inequality "threatens, as itdid in the Great Depression, the social stability ofthe country. It has come to under-mine our sense of ourselves as a nation of equals. Economic inequality, in this way,challenges the essential unifying myth ofAmerican national life," He sees this chal-lenge manifesting itself in politics, surfacing in "bitter discussions of budgets, welfareand entitlement programs," He argues that "a high degree of inequality causes thecomfortable to disavow the needy" and "increases the psychological distance" sepa-rating different economic groups. For example, the "end of welfare as we know it," heargues, "became possible only as rising inequality insured that those who ended wel-fare did not know it, that they were detached from the life experiences of those on thereceiving end" (Galbraith 1998), Darity and Meyers (1998) also argue that policiesdesigned to improve the economic prospects of women and minorities become partic-ularly "unpopular and divisive" in a world where general inequality is extensive andwidening.


The widening social and economic distance between the top and bottom of theincome distribution also contributes to the political "invisibility ofthe poor" and theirvirtual disappearance from national policy discussions. Theda Skocpol (1999) dis-cusses this phenomenon in her recent book The Missing Middle, in which she com-pares the rhetoric ofthe 1991-1992 Clinton presidential campaign with PresidentClinton's 1999 State ofthe Union Address. She points out that despite the attack on"welfare," during the 1991-1992 campaign Clinton stressed the importance of "put-ting people first" and bemoaned the twelve years of "Republican-dominated govem-ment rewarding 'those who speculate in paper,' while 'the forgotten middle classworked harder for less money' and 'the working poor had the door of opportunityslammed in their face."' In his 1999 State ofthe Union Address, President Clintontook credit for eliminating the federal budget deficit and "achieving the longest peace-time expansion in our history." Conspicuously missing, however, "were the 'forgottenmiddle class' and the 'working poor' so prominently featured in 1991 and 1992."

In a recent article in The New York Times Magazine (March 16, 2000) titled "TheInvisible Poor," James Fallows also notes the striking lack of attention to the poor incurrent national political discussionsboth compared with eight years ago and com-pared with previous eras of prosperity. He attributes this to what he describes as the"social and imaginative separation between prosperous America and those still leftout." This arises, he argues, not only from the high degree of income inequality butalso from the particular characteristics ofthe "new economy"or, what he calls "thecomputer-financial complex." Although he acknowledges that "relatively few Ameri-cans actually work in the 'information technology' business," he argues that "techwealth" has a "disproportionate commanding-heights effect on today's culture" and,therefore, it is disproportionately significant that for reasons of geography, personalbackground and working style the tech wealthy have very little sense that they live inthe same country with anyone who is poor."

Fallows (2000) describes the world of "tech wealth" as one where money ceasesto matter in the "normal way" (that is, in terms of the possessions or leisure it allowsone to buy) and it instead becomes primarily symbolica marker of "how you standrelative to others at the top." He quotes the founder of an Internet company who saysthat "every dollar earned up to $300 million is positive, but beyond that point, since itmainly becomes a gauge for comparison with others, it increasingly reminds you thatothers have more." Fallows argues that

A world where money is a marker and all comparisons are directed upwardmakes it hard to understand people for whom a million dollars would be a for-tune, or those for whom $10,000 would be the difference between affordingcollege or not, not to mention those for whom $246 is a full week's earnings,before tax, at the minimum wage.

He continues that


The titans of earlier eras were forced into an awareness that there was a prole-tariat. Andrew Camegie and J.P. Morgan had to consider at least the existenceof a working class willing to strike over a dollar's difference in weekly pay.The financial-engineering wave ofthe 198O's also gave leveraged-buyout art-ists the same uneasy exposure to working America that bomber pilots have tothe civilians below, since reorganizing a company often meant liquidatingjobs. With the tech economy, the connection is faint.Fallows illustrates this point with a quote from Intemet entrepreneur Charles Fer-

guson, who founded a software company and sold it to Microsoft for well over $ 100million: "If you were manufacturing cars, you had no choice but to deal with a largeblue-collar work force of comparatively uneducated people . . . If you are a net entre-preneur, you don't have to give a damn."

Conclusion

For those who were introduced to institutional economics through ThorsteinVeblen's The Theory ofthe Leisure Class, the argument that institutional economicsoffers a framework of particular relevance for thinking about the challenges of thisbrave "new economy" comes as no surprise.

Retuming to the 1984 special policy issue ofthe Journal of Economic Issues,Tool wrote that institutionalist approaches to economic policy recognize that

the structure and perfonnance ofthe political economy is at all times largely aconsequence of choices made by individuals in positions of discretion in gov-emment, industry, and elsewhere. The existing economy is a myriad of priorchoices; through the making of new choices, its structure is modified. Prob-lems are resolved only through institutional change.

At a time when rapid technological and economic changes give the perception ofan economy that is beyond the control of mere mortals and support a renewed loveaffair with the "invisible hand," a recognition ofthe discretionary nature ofthe econ-omy is as critically important. As Osterman (1999) argues in his analysis of contempo-rary labor markets:

a political and intellectual stmggle, sometimes overt and sometimes hidden, istaking place over the shape of the American labor market and the mles thatwill govem it for the foreseeable future. Economics and technology mayframe this stmggle, but choices remain open.

Economic policy is about making these choices. Also in the 1984 special policyissue of the Journal of Economic Issues, J.R. Stanfield wrote that "[ejffective eco-nomic policy is inseparable from the fundamental function ofthe economic processand its place in human society, that is, provisioning the human life process." Thus,


effective economic policy begins with a recognition that the economy is an evolvingset of institutions engaged in the process of providing for the material means of itsmembers and that the purpose of economic inquiry is to provide the tools to activelyguide this process toward outcomes that promote the full participation of all individu-als and the non-invidious re-creation of community (Tool 1979),

From this perspective, the increases in inequality that the United States has expe-rienced over the last two decades are simply not acceptablethey violate the instm-mental principle that an "effective income distribution is one that sustains continuityand restrains invidiousness" (Stanfield 1984), The particular policy relevance of insti-tutional economics today is rooted in its foundational rejection of increasing inequal-ity as an acceptable economic outcome and its belief that such an outcome is the resultof discretionary choices that can and should be altered. Institutional economics has atits core a recognition ofthe fiindamental importance and legitimacy ofthe concems ofthose for whom it is "the worst of times" and a commitment to promote the social andeconomic choices and changes that address these concems.

Janice Peterson

The author is a Study Director at the Institute for Women's Policy Research. This paperwas presented as the Presidential Address at the annual meeting ofthe Association forInstitutional Thought in San Diego, California, in April 2000.

ReferencesBemstein, Jared, Elizabeth C, McNichol, Lawrence Mishel, and Robert Zahradnik, Pulling Apart: A

State-by-State Analysis of Income Trends, Washington, D,C,: Center on Budget and Policy Prioritiesand the Eeonomie Policy Institute, January 2000,

Collins, Chuck, "The Wealth Gap Widens," Dollars & Sense 12 (September 1999): 12-13,Crutsinger, Martin, "Net Worth of Typical U,S, Families, Ignited by Mid-90s Economy, Rose 17,6 %," The

Buffalo News, January 19, 2000,Darity Jr,, William A,, and Samuel L, Myers Jr, Persistent Disparities. Cheltenham: Edward Elgar, 1998,Edelman, Peter, "Clinton's Cosmetic Poverty Tour," The New York Times, July 8, 1999,Fallows, James, "The Invisible Poor," The New York Times Magazine, Mareh 16,2000,Galbraith, James K, "With Economic Inequality for All," The Nation 267, no, 7 (Sept 7, 1998): 24-28,Greenstein, Robert, Jim Jaffe, and Toni Kayatin, "Low Unemployment, Rising Wages Fuel Poverty De-

cline," Washington D,C,: Center on Budget and Poliey Priorities, Oetober 1999,Larin, Kathym, "Should We Be Worried About the Widening Gap Between the Rich and the Poor? Yes: In-

come Disparities are Hitting Families With Children the Hardest," Insight on the News 14 (February 9,1998): 24-35,

Leone, Richard C, "Foreword," In Securing Prosperity, by Paul Osterman, xi-xiii. The Century Foundation,Princeton: Princeton University Press, 1999,

Osterman, Paul, Securing Prosperity, The Century Foundation, Princeton: Princeton University Press, 1999,Skocpol, Theda, The Missing Middle, The Century Foundation, New York: W,W, Norton, 1999,Stanfield, J,R, "Social Reform and Eeonomic Poliey," yo/'na/o/'conoK'c/s,sMe,s 18 (Mareh 1984): 19-44,Stevenson, Richard W, "In a Time of Plenty, The Poor are Still Poor," The New York Times. January 23,

2000,


Tool, Marc. The Discretionary Economy. Santa Monica, California: Goodyear, 1979.. "Economic Policy for the 1980s and Beyond: An Institutionalist Agenda," editor's introduction.

Journal of Economic Issues 18 (March 1984).Wall Street Journal. "Charting the Pain Behind the Gain." November 1, 1999.

the policy relevance of institutional economics

Documents