What’s the one thing Pope Francis, Barack Obama, Marco Rubio, and Warren Buffett all agree on? America needs to change the way it sets wages to overcome its economically and politically unsustainable levels of income inequality.
The question is how? Let’s start with some lessons from history and see how we can apply them to today’s economy and society.
For 30 years after World War II, wages and productivity in the U.S. moved up in tandem, creating a growing middle class and ensuring baby boomers could realize their American Dream. We called that the “post-war Social Contract.” Then in the 1980s, the social contract fell apart, starting 30 years of stagnant wages, growing inequality, and political polarization.
The post-war Social Contract was possible because the New Deal established a floor on minimum wages and protected workers’ rights to organize and engage in collective bargaining. Then in the mid-1940s as the domestic economy grew on the basis of purchasing power pent up during the war, United Auto Workers’ President Walter Reuther and General Motors (GM) CEO Charles Wilson negotiated what was called the “Treaty of Detroit,” specifying that wage increases would be set to match growth in the cost of living and productivity. The strength of unions then helped spread this “pattern” bargain across American industry.
When a bank considers a loan, it looks at the borrower’s income, assets, credit history, and plans for the money. On microloan websites, lenders have one other way to evaluate a borrower’s creditworthiness. They can observe the behavior of other lenders.
With a colleague, Peng Liu of Cornell University, I have been studying Prosper.com, the largest of the microlending sites. On Prosper, lending is transparent. Borrowers make requests in public postings and typically rely on multiple lenders. Prosper assigns credit ratings to borrowers, and friends of borrowers can post endorsements. Once the process is under way, lenders can see how other lenders respond to the listing.
We analyzed over 2 ½ years of Prosper data to determine the dynamics of lender behavior. We thought we might see what is known as “irrational herding,” or mimicking. If irrational herding is at work, then a listing that received a strong initial response would attract more and more lenders. As we sifted through the data, we found no evidence this was happening.