What I got wrong about Economics — and what changed my mind

Three reasons why my perspective on Economics has changed by 180 degrees

Photo by Sophie Backes on Unsplash

Back in 2013, I was doing my A levels, and during my Social Sciences oral exam, I was asked to give my opinion on an Economics text. The opinion I chose to advocate for was mainly shared by the AfD, the far-right party in Germany, deeply rooted in the neoliberal part of the economic spectrum.

Today I am writing this as a former volunteer of the Bernie Sanders campaign in 2019, as a former worker for a Social Democratic MP in the German Bundestag, and as a former Intern of the Young Socialists, the youth organization of the Social Democratic Party in Germany.

So, basically, my perspective on Economics has changed by almost 180 degrees. And what I’d like to share with you today is: Why? And what has changed my mind.

The beginning of my journey across the political spectrum

It all started when I got accepted to a semester abroad program at the LSE. At the time, it was something I had simply considered as another stepping stone for my career trajectory, which was — after my degree from a private business school, the “mandatory” consulting internship, and now a semester at LSE — supposed to get me into one of those fancy McKinsey offices, or make me one of those over-ambitious and over-worked investment bankers at a firm, that I didn’t care about, but that had a name recognizable enough to impress people on LinkedIn.

Yet, my professors, peers, and the numerous public lectures I had the privilege to attend showed me how wrong some of my core assumptions were. Not just about my personal politics, but more broadly speaking about economic life.

And when I look back now, I realize that I had bought into three fundamental fallacies that do a fantastic job at justifying our current economic system, but that are, in my opinion, simply not true.

Fallacy 1: Our education system improves social mobility

The general idea is quite straightforward: Education is supposed to enhance social mobility. Everyone should be able to achieve anything they want in life, no matter the social circumstances they were born into. It would be difficult to find researchers, politicians, or people working in education disagreeing with that statement publicly. The U.K. government even published “A Plan for improving social mobility through education” — called “Unlocking Talent, Fulfilling Potential” (Greening, 2017), whose goal it is to allow everyone to unlock their potential by removing barriers regarding class mobility.

But, when wandering around the LSE campus and talking to different students from different departments, I realized something: Not only are students here very bright, hardworking, and engaging, but they tend to come from very privileged backgrounds.

Data from the UCAS supported my feeling, showing that in 2017 — the year I attended LSE — for the most privileged students, the chances of entering the elite universities in the U.K. were 14.5 times higher than for students from less privileged households (Busby, 2019). In Oxford, 82% of offers went to students from the top two socio-economic groups — in Cambridge, it was 81% (Weale et al., 2017).

In the United States, the data looks even grimmer. At Ivy Plus colleges (Ivy League, Chicago, Stanford, MIT & Duke), there are now more students from the top 1 percent of the income distribution than the entire bottom half (Chetty et al., 2020).

Access to elite education is largely dependent on parents income (Chetty et al., 2020)

So, student bodies at elite universities in the U.K. and the U.S. skew dramatically towards wealth. Yet, it is essential to understand that, on average, this is not because wealthy families just donate their children’s way into those institutions. It is because they are able to invest an ever-increasing share of their wealth into their children’s education, sometimes through outrageous tuition fees, private teaching, and preparation for standardized tests such as the SATs (Sandel, 2020).

And it pays off! The gap in SAT scores between the rich and the middle class is now twice as big as the gap between the middle class and the poor (Markovits, 2019). Furthermore, children from wealthy households can afford to study abroad or accept unpaid internships in expensive cities (i.e., at the U.N. in New York or Geneva) that boost their C.V.s and increase their opportunities in a merit-based competition.

Children from privileged backgrounds — including myself — undeniably work incredibly hard and put in tons of effort, but all we’re doing is merely winning a competition that has been rigged in our favor. Or, as Daniel Markovits, Yale Law School Professor and LSE Graduate, put it: “Even as top universities emphasize achievement rather than breeding, they run admissions competitions that students from middle-class backgrounds cannot win, and their student bodies skew dramatically toward wealth” (2019, p. 14).

In a world where graduates, almost exclusively from those elite universities, are hired for the highest paying jobs — like in Finance, Law, or Consulting (Rivera, 2016) — we have created a vicious cycle of the rich staying rich with the majority of the population being left out.

I must have intuitively reached this conclusion from the get-go because I so desperately wanted to become part of this elite club, thus motivating me to apply to the LSE in the first place.

But, there was something else I came to realize about those top-level jobs when studying here.

Fallacy 2: Compensation and the value of work for society are related

I assumed that a job’s compensation is perfectly correlated with the job’s value for my firm and, more importantly, the broader society. After all, there are so many smart people working in those companies who simply must make the world a better place with the stuff they are doing. Whenever I told someone I was planning on working in Management Consulting after graduating, they were always very impressed. So not only do these jobs accrue massive paychecks, but they also derive considerable social appreciation and status. Doing good, while getting rich and being admired — a win-win-win for me.

Well, then I started reading some of the articles and books written by this super intriguing yet slightly spaced-out LSE Anthropology professor. His name was David Graeber — and his work has influenced me like almost no one else’s. Graeber famously said that there is an inverse relationship between the amount of money you’re going to get for a job and how much it actually helps people (Moreau, 2019). But how could that be true?

Well, when looking into the transformation of Finance and Investment Banking since the 1980s as an example, it becomes pretty evident that Graeber was spot on. Deregulation — driven by big money interests and corporate lobbyists — has changed the financial sector, from primarily serving the middle class and medium-sized businesses in need of credit into an industry full of highly educated speculators focusing almost all of their hard work on enriching an already wealthy elite (Markovits, 2019). While the benefits are split up among the rich (Wolff, 2017), the losses are socialized with average taxpayers paying the bill for the ever-more-frequent financial crises caused by over-boarding speculation and risk.

Mariana Mazzucato (2018) has shown impressively how modern Finance is extracting value from the economic system rather than adding it. Even research by Deutsche Bank has shown that the deregulation of Finance has increased the frequency of financial crises (Reid et al., 2017). And what happens in the aftermath of those crises caused by the wealthy?

Let’s take the most recent financial crisis in 2008 as an example: Once again, it was the average Joe who suffered from job losses and cuts to public services like education, transportation, or affordable housing, while at the same time, 91% of all new income went to the top 1% of the income distribution (Carter, 2012; Saez, 2015).

Practices like these don’t benefit the wider society, yet bankers are still paid a fortune. It truly is the perfect example of what David Graeber was telling us. I am not implying that this is true for all high-paying jobs, but in Finance and Investment Banking, there is definitely a case to be made.

On the other hand, people in jobs that actually benefit society — rather than just themselves and their wealthy bosses — are, as Graeber (2021) puts it: ”overtaxed, underpaid, and daily humiliated.” Yet they are the people doing the lion’s share of care work. They are the ones who put their lives on the line on a daily basis. They are the ones who have taken care of our families and our loved ones in this deadly pandemic, doing everything in their power to keep them and us alive. And what do they get from us? Applause, banners, and a one-time bonus for them to then go back to terrible working conditions, low salaries, burnouts, and depression. Why can’t people whose dream it is to help others experience social appreciation, decent working conditions, and make a fortune in our society, rather than greedy bankers who are right now on track to create the next financial crisis (Schwarz & Grim, 2021)? Why do we accept that? And why did I ever want to be a part of this?

But it was not just about the ridiculous relationship between the value of work for society and compensation. I realized it was about the broader economic system heading in a direction that I couldn’t support.

Fallacy 3: Our economic system benefits everyone

When mainstream economists or politicians excitedly reference low levels of unemployment or positive economic growth rates, one would logically assume that everyone is benefiting.

And yet, when I actually started looking at other economic, sociological, or psychological indicators, that claim appeared to be questionable at best. For instance, in the U.S., income inequality in 2018 has reached its highest level since the Census Bureau has started measuring it in 1967, despite the close to record-low unemployment rates and almost a decade of economic growth (Telford, 2019). In fact, since the late 1970s, both the income and wealth share captured by the top 10 percent of the distribution has increased significantly, while the bottom 90 percent have lost out (Saez, 2019, Wolff, 2017). What we have seen is not the rise of an inclusive economy but a massive transfer of income and wealth from the poor and middle class to the rich.

Distribution of Taxable Income for 1975 to 2018 (Hanauer & Rolf, 2020; based on data by: RAND)

A new landmark study by the RAND Corporation shows that had income inequality held steady at the level it had been at in the post World War II period (until 1974), the bottom 90 percent of earners — between 1975 and 2020 — would have received a staggering total of $50 trillion more in income (Price & Edwards, 2020; Hanauer & Rolf, 2020). But due to rampant inequality, it all went to the top of the distribution — enriching an already wealthy elite.

When talking about inequality, most economists and politicians tend to focus on a global or national scale. For me, there are two problems attached to that approach: First, it doesn’t offer much information as to where exactly inequality is being created. And secondly, based on that, pretty much all conclusions drawn from this approach then involve state-run redistribution of income and wealth, which — among other things — require a high level of trust in the Government, that in countries like the U.S. simply does not exist (Pew Research Center, 2019). Therefore, I believe that we need to take a closer look at compensation structures in corporations and analyze if they have created growing intra-company inequality. That approach has the potential to address the initial distribution of income while circumventing the idea of the Government getting too much involved in the process of post hoc income and wealth allocation.

When measuring inequality within corporations, the most helpful tool to look at is the CEO-to-worker pay gap. It is calculated by dividing the CEO pay of a firm by the median pay of an employee (Melin, 2020). Timewise, the important cap to look at is the beginning of the 1980s when Ronald Reagan came to power, and we entered the era of neoliberalism and deregulation. Before neoliberal policies roamed free, in 1978, the CEO-to-worker pay gap was 31-to-1, nowadays, it is 320-to-1 (Mishel & Kandra, 2020). CEO pay between 1978 and 2019 has grown by a staggering 1,167%, while typical worker compensation only went up by 13.7% over the same period (Ibid.).

CEO-to-Worker compensation ratio, 1965–2018 (Mishel & Kandra, 2020, P.12)

It is crucial to understand that while CEO pay has even outperformed S&P Stock market growth, workers’ wages significantly underperformed productivity growth (Bivens et al. 2014, Updated 2019).

Productivity growth and hourly compensation growth, 1948–2018 (Bivens at al. 2014, Updated 2019)

Of course, the question now has to be: Why? And what the hell happened? There are two underlying reasons I was able to identify:

The first one is that the structure of CEO pay has changed significantly. While base salary has almost stayed the same since the 70s, stocks and stock options were added on top (Frydman & Jenter, 2010). Today around three-quarters of CEO pay is stock related, making CEO compensation more and more dependent on stock performance and providing a massive incentive for CEOs to maximize share value at all cost (Mishel & Kandra, 2020).

The second reason is the rise of Shareholder-Value Maximization (SVM) as the dominant ideology for businesses. The idea — famously advocated for by Milton Friedman (1970) — is pretty straightforward: A company’s job is to maximize its profits and always act in its owners’ (meaning its shareholders) interest.

Combining SVM with the deregulation agenda of the Reagan era has had an enormous impact on business investment. Rather than prioritizing spending money on R&D, production facilities, or raising wages for workers, the Fortune 500 companies have spent $7.6 trillion 91% of their net earnings — on stock buybacks and dividends between 2009 and 2018 alone. This strategy serves to ramp up stock value, thus further lining the pockets of CEOs, top management, and the rich in general (Lazonick et al., 2020). For context, 84% of stocks are owned by the richest 10% of Americans (Wolff, 2017).

Why can companies do that? Because through deregulation and the liberalization of labor markets, power within corporations has been centralized at the very top, with workers barely having a say in any sort of essential decision-making processes (Anderson, 2019; Markovits, 2020).

Companies nowadays are organized like oligarchies, where CEOs, top management, and a couple of wealthy shareholders have accumulated almost all decision-making power — and they mainly use it to prioritize enriching themselves over anything else.

Call to action

So, what can we do?

Well, first, we need to understand that our current economic system is not working for the vast majority of people. It is not inclusive, it creates severe societal distortions, and it is mainly serving a wealthy elite while creating exorbitant levels of inequality.

We need to overcome the dogmas of deregulation and “free-markets no matter what” and establish an economic system that is based on society’s needs and the Common Good first. We need to ask ourselves: What is the sort of society we want to live in? — and then use the economic system as a means to get there. One of the main mistakes we have made in the past 40 years is to have treated mainstream economic measures as ends in themselves. However, I have demonstrated before that growth and low levels of unemployment do not imply an inclusive economic system, while rising inequality actually has severe negative consequences for society (Wilkinson & Pickett, 2010; 2020). The goal of economics is and always has been to enhance human welfare for society — but somehow, we seem to have forgotten that along the way.

When we start to question the central tenets of neoliberal economics, I hope we come to realize that a more democratic workplace would be beneficial for everyone. Not only would inequality be reduced because workers were to be included in high-level decision-making, but employers could, in fact, even benefit from the knowledge of their employees and use that for investment advice, rather than focus on extracting money for personal gains or the sake of shareholder value. Furthermore, autonomy increases employees’ intrinsic motivation, not to mention the potential to simultaneously reduce the experienced powerlessness and uselessness by workers in so-called Bullshit Jobs — an actual win-win-win (Deci & Ryan, 2012; Graeber, 2018).

And lastly, I think we urgently need some sort of democratization of the stock market as well. And that’s not done by organizing in Subreddits to ramp up share prices to challenge Hedge Funds shorting a company we like. But, through plans like the Corporate Accountability and Democracy Act proposed by Senator Bernie Sanders, which centers around the idea that it should be workers — not Hedge Funds — owning the companies they work for. Why? Simply put: To reinstate another old rule of economics we have forgotten about: When a company prospers, everyone working there should benefit from that because everyone has contributed to that success.

Now, I am well aware of what kind of drastic change I am calling for here. But it is by no means impossible. In a famous TED talk, Harvard researcher Erica Chenoweth shared fascinating insights on her work about civil resistance, showing that it only takes about 3.5% of the population to bring about meaningful social change.

When we focus on educating people on economics and how our current system is failing them, I strongly believe that we can change our economic system to the benefit of everyone involved. I mean — after all, we are the 99%, aren’t we?

Bibliography

Anderson, E. (2019). Private government: How employers rule our lives (and why we don’t talk about it). Princeton University Press.

Bivens, J., Gould, E., Mishel, L. R., & Shierholz, H. (2014). Raising America’s Pay: Why It’s Our Central Economic Policy Challenge. Economic Policy Institute.

Busby, E. (2019). Gap between rich and poor students at top universities widens for first time in decade. The Independent. Retrieved from: https://www.independent.co.uk/news/education/education-news/students-universities-applications-ucas-social-mobility-equality-gap-russell-group-a8755156.html

Carter, Z. D. (2012). Austerity’s big winners prove to be Wall Street and the wealthy. Huff Post. Retrieved from: https://www.huffingtonpost.co.uk/entry/austerity-wall-street_n_1690838?ri18n=true&guccounter=1&guce_referrer=aHR0cHM6Ly9jb25zZW50LnlhaG9vLmNvbS92Mi9jb2xsZWN0Q29uc2VudD9zZXNzaW9uSWQ9M19jYy1zZXNzaW9uXzdiYTdlOTIzLThiM2UtNDA1Mi05MmE5LWI0MzJlYzdhY2E1Mw&guce_referrer_sig=AQAAAEGS4C4VnvjeRY0nLdiI7N0S9zpKQPTGLi5FXB0OrKP1du-a8nCMHi1mvQDDakfj7l9Lf5fne6XkkmZvENjDRLDsyv6-z0d8ql5gicaWQ1PJyfaO9mNU1vYaJ7EW_tq5NehyiBAz1nVBchrrfJqIrPOmgM_3aHzQNekciauSJ-3h

Chenoweth, E., Stephan, M. J., & Stephan, M. (2011). Why civil resistance works: The strategic logic of nonviolent conflict. Columbia University Press.

Chetty, R., Friedman, J. N., Saez, E., Turner, N., & Yagan, D. (2020). Income segregation and intergenerational mobility across colleges in the united states. The Quarterly Journal of Economics, 135(3), 1567–1633.

Deci, E. L., & Ryan, R. M. (2012). Self-determination theory. In P. A. M. Van Lange, A. W. Kruglanski, & E. T. Higgins (Eds.), Handbook of theories of social psychology (p. 416–436). Sage Publications Ltd. https://doi.org/10.4135/9781446249215.n21

Friedman, M. (1970). The Social Responsibility of Business is to increase its Profits. The New York Times Magazine.

Frydman, C., & Jenter, D. (2010). CEO compensation. Annu. Rev. Financ. Econ., 2(1), 75–102.

Graeber, D. (2018). “Bullshit Jobs. A Theory. ”London: Allen Lane.

Graeber, D. (2021). After the Pandemic, We Can’t Go Back to Sleep. Jacobin. Retrieved from: https://jacobinmag.com/2021/03/david-graeber-posthumous-essay-pandemic

Hanauer, N. & Rolf, D. M. (2020). The top 1% of Americans have taken $50 Trillion from the Bottom 90% — And that’s made the U.S. less secure. Time. Retrieved from: https://time.com/5888024/50-trillion-income-inequality-america/

Lazonick, W., Sakinc, M. E., & Hopkins, M. (2020). Why stock buybacks are dangerous for the economy. Harvard Business Review, 7.

Markovits, D. (2019). The Meritocracy Trap: Or, The Tyranny of Just Deserts. Penguin U.K.

Markovits, D. (2020). How McKinsey Destroyed the Middle Class. The Atlantic. Retrieved from: https://www.theatlantic.com/ideas/archive/2020/02/how-mckinsey-destroyed-middle-class/605878/

Mazzucato, M. (2018). The value of everything — Making and taking in the Global Economy. Penguin U.K.

Melin, A. (2020). KKR’s $277,500 Median Employee Salary Tops in Private Equity Pay. Bloomberg. Retrieved from: https://www.bloomberg.com/graphics/ceo-pay-ratio/

Mishel, L. & Kandra, J. (2020). CEO compensation surged 14% in 2019 to 21.3 million. Economic Policy Institute.

Moreau, A. S. (2019). David Graeber on capitalism’s best kept secret — Income and utility are inversely proportional. Philonomist. Retrieved from: https://www.philonomist.com/en/interview/david-graeber-capitalisms-best-kept-secret

Pew Research Center. (2019). Public Trust in Government 1958–2019. Retrieved from: https://www.pewresearch.org/politics/2019/04/11/public-trust-in-government-1958-2019/

Price, C. C., & Edwards, K. A. (2020). Trends in Income from 1975 to 2018. RAND.

Reid, J., Nicol, C., Burns, N., & Chanda, S. (2017). Long-term asset return study: The next financial crisis. Deutsche Bank Market Research, Deutsche Bank.

Rivera, L. A. (2016). Pedigree: How elite students get elite jobs. Princeton University Press.

Saez, E. (2015). The Evolution of Top Incomes in the United States (updated with 2014 preliminary estimates). University of California, Berkeley, Working Paper. Retrieved from: http://eml. berkeley. edu/~ saez/saez-UStopincomes-2012. pdf.

Saez, E. (2019). Striking it Richer: The Evolution of Top Incomes in the United States (Updated with 2018 Final Estimates). UC Berkeley.

Sandel, M. J. (2020). The Tyranny of Merit: What’s Become of the Common Good?. London: Allen Lane.

Sanders, B. (2019). Corporate Accountability and Democracy. Bernie Sanders campaign. Retrieved from: https://berniesanders.com/issues/corporate-accountability-and-democracy/

Schwarz, J., & Grim, R. (2021). The bigger Short. The Intercept. Retrieved from: https://theintercept.com/2021/04/20/wall-street-cmbs-dollar-general-ladder-capital/

Telford, T. (2019). Income inequality in America is the highest it’s been since Census Bureau started tracking it, data shows. Washington Post. Retrieved from: https://www.washingtonpost.com/business/2019/09/26/income-inequality-america-highest-its-been-since-census-started-tracking-it-data-show/

Weale, S., Adams, R., & Bengtsson, H. (2017). Oxbridge becoming less diverse as richest gain 80% of offers. The Guardian. Retrieved from: https://www.theguardian.com/education/2017/oct/19/oxbridge-becoming-less-diverse-as-richest-gain-80-of-offers

Wilkinson, R., & Pickett, K.(2010). The spirit level: Why equality is better for everyone. Penguin UK.

Wilkinson, R., & Pickett, K. (2020). The inner level: How more equal societies reduce stress, restore sanity and improve everyone’s well-being. Penguin Books.

Wolff, E. N. (2017). Household Wealth Trends in the United States, 1962 to 2016: Has Middle Class Wealth Recovered? (№24085). National Bureau of Economic Research.

Studying Psychology of Economic Life in London. Interested in inequality of income, wealth and power.