The Grand Bargainer

With President Bush having finally acknowledged the problem of growing income inequality, and Democratic leaders tripping over each other to do something about it, we desperately need a trustworthy moderator for this national debate.

Now we may have one, in Federal Reserve Chairman Ben Bernanke.

In a speech yesterday to the Greater Omaha Chamber of Commerce, the former Princeton University professor cut through all the usual cant of the left and right and drew on the best and latest research to quantify just how much inequality has increased over the past 30 years. He gently, but deftly, dismissed the favorite conservative arguments that the story is not one of greater inequality so much as one of greater mobility. At the same time, Bernanke exposed as myth all those overblown fears about the broad decline in standard of living and the death of the American middle class.

The causes of rising inequality are well known: technological change that has reduced demand for unskilled labor and increased it for skilled labor; increased trade and immigration, which march under the now-tainted banner of globalization; the winner-take-all dynamic of certain labor markets that produces superstar salaries for professional athletes, entertainers and chief executives; and changing "institutional arrangements," from the declining power of unions to deregulation.

Much effort has gone into figuring out the relative importance of these factors, driven in part because how you define the problem often dictates how you craft a solution. Bernanke tends to side with those who credit new technologies, like computers, that have increased the demand -- and thus the relative pay -- for educated workers. This analysis suggests the answer lies in more education, which appeals to market-oriented conservatives who are anxious to avoid solutions that might throw sand in the gears of globalization. It also appeals to academic economists, who have a natural preference for anything that involves hiring more college professors.

As it happens, this line of argument ignores the fact that inequality is increasing as much within groups of people who have the same amount of formal education as it is between those with various academic degrees. The Goldman Sachs partner with an MBA is pulling away from the MBA who is an assistant comptroller of a mid-sized insurance company, while the immigrant stonemason who never made it past elementary school is in much higher demand than the immigrant security guard at a downtown office building. Economists have trouble dealing with this kind of inequality because it is based on characteristics that can't easily be quantified and modeled. Moreover, to the degree within-group inequality is a driving factor, they suggest "institutional" fixes, such as reviving labor unions, reforming corporate governance and breaking up cartels.

Having followed this debate for nearly 20 years, I've come to the conclusion it has become a meaningless exercise. In the real world, the factors behind inequality are hopelessly tangled. For example, while it may appear that changing technology is the culprit, it's equally clear that the increased competition caused by international trade drove the demand for, and adoption of, that technology. Conversely, you have to ask if globalization wouldn't have happened but for new technologies that have revolutionized communication and transportation. And is it globalization or technology that we should thank for all those Google millionaires?

Perhaps the best part of Bernanke's speech yesterday was the graceful way he framed the tradeoff between growth and equality.

One reason the U.S. economy is the most productive, the most dynamic, the most innovative in the world, Bernanke explained, is that we offer the biggest rewards to skill, effort and ingenuity. We also have an economic framework that not only allows companies and individuals the flexibility to adapt to changes in technology or consumer tastes or competition, but rewards them handsomely when they do.

Bernanke says the flip side of this dynamism has been to generate not only a higher level of inequality, but also a higher level of economic insecurity. Now, he says, the only way to make these politically acceptable is to "put some limits on the downside risks to individuals affected by economic change."

One way to limit those risks, of course, would be to restrict trade, impose new regulations on labor and product markets, or use the tax code to massively redistribute incomes. For Bernanke, the costs in terms of slower growth and higher unemployment would be too high.

The better alternative, he argued, is to preserve the political consensus for open and flexible markets by offering Americans a stronger economic safety net -- one that might include more portable and affordable health insurance and pensions, some expansion of income support in the event of a job loss and a big new investment in education and training, from early childhood through adulthood.

All of this sounds suspiciously like the idea of an economic "grand bargain" that has been gaining momentum since the November election. The policy outlines of such a bargain have already been sketched at think tanks like the Peter G. Peterson Institute for International Economics and the Brookings Institution's Hamilton project. It has been embraced explicitly by influential liberal Democrats like Rep. Barney Frank and Sen. Barack Obama, and New Age labor leaders like Andy Stern of the Service Employees International Union. Elements of a grand bargain have attracted the interest of business groups like the Business Roundtable and key members of the Bush economic team. And yesterday it got a significant boost from the chairman of the Federal Reserve.