“Inequality has emerged as a major issue in the US and beyond. A generation ago it could reasonably have been asserted that the overall growth rate of the economy was the main influence on the growth in middle-class incomes and progress in reducing poverty. This is no longer a plausible claim.
“The share of income going to the top 1 per cent of earners has increased sharply. A rising share of output is going to profits. Real wages are stagnant. Family incomes have not risen as fast as productivity. The cumulative effect of all these developments is that the US may well be on the way to becoming a Downton Abbey economy. It is very likely that these issues will be with us long after the cyclical conditions have normalized and budget deficits have at last been addressed.”
– Lawrence Summers (in the Financial Times)
“Cyberpunk is a postmodern science fiction genre noted for its focus on ‘high tech and low life.’ It features advanced science, such as information technology and cybernetics, coupled with a degree of breakdown or radical change in the social order. ‘Classic cyberpunk characters were marginalized, alienated loners who lived on the edge of society in generally dystopic futures where daily life was impacted by rapid technological change, an ubiquitous datasphere of computerized information, and invasive modification of the human body.’”
– Lawrence Person (Wikipedia)
A new word is achieving ubiquity. The word has always been with us and at times has been a beacon to attract the friends of liberty and opportunity. But now I’m afraid it is beginning to be used as a justification for social and economic policies that will limit the expansion of both liberty and opportunity. The word? Inequality. More specifically, the word has become problematic when used in close proximity to the word income. There are those who believe that income inequality is the proximate cause of the Great Recession, if not the imminent demise of Western Civilization, pushing us into a dystopian world that will come to resemble the one depicted in the movie Blade Runner.
(Note: Blade Runner exemplifies a genre of science fiction called cyberpunk, defined above.)
This week we begin what will probably be a multi-week series on the subject of income inequality. Over the years, I’ve written many times about the lack of income growth for the middle class in the developed world. We have also looked at the growing spread between the top 1% or 5% or 10% and those further down the income scale. The widening spread is an undeniable fact. But what should be done about it? Do we take money from the more well-off, or do we increase opportunities for all? How do we increase opportunity without social expenditures for education and healthcare, and where will the money come from? What trade-offs do we get for the lost productivity and reduced savings that result from increased taxes? What institutional and policy barriers are there? These are all fundamentally important questions.
What spurred me to start this series was a recent paper from two economists (one from the St. Louis Federal Reserve) who are utterly remarkable in their ability to combine more bad economic ideas and research techniques into one paper than anyone in recent memory. Their even more remarkable conclusion is that income inequality was the cause of the Great Recession and subsequent lackluster growth. “Redistributive tax policy” is suggested approvingly. If direct redistribution is not politically possible, then other methods should be tried, the authors say.
So what is this notorious document? It’s “Inequality, the Great Recession, and Slow Recovery,” by Barry Z. Cynamon and Steven M. Fazzari. One could ask whether this is not just another bad economic paper among many. If so, why should we waste our time on it? And this week we’re actually not going to lay the paper out on the slab and dissect it; we’re just going to prepare for the post-mortem by getting up to speed on the issues it tries to address.
The problem is that the subject of income inequality has now permeated the national dialogue not just in the United States but throughout the entire developed world. It will shape the coming political contests in the United States. How we describe income inequality and determine its proximate causes will define the boundaries of future economic and social policy. In discussing the multiple problems with the paper, we have the opportunity to think about how we should actually address income inequality. And hopefully we’ll steer away from simplistic answers that conveniently mesh with our political biases.
I am pretty certain that by the end of the series I will have been able to offend nearly every reader, and some of you multiply. That’s OK – it means we’re thinking outside our boxes. I will admit to having been forced, of late, to change some of my more reflexively conservative positions with regard to the structural causes of income distribution trends and, even more importantly, the distribution of opportunity. It is the latter concept that should command our particular attention, and a fair distribution of opportunity should appeal to both libertarians (I more or less think of myself as one) and progressives.
The unfair distribution of opportunity is not an injustice that can be redressed simply by composing erudite paeans to free markets or social justice, even though politicians will try. The problem is far more complex than that. Are we in fact, as Larry Summers suggests, on the road to a Downton Abbey economy – or, even worse, a Blade Runner-like dystopia?
I should note that Professor Summers’ op-ed is a not entirely uneven discussion of the problem. “Given the widespread frustration with stagnant incomes, and an increasing body of evidence suggesting that the worst-off have few opportunities to improve their lot, demands for action are hardly unreasonable. The challenge is knowing what to do.” We will address Summers’ conclusions later in this series, but for now let’s think about how to approach the challenge of income inequality.
A quick search for the word inequality in Google Trends reveals that the general public is starting to take a lot more interest in the concept. Monthly searches for the word inequalityhave more than doubled in the past year or so. (Odd trivia fact: Indiana is the state with the highest search interest in inequality, ahead of college liberal Massachusetts.)
Of the underlying or related searches, income inequality is the most frequently searched term. It spiked to all-time highs after President Obama’s State of the Union address in January.
We have to take this data with a grain of salt, but it clearly shows that inequality is becoming a more popular search term. And if it is becoming a more popular search, that is clearly because people are thinking and talking about it a lot more. And if people are thinking and talking about the subject of income inequality a lot more, then my readers, who are by and large thought leaders in their respective worlds, have a serious responsbility to inform that discussion.
The fact that incomes of various segments of our society are diverging is not really disputable. There are many ways to sort for the reasons for income differentials, but one of the ways is by education level, where the income differences have become rather stark over the last 40 years. Note in the chart below that incomes for all segments of the population generally rose in tandem up until the beginning of the Information Age in the early ’70s, and then the disparity began to grow. Those with more education saw their incomes increase while those with less education saw their incomes fall.
As Summers noted, a rising share of GDP is going to profits as opposed to wages. This is a trend that started at the beginning of the last decade.
One other odd bit of information that I came across while researching this topic is that between 1979 and 2002 the frequency of long work hours (more than 50 hours a week) increased by 14.4 percent among the top quintile of wage earners but fell by 6.7 percent for the lowest quintile. And those extra hours translate into extra income. (You can see the NBER study here.) I don’t know about you, but my hours have significantly increased since 2002. Not sure that is relevant, but just saying.
Let’s take a somewhat philosophical and less databased approach to income inequality. Mainstream economists and policy makers are still thinking of inequality through the lens of 19th and early 20th century experience, when robber barons like Carnegie, Rockefeller, and Vanderbilt supposedly lined their pockets by withholding reasonable wages from the working poor.
This is precisely what Larry Summers was getting at in this week’s Financial Times op-ed:
The share of income going to the top 1 percent of earners has increased sharply. A rising share of output is going to profits. Real wages are stagnant. Family incomes have not risen as fast as productivity. The cumulative effect of all these developments is that the US may well be on the way to becoming a Downton Abbey economy.
That thinking assumes that if income inequality is rising, the top 1% is getting richer at theexpense of the working class, because it assumes production still heavily exploits the relatively unskilled labor that most Americans can provide through hard work. It does not discriminate between value-added labor and value-added information and innovation.
As I argued three weeks ago, the gains from the Information Age have been unevenly distributed throughout the economy. This is a structural problem in the sense that the productivity gains from the first two Industrial Revolutions are essentially thoroughly distributed through the economy. All workers saw their incomes increase along with increasing productivity for the 200 years of the Industrial Revolutions. Yes, entrepreneurs, innovators, and knowledge workers saw their incomes rise faster, but a rising tide of productivity lifted all boats.
The same phenomenon is playing out now in developing markets, where much of the basic infrastructure of industrial revolution is still being built. I would expect that the same income inequality issues would develop in those markets in conjunction with the full rollout of industrial revolution and the shift to a knowledge-based economy.
Another observation that I did not make three weeks ago but have subsequently come to embrace is that knowledge workers have indeed seen their incomes increase because of their ability to put their knowledge to work more productively. Goods-producing workers have by and large not seen much rising productivity in the last 30 years due solely to their work and thus have not seen an increase in their incomes. To the extent that workers have skills, their incomes rise.
(Please. I get that it is more complicated than this. Increased foreign competition for lower-skilled jobs and the bursting of two major bubbles have also put a dent in US incomes.)
That being said, the top 1% is getting richer either by (1) allocating capital to the right places (which all right-thinking people want to see happen), or (2) by employing skills that most of the American work force does not have – because production increasingly depends on the hard work of creative workers with hard-earned skills gained through education and experience.
Today, a much smaller percentage of our labor force is responsible for a much greater percentage of economic output. Their wages are rising because their productivity is rising.
The trouble with conventional wisdom about income inequality is that it is so fails to factor in productivity and the sources of productivity.
While populist politicians, mainstream economists, and envious market watchers would like to brand billionaire inventors like Tesla CEO and PayPal Founder Elon Musk, Facebook CEO Mark Zuckerberg, or eBay cofounder Pierre Omidyar as modern-day robber barons,they haven’t really robbed anyone. The emerging class of billionaires is creating value that did not exist before they arrived, and they’re doing it with relatively small teams of highly skilled knowledge workers. And they deserve every penny they earn.
On the flip side, a growing majority of our labor force is responsible for a much smallerpercentage of economic output. Their wages are stagnant because more people are competing for a shrinking number of jobs.