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http://asr.sagepub.com/ American Sociological Review

http://asr.sagepub.com/content/76/4/538 The online version of this article can be found at:

DOI: 10.1177/0003122411414827

2011 76: 538 originally published online 10 July 2011American Sociological Review Donald Tomaskovic-Devey and Ken-Hou Lin

Income Dynamics, Economic Rents, and the Financialization of the U.S. Economy

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American Sociological Review 76(4) 538 –559 © American Sociological Association 2011 DOI: 10.1177/0003122411414827 http://asr.sagepub.com

I think everybody a few years ago got caught up in the idea that the markets are self- correcting and self-disciplined, and that the people in Wall Street will do a better job pro- tecting the financial system than the regulators would. I do think the S.E.C. got diverted by that philosophy. – Mary Shapiro, Chair, Securi- ties and Exchange Commission 2010

We examine the institutional processes that facilitated the financialization of the U.S. economy and its implications for income dis- tribution. The great recession of 2008 to 2010 focused attention on the role of finance in destabilizing the global economy, but scholars have paid little attention to the long-term redis- tribution of income produced by financializa- tion. The 2008 collapse of global finance is commonly attributed to the collapse of a spec- ulative U.S. real estate investment bubble (e.g.,

Fligstein and Goldstein 2010; Lewis 2010). This account, while proximately reasonable, misses the historical and institutional develop- ments that facilitated financialization of the U.S. economy. It is these longer term institu- tional transformations that provided the yeast for the latest investment bubble; these transfor- mations are unlikely to dissolve simply because this particular bubble has popped.

We first describe financialization, propos- ing that at its core it is a system of income redistribution. We borrow rent theory from

414827ASRXXX10.1177/0003122411414827Toma skovic-Devey and LinAmerican Sociological Review

aUniversity of Massachusetts

Corresponding Author: Donald Tomaskovic-Devey, Department of Sociology, University of Massachusetts, Amherst, MA 01003-9278 E-mail: [email protected]

Income Dynamics, Economic Rents, and the Financialization of the U.S. Economy

Donald Tomaskovic-Deveya and Ken-Hou Lina

Abstract The 2008 collapse of the world financial system, while proximately linked to the housing bubble and risk-laden mortgage backed securities, was a consequence of the financialization of the U.S. economy since the 1970s. This article examines the institutional and income dynamics associated with the financialization of the U.S. economy, advancing a sociological explanation of income shifts into the finance sector. Complementary developments include banking deregulation, finance industry concentration, increased size and scope of institutional investors, the shareholder value movement, and dominance of the neoliberal policy model. As a result, we estimate that between 5.8 and 6.6 trillion dollars were transferred to the finance sector since 1980. We conclude that understanding inequality dynamics requires attention to market institutions and politics.

Keywords income inequality, financialization, market, neoliberalism, institution

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Tomaskovic-Devey and Lin 539

the study of social stratification to help explain this redistribution. We advance rent theory by stressing the importance of an insti- tutional analysis of markets to understand the processes generating income rents. In doing so, we incorporate a multi-actor view of the politics of markets. With these theoretical and methodological extensions to rent theory, we then outline the key institutional shifts that produced financialization. Finally, we exam- ine the timing and distribution of the transfer of income into this sector of the economy.

FInAnCIALIzATIon

Financialization refers to two interdependent processes. The first process is financial services firms’ increasing importance—in economic,

social, and political terms—to U.S. society (Davis 2009). The second process is the linked trajectory of nonfinancial firms’ increased involvement in financial activity (Krippner 2011).

During the past 30 years, economic activity in the United States has been moving away from manufacturing and service production to financially oriented investment and managerial strategies (Epstein and Jayadev 2005). Figure 1 displays profits in the financial sector as a proportion of total corporate profits. Financial sector profits as a proportion of all profits in the economy grew slowly between 1948 and 1970, dropped across the 1970s, and increased dramatically after 1980 (Krippner 2005). The post-1980 pooling of corporate profits in the finance sector accelerated after 2000. Using

Figure 1. Finance Sector Profits as Percent of all U.S. Profits Source: Bureau of Economic Analysis, Table 6.17 Corporate Profits Before Tax by Industry and Table 6.22 Corporate Capital Consumption Allowance by Industry. Classification: SIC1972: 1948–1987, SIC1987: 1988–2000, NAICS2002: 1998–2009. *Realized profits do not include capital consumption adjustment; profits before taxes (PBT) include capital consumption adjustment. Profits reported here are corporate profits with inventory valuation adjustment before tax and dividends are paid. We use realized profits instead of cash flow (Krippner 2005) to conceptualize the sum of profits before tax and capital consumption allowance. Cash flow is commonly used to indicate the sum of undistributed profits (i.e., profits net of dividends and tax) and depreciation allowance. Realized profits can also be interpreted as profits before tax with inventory valuation and capital consumption adjustments plus consumption of fixed capital. **This category includes nonfinancial holding companies.

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540 American Sociological Review 76(4)

the conventional accounting measure (i.e., net income – capital consumption adjustments), this trend peaked in 2002 when 45 percent of all taxable profits in the private sector were absorbed by finance sector firms.1

Because capital depreciation is typically larger in sectors with large physical capital investments (e.g., oil and automobiles), the second time series in Figure 1 (i.e., realized profit) shows that the finance sector receives a consistently smaller share of total profits in the economy. The same basic pattern of increased profits pooling in the financial sec- tor is evident, however, with the finance sec- tor retaining 30 percent of all capital income in the U.S. economy by 2002.

The finance sector has also seen a rise in employee earnings since 1980 (Philippon and Reshef 2009). Employees on Wall Street— including CEOs and investment managers in commercial and investment banks, bank hold- ing companies, and hedge funds—made up an increasing share of the very highest earners in the economy (Rauh and Kaplan 2010).

Figure 2 displays the ratio of employee compensation (including salary, bonuses, and

benefits) as a proportion of total national com- pensation over sector employment as a propor- tion of total national employment. Prior to 1980, finance sector employees earned about their per capita share of employee income. Following three decades of stability, employee compensa- tion in this sector soared after 1980. By 2000, average compensation was 60 percent higher than the national average. Because estimates are at the sector level, these data do not tell us which industries or which employees benefited, a question we will return to later.

THEoRETICAL TooLS Why did the finance sector garner an increased share of national income after 1980? A neoclas- sical explanation would be that finance sector productivity soared during this period. Because productivity is typically defined circularly in terms of value realized in markets, this is tauto- logically true. We look to rent theory in stratifi- cation and institutional economic sociology for an alternative explanation.

Sorensen’s (1996, 2000) model of income inequality stresses the institutional and political

Figure 2. Finance Compensation Share Over National Employment Share Source: Bureau of Economic Analysis, Table 6.2 Compensation of Employees by Industry and Table 6.5 Full-Time Equivalent Employees by Industry. Classification: SIC1972: 1948–1987, SIC1987: 1988–2000, NAICS2002: 1998–2009. *This category includes nonfinancial holding companies.

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Tomaskovic-Devey and Lin 541

mechanisms through which actors in markets manipulate supply and demand to create and maintain economic rents or to destroy other actors’ rents. An economic rent is an income above what would be realized in a perfectly competitive market. Actors work to create and sustain monopolies or market niches to evade the discipline of competitive markets. Sometimes these monopolies are short-lived, as when a firm produces a new product before competitors enter the market. When firms can secure relatively permanent advan- tage—through state-sanctioned monopolies or scale-based barriers to entry—they can capture rents above market incomes for long periods.

The main contrast between rent theory and conventional market accounts is that rent theory questions the market assumption that actors are fairly rewarded according to their productivity under the assumption of com- petitive markets. Rent theory argues that mar- ket equilibria are neither neutral nor natural but constructed, and thus subject to political, institutional, and ideological projects. In this way, rent theory is consistent with Weberian accounts of opportunity hoarding (Parkin 1979) and neo-Marxian accounts of monop- oly capital (Baran and Sweezy 1966). Impor- tantly, rent theory is also consistent with institutional accounts of markets as fields of power relations (Fligstein 2001). Rent theory is not in agreement with either neoliberal policy models that treat income distributions as naturally just or human capital models that assume underlying individual productivity produces aggregate income distributions.

Rent theory is explicit in stating where money rents come from. When economic rents are associated with firms’ (or indus- tries’) power to reduce competition, above market profits come from consumers who pay higher prices than they otherwise would. Sim- ilarly, employment rents (i.e., above market wages to employees) derive from some com- bination of other employees, a lower capital share of income, or passing high labor costs on to customers. Such market power has been linked to relative power in supplier and

customer markets (Burt 1983), in production (Kalleberg, Wallace, and Althauser 1981), and in both (Tomaskovic-Devey and Skaggs 1999). Some scholars refer to this income distribution process as one of exploitation, in which an actor’s material conditions depend on exchange partners’ contributions (Roemer 1982; Sakamoto and Kim 2010; Tilly 1998).

These approaches all share the assumption that income distributions are socially negoti- ated rather than natural or optimal. Rent destruction or creation is expected to respond to shifts in actors’ relative power in organiza- tional fields or in production to make claims on income flows. In the most agentic version, this shift will follow a political process in which organized actors secure and protect economic rents by manipulating market regu- lations. We suspect that rents may also be produced as a function of unintended demand, institutional or ideological shifts. Because market actors rely on the state to create or endorse the ground rules for market exchange, the state is often an important audience and actor in rent creation and destruction (Flig- stein 2001).

The rent model directs scholars’ attention to institutional bases of market avoidance and rent creation, such as state licensing (Weeden 2002) or political manipulation of demand or regulatory structures (Fligstein 2001). In the next section, we will show that both proc- esses—decline of market competition and changes in regulatory structure—are impor- tant explanations for the shift of national income into the finance sector. We also find that demand shifts played a role: the rise of institutional investors sharply increased demand for financial services and is clearly a source of the historically contingent growth of finance sector rents.

Our key contribution to rent theory is that we import from economic sociology an insti- tutional analysis of how markets and organi- zations change. In previous applications, rent shifts are typically inferred by positive shifts in residual income in a human capital model. We believe that causal inferences are strength- ened by documenting actual shifts in actors’

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542 American Sociological Review 76(4)

constraints and behaviors. We provide a detailed institutional analysis of changes in finance sector market power and regulatory structure.2 This allows for a closer examina- tion of the timing of income dynamics, which should follow the institutional shifts we argue are producing them. We disaggregate the finance sector into detailed industries to observe which actors, during which historical moments, realized increased income associ- ated with financialization.

We also note an affinity between rent the- ory and political economy traditions that focus on the realization of capitalist class interests through capture of the state. Two important applications to financialization are Harvey (2010) and Hacker and Pierson (2010). Harvey describes financialization as central to the rise of the neoliberal policy model. Hacker and Pierson describe finan- cialization as central to the rise in U.S. income inequality. While we agree with these two observations, we think their focus on the capitalist class’s power in creating institu- tional shifts is a partial analysis at best. Like rent theory in stratification, they forego a more careful institutional analysis in favor of broad brush inferences of action based on who benefits. We see a pure market approach and a pure state capture approach to eco- nomic rents as prematurely limiting the potential set of causal factors at work (for a similar criticism, see Kenworthy 2010).

InSTITUTIonAL RooTS oF FInAnCIALIzATIon This section provides a historical analysis of the institutional shifts in and around financial markets since the 1980s. We start from the end of the postwar economic boom in the 1970s, which was perceived at the time as a crisis of U.S. capitalism. Scholars also described this period as a failure of Keynesian macroeconomic theory that provided no clear explanation or solution for the stagflation of the time. We document the rise of the neolib- eral policy model and the solutions proposed to control inflation and stimulate the finance

sector. Finally, we outline related develop- ments in the era of deregulation that produced the systematic reorientation of the U.S. econ- omy toward financial activity.

The 1970s Capitalist Crisis

In the 1970s, there was a strong perception of political and economic threat to U.S. capital- ism. Following post-WWII prosperity, this was the first postwar crisis for U.S. capitalism. A series of threatening events occurred simulta- neously. In 1973, surges in oil prices increased the cost of manufacturing and transportation while transferring income to oil producing firms and countries. The rise in union and con- sumer power put real limits on corporate autonomy in the labor process and the market. Manufacturing competition from Japan and northern Europe ended the postwar era of U.S. global manufacturing hegemony. The resulting low-growth, high-inflation macro-economy undermined the legitimacy of Keynesian eco- nomic solutions. This configuration of threats led the large-firm corporate sector to mobilize to reinvent the system; they pushed for eco- nomic deregulations, lower taxes, and a smaller state (Harvey 2005; Miller and Tomaskovic- Devey 1983; Useem 1983; Vogel 1989).

Following this mobilization, we can point to the era around 1980 as a watershed in the orientation of the U.S. federal government toward the economy in general and economic regulation in particular. Scholarly consensus holds that this capitalist mobilization led to installation of the neoliberal policy model. By neoliberal policy, we do not refer to a coher- ent policy agenda but to the development of a series of state practices that favor market rather than regulatory or administrative solu- tions. Beyond this, we agree with Harvey (2005) that the neoliberal policy orientation rejected the Keynesian commitment of state responsibility for the population’s well-being in favor of fostering a pro-business climate. While this typically took the form of market solutions to economic and political crises, it did not preclude state intervention to prop up particular firms or sectors.

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There is some debate as to which actors were decisive in bringing this new policy model about. The dominant point of view is that the neoliberal model was installed through a capitalist class offensive against Keynesian regulation and labor in general (Harvey 2005; Vogel 1989). It is clear, how- ever, that these ideas had their roots in neoclassical economists who were intellec- tual and technical experts (Davis 2009; Four- cade-Gourinchas and Babb 2002), and that political entrepreneurs within the state were searching for market-oriented policy responses to the era’s crises (Prasad 2006). All accounts agree that the post-1980 neolib- eral policy consensus made regulation of the new financial instruments and organizational forms that developed after 1980 unlikely. Harvey (2005) suggests that one of the defin- ing actions of neoliberal policy was to pro- tect financial institutions at all costs, despite the contradiction of bailouts with neoliberal theory.

Finance Market Dynamics

One of the central components of the 1970s crisis era was stagflation—that is, the joint occurrence of slow or no economic growth and high inflation. Slow growth led to fewer outlets for domestic investment. Inflation undermined banks’ traditional practice of bor- rowing money from customers and lending it to investors. Stagflation led to a sharp drop in bank profitability (see the late 1970s in Figures 1 and 4). In response, the Federal Reserve Bank fought inflation by rapidly increasing interest rates (Epstein and Jayadev 2005; Krippner 2011). This tight monetary policy slowed inflation in the early 1980s and lured foreign capital to invest in U.S. interest bearing bonds.

Low inflation and high interest rates cre- ated conditions for rising profits for banks, insurance companies, and any entity extend- ing credit to consumers and nonfinancial firms (Epstein and Jayadev 2005). In the early 1980s, conflicts between an inflation fighting Federal Reserve chief Paul Volker and a deficit

spending Ronald Reagan were resolved with a massive influx of foreign capital, particu- larly from Japan. This money funded deficits and initiated a continuous stream of foreign capital to feed debt-based consumption by consumers, corporations, and the U.S. federal government (Krippner 2011).3

Declines in domestic investment by U.S. manufacturing firms, coupled with surges in bank deposits associated with the rise of capital surpluses in OPEC and European countries, led to increased deposits in U.S. banks (Harvey 2010; Tomaskovic-Devey and McKinley 1981). The rise of institutional investors, both private (e.g., pension funds) and public (e.g., countries running budget surpluses such as Japan in the 1980s and China more recently), provided a steady source of investment capital to feed continued U.S. financialization (Orhangazi 2008). By 2008, the United States accounted for 43 per- cent of all capital imports in the world (Guil- lén and Suaréz 2010).

While tight monetary policy stabilized the finance sector’s income by taming inflation, it was deregulation that fundamentally shifted the basic structure of the economy to favor the financial sector. Prior to 1980, commer- cial banks, in particular, had been pressing for deregulation in their ability to merge, operate across state lines, and set flexible interest rates on loans and savings accounts (Krippner 2011). This was not simply a rejection of regulation but an attempt by bankers to increase market penetration and the scope of their operations.

Finance Sector Deregulation

The first act in finance sector deregulation came in 1978 when the Supreme Court ruled in Marquette National Bank of Minneapolis v. First of Omaha Service Corporation that credit card companies could charge the allow- able interest rate in the state in which they were chartered. This led most credit card companies to charter or recharter in South Dakota or Delaware, states without usury laws.

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544 American Sociological Review 76(4)

The second and probably most profound deregulatory action was the 1980 Depository Institutions Deregulation and Monetary Con- trol Act, in which Congress repealed a set of banking regulations in place since the Glass- Steagall Act of 1933. After the financial crash of 1929, the Glass-Steagall Act was designed to regulate risk in the finance sector, prevent further concentration of the industry, and pre- vent investment speculation from causing a repeat of the Great Depression. The 1980 act allowed banks to merge, removed regulatory control over interest paid on savings accounts, allowed credit unions and savings and loans to offer interest on checking accounts, and removed state usury caps on interest rates charged by financial institutions. Ironically, consumer movements supported interest rate deregulation in an attempt to protect house- hold savings against inflation. This broke a decade-long political stalemate between com- mercial banks, who favored interest deregula- tion, and savings and loan institutions, who did not (Krippner 2011).

The act weakened the distinction between mutual funds, commercial banks, and savings and loan firms, leading to a decline in banks’ traditional function of raising money through deposits and loaning money out for invest- ment purposes. In response to declining profit opportunities in the traditional deposit–loan cycle, banks turned to fees for financial serv- ices as the source of their income stream. Banks invented a host of new financial instru- ments to absorb the increased investment flow associated with the rise in institutional investors and the diversion of household sav- ings from traditional savings accounts into financial markets (Davis 2009).

In the 1980s, the Federal Reserve allowed bank holding companies to own banks in multiple states, and in 1994, the Riegle-Neal Interstate Banking and Branching Act repealed the final prohibition on interstate banking. Figure 3 shows the concentration of the banking industry post-1980: fewer organi- zations, which were now allowed to merge and operate across state lines, controlled rap- idly growing financial assets in the economy.

During the 1980s and 1990s, the Federal Reserve and the Securities and Exchange Commission pulled back from their regula- tory role and became cheerleaders for new financial instruments; they allowed new organizational arrangements to flourish with- out regulatory oversight (Fligstein and Gold- stein 2010).

Regulators even tolerated formally illegal cross-industry activity, such as investment, insurance, and banking all located in a single firm. Eventually, with the Financial Services Modernization Act of 1999, which passed in response to the merger of Citicorp and Trave- ler’s Insurance Company, Congress repealed the last regulation on finance-sector behavior from the Glass-Steagall Act. It was now legal for investment banks, commercial banks, and insurance companies to combine operations. This led to the immediate expansion of con- solidated bank holding companies, which operated simultaneously in all financial mar- kets; it created the consolidated financial services industry in which family and com- mercial banking, insurance, and investment services could all be provided by a single firm; and it eventually generated the systemic (i.e., concentrated densely networked) risk associated with the financial collapse of the later 2000s (Guillén and Suaréz 2010). Although key shifts in the regulatory field that led to financialization happened in the early 1980s, the 1999 Financial Services Modernization Act increased concentration of the finance industry and the centrality of the largest financial institutions to the economy (Davis 2009).

In the 1990s, after decades of experimen- tation with methods to obscure their political role in limiting wage and employment growth, the Federal Reserve prioritized fighting infla- tion over employment or wage growth and embraced the efficient markets hypothesis— that is, the prevailing view on Wall Street and in finance economics that financial markets are self-regulating. This ultimately led Fed- eral Reserve officials to support bank requests to end prohibition of multiple financial serv- ices within a single firm (Krippner 2011).

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The regulatory system was not overhauled to reflect the emerging financial structure. The system remained fragmented, mirroring the Glass-Steagall mandated fragmentation of financial service activity, even as the largest financial service firms became cross-sector bank holding companies. Fragmented regula- tion meant that after 1999, financial service firms could shop for regulators, and new finan- cial instruments, such as credit default swaps and over-the-counter derivatives, were com- pletely unregulated. No regulator had an overview of the whole system, mirroring the increasing within-firm complexity of financial service firms (Guillén and Suaréz 2010). Hacker and Pierson (2010) refer to this absence of adap- tive regulation in the face of new finance sector organizational forms and products as regulatory drift. Fligstein and Goldstein (2010) refer to the refusal of the Federal Reserve Bank and the Securities and Exchange Commission to regu- late new financial practices as a form of regula- tory capture. Both seem to be apt descriptions of what happened.

These shifts in institutional rules, which reduced regulatory oversight over current and emerging investment devices, encouraged financial investment over physical capital

investment and unleashed speculation in financial assets. Because these policies led to increased volatility in interest rates and stock market performance, they also encouraged the creation of new financial instruments to profit from risk, including variable rate mort- gages, credit default swaps, and mortgage- based and other derivative securities (Harvey 2010; Krippner 2011).

The Finance Conception of the Firm

During this time, the finance conception of a firm as a bundle of tradable assets replaced nonfinance sector managerial commitments to investment and innovation in specific mar- kets (Davis 2009; Fligstein 2001). This shift led to a fundamental change in managerial behavior. Finance-oriented managers now controlled major corporations, and short-term planning to increase stock prices became a primary managerial focus (Dobbin and Zorn 2005; Krier 2005). This shareholder value conception of a firm was reinforced by link- ing top management pay to stock options rather than long-term market share, sales, or production-based profit. Nonfinance sector financialization encouraged corporate leaders

Figure 3. Total Number of Firms and Total Assets of FDIC Commercial Banks, 1948 to 2009 Source: Banking Statistics, FDIC.

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546 American Sociological Review 76(4)

to switch their investment strategies from long- to short-term and from productive to financial investments. Increased financial engagement of nonfinancial business, rising shareholder activism, and the development of a market for corporate control shifted mana- gerial orientations from long-term goals of corporate growth to short-term goals of prof- itability (Davis 2009; Stockhammer 2004; Useem 1993). One consequence was that investment in new productive capital became less attractive and financial investment became more attractive.

Dobbin and Jung (2011) suggest the share- holder value movement was a misapplication of agency theory’s notion that it is necessary to align executives’ incentives with stock- holders’ long-term interests.4 Institutional investors encouraged corporate CEOs to adopt the aspects of agency theory they pre- ferred, focusing on short-term stock market value goals and tying executive compensation to stock price. Aspects of agency theory tar- geting the control of risk—that is, increased outside director influence and long-term sig- nificant executive stock holdings—were not embraced. The result was an incentive system for high risk, short-term behavior. In the end, the shareholder value movement aligned the short-term incentives of finance and industrial- sector executives. These executives created a system in which they were paid for increases in company stock value, but no one was sanc- tioned for stock or balance sheet losses (Krier 2005).

Ownership of stock declined from an aver- age length of five years prior to 1980 to only a single year by 2002 (Crotty 2005). The discipline of the stock market upon corporate leaders thus switched from long (or at least medium) term to short-term performance. During this period, CEO pay became tied to stock performance, so the rise of the finance sector shifted nonfinancial firms’ behavior away from long-term capital investment into short-term financial manipulation.

Nonfinancial firms increasingly invested in financial instruments instead of their core busi- nesses. One estimate places total investments in

financial instruments by non-financial firms at 28 percent before 1980 and at 50 percent by 2000 (Davis 2009). Using firm-level data, Orhangazi (2008) shows that increased finan- cial payments as interest, dividends, and stock buy-backs by nonfinancial firms had a signifi- cantly negative effect on most firms’ new capi- tal investment, while profit on nonfinancial firms’ growing investment in finance instru- ments had an additional negative effect on capi- tal investment among large firms (see also Stockhammer 2004). Financialization appears to have crowded out capital investment in real productive assets.

At the same time, the financial sector absorbed an increasing percentage of non- financial corporations’ cash flow, rising from less than 30 percent of cash flow paid to inter- est, dividends, and stock buy-backs prior to 1980 to as high as 78 percent afterward, with a long-term average between 1980 and 2000 of 54 percent of corporate free cash going to investors rather than to reinvestment in pro- ductive capacity (Davis 2009). Shareholder value strategies, such as mergers, layoffs, and investments in labor saving technology, led to reduced employment, particularly for union- ized workers, but not to increased profitabil- ity (Fligstein and Shin 2007). Firms that became dependent on increasing shareholder value and CEO stock options were also more likely to engage in financial manipulation of their corporate accounts (Prechel and Morris 2010).

Table 1 summarizes this institutional account, highlighting the finance sector’s increased power to structure its market. Construction of rent opportunities involved multiple actors and was not simply the result of self-conscious political influence from the finance sector or an inevitable result of neoliberalism. While the finance sector’s political influence increased across this period, interaction with other actors was critical in generating finance deregulation and the more general financialization of the political economy.

Elimination of the prohibition against cross-industry financial activity and acceler- ating income shifts into the finance sector

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548 American Sociological Review 76(4)

Figure 4. Finance Realized Profit as Percent of All Profit by Industry Source: Bureau of Economic Analysis, Table 6.17 Corporate Profits Before Tax by Industry and Table 6.22 Corporate Capital Consumption Allowance by Industry. Classification: SIC1972: 1948–1987, SIC1987: 1988–2000, NAICS2002: 1998–2008. *This category includes nonfinancial holding companies.

after 1999 suggest that financialization deep- ened in the 2000s. The stock market collapse early in the new century was quickly fol- lowed by a real estate bubble fueled by low interest rates and rising housing prices. The finance sector inflated this bubble through aggressive marketing of subprime mortgages to feed their profitable business in mortgage backed securities.5 In a particularly thorough analysis of these events, Fligstein and Gold- stein (2010) show that this market was cre- ated by a handful of financial institutions participating in all aspects of the process, with collusion from the three rating agencies that rated risky securities as AAA investments and a set of federal regulators who deeply believed financial markets were efficient and self-regulating. The global financial crisis of 2008 resulted proximately from the collapse of this particular investment bubble. How- ever, from a longer term institutional perspec- tive, we think the crisis was a result of the concentration of finance activity in fewer rent-seeking firms, which were embedded in an increasingly retiring and obsolete regulatory structure, coupled with nonfinance-sector

executive incentive systems that favored short-term financial speculation over long- term growth.

DISTRIbUTIon oF FInAnCE SECToR REnTS We now turn to the distributional consequences of these institutional shifts in income generating opportunities. We contrast the pre-1980 regula- tory period, the period of deregulation (1980 to 1999), with the post-2000 financialization acceleration and consolidation of bank holding companies. We begin by documenting industry- specific trends in the share of capital profit mov- ing to the financial sector.

Figure 4 disaggregates sector profits by industry. Consistent with our institutional account, before 1980, finance sector profits as a percentage of all profits in the economy were either flat (e.g., securities, insurance, and real estate) or slowly growing (e.g., bank- ing). Banking profits dropped sharply during the high inflation period at the end of the 1970s, precipitating the 1980 Depository Insti- tutions Deregulation and Monetary Control

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Tomaskovic-Devey and Lin 549

Act. After 1980, banks, and later bank hold- ing companies, reaped the longest term increased profits from this and later acts that repealed various provisions of the 1933 Glass-Steagall Act. In response to falling bank profits in the early 1990s, two more banking deregulation acts were passed—the 1994 Riegle-Neal Interstate Banking and Branching Act and the 1999 Financial Serv- ices Modernization Act. After 1999, we see a second, even steeper, surge in the proportion of national profits accumulated by banks and bank holding companies.

Other finance sector industries also show profit gains, but they happen later and are less dramatic. Insurance realized strong gains across the 1980s, declines across the 1990s, and stronger gains again after 2000. Using 1980 as a baseline, bank profits as a propor- tion of all profits in the economy grew 300 to 400 percent over the next 38 years. During the same period, insurance profits grew by slightly less than 100 percent. Real estate profits grew strongly after 1990, but by 2008 they were a smaller proportion of the total than they had been in 1970. Securities, com- modities, and investments, the industry of investment banks, hedge funds, and mutual funds, shows great year-to-year fluctuations in profitability and a sustained boom as a proportion of national profits only after 2000. The most recent bubble was clearly profitable for this industry. Most striking is that the long-term trend prior to 1994 was low, no, or negative profits in the securities, commodi- ties, and investments industry. Deregulation of banking and financialization of the econ- omy seem to have been most influential in inflating banking sector profits. Insurance had weaker gains, and the security industry saw gains only after the 1999 Financial Serv- ices Modernization Act.

In Figure 5 we disaggregate employee income. Employee income as a share of national income is remarkably stable prior to 1980. After 1980, employees in all four finance sector industries experience relative earnings growth. Growth in employee income in the securities, commodities, and investment industry is extraordinary. Total compensation goes from

1.5 to a remarkable 4 times per capita national earnings. In 2007, workers employed in this industry earned $6,891 per week nationally, and $16,918 per week if employed in Manhattan, compared with the national average of $884 per week. Between 2006 and 2007, just prior to the collapse of the financial system, first-quarter wages in the securities and commodities indus- try grew a remarkable 16.4 percent nationwide and 21.5 percent in Manhattan (Sum et. al 2008).

Financialization of the economy reflected the rise of institutional investors, rapid turn- over in stock and commodity markets, and a general intensification of finance related activities. Commission-based employees in this industry reaped the greatest earnings ben- efits from the increased volume and velocity of investment activity. Figure 5 shows that this industry had weak profit gains, and these gains did not begin until after 1999, leading to the conclusion that financialization, at least before 1999, primarily benefited employees rather than owners in the security industry. This result contrasts with banking and insur- ance, where employees made only small gains in total compensation after 1980 and those gains tended to flatten after 2000, even as absolute profits accelerated. Real estate compensation, on average, was flat and near the national average across all years. Of course, small gains at the industry level can mask large inequalities within an industry. Separate identification of bank holding companies after 1999 clearly shows a much higher average income in mixed banking– investment–insurance hybrids than in con- ventional banking.

Taken together, Figures 4 and 5 suggest that income rents associated with financiali- zation were realized primarily by capital in the banking, insurance, and real estate indus- tries and by employees in the securities indus- try. Banking, in particular, seems to have profited most consistently from deregulation of financial markets and the resulting ability to collect economic rents from society over- all. Employees of security and commodity firms, which were historically organized as partnerships, were able to capture windfall

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550 American Sociological Review 76(4)

compensation from the increasing flow of investment activity.

To further explore the distribution of income within the finance sector, we turn to nationally representative data on individuals from the Current Population Survey (CPS) (King et al. 2010). These data are self-reports and are top-coded for salaries, thus truncating the really high compensation reported by Rauh and Kaplan (2010) and the press during and after the financial crisis.6 Figure 6 reports simple trends in annual earnings for employ- ees of various finance sector industries rela- tive to nonfinance sector average earnings.7 Basic trends we saw in Figure 5 are repeated, and basic ratios are about the same for banks, insurance, and real estate. The clear exception is in securities, commodities, and investment, where salaries, while still rising much faster than in the nonfinancial economy, climbed from 1.5 to 3 times the national average, rather than soaring from 1.5 to 4 (as in Figure 5, which includes all compensation). Reflect- ing sampling and earnings top-codes, the CPS

estimates are least accurate for capturing wage rents accrued by very high earners in the securities, commodities, and investment industry. Rauh and Kaplan (2010) find that these individuals are increasingly in the top one-tenth of one percent of earners nationally.

Philippon and Reshef (2009) suggest that upgrades in employees’ education levels and the skill mix of jobs may account for at least some of the rising incomes in this sector, rather than an increase in income rents to the sector’s average employee. Yet, popular com- mentators describe skilled workers flocking to this sector because of the high incomes, not high incomes being produced by skilled actors. In supplemental analyses, we find that the proportion of college educated employees grew faster than in the rest of the economy in banking and securities, but not in real estate or insurance. Similarly, only in banking and securities do we see an upgrading of the occu- pational structure during this period (see Table S2 in the online supplement [http://asr .sagepub.com/supplemental]).

Figure 5. Finance Compensation Share Over National Employment Share by Industry Source: Bureau of Economic Analysis, Table 6.2 Compensation of Employees by Industry and Table 6.5 Full-Time Equivalent Employees by Industry. Classification: SIC1972: 1948–1987, SIC1987: 1988–2000, NAICS2002: 1998–2009. *This category includes some nonfinancial holding companies.

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Figure 7 reports predicted sector-specific annual income trends based on a regression model that adjusts for shifts in employee experience (age), education, sex, race, and hours of work, as well as occupational struc- ture over the time period.8 The same basic pattern of rising average employment income is evident for each industry in Figure 7, although the peaks are not as dramatic. In the security industry, rents rose to about 2.25 times the national average, rather than 3 times, as seen in Figure 6. Rents also rose in the other three finance sector industries, to 1.17 for real estate and 1.35 for insurance and banking. Controlling for compositional shifts explains little of the rise in bank and insur- ance earnings and none of the rise in real estate. Although the security industry sees strong gains in proportion college educated and in the share of high-skilled occupations, our models do not isolate causal order. It is entirely possible, and we think likely, that these shifts were a response to increased industry income rent opportunities, rather than increased income being caused by shifts in employees’ education level or the indus- try’s occupational structure. Oyer (2008) pro- vides evidence consistent with this intuition,

finding that investment bankers are largely “made” on Wall Street, rather than bringing some set of a priori superior skills to work. Crotty (2009) and Roth (2004) suggest that investment firms, in particular, select on bases of social similarity with existing traders rather than on skill.

To further examine income distribution within each industry, we extend our regression models to explore education, occupation, sex, and race specific trends in economic rents for employees in the finance sector. We find that the substantial increase in income rents to finance sector employees did not extend to all employees. In all four finance sector indus- tries, the post-1980 rise in industry rents went primarily to highly educated employees in managerial, professional, and sales occupa- tions. Lower level occupations and less edu- cated workers saw limited or no income benefits. White men had income growth beyond their human capital and occupational positions in all four industries after 1980, while minority men and women and white women displayed flat income trajectories (see regres- sion Tables S3, S4, and S5 in the online supple- ment). Compared to national trends (e.g., Morgan and McKerrow 2004), the finance

Figure 6. Observed Annual Earnings Relative to the Nonfinance Economy by Industry, CPS Estimates

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sector is unusual in that white men have increased earnings rents, even net of their privileged occupational position. Clearly, the institutional transformations we described ear- lier are more fundamental and exogenous to the increase in sector earnings than are the professionalization and white male opportu- nity hoarding that accompanied and took advantage of these income opportunities.

Counterfactual Estimates of Aggregate Rents

To gauge the size of aggregate income rents transferred to the finance sector during the period of financialization, we explore a coun- terfactual analysis. We ask, what would cur- rent profit and compensation levels in the finance sector look like if their income claims and employment as a proportion of the national economy had stayed at the 1948 to 1980 historical levels?9 We approach these estimates with two simple counterfactuals that ask the following: What if the institu- tional shifts in the finance field associated with increased concentration, regulatory relaxation, and a general belief by all actors

that finance markets are smart and self- regulating had not happened? To do this, we assume that compensation per employee, employees as a share of total employment, and profit shares in the economy stayed at pre-1980 levels. In the first counterfactual, we examine the outcome if the longer term average income shares between 1948 and 1980 had prevailed after 1980. In the second, we estimate a linear trend from 1948 to 1980 and use that trend to predict post-1980 expected income. Because compensation trends were so stable prior to 1980, there is little difference between the two estimates. There was already an upward slope to bank- ing profits as a proportion of the economy before 1980, so the trend counterfactual produces a somewhat smaller estimate of net profit flow into the industry as a result of financialization. Because trends before and after 1980 are different for each industry, we estimate the counterfactuals separately for each industry and then sum to the sector level.10

Table 2 displays estimates of the net addi- tional income captured in the finance sector as profits and employee compensation. We

Figure 7. Predicted Annual Earnings Relative to the Nonfinance Economy by Industry, CPS Estimates Adjusted for Shifts in Employee and Occupational Composition of Industries

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estimate that financialization transferred somewhere between 5.8 and 6.6 trillion 2011 dollars in income into the finance sector between 1980 and 2008, about two-thirds as profits. Banks and bank holding companies earned the lion’s share of this increased income (65 percent), and of that money, up to 90 percent were profits. Importantly, and con- sistent with the institutional story, much of this income transfer happened after 2000. About half of the $5.8 to $6.6 trillion income transfer happened after 2000.

ConCLUSIonS In 2008, almost a quarter of the GDP and more than a quarter of profits accumulated in the finance sector. In this sector, employee compensation went from being about average for the economy overall to about 60 percent higher than the rest of the economy. These shifts represent a transfer of between 5.8 and 6.6 trillion 2011 dollars in income into the finance sector, mostly as profits. To put this in perspective, 6.6 trillion dollars was about 13 percent of all increased income (profits + compensation) in the private sector between 1980 and 2008, or 73 percent of the cumula- tive U.S. federal debt in 2010. In terms of the short-term cost of the financial collapse, 6.6 trillion dollars is more than twice the size of the IMF’s estimate of the global assets lost when the U.S. subprime real estate bubble burst (Lewis 2010).11

Of course, actors in the finance sector would probably interpret this as income earned rather than income transferred. From the perspective of rent theory, there was clearly a shift in these actors’ power to accu- mulate a larger share of national income. This happened as market competition and regula- tion decreased, providing the institutional and market power for this transfer of income to occur. Of course, income shifts would not have occurred if finance sector actors had failed to take advantage of their increased market power. There was clearly considerable lobbying intervention on their part to produce the surge in earnings. From the point of view of actors within these firms, this would have looked like a surge in individual and collec- tive productivity: we can all tell stories that explain our market successes in terms of our individual talent.

The finance sector’s rising share of national income likely came at the expense of other actors in the economy. In a neoclassical eco- nomic model, one might be tempted to claim that financialization, because it may increase efficient allocation of capital, may also increase economic activity overall, thereby raising all actors’ income. However, Stockhammer (2004) and Orhangazi (2008) find that financialization actually reduced nonfinancial firms’ capital investment in new productive assets and increased the share of their cash flow diverted to the finance sector as increased profits. Flig- stein and Shin (2007) and Krier (2005) find

Table 2. Counterfactual Estimates of Income Transfers into the Finance Sector, 1981 to 2008, in Millions of 2011 U.S. Dollars

1981 to 2008 2000 to 2008

Method Average Trend Average Trend

Net Additional Profits $4,844,904 $3,484,117 $2,219,578 $1,767,677 Net Additional Compensation $1,714,435 $2,335,738 $961,463 $1,239,321 Total Rent $6,559,339 $5,819,855 $3,181,041 $3,006,998 Profits/Total 73.9% 59.9% 69.8% 58.8%

Note: Average method uses the yearly average share of national profits/compensation by detailed finance industry for 1948 to 1980 to predict expected income after 1980. Trend method uses the linear trend in shares of national profits/compensation by detailed finance industry for 1948 to 1980 to predict expected income after 1980.

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that when nonfinancial firms pursued share- holder value strategies, they did not actually produce increased profitability.

We disaggregate income gains within the finance sector by detailed industry, between labor and capital, and among classes of employees. Most profit growth in this sector went to the banking industry, including the bank holding companies created after the 1999 Financial Services Modernization Act. These bank holding companies (plus the insurers AIG, Fannie Mae, and Freddie Mac, as well as GM and Chrysler) were the direct beneficiaries of the 2008 to 2009 federal bailout of the col- lapsing financial system. The bailout of the financial system, no matter how important it was to preserve the world financial system, saved a set of firms that had, since 1980, increasingly been accumulating the economic surplus of the entire economy. After 1990, the banks consistently controlled over 15 percent of total profits in the economy, rising to over 20 percent after 2000. Prior to being bailed out, they had, relative to their post-WWII historical norm, already extracted around 4.9 trillion dol- lars in extra profits.

We hope this article makes a contribution to rent theory and stratification analyses more generally. These literatures tend to observe income dynamics and infer the processes that generate them. By outlining the institutional transformations that made industry rents pos- sible, we have made visible the political and market mechanisms producing and distribut- ing national incomes into this sector. We also think rent theory is more plausible when the evidence includes accounts of actual institu- tional practices and political adjustments of market rules that produce (or destroy) income rents. Introduction of an institutional account is an important contribution to market and political power explanations of rent, because the actual bases of market power are revealed rather than assumed.

Krippner’s (2011) analysis of financializa- tion suggests that it arose from a series of ad hoc and seemingly independent developments, all of which led to abundant credit and relaxed regulation of markets. By contrast, rent theory

tends to focus on political actions to secure or stabilize market rents. While the finance sector certainly has done the latter, our account sug- gests a certain happenstance in producing the former. Deregulation, while advocated by the finance sector, was no doubt primarily facili- tated by the more general rise of the neoliberal policy consensus. Deregulation inspired by the finance sector’s resistance to Glass-Steagall has been a constant in the post-1980 period. Vigorous resistance was certainly present in 2010, when the finance sector lobbied furi- ously to limit the scope of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Further lobbying to limit the influence of the Dodd-Frank Act will no doubt unfold as the regulatory particulars are developed in the executive branch of government.

Our account also suggests that institutional investors, domestic and international, played a role by creating increased demand for finan- cial investments. While market power derived from industry concentration and the political power to repeal, define, and elude regulation are clearly important, demand for financial services and speculative returns from institu- tional investors certainly also mattered. Of course, the lack of regulatory structure made these investments more attractive and the rise of financial speculation and innovation cre- ated a self-fulfilling cycle of high expected returns leading to new institutional, and even- tually household, investments in financial assets. One can over tell the demand story. Absent recurrent financial bubbles, investors may have invested in productive rather than financial assets.

In presenting this institutional account, we think we have discovered another modification to rent theory, which we view as a multi-actor alternative to simple power stories. Because rent theory typically does not observe the institutional process, it usually tells a single- actor market power story—for example, banks (Crotty 2009) or business elites (Hacker and Pierson 2010) control the government. We observe a more complex process, in which a general capitalist crisis legitimated demands for deregulation. Low bank profits during the

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high inflation of the 1970s, coupled with con- sumer demand for higher interest rates, led to the initial deregulation of the industry. In the 1980s and 1990s, the rise of institutional investors fueled financial innovation in the deregulated industry, which began to grow more concentrated. The 1999 repeal of the final Glass-Steagall constraints on finance- sector product coupling, as well as regulators’ adoption of the efficient markets theory, facil- itated the creation of giant multiservice bank holding companies that now dominate U.S. and global financial markets. By the 2000s, the search for expanding profits had gener- ated the real estate bubble: more mortgages were needed to feed a completely unregulated market in mortgage-based securities and their risk-hedging partner—credit default swaps.

Clearly, the market and political power accounts in rent theory are present in this series of events. But so are other actors: consumers looking for interest rates better than inflation, institutional investors with cash to invest, cor- porate CEOs and shareholders seeking to max- imize short-term profits for immediate rewards, and even the Federal Reserve Bank, attempting to obscure its political role in producing unem- ployment and slowing wage growth. While we do not dispute power’s fundamental role in producing market rents, a great deal of idio- syncrasy is produced by multiple actors attempting to solve multiple problems as they arise in real historical time. Nonfinancial busi- ness elites and the state might have been the most commanding actors around 1980, but they gradually lost their dominance to the financial sector.

We also document that industry rents pro- duced by financialization went to some classes of labor as well as to capital. Managerial, pro- fessional, and sales occupations in each of these industries reaped growing above market earnings after 1980. In the security industry, employee earnings grew most rapidly and pre- ceded the onset of increased firm profitability. For the security industry, growth in powerful employees’ compensation, rather than high profits, seems to have characterized the period of financialization. Historically, investment

banks were organized as partnerships rather than corporations (Davis 2009), which may be the institutional precursor for the high returns to employees we observe. In addition, in insur- ance and the security industry, increased aver- age employee pay preceded increased industry profitability. In both cases, it seems likely that performance-based compensation schemes for managerial and sales personnel preceded and perhaps even helped create the profit surges associated with investment and real estate bub- bles. Crotty (2009), among others, agrees that these surges in employee earnings are eco- nomic rents; suggesting that rainmakers’ very high compensation in the investment commu- nity was a source of the systemic risk-taking that eventually led to the collapse of the world financial system.

The 2008 collapse of the finance sector is clearly important in a historical sense. It is also potentially a moment of rent destruction for this sector. We already know that profits fell into the negative range across the industry in 2008 but rebounded strongly in 2009 and 2010. Philippon and Reshef (2009) show a tremendous drop in finance sector rents dur- ing and after the Great Depression of the 1930s. Some of this was due to the shock of the banking system’s collapse, but much of the drop reflected the ensuing regulation of the industry. The 2008 collapse of the finance sector and re-inflation through the federal bailout will likely be interesting theoretically and politically as a potential moment of rent destruction. At this point, however, we know little about the consequences of this sector’s collapse, but rent theory suggests that politi- cally powerful actors will attempt to defend existing market institutions and the resulting capacity to extract rents. This is certainly what U.S. politics in 2009 to 2011 looked like. We saw much media and political atten- tion directed to the high wages and bonuses paid to employees in the finance industry. We also saw major banks and bank holding com- panies struggling to repay federal bailout money as quickly as possible, an action often rationalized as necessary to pay high salaries to their top employees. Finally, and most

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consequentially for future income distribu- tions, there is a struggle between banks and other actors over the appropriate form of new regulations to manage systemic risk and pro- tect consumers from rent extraction. What form these regulations take and how they are practiced will likely determine the degree to which the finance sector will be able to con- tinue to accumulate large proportions of the national income. Unfortunately, there is good reason to expect there will not be a fundamen- tal shift in the regulatory approach to the finance sector, and that finance as the new religion of economic policy will continue its sovereignty (Davis 2009).

Our analysis points to the federal govern- ment as the source of the deregulation of the finance sector. Furthermore, the federal gov- ernment failed to regulate emerging financial markets and innovative financial instruments. If neoliberalism is a policy and intellectual movement away from state regulation, finan- cialization is perhaps its most fundamental product. Certainly, the transfer of national wealth into the finance sector is one of its most dramatic consequences. Now that this sector has crippled the world economy while creating conditions of profound economic uncertainty for investors, unprecedented fed- eral spending deficits in the United States and elsewhere, and intense suffering for house- holds, it seems clear that the economic power of the finance sector and the consequences of that power for income distributions should be central to future incomes policy.

There are many promising avenues for future research. Income shifts into the finan- cial sector imply that actors elsewhere in the economy may have realized income losses and that financialization may have influenced increasing national income inequality during this period (Hacker and Pierson 2010). We wonder, too, if financialization produces sim- ilar income transfers in other countries. We suspect the cultural and material centrality of finance may have undermined production workers’ ability to make claims on income. We are investigating these dynamics in our current work.

The real possibility that financialization reduced aggregate economic growth should be explored systematically as well. There are at least two contrasting points of view here. First, financialization reduces investment in the real economy (Stockhammer 2004). Sec- ond, U.S. financialization, coupled with the United States’ dominant role in the world economy, encourages increased foreign investment in the United States. The relative macroeconomic consequences of these two processes are not at all clear.

The collapse of the U.S. financial sector raises real issues of systemic risk, which we suspect could profitably be studied with net- work models of national and global embed- dedness. The U.S. financial collapse led to an immediate recession in the United States, and it clearly had global consequences. Some consequences were probably due to the same systemic network process, but the institu- tional diffusion of U.S.-style financialization may have produced uneven patterns of risk in various economies.

Somebody, of course, always pays the rent. In this case, it seems to have been the rest of the U.S. economy: nonfinancial firms paid increasing portions of their incomes to the finance sector, and households’ wages were restricted by their employers’ declining market power and their increased payments of fees and interest to a financial sector ever more clever at extracting income from other actors in the economy. There is also the dis- turbing possibility that the financialization of economic activity will lead institutional investors to neglect long-term investment in productive assets in favor of financial specu- lation in search of short-term returns.

Funding This research was supported by the National Science Foundation (SES- 0956273).

Acknowledgments We thank Dustin Avent-Holt, Dan Clawson, Alan Dorsey, Larry Devey, Emily Erikson, Greta Krippner, James Crotty, Clara Miller, Joya Misra, and Art Sakamoto for generous comments on the article and Howard Krakower

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of the BEA for help with the National Income and Product Accounts.

notes 1. Throughout this article, we display time series as

ratios of national income. Focusing on ratios simpli- fies temporal comparisons controlling for dynamics associated with inflation, growth, and to some extent the business cycle. These data are primarily derived from income tax returns reported to the IRS, aggre- gated to the industry level, and so are more accurate than conventional survey or business press data. See Table S1 in the online supplement (http://asr.sagepub. com/supplemental) for the concordance we use to harmonize Standard, North American, and Census Bureau Industrial Classifications across time.

2. We do not trace intra-organizational changes within the finance service industries that responded to these environmental shifts, but note that the literature sug- gests these industries were powerfully transformed in its labor processes and products as a result (Ho 2009; Lewis 2010).

3. Prior to 1984, there was a 30 percent withholding tax on interest earned by foreigners on U.S. investments. The Reagan administration removed this tax as inter- est rates soared and foreign investment flowed into the United States (Krippner 2011).

4. Agency theory is an economic theory of the firm that became influential across the period of financializa- tion. See, for example, Jensen and Meckling (1976) for an original statement.

5. Although Figure 2 suggests a retreat in financial sector profit as a share of all profit after 2003, this primarily reflects a growth in profits in other sectors of the economy. Absolute finance sector profits soared, and the sector as a proportion of GDP contin- ued to climb through 2006.

6. In banking and insurance there are about twice as many top-coded observations as in nonfinance indus- tries, whereas in securities there are 13 times as many top-coded observations (Philippon and Reshef 2009).

7. Following Philippon and Reshef (2009), we multiply top-coded incomes in all survey years until 1995 by a factor of 1.75 to adjust the underestimation of relative earnings in the financial sector. After 1995, the CPS uses group means within top-code categories to impute a top-code value.

8. The basic regression model is estimated in OLS sepa- rately for each year and takes the following conventional form: Annual Earnings = b

0 + b

1 Education + b

2 Age +

b 3 Sex + b

4 Race + b

5 Annual Hours of Work + b

6–8 Occu-

pation Groups + b 9 Finance Industry + e.

9. One can imagine much more elaborate counterfactu- als. If we assume that financialization reduced real economic growth by diverting capital investment out of the real economy, than we might want to estimate how much additional income was lost by the rest of

the economy. On the other hand, one might argue that financialization attracted foreign investment to the United States that would otherwise have gone else- where, thus increasing aggregate income beyond what would have happened in its absence. We suspect the truth lies closer to the former than to the latter, but we do not have any sound basis upon which to derive plausible alternative GDP growth rates.

10. Compensation estimates in Table 2 include holding company income in the finance sector after 1998. This corresponds to shifts from SIC to NAICS coding, and our visual inspection of shifts in income during the period of overlap in the two systems suggests most income was in fact earned in the finance sector.

11. The impact of the U.S. financial collapse on incomes worldwide is beyond the scope of this article, but we suspect that Harvey (2010) is correct in pointing out that it depends on how countries were tied to the United States. Countries that emulated U.S. financial and housing markets (e.g., Ireland and Spain) would see similar collapses, those that depended on exports to the United States or financing through the global finance sector would experience generalized reces- sions, and those that were only lightly infected for reasons of principle (e.g., Germany) or happenstance (e.g., Lebanon) would be barely touched.

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Donald Tomaskovic-Devey is Professor and Chair of the Sociology Department at the University of Massachusetts- Amherst. He is currently doing research on long-term trends in workplace sex and race segregation, as well as developing theory and empirical models on the labor process and work- place inequality. Recent publications from these projects have appeared in Work & Occupations, the American Socio- logical Review, and the American Journal of Sociology.

Ken-Hou Lin is a graduate student in the Sociology Department at the University of Massachusetts-Amherst. His research interests include inequality, economic soci- ology, race and ethnicity, and quantitative methods. He is currently exploring how the financialization of the U.S. economy reshaped income dynamics in the nonfinance sector (with Donald Tomaskovic-Devey). His other proj- ect analyzes how race, gender, and sexual orientation jointly determine the likelihood of interaction among Internet daters (with Jennifer Lundquist).

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