Workers of the world, good night!

I spent the 1981-82 school year in Israel as a visiting professor at the Hebrew University in Jerusalem through a Fulbright Fellowship. This was the year of the bombing of the Ossiraq Nuclear reactor near Baghdad and the Lebanon War. Though less threatening than the 1967 Six-Day War and the 1974 Yom Kippur war, the cost in lives was palpable, because of the small size of Israel and the many interrelationships of its society. Our babysitter there, still a high school student, had six friends killed. One of the professors that I worked with at the Hebrew University lost his son, a mathematician who served as a tank commander. (There are not many countries where tank commanders hold PhD's in mathematics).

During the war I was traveling throughout Israel with a biblical geography class. We drove through the narrow mountain pass by Mount Carmel, part of the ancient international coastal highway that the Egyptian army used 3000 years ago as they marched to points east. On this same route, now a paved highway but still cutting narrowly through the mountains, our tour bus followed behind an army truck with artillery shells stacked on its open bed. Later that day we arrived at the remains of the ancient fortified city of Hatzor which was strategically stationed to protect against Assyrians approaching from the north. A mobile antiaircraft installation now stood on a rise a stone's throw away, its missiles pointed northward.

For all the distress and tragedy that surrounded that war, one thing that it brought forward was the great vitality of Israeli society. Being at such risk and having the realization of death so nearby made life valued and vibrant. It brought the things of importance to the forefront. There was no space for trivialities, no discussion of prestige addresses or showy cars; no concern with the quality of restaurants or the latest social scene. The Israeli society of 1981 was true to the country's egalitarian roots, the idealism of the Zionist movement embodied in the socialist Kibbutzim.

Things are different now. Protests have erupted in Israel decrying the wide disparity in the distribution of income, a widening gap that is seen in few other developed economies. A handful of families that dominate the Israeli economy are the targets of the protests. The tax code allows the families to recycle their capital with hardly any dampening effect, leapfrogging to seize one enterprise after the next in what the Israelis term a pyramid strategy. They control some 30 percent of the economy, including the banks, supermarket chains, cellphone and insurance companies, and media.

Just as Greece, one of the economically weakest EU countries, became the canary in the coal mine for credit issues that then struck the European countries more broadly, Israel, historically one of the most egalitarian countries and now one with the greatest disparity in the distribution of income, may become the canary in the coal mine for a broad crisis in the socioeconomic realm.

Israel may have made the biggest u-turn in terms of social disparity, but it is not alone. Similar disparities are emerging in the United States. Since 1993, more than half of the nation’s income growth has been captured by the top 1 percent of earners, and the gains have grown larger over time: from 2002 to 2007, out of every three dollars of national income growth, the top 1 percent of earners captured two.

The most recent of a drum roll of articles that have appeared in the last several years on the subject appears in, “Can the Middle Class be Saved?” in this month's Atlantic.

The author Don Peck writes:

America’s classes are separating and changing. A tiny elite continues to float up and away from everyone else. Below it, suspended, sits what might be thought of as the professional middle class—unexceptional college graduates for whom the arrow of fortune points mostly sideways, and an upper tier of college graduates and postgraduates for whom it points progressively upward, but not spectacularly so. The professional middle class has grown anxious since the crash, and not without reason. Yet these anxieties should not distract us from a second, more important, cleavage in American society—the one between college graduates and everyone else....The return on education has risen in recent decades, producing more-severe income stratification. But even among the meritocratic elite, the economy’s evolution has produced a startling divergence.

These disparities in the U.S. are not the subject of protests as in Israel. At least not yet. Right now the opposite seems to be the case. Surprisingly and somewhat inexplicably those who would be the natural vanguard of such protest--the unemployed, underemployed, and more broadly those who see their standard of living diminishing --continue to root for the success and the protection of the wealthy. But things can change quickly; draw a line from the emerging focus on the "Acela Corridor" elites.

Capitalism-lite: Can you spell 'capitalism' without capital?
Among the many sources of this rising disparity in income is the changing nature of capitalism. A little bit of capital goes a lot further in building out the virtual world than it did in the burgeoning industrial revolution with its railroads, steam-driven mills and iron foundries, or even in the pre-rust belt, brick and mortar 20th century. Not only does it take less capital, the capital that is required need not be committed for very long before the outcome of the enterprise is manifest.

The reduced capital requirements for creating even multibillion dollar businesses can be thought of as providing a new type of leverage, what might be called functional leverage. Functional leverage means that a given amount of capital can capture a greater base of production. Which means that it is easier for the entrepreneur to bootstrap up from one enterprise to the next while maintaining a much higher equity stake than would have occurred during the period of capital intensive production. Think of the trajectory of Google, Facebook, LinkedIn or GroupOn. How much capital was needed to push the businesses past the billion dollar valuation mark, and how long was that capital required? When the IPOs in these businesses finally do occur, it is not so much to allow access to further capital as to provide a channel for the owners to monetize their stake.

Functional leverage widens the distribution of income by changing the odds and payout for risk-taking activities. Think of a casino where the bet limit is kept low and the odds of winning are close to fifty percent. At the end of the day there will be winners and losers, but the implications for their relative wealth will be small; the distribution of income that arises will be tight around the mean. With functional leverage of the new capitalism, the casino allows very high limits and the bets are ones with high odds but high payoffs. Such a casino alters the distribution of wealth by creating a large right-hand tail.

Thus the rise of the super-elite is not a product of educational differences, but rather a result of the new capitalism which creates bigger winners, and does so much more quickly than in the capital-intensive capitalist era. Less capital is needed, it is applied for a shorter period before the results are realized, and because less capital is required, the entrepreneur captures more of the value of the enterprise. The result is an accentuation in the very wealthy.

The new capitalism also comes with its version of the monopoly power that catapulted the Gettys and Rockerfellers into the stratosphere: lock-in. Lock-in occurs when consumers have invested so much in a product that its not worth making a switch even if a competitor is offering a marginally better product. Think of transferring all your Gmail or Facebook connections to someplace else, or running up the learning curve for using an alternative to Windows. Lock-in creates barriers to entry and pricing power not unlike that enjoyed in the past century by the barons of steel, railroads and oil, albeit through a much different mechanism.

Of course, the move toward capitalism-lite is not the only force behind the widening distribution of income. It might explain what is occurring on the right-hand tail, but there is another edge to the scissors: workers are being pushed further toward the left tail. For example, financial innovation that allows a broader group to enter the game and increase risk to their wealth in the process – extending down to the lower middle class. Financial innovations in the mortgage market are the prime example. And there is the change in manufacturing. Since 2000, U.S. manufacturing has lost a third of its jobs. As Peck notes, the real median wages of men have fallen by 32 percent since their peak in 1973 once you account for the those who have become unemployed. Part of this is due to global competition, but part of it is increased efficiency and a move toward products that are less labor intensive. We have remained preeminent in agriculture even though now only two percent of the U.S. workforce are farmers. The same might now be occurring in industry. Also, there is what I have called the consumption trap – as more of our time is spent in the virtual world, there is dwindling demand for goods that are labor (and capital) intensive.

Marx considered the role of labor and capital during the Industrial Revolution and called capital the king and workers the subjugated. Now we may be moving into an era of capitalism where capital -- and workers -- become incidental.

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