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JOURNAL OF ECONOMIC ISSUES

Vol. XXXV

No. 1

March 2001

Notes and Communications

The Policy Relevance of Institutional Economics

In March 1984, the Journal of Economic Issues published a special national economic
policy issue titled "Economic Policy for the 1980s and Beyond: An Institutionalist
Agenda," In the editor's introduction Marc Tool wrote:
Presumably it is always "the best of times" for some, perhaps a few, and "the
worst of times" for others, often the many. Economic policy is, and always has
been, addressed to economic problems characterizing "the worst of times," as
experienced by those adversely affected and as perceived by those with understanding, 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 economyand the economic policy challenges this performance gives rise tothan in
terms ofthe "best of times" and the "worst of times,"
In the popular press, the last decade is typically presented as a period of great
prosperity for the United States, and in a recent poll over 70 percent of respondents
identified 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 1998
the median real income for households had reached an "all-time high" of $38,855. In
addition, it reported that the overall poverty rate had declined to 12,7 percent, the lowest level since 1979, and that the child poverty rate had declined to 18,9 percent, the
first time it was below 19 percent since 1980 (Wall Street Joumal 1999; Greenstein et
al, 1999). It has also been widely noted that in 1998 the "percentage ofAmerican families holding stockeither directly or indirectly as part of a mutual fund or retirement
accounthit an all-time high of 48,8 percent" (Crutsinger 2000),
Another recent poll, however, found that 75 percent of Americans believe that the
benefits ofthe "new economy" are being distributed unequally (Stevenson 2000), and
many ofthe economic trends ofthe last decade support this perception. In particular, a
look beyond median income to the distribution of income reveals that, in the words of
the Wall Street Joumal (1999), "the fruits of prosperity in this decade have been more

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heavily skewed to the rich than in prior booms" and "life is still a struggle for millions
of Americans."
Inequality: Recent Trends
Although the statistics on recent trends in the distribution of income in the United
States 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 the
Economic Policy Institute, US Census data for 1998 indicate that income disparities
between the rich and poor in that year were at "their widest point since the Census
Bureau began collecting these data several decades ago" (Greenstein et al. 1999).
They also report that nationwide, income inequality increased significantly during
both the 1980s and 1990s, with the gaps in income between high-income families and
poor 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 ofthe
lowest-income families grew by less than 1 percent and the average real income of
middle-income families grew by less than 2 percent, while the average real income of
high-income families grew by 15 percent. This small growth in the incomes of
low-income families in the 1990s was not enough to make up for the decline in
incomes during the 1980s: from the late 1970s to the late 1990s, the average real
income of the lowest-income families fell by over 6 percent and the average real
income of middle-income families grew by about 5 percent. In contrast, the average
real income ofthe highest-income of families increased by over 30 percent (Bernstein
et al. 2000).
The resulting income disparities are substantial. Nationwide, in the late 1990s, the
average income of families in the top 20 percent ofthe income distribution was more
than 10 times as large as that ofthe poorest 20 percent. At the state level, in the late
1970s there were no states where high income families had an average income that
was as much as 9.5 times larger than the average income of low-income families; by
the 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 even
more pronounced when race is taken into account. For example, in their recent book
Persistent Disparity, William Darity and Samuel Meyers (1998) illustrate that "simultaneous with the rise in general inequality has been a worsening ofthe relative income

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position of black families in America." That is, there has been a "widening ofthe gap
between whites and blacks," even as "some blacks are doing well fmancially." They
argue 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 got
poorer."

Poverty
These trends in income inequalityparticularly the lack of progress at the bottom
of the income distributionhave obvious and important implications for poverty.
Although the United States did see a reduction in the incidence of poverty in 1998, the
poverty rate was still higher than it was in "nearly all years ofthe 1970s, even though
the 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 during 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 United
States remain poor" (Greenstein et al. 1999).
There have also been increases in the depth of povertythat is, poor families are
poorer, on average, now than they were a few years ago. The Center on Budget and
Priorities reports that even when food stamps, housing subsidies, and the earned
income tax credit are counted as income, "the average amount by which the incomes
of poor families fall below the poverty line was $245 greater per family member in
1998 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 up
between 1995 and 1997, including an increase in the numher of children living in
extreme poverty (Edleman 1999).

Wealth
While the income distribution data are startling, the increase in inequality in family income during the 1990s was "surpassed by the growing imbalance in the accumulated wealth of families" during that time period. Due in part to the well-publicized
gains in the stock market, the United States has seen a tremendous increase in the
value of certain assets, and most of the increases in this wealth were concentrated
among the richest families (Larin 1998). In fact, the median value of assets owned by
families with incomes less than $25,000 annually (including everything from bank
accounts and stocks to homes and cars) actually fell during the mid to late 1990s, while
families 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 January 2000, newspaper articles around the country celebrated the increase in the net

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worth ofthe "typical" American family, based on a report by the Federal Reserve that
indicated a 17,6 percent increase in the median net worth of families between 1995
and 1998, In the same report, however, the Fed indicated that "families eaming less
than $ 10,000 annually actually saw their median net worth fall by 25 percent,,, while
the median net worth of families eaming between $10,000 and $24,999 was down 20
percent,,, The median net worth of families eaming $25,000 to $49,000 was up 6,3
percent , , , while families eaming $50,000 to $99,000 enjoyed , , , a 20 percent
increase," Families with income over $100,000 saw their median net worth remain
roughly the same (at about $511,000), but the average net worth for this groupa
measure 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 even
more stark for blacks and Hispanics, In 1995, for example, "nearly one in three black
households had zero or negative net worth," and half the Hispanic population in the
United States had "more debts than assets" (Collins 1999).
Some "good news" is reported from the most recent income data, which indicate
that 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 high
level" (Wall Street Joumal 1999), Thus, the causes and consequences of inequality
remain 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. Three
areas of concem that appear to be particularly important are changes in labor markets,
the concentration of asset ownership and investment income, and govemment

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

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In addition, the growing gap between high and low income workers is even more
dramatic when total compensation (wages plus fringe benefits) is considered.
Although the average amount employers have spent on fringe benefits has increased
over the last two decades, the benefits of these increases have been concentrated
among high-income workers. A particulariy striking comparison reveals that while the
average total compensation of "top executives at major U.S. companies nearly tripled
during the last two decades, average total compensation actually has fallen for the 80
percent of the workforce who are production and nonsupervisory workers" (Larin
1998).
Analysts have identified a number of broad factors contributing to rising labor
market inequality, including globalization, the decline in manufacturing jobs and the
expansion of low wage service jobs, and the weakening of key labor market institutions. These factors have been particularly significant in leading to "an erosion of
wages for workers with less than a college educationapproximately the lowest earning four-fifths of the workforce" (Bernstein et al. 2000). These changes have been
accompanied by fundamental changes in the structure of employment and in the relationship between labor and management, illustrated, for example, by the "increased
willingness of companies to lay-off large numbers of workers even during profitable
periods" and the "growing use of labor on a 'contingent' basis" (Leone 1999).
In his recent book Securing Prosperity, Paul Osterman (1999) attributes what he
calls the "good news/bad news" character ofthe "new labor market" to changes taking
place both within the firm and in the external labor market. Inside firms, employers are
reorganizing work into new systems that, for some workers, "bring more interesting
and more highly skilled employment." At the same time, however, these new systems
weaken "the ties that bind the workforce to the firm," thus reducing employment security 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 experienced considerable wage gains. They have the good fortune to have high-level
skills that are in strong demand. They believe that they indeed can manage
their own careers, and high rates of job changing and weak attachments to
employers 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, "employment
security is declining, and the consequences of being dislocated are severe"; the situation 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

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

Investment Income
Besides wages, the other major source of income is investment income (such as
dividends, rent, interest, and capital gains) and since investment income primarily
accrues to those at the top ofthe income distributionfor example, "eighty percent of
capital gains income goes to the richest 20 percent of the population" (Larin
1998)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 income
levels and the fact that nearly half the population now owns some stocks, "very few
have sizeable stock holdings." For example, in 1995 "nearly three-quarters of stockholders held less than $5,000 worth, including stock in retirement plans and muUial
funds.... Financial assets like stocks and bonds remain concentrated in relatively few
hands, with the richest 10 percent ofthe population owning 88% of stocks and 90% of
honds." It is interesting to note that even among the richest 10 percent, wealth is highly
concentrated. For example, one percent of households, "each with at least $2.4 million
in net worth... now own 40% ofthe nation's wealth, twice the share they claimed two
decades ago" (Collins 1999).

Government Policy
Federal and state govemment policiesboth in they "have done and what they
have not done"also contributed to the increase in income inequality over the past
two decades. Policies and policy changes in virtually every sector ofthe economy may
he of relevance here. For example, "deregulation and trade liberalization, the weakening ofthe social safety net, the failure to have effective labor laws regulating the right
to collective bargaining, and a minimum wage" that was allowed to decline in real
terms 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 many
cases, accelerated rather than moderated the trend toward growing inequality" emerging from labor and fmancial markets (Bemstein et al. 2000)].
From the perspective of those at the bottom ofthe income distribution, changes in
programs that provide public assistance to low-income families have been particularly
significant. For example, in "the typical state, cash assistance benefits for a family of
three with no other income fell 40 percent between 1975 and 1996, after adjusting for
inflation." In addition, in every state the receipt of cash assistance has declined dramatically with the implementation of welfare reform in 1996. While various studies

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indicate that between one-half and three-quarters of former welfare recipients are
employed shortly after they leave the program, it is also the case that this employment
often fails to provide steady work at above-poverty level wages or to provide basic
health, family, or pension benefits (Bemstein et al. 2000),
The Center on Budget and Policy Priorities also reports that a significant part of
the increase in the depth of poverty that has occurred among poor families with children in the mid to late 1990s also "appears to reflect sharp decreases in the proportions
of poor children and families that receive cash assistance and food stamp benefits. The
percentage of poor children whose families receive cash assistance benefits fell from
62 percent in 1994 to 43 percent in 1998, The percentage of poor children whose families receive food stamp benefits dropped from 94 percent to 75 percent during the
same period" (Greenstein et al,1999).
Inequality: Consequences
The consequences of these trends in inequality are extensive and varied, ranging
from the economic to the social and political. In terms of the long-run economic
impact, Jared Bemstein has cautioned that the under-investment in the "lives of the
have-nots" that typically accompanies inequality can ultimately defeat economic
growth (Stevenson 2000), And, because income disparities are hitting families with
children the hardest, the long-mn impacts may be particularly severe: "Recent
research on the effect of poverty on children has shown that when all other factors are
controlled for, poverty can have a substantial effect on child and adolescent
well-being," negatively impacting their health, educational achievement, and future
employment prospects (Larin 1998),
Socially and politically, the consequences may be equally dire, James K.,
Galbraith (1998), for example, argues that contemporary inequality "threatens, as it
did in the Great Depression, the social stability ofthe country. It has come to undermine 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 challenge manifesting itself in politics, surfacing in "bitter discussions of budgets, welfare
and entitlement programs," He argues that "a high degree of inequality causes the
comfortable to disavow the needy" and "increases the psychological distance" separating different economic groups. For example, the "end of welfare as we know it," he
argues, "became possible only as rising inequality insured that those who ended welfare did not know it, that they were detached from the life experiences of those on the
receiving end" (Galbraith 1998), Darity and Meyers (1998) also argue that policies
designed to improve the economic prospects of women and minorities become particularly "unpopular and divisive" in a world where general inequality is extensive and
widening.

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The widening social and economic distance between the top and bottom of the
income distribution also contributes to the political "invisibility ofthe poor" and their
virtual disappearance from national policy discussions. Theda Skocpol (1999) discusses this phenomenon in her recent book The Missing Middle, in which she compares the rhetoric ofthe 1991-1992 Clinton presidential campaign with President
Clinton'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 "putting people first" and bemoaned the twelve years of "Republican-dominated govemment rewarding 'those who speculate in paper,' while 'the forgotten middle class
worked harder for less money' and 'the working poor had the door of opportunity
slammed in their face."' In his 1999 State ofthe Union Address, President Clinton
took credit for eliminating the federal budget deficit and "achieving the longest peacetime expansion in our history." Conspicuously missing, however, "were the 'forgotten
middle 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 "The
Invisible Poor," James Fallows also notes the striking lack of attention to the poor in
current national political discussionsboth compared with eight years ago and compared with previous eras of prosperity. He attributes this to what he describes as the
"social and imaginative separation between prosperous America and those still left
out." This arises, he argues, not only from the high degree of income inequality but
also from the particular characteristics ofthe "new economy"or, what he calls "the
computer-financial complex." Although he acknowledges that "relatively few Americans actually work in the 'information technology' business," he argues that "tech
wealth" has a "disproportionate commanding-heights effect on today's culture" and,
therefore, it is disproportionately significant that for reasons of geography, personal
background and working style the tech wealthy have very little sense that they live in
the same country with anyone who is poor."
Fallows (2000) describes the world of "tech wealth" as one where money ceases
to matter in the "normal way" (that is, in terms of the possessions or leisure it allows
one to buy) and it instead becomes primarily symbolica marker of "how you stand
relative to others at the top." He quotes the founder of an Internet company who says
that "every dollar earned up to $300 million is positive, but beyond that point, since it
mainly becomes a gauge for comparison with others, it increasingly reminds you that
others have more." Fallows argues that
A world where money is a marker and all comparisons are directed upward
makes it hard to understand people for whom a million dollars would be a fortune, or those for whom $10,000 would be the difference between affording
college or not, not to mention those for whom $246 is a full week's earnings,
before tax, at the minimum wage.
He continues that

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The titans of earlier eras were forced into an awareness that there was a proletariat. Andrew Camegie and J.P. Morgan had to consider at least the existence
of 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 artists the same uneasy exposure to working America that bomber pilots have to
the civilians below, since reorganizing a company often meant liquidating
jobs. With the tech economy, the connection is faint.
Fallows illustrates this point with a quote from Intemet entrepreneur Charles Ferguson, who founded a software company and sold it to Microsoft for well over $ 100
million: "If you were manufacturing cars, you had no choice but to deal with a large
blue-collar work force of comparatively uneducated people . . . If you are a net entrepreneur, you don't have to give a damn."
Conclusion
For those who were introduced to institutional economics through Thorstein
Veblen's The Theory ofthe Leisure Class, the argument that institutional economics
offers a framework of particular relevance for thinking about the challenges of this
brave "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 a
consequence of choices made by individuals in positions of discretion in govemment, industry, and elsewhere. The existing economy is a myriad of prior
choices; through the making of new choices, its structure is modified. Problems are resolved only through institutional change.
At a time when rapid technological and economic changes give the perception of
an economy that is beyond the control of mere mortals and support a renewed love
affair with the "invisible hand," a recognition ofthe discretionary nature ofthe economy is as critically important. As Osterman (1999) argues in his analysis of contemporary labor markets:
a political and intellectual stmggle, sometimes overt and sometimes hidden, is
taking place over the shape of the American labor market and the mles that
will govem it for the foreseeable future. Economics and technology may
frame this stmggle, but choices remain open.
Economic policy is about making these choices. Also in the 1984 special policy
issue of the Journal of Economic Issues, J.R. Stanfield wrote that "[ejffective economic policy is inseparable from the fundamental function ofthe economic process
and its place in human society, that is, provisioning the human life process." Thus,

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effective economic policy begins with a recognition that the economy is an evolving
set of institutions engaged in the process of providing for the material means of its
members and that the purpose of economic inquiry is to provide the tools to actively
guide this process toward outcomes that promote the full participation of all individuals and the non-invidious re-creation of community (Tool 1979),
From this perspective, the increases in inequality that the United States has experienced over the last two decades are simply not acceptablethey violate the instmmental principle that an "effective income distribution is one that sustains continuity
and restrains invidiousness" (Stanfield 1984), The particular policy relevance of institutional economics today is rooted in its foundational rejection of increasing inequality as an acceptable economic outcome and its belief that such an outcome is the result
of discretionary choices that can and should be altered. Institutional economics has at
its core a recognition ofthe fiindamental importance and legitimacy ofthe concems of
those for whom it is "the worst of times" and a commitment to promote the social and
economic choices and changes that address these concems.
Janice Peterson
The author is a Study Director at the Institutefor Women's Policy Research. This paper
was presented as the Presidential Address at the annual meeting ofthe Association for
Institutional Thought in San Diego, California, in April 2000.
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