Daron Acemoglu on Inequality and the Financial Crisis 02/21/2011
What this covers
Economist Daron Acemoglu and host Russ Roberts debate competing explanations for the 2008 financial crisis and the surge in top-end inequality. The core disagreement centers on causality: Raghuram Rajan's account treats politics as a responsive channel—inequality in labor markets created political pressure for redistribution, which pushed toward higher homeownership and ultimately destabilized finance. Acemoglu counters that politics operated as an independent force, with lobbying, campaign finance, and privileged access reshaping the financial industry's rules over decades, producing both the crisis and the outsized rewards that concentrated at the very top.
The conversation rests on a crucial distinction between labor-market inequality (gaps up to the 90th percentile, driven mainly by technology) and top-end inequality (the explosion of the top 1% and 0.1%), which Acemoglu argues are separate phenomena with different causes. He marshals evidence that Wall Street wage growth accelerated from the 1970s onward, that senators' votes track high-income constituents almost perfectly while ignoring low-income ones, and that distorted financial incentives—where executives pocket enormous upside while losses fall on taxpayers through bailouts—seeded both crisis and inequality. The pair examine why Community Reinvestment Act policy had negligible effects, how media coverage constrains political misbehavior, whether Wall Street's capital allocation genuinely justifies its rewards, and what reforms might untangle money from politics. Throughout, they weigh timing problems in Rajan's narrative against mechanisms that would make Acemoglu's account plausible.
Acemoglu argues that the financial crisis and rising top-end inequality were driven primarily by politics acting as an autonomous force—lobbying, campaign finance, and privileged access reshaping the financial industry—rather than by Rajan's account where politics merely responds to labor-market inequality with cheap credit.
- Labor-market inequality and 'top inequality' (top 1%/0.1%) have distinct causes; the explosion at the very top is unprecedented and disproportionately financial-sector driven
- Political scientists find legislators' votes correlate strongly with high-income constituents and not at all with low-income ones, pointing to money/access rather than appeasing the poor
- Distorted incentives in finance (asymmetric upside, bailouts) both seeded the crisis and enriched risk-takers before risks turned south
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There is a crucial distinction between 'labor-market inequality' (gaps measured up to the 90th percentile, e.g., college premium, 90/10 ratio) and 'top inequality' (how much the top 1% or 0.1% earn relative to the rest); the causes and data sources for each differ, and standard survey/census data are top-coded so they cannot reveal what happens at the very top.
“I think there is a difference between what I'm gonna call labor market inequality which is what I think Rajan is talking about and top inequality”
Per Piketty and Saez IRS data, the top 1% of US earners captured about 10% of national income in the 1970s, rising to nearly 25% by the late 2000s—and remarkably, these mega-earners shifted from being rentiers living on inherited capital to being W-2 wage earners.
“in the 1970s you know the top 1% of the earners in the United States captured about 10 percent of all national income in the United States in the late 2000s that number rises to almost 25 percent”
Research by Thomas Philippon and Ariell Reshef shows that beginning in the 1970s there was a remarkable explosion in wages in the financial sector relative to the rest of the economy, indicating finance plays a disproportionate role in the top 1%.
“doing precisely this period starting from the 1970s there is just a remarkable explosion in the wages in the financial sector relative to the to the rest of the economy”
There is causal evidence that access to different information sources affects political outcomes: DellaVigna and Kaplan's Fox News study (exploiting staggered cable rollout) finds a sizeable effect on Republican presidential vote share, and other studies (Stromberg-Snyder, Ferguson) show politicians behave differently and lobbies are countered more where media coverage is greater.
“there is an interesting paper by stefano de lavinia and ethan kaplan on the Fox News effect... they find a not a very very large but a sizeable effect of you know having access to Fox News on Republican presidential boat share”
Acemoglu's alternative is that politics was not merely an intervening channel responding to inequality, but an autonomous driving force: lobbying, campaign contributions, and privileged access by the well-off and well-organized shaped the financial industry over 25 years, and those distortions then caused both the financial crisis and much of the top-end inequality observed in the US.
“it might actually have been that it was politics acting as sort of an autonomous force... really shaped the state of Finance and the financial industry in the United States especially over the last 25 years or so and developments in the financial industry then caused both the financial crisis and also through related processes part of the inequality”
Allocating capital is genuinely socially valuable, but it is unclear whether profiting from short-run price fluctuations contributes to getting the long-run prices right; if you can make millions from a few hours of mispricing that doesn't materially affect the long-run allocation of capital, that activity's social value is questionable.
“the question that is in my mind... is whether when you are making money on short-term price fluctuations that whether that actually is essential for getting the long-run prices that are more important for the allocation of the trillions of dollars”
Wall Street's influence stems not just from money but from a near-monopoly on financial expertise—possibly greater than its true expertise justifies—so when policymakers like Paulson consult Blankfein or Dimon during critical periods, they receive not objective truth but truth filtered through and shaped to fit those firms' interests.
“Wall Street has the sort of the monopoly on expertise perhaps even it has more of a monopoly that its own true expertise justifies on financial matters”
Three bipartisan policy patterns represented failures of political competition that helped cause the crisis: (1) since 1984, bailing out large failing financial institutions by protecting bondholders/creditors at 100 cents on the dollar while only stockholders lose; (2) the mid-1990s bipartisan push to raise homeownership rates, which in supply-constrained areas drove large price increases; and (3) the bailouts funneling money directly into institutions that made bad investments.
“when a large financial institution is about to go bankrupt what should we do and the answer since 1984 is almost always let the stock holders lose all their money and let the creditor the bondholders... get all their money back 100 cents on the dollar”
The rise of top earners as wage (rather than capital) earners cannot be explained solely by increased demand for skills; organizational changes in how industries are structured and how top management and finance professionals are incentivized (options, bonuses, and broader changes) must also be responsible.
“it's also difficult to think that this is just an increase in the demand for skills and that there must there must be other organizational changes in society and how we organize different industries and how we incentivize people”
Rajan's thesis holds that an exogenous, technology-driven rise in inequality created political pressure that led the government to encourage GSEs like Fannie and Freddie to provide cheap, subsidized credit to lower- and middle-income households, fueling a housing bubble whose collapse caused the financial crisis.
“it essentially encourages government-sponsored enterprises the the likes of Fannie and Freddie to provide cheap credit to the to the to the bottom of the income distribution... and this political response then lays the groundwork for the financial crisis where there is a housing boom”
Wall Street differs fundamentally from venture capital: a VC who consistently picks badly loses access to capital and exits the game, but on Wall Street executives and traders who lose enormous sums for their firms still earn immense personal sums and stay in the game—because they risk other people's money and the Fed bails them out—creating disastrously inefficient incentives.
“if you continually start companies that fail with other people's money you go out of business... but on Wall Street what has happened in the last twenty five years is that if you do really stupid things and you lose a lot of money for your firm you keep going you make a lot of money”
Research by Neil Bhutta finds that the Community Reinvestment Act and the GSE underserved-areas goal provisions (setting Fannie/Freddie targets for mortgages in lower-income and minority areas) had only very small effects, suggesting these specific policies were not decisive causes of the housing boom.
“there's these two interesting papers by Neil buta who is now at the Federal Reserve Board... what he find is that those had very small effects”
Political science evidence (Larry Bartels and others) shows that senators' votes—on both economic and social issues—are highly correlated with the opinions of their high-income constituents (top third), moderately correlated with middle-income constituents, and not at all correlated with low-income constituents, making it implausible that politicians were responding to the bottom's discontent.
“the way that senators vote is very highly correlated with what their high income constituencies think it's moderately consider correlated with what their middle-income constituents think... it's absolutely not correlated with what the low-income one”
The explosion in political action committees, campaign financing, and lobbying expenditures over the last 30-35 years provides a mechanism for why politicians track high-income constituents: influence comes not only from buying politicians but from access—being able to talk to and shape their views—which itself requires money.
“there's a good channel for why politicians are going to be more correlated with their high income constituents because they want the money of the high income constituent”
Even a milder version where bankers get a large cut of profits but bear no downside beyond losing their job (still keeping a respectable salary) creates terrible incentives, because they can make humongous amounts by succeeding at risky bets while not bearing the losses.
“even if the story was much less bad than what you just put... that already creates terrible incentives... because you know you don't bear the downside of the losses and you can make you know humongous amounts of money by being successful in the risks that you take”
Media is a key check on money-driven politics, but a vicious circle exists: democracy corrects misbehaving politicians via voting, yet campaign contributions enable politicians to influence votes (through advertising and name recognition), so money can blunt the very mechanism meant to discipline it.
“the way that we correct politicians misbehaving is by voting yes but what do what does the campaign contributions do campaign contributions enable the politicians to influence the vote in a very strong way”
Labor-market inequality, while higher now than at any point since World War II, is not out of line with historical trends (e.g., early 20th century US) and is far below levels seen in Latin America; in contrast, the rise in top inequality is historically remarkable.
“we are more unequal now than any time before any time since World War two but the levels of inequality that we're seeing in the in the labor market... are are certainly not comparable to what what's going on in in in labor markets in Latin America”
The consensus in labor economics is that rising labor-market inequality over the last 30 years is led mainly by technology (information technology, robotics, new organizational forms increasing demand for skilled/abstract labor) combined with a slower increase in the supply of skills, with trade playing a role intermediated by technology (offshoring/outsourcing) and institutional factors like union decline and the minimum wage still contested.
“most most economists are so comfortable in thinking that you know technology has played a leading role here trade has probably played quite a major role too but intermediated by technology”
The most troubling feature of the financial sector's success was not just CEO pay but the sheer number of non-CEO people who made enormous sums of money, much of it for unproductive reasons using other people's money rather than for genuine value creation.
“the other chilling part is the note the sheer number of people other than the CEO who made enormous sums of money”
Reform should avoid big top-down interventions and instead make existing US political processes work better—curbing the worsening of money in politics, strengthening media's checking role, enacting campaign finance reform, and ensuring broad, informed participation; the Citizens United decision moved in the wrong direction by undermining checks on campaign contributions.
“I think we have to find ways of encouraging the existing political processes in the United States to work better... we've gone in the other direction with doing the recent Citizens United case... we might have undermine any kind of check on on campaign contributions”
A simple test of money's importance in politics is how much time and energy politicians devote to collecting it—since specialists in fundraising spend nearly every waking hour on it, money is clearly important regardless of identification problems in the formal evidence.
“my simple test for whether it's money is important is how much time and energy politicians to vote to collecting it they're specialists... why are they losing their every waking hour”
The timing of inequality undermines Rajan's hypothesis: the big increases in both 90/10 and 50/10 inequality occurred in the 1980s, while the late 1990s and 2000s were remarkable for the bottom and middle doing reasonably well—so Rajan's story requires an awkward ~20-year delay between the 1980s inequality rise and the crisis.
“the big increase in inequality... is actually in the 1980s... it's certainly not in the late 1990s... so you need the story that the inequality caused it... a 20 year delay”
Requiring transparency about who walks into politicians' offices and who they talk to (and for how long) would be a healthy reform, since media exposure—while not always sufficient to stop misconduct—does have a corrective effect.
“wouldn't it be interesting to know about who walks into a politician's office and who they talk to on the phone and for how long... you think requiring that would be a healthy thing”
The standard defense that Wall Street creates value by allocating capital is undermined by the fact that the industry channeled trillions toward housing—a destructive misallocation engendered by bad policy rather than a natural market process—so the social benefit was small relative to the costs.
“when you allocate trillions of dollars towards housing you've clearly made a horrible blunder... I believe that was not a natural market process that was a destructive one engendered by bad policy”
The average person is not really aware of others doing much better, so inequality as a generator of political demand is weak; the tangibility of relative comparison is too low to drive political pressure.
“I don't really think that the average person sits around thinking that there's all these other people doing much better and our access to that are the tangibility of it's very weak”
It is fascinating how little populist politicians have exploited public awareness that the burden of the crisis was unequally borne while bankers retained very high salaries.
“it's actually if anything it's fascinating me how little politicians of a populist stripe have exploited that”
Acemoglu remains an optimist about US institutions, noting they are among the strongest in the world, that overt corruption and self-enrichment by politicians have been limited, and that the political system is not stuck or in the pocket of any single group—though the revolving-door lobbying culture is distasteful.
“I'm still an optimist that you know u.s. still has some of the strongest institutions in the world... the extent of overt corruption has been limited... the political system is not stuck and it's not it's not in the pocket of just one group or another”
The optimistic reading of finance's privileged political access is that so few people are able to exploit such connections—most Americans and even CEOs in other industries cannot steer policy—so one might be grateful the power is concentrated only in the financial sector.
“the cheerful version of this of course is that the glasses is half-full just think how few people were able to exploit that connection”
Welcome to EconTalk, part of the Library of Economics and Liberty; the host is Russ Roberts and the website is econtalk.org.
“welcome to econ talk part of the library of economics and liberty I'm your host Russ Roberts”