The Inequality Engine
MANY SOCIAL CRITICS ASSAIL rising income inequality in America, but in the assessment of Tyler Cowen, a George Mason University economist and author of the
new book The Great Stagnation, it's what is causing the inequality that is truly troubling: namely, an unwieldy financial industry whose core practices undermine the stability of the economy and the prosperity it provides.
There is no question that income inequality has increased over the last couple of decades. The share of pre-tax income earned by the richest one percent of Americans went from about eight percent in 1974 to more than 18 percent in 2007. But the real drama is at the apex of the pyramid: The richest 0.01 percent (about 15,000 families) claimed less than one percent of pre-tax earnings in 1974, but more than six percent in 2007.
What's fueling the gargantuan income increases of the mega-rich? It's not manufacturing, which once propelled men such as Henry Ford into the stratosphere of wealth. It's the world of finance. In 2004, the top 25 hedge fund managers together earned more than all the CEOs of the companies listed in the S&P 500. Among people earning more than $100 million a year, Wall Street investors outnumbered executives of publicly traded companies nine to one.
Two practices central to the financial industry drive the skyrocketing incomes: "going short on volatility" (betting against unlikely swings in market prices) and "moving first" (being faster than the competition when new information emerges, sometimes by seconds or less, in a winner-take-all system).
Going short on volatility involves betting against unlikely events--such as a collapse of the mortgage bond market. …