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Inequality


Cover Story

INEQUALITY

When Armando G. de los Santos graduated from Fort Collins (Colo.) High School in 1985, he landed a minimum-wage job bagging groceries in a local market. He has since moved to another store, where he makes $9.50 an hour in the meat section. But years of searching for something better have taught him a harsh reality: The well-paying blue-collar jobs that gave U.S. workers rising living standards for most of this century are vanishing. Today, you can all but forget about joining the middle class unless you go to college.

That's an economic hurdle de los Santos can't clear. One of eight children, he couldn't turn for assistance to his parents, a custodian and a homemaker. In 1992, he won a $1,500 scholarship to Colorado State University, attending class days and working nights. But when his grant and savings ran out after a year, he couldn't afford the $4,000 annual tuition. So he went back to supermarket work full-time and, at 26, began moonlighting as a bartender to save for more schooling. "I want a better job," he says, "but I need a BA."

De los Santos is wrestling with a challenge that confronts millions of Americans--and holds dire consequences for the entire economy. Since the late 1970s, an explosion of income inequality has occurred along educational lines. Families in the mostly college-educated top quarter--those with annual incomes today of more than $64,000--have prospered thanks to rising demand for highly skilled workers and tax cuts for the rich (charts). Meanwhile, import competition and the decline of unions have left families in the bottom quarter--whose breadwinners often dropped out or stopped after high school and earn less than $22,000--stranded in low-wage limbo. This has led to the widest rich-poor gap since the Census Bureau began keeping track in 1947: Top-fifth families now rake in 44.6% of U.S. income, vs. 4.4% for the bottom fifth. As recently as 1980, the top got 41.6%, the bottom 5.1%.

Even as a good education has become the litmus test in the job market, moreover, the widening wage chasm has made it harder for lower-income people to get to college. Kids from the top quarter have had no problem: 76% earn bachelor's degrees today, vs. 31% in 1980. But less than 4% of those in bottom-quarter families now finish college, vs. 6% then. Their troubles start early: Lower-income children, a growing share of the total, do worse in school and drop out more than three times as often as top-half kids.

As distressing as those trends are, a small but expanding cadre of economists argues that they may herald something much worse: lower U.S. growth fueled by inequality. It's already clear that income disparities hurt skills. The share of new workers with college degrees, which soared in the 1970s as baby boomers and women entered the workforce, has leveled off. The national high school dropout rate remains in the double digits. And test scores are flat for junior high and high school students: America ranks No.13 in math and science skills among 15 industrialized nations. All these averages are pulled down by lower-income students.

This lack of progress comes at a critical moment. In nearly every industry, the spread of new technologies is creating a need for employees who know how to do more. As companies reorganize, moreover, they're pushing decision-making down the ladder. If U.S. workers can't handle these changes, companies will be less productive than they should be. And that's a prescription for a stunted economy. "A great skill shortage is going to occur that will eat away at our competitiveness," worries John L. Clendenin, chief executive of BellSouth Corp., which interviews up to 50 applicants for each technician job. "And economics has a lot to do with it."

"BIG SHOCKER." Most of the new theory linking inequality and the overall economy is based on mathematical models of growth created by economist Paul Romer at the University of California at Berkeley. Recently, a half-dozen economic theorists have used his methods to show how income gaps hurt gross domestic product by lowering efficiency. At the same time, urban economists have provided some empirical verification by showing that growth in jobs and income is slower in cities with wide wage inequities and faster where incomes are more on a par. "Maybe even the rich can be worse off from inequality," says Romer. "We now must think seriously about something we didn't believe could happen."

Such ideas turn traditional economic thought on its head. The conventional wisdom holds that the overall economy is largely unaffected by how income

is shared. It's total income that matters, the thinking normally goes, since consumers fuel demand--be it for yachts or bread. It's O.K., too, if the rich just save their surplus, since that will finance new investment. Until recently, in fact, most economists thought inequality was a result, not a cause, of slow growth. That view lost its luster in the 1980s, however, when "the big shocker was that the country got richer and those on the bottom didn't," says Northwestern University sociologist Christopher Jencks.

If this trend persists, it could tarnish America's image as a land of opportunity. True, there's still more economic mobility in the U.S. than in most countries. But "a society divided between the haves and the have-nots or between the well-educated and the poorly educated...cannot be prosperous or stable," warned Labor Secretary Robert B. Reich upon the release of a May report documenting rising inequality. Adds Republican strategist Kevin Phillips: "This stratifying starts to make us into a different country. It goes to the American notion of fairness."

Just ask Michelle M. Mouzon, whose lack of education has left her nearly destitute since she lost her $12-an-hour factory job last year. A high school graduate who lives in Waukesha, Wis., Mouzon enrolled in a technical college to learn accounting. But she says tensions over her job loss contributed to a separation from her husband in January. Unable to afford their apartment by herself, Mouzon lived in a hotel with friends while Amber, her 11-year-old, stayed with grandparents--and paid a price. "Amber has been in three different schools this year," says Mouzon. "It has set her back." Mouzon finally found an inexpensive one-bedroom apartment and landed a $6.50-an-hour, three-month accounting internship through the college. Now, she works days and goes to school nights to finish her degree.

CORRECTION TIME? There's a theory that inequality may not stay high for long. University of Chicago economist Steven J. Davis says that when wage gaps get too skewed, college enrollments tend to surge, creating a surplus of graduates whose pay then goes up more slowly. For now, though, the baby bust--and inequality itself--are limiting the numbers of BAs, so pay for the educated keeps rising. The result, predicts Anthony P. Carnevale, chief economist at the American Society for Training & Development: "Inequality will get worse as the economy accelerates, because companies need more skills."

Nor will Washington provide solutions. The Clinton Administration has responded with measures to bolster training and education--promoting apprenticeships and granting more generous college loans. But budget constraints have hampered these efforts. And in any case, they are minuscule compared with strategies Europe uses to fight inequality, such as high minimum wages and mandated corporate-training expenditures (page 82). Unable to win over Congress, Clinton has dropped such ideas, which he embraced in his campaign.

Actually, the rich-poor debate has narrowed considerably since flaring during the Reagan years. "The facts about higher inequality are no longer in dispute," says Davis. One secondary argument centers on which of several factors are paramount: rising imports, the decline of organized labor, an influx of unskilled immigrants, demand for higher-skilled workers prompted by new technology, or Reagan-era tax cuts, which many studies show to be at least part of the problem. There is also a theory, offered by Northwestern's Jencks and others, that the poor may have held their own to some degree. The evidence is their consumer spending, which some studies find hasn't fallen. Other research, however, such as that by Harvard University economists David M. Cutler and Lawrence F. Katz, has found the opposite. And in any case, note Jencks and others, statistics on consumption aren't as reliable as the income figures the Census Bureau reports.

DOMINO EFFECT. Those show better-off Americans rapidly outpacing the field. Pretax hourly pay climbed 2% after inflation for the top quarter of earners between 1980 and 1992, says Rand Corp. economist Lynn A. Karoly, while the real hourly pay of the bottom quarter skidded 4%. The gap is starker by education level. Pay of dropouts had plunged 20% by 1991, the latest comparable year available, while that of college grads bumped up 4%, according to an analysis of Census figures by the Economic Policy Institute, a Washington research group. The story is similar for family income, which includes two-salary couples plus earnings such as interest and rent. Top-quarter families have beaten inflation by 16% since 1980 and earned $91,000 on average in 1992, according to Census. But the bottom quarter slipped by 7%, to $11,500.

It has taken economists 60 years to show that such gaps can hinder growth. During the Depression, British economist John Maynard Keynes worried that inequality sapped aggregate demand. But in the 1950s, American Simon Kuznets redirected the debate by arguing that inequality waxed as countries develop and waned after they industrialized. Since this squared with the falling rich-poor gap in Western countries after World War II, experts subsequently focused on how growth affected income distribution, not vice versa.

The new theory finds that the effect can go both ways. It employs concepts pioneered by Berkeley's Romer to show that a company's productivity improvements depend not just on capital investments and the skill of workers but also on the efficiency gains of its competitors, whose better methods spread through an industry. The new theory uses similar equations to show that individual skills depend on more than innate ability: They're also affected by family and neighborhood income. Such ideas are usually presented in highly theoretical papers, which argue that because large income gaps undercut worker skills, employers will face shortages of qualified employees that undermine corporate efficiency.

Some samplings of this work: Brown University economist Oded Galor concludes that productivity suffers when poor families can't borrow enough to educate their kids. In another study, University of Wisconsin economist Steven N. Durlauf concludes that widening inequality hurts education in poor communities deprived of school tax dollars and the role models of professional parents. Beyond that, theorizes Columbia University economist Roberto Perotti, as the rich race ahead, they balk at the high taxes needed to educate poor children better.

That's shortsighted, because inequality may brake growth so much that even the rich lose out over 5 to 10 years, calculates Massachusetts Institute of Technology economist Roland Benabou in another paper. "If you move to a rich suburb, it will improve your children's education," he says. "But if their co-workers still in the city are left sufficiently deficient in their education, it will more than offset the advantages your children gained," because productivity and growth suffer.

DOWNTOWN SLOWDOWN. There's a mounting, though still largely circumstantial, body of evidence to back up the theory. So far, most of it comes from urban economists, who look at regional rather than macroeconomic trends. Still, they offer some compelling evidence. For instance, central cities' per capita incomes were nearly equal to those of their suburbs in 1973, according to a study of the 85 largest metropolitan areas by Larry C. Ledebur, an urban studies professor at Wayne State University. But by 1989, city dwellers earned 16% less.

And where inequality rose the most, everyone suffered. Employment climbed an average 41% in the 1980s in 13 metropolitan areas where the suburbs' average household income was only 12% more than the city's, according to Ledebur. But job growth was only 14% in the 13 areas where suburban incomes were 40% higher. Ledebur thinks that lagging city incomes generate poverty and fiscal crises, which stunt investment and productivity in downtown companies that employ suburbanites.

Hank V. Savitch, an urban policy professor at the University of Louisville, has even quantified how much the well-off lose. Suburbanites forgo $690 in annual income for every $1,000 gap between their earnings and the city's, he and three colleagues found in a study of income growth between 1979 and 1987 in 59 metropolitan areas. Like Ledebur, he thinks cities and suburbs prosper or decline together. "As the disparities increased in the 1980s, it dragged down everyone's income," Savitch says.

No one yet has proven similar links between inequality and the entire economy. Most economists agree, however, that education and skills are key to economic growth. And there's lots of evidence that skills suffer when the wealthy go it alone. For example, school districts that mix rich and poor kids have higher reading and math scores than those where each group attends different schools, according to a 1989 study of 475 California districts. Rich kids do score higher when they're all in one school. But with mixing, "low-achieving kids are pulled up more than the high end is dragged down, so the average is higher," says study co-author Mark Dynarski, an economist at Mathematica Policy Research Inc. in Princeton, N.J.

DESPAIR AND REBELLION. Janet Haffner's alternative school in Flint, Mich., embodies this tale of two cities in one building. The Valley School, a prep school that charges $6,000 a year, occupies two floors of a former junior high. All of its students go on to college. On the third floor, Haffner runs a public program for kids who have failed two grades--and who illustrate how the poor get left behind. More than 85% of her 110 remedial students get a federally funded free lunch, which means their parents make less than $18,655 a year. Two have been killed in street violence. To Haffner, success is getting her charges back into 9th grade so some might finish school.

Haffner's kids are hurt not so much by poverty itself as by despair bred by economic disparities. Indeed, Korean and Taiwanese students outperform Americans in math and science even though their incomes are much lower. But experts say children whose families are losing ground--while the affluent gain--often don't see the point of school. "You feel left out when you're low-income and inequality is rising," says University of Illinois sociologist Jonathan Crane. "Lower-class kids lose a sense of self-worth, which leads many to rebel or lose their initiative." Haffner sees this every day. "Our students are really discouraged kids," she says. "They move constantly, change schools, lose friends, and lose hope."

That describes more and more kids. The ranks of low-income students--those who get a free lunch--have risen to 25% of all children from 21% in 1980. And that helps explain why U.S. students aren't gaining on their foreign counterparts. Poor kids score 30 points lower than affluent ones on standardized math tests, for instance. That weighs down the average score of U.S. 12th-graders, which remained at about 300 out of a possible 500 points in the 1980s. The same goes for dropout rates: They're 50% higher for white 12th-graders in single-parent families--which earn 40% less than two-parent ones--according to a 1993 study led by University of Wisconsin sociologist Robert M. Hauser. By contrast, University of Illinois' Crane found in a 1991 study, poor teens drop out a third less often if they live where enough adults--about 13%--are professionals. He says good neighbors make good role models.

RISKY BUSINESS. The diverging fortunes of the rich and poor have wreaked the most havoc at the college level. Tuition at public colleges, where 80% of students go, jumped an inflation-adjusted 49% in the 1980s, to $1,900 a year, according to a study by Harvard University economist Thomas J. Kane. With room and board, the tab will run to $5,400--an amount families should be expected to pay only if they earn $52,000 a year, according to federal guidelines. Meanwhile, Pell grants--the federal program that gives an average of $1,500 a year to more than a quarter of the country's 14 million college students--trailed inflation by 13% in the 1980s, Kane found. True, there are more loans, which now account for two-thirds of college subsidies, vs. one-third in the 1970s. But loans are dicey. "College is an experiment for most low-income families," says Thomas G. Mortenson, who publishes an education newsletter in Iowa City, Iowa. "Shelling out borrowed money on something so risky doesn't make sense to them."

Even many middle-class kids feel this way. Raymond D. Cristelli just finished high school in North Clarendon, Vt., and is aiming for college. But his parents have been unable to help since the recession hit his father's auto-repair shop. And anything the family can spare will go first to his older brother, who left college when the money ran out and wants to return. During school, Cristelli worked nights and weekends at Taco Bell and a record store. Now, he is working both jobs to save for college. "I'm not comfortable taking loans, though I'm starting to face the idea that I'll have to if I really want to go," he says. Cristelli's story is typical. "The rich go to college more, which causes states to cut grants and raise tuition, keeping out poor students," says Kane.

Will anything reverse the problems inequality is causing? Clinton's attempts to make training and college more available will have some impact. But even in his dreams, he didn't envision the massive effort--such as a G.I. bill--that many experts believe is needed to give workforce skills a real boost. Nor is the U.S. likely to adopt European-style social programs or labor laws.

Market pressures may still make a difference, some economists argue--pushing more people through college until they glut the labor market, their pay raises slow, and inequality eases. Indeed, the share of high school grads going to college has jumped to 62% from 49% in 1980. Still, the shortage of grads may continue. With bottom-half students stymied by falling incomes, most new enrollment has come from top-quarter students--81% of whom now go to college. The number of college-age youth is rising but only in lockstep with other groups: They'll stay at 10% of the population until 2005, Census projections show. In sum, the number of workers with a BA may edge up 1.5 points by 2000, to 26%--vs. a nearly 7-point hike in the '80s, says Cornell University economist John H. Bishop. He adds: "Even if enrollment rates rise for 10 years, there won't be enough college grads to drive their relative wages down."

Ever since slavery ended, the U.S. has at least partly lived up to the ideal that everyone should have an equal opportunity to prosper. Now, heightened inequality is undermining this concept. The U.S. will continue to suffer socially if the trend continues. And it's likely to suffer economically, too.Aaron Bernstein in New York, with bureau reports


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