Krugman: Gilded Age II, Here We Come

Greg Mankiw asks Paul Krugman to explain his comments in his recent column. He does so in an email:

OK, ... here's some explanation.

First, the question of which dates to look at depends on the question you're trying to answer. If you're asking why the public doesn't feel good about the economic growth since 2003 - which was, after all, what my "Left Behind" column was about - pointing out that inequality fell between 2000 and 2003 is irrelevant; everyone felt lousy about the economy during those years. The point is to explain why most people don't feel better about performance since 2003 - and rising inequality since then is the explanation.

Second, the data aren't encouraging about the long-term trend. The slump in top income shares after 2000 gave us reason to hope that the extreme income concentration at the end of the 90s was an artifact of the bubble, and would not return. But 2004 data already show a return almost to 2000 levels of inequality, and other indicators suggest that the trend has continued since then. Gilded Age II, here we come.

Third, both Greg and Eddie Lazear have asserted not just that rising inequality is partly due to an increased skill premium, which is true, but that it's mainly due to skill, which is false. I don't see why this distinction is so hard to understand. The median income of college grads is up since 1980, but only modestly, around 1 percent per year; the big gains are for people at the 99th percentile and beyond.

Update: Brad DeLong adds:

Incomplete and Partial Thoughts on Greg Mankiw's Updated "Lazear vs Krugman": Greg Mankiw quotes my claim that the Piketty-Saez data are hard to interpret as the result of a general rise in the economy's skill and education premium driven by skill-favoring technological change:

Greg Mankiw's Blog: Lazear vs Krugman: Update 2: Brad DeLong tries to explain what Paul might have been thinking:

DeLong: The big rise in inequality in the U.S. since 1980 has been overwhelmingly concentrated among the top 1% of income earners.... It's hard to attribute this pattern to a rise in the premium salary earned by the well-educated by virtue of the skills their formal education taught them. Such a rise in the education premium would produce a much smoother rise in relative incomes among the whole top tenth of the income distribution...

And he comments:

I am not convinced that the conclusion follows from the facts presented. I would guess that the top 1 percent of income earners (those [household tax units] earning more than $276,945) are disproportionately very well educated--doctors, lawyers, MBAs, etc. So the rise in the income of the top 1 percent could well represent in large part a higher education premium.

What might well be true is that the returns to education have become increasingly non-linear: The most educated are now getting a bigger return from a marginal year of education than those with moderate amounts of education. In other word, two years getting an MBA from Harvard Business School may increase a person's income more in percentage terms than does two years getting an Associate Degree from Mass Bay Community College. My understanding from my labor economist friends is that some evidence favors this hypothesis of increasing nonlinearity...

I don't think this works particularly well. Yes, if you confront a computer with a strongly nonlinear increase in inequality and ask it to explain it by increases in skills and the values of skills of those at the top, it will spit back that there is evidence of nonlinearity. But so much? The top 0.1% in the United States has gone from 2.3% of income in 1980--23 times average--to 7.6% today--76 times average. The next 0.9% has gone from 6.3 times average to 9.2 times average. And the next 4% has gone from 3.2 to 3.7 times average. Just what have been the changes in technology over the past twenty-five years that have made the skills of the 130,000 households in the top 0.1% so much more highly-valued vis-a-vis the skills of Mr. and Ms. 95th percentile? We are awarding 550,000 advanced degrees a year in this country. The overwhelming majority of them must be gaining little or nothing in relative-income terms vis-a-vis their predecessors of 1980--and those 15,000 a year or so who will someday join the top 1% have seen their relative incomes triple. Continuity: just what is it that the top 13,000 have learned that the other 537,000 have not that is so valuable?

Mankiw also comments, I think more promisingly:

To some extent, the returns to human capital are random (as is true of physical capital). Getting an MBA gives you a shot at being CEO, but it is not a guarantee. This may be part of the Lemieux finding that higher levels of education are associated with higher residual variance. And perhaps it can reconcile the differing perspectives of Krugman and Lazear...

The implicit model, I think, is that when you get an advanced degree--or perhaps when you get an advanced degree from a good school--you not only get skills, but you also get a lottery ticket. Either because of dumb luck or because of the interaction of talent with formal education and technology or because of the interaction of the willingness to work like a dog beyond all reasonable measure with formal education and technology, the lucky or talented or workaholic today can, thanks to revolutions in computer and communications technology, leverage their symbolic-analyst skills over a much larger base of routine manufacturing, marketing, and distribution workers than they could have a generation ago. In this model, we have become much more of a "winner take all" economy than we used to be. Much more income is distributed in the form of winner-take-all tournaments than used to be the case.

My first reaction is that this is possible, but unproven. My second reaction depends on whether victory in the winner-take-all tournaments is due to luck, talent, or industriousness. If it is luck or talent, the 60% of me that is a social democrat thinks that this is grossly unfair, and that we should think very seriously about powerful public policies that will level the distribution of income.

Then the 20% of me that is a libertarian breaks its chains, comes running out of the cave, hits the social democrat on the head with a brick, grabs the microphone and rants: "Do you really trust the American government to manage a major downward redistribution of wealth without doing immense harm? And who would you rather have deciding how Bill Gates's $100 billion and Warren Buffett's $40 billion will be spent--Karl Rove or Bill Gates and the staff of the Bill and Melinda Gates Foundation?"

Now let's return the libertarian to its cave. There, there, everything will be all right. See? Just inside? Catalaxy. Zero government. Private order. A free society of associated autonomous producers...

Where was I?

Oh yes, in the event that it is neither luck nor talent, but instead industriousness, things become harder to evaluate. Organizations adopt winner-take-all compensation policies because they see a benefit, and the benefit is that they get a lot more people than there are big prizes to work very hard. These non-tournament winners are probably irrational--overestimate their chances of winning the tournament--and are thus exploited by the rest of society: putting in MorganChase hours and doing MorganChase-quality work without getting MorganChase pay scales. Jim Mirrlees has argued that such a society--in which those with a high marginal product were forced to work like dogs and had a relatively low utilitarian happiness--could well be optimal on utilitarian grounds.

We should think, and think hard, about all these issues. But I don't think that it's useful to characterize this mechanism for increasing inequality as "a rise in the premium paid to the skills acquired through education." I'm not sure what to call it, but it is something very different.

Comments

[save_the_rustbelt]

I never thought I would hear myself saying this, but...

Krugman is absolutely correct.

And here in the Rustbelt, the problem is even worse.

[anne]

Mark Thoma has superbly edited and set down an argumentative series of posts on the increasing tendency to income inequality, and I am especially grateful. Oh, and what is a worry here is a worry in Africa if we can but look beyond our endlessly mirrored reflections.

[No Name]

So what do we do? Taxes dont seem to fix the underlying problem that wages (I should say earnings) are much higher for the top percentiles. Education apparently isnt going to help. It seems that the people that control the earnigns spigot (shareholders - ha ha damn those money managers) are more interested enriching the top managers, or is it that they see not in the value of other workers.

And the minimum wage doesnt help college graduates unless we say that increasing the minimum wage increaes everyones wage, which might be true of some jobs closer to the lower pay scales.

[Movie Guy]

The income inequality argument thus far is disappointing and embarrassing if the U.S. public is to have any faith in key economists.

There are other sources of income beyond wages and salaries that come into play which impact income inequality. And other types of income earners beyond CEOs and hired guns in various disciplines who skew the income inequality we are observing. Educational attainment is not the only consideration among the success of the top 10%, top 1%, and top 0.03% of income recipients. That's an absurd claim. All business hired guns aren't sitting on piles of advanced degrees.

Most troubling, on the front end of the arguments against Paul's position, is the lack of distinction between those elements of discussion focusing on wages and salaries as compared to remarks directed at total income. Sometimes the subject jump is made in the same paragraph by the authors. That offers the first element of confusion or misdirection.

Further, the lack of acknowledgement that U.S. tax policy changes and trends have direct bearing on portions of income inequality is a remarkable oversight if not an overt attempt at slight of hand misdirection.

The frequent glossing over of capital income growth and spread is also a significant error of omission.

The income inequality argument is not well organized thus far.

But Paul Krugman is correct in his observations.

And Greg ManCow (a humorous nickname I granted him) is missing parts of the income inequality picture altogether. He's just drawing a big blank.

[save_the_rustbelt]

Perhaps it is educational attainment combined with "category enrichment."

A school superintendent with an EdD. has spent about the same amount of time in school as a trial lawyer, but trial lawyers as a group have been very effective in steering economic benefits in their own direction.

An MD will likely make a great deal more money than a history professor. An accounting professor will make more money than an English professor.

An MBA from Harvard will likely make much more money than an MBA from the University of Toledo, although there will be occasional exceptions. There are only so many slots in the Fortune 500 or hot new ventures.

It is not just the quantity of the education, but the track a person is launched on. There are only so many spaces in the high dollar categories, and the high dollar guys are able to buy many more politicians than the rest of us.

The rich are getting richer.

[Tymbrimi]

Oh jeez! Are you still obsessing over this? Oh, poor me, how can I ever be happy when people are making more money than me? Get over it, get help, go for counseling! Reminds of the time it was either Krugman or Delong complaining because Barro, I think his first name was Robert, was being paid more than him. Well, Barro is a much better economist than either one of them. Duh!

Anyway, why not obsess over something worthwhile like increasing the growth in productivity, or eliminating poverty?

[Winslow R.]

Some thoughts (random)

Krugman does need to eventually show what the effects of income inequality are. Why worry?

As government distorts the market (not always a bad thing), government shares a heavy responsibility for income inequality as a truly 'free' society without government would lack any income. As STR states, the purchasing of politicians may be more correlated to inequality than education. Corruption would seem to be a positive feedback loop with little damping.

As Mexico, Brazil et. al. are examples of greatly inequal societies, what policies in these countries have allowed for inequality to flourish? Do they also have an growing educational premium that caused the inequality or is it corruption?

I still go back to Krugman's 'crowding out' argument with regards to government spending. First who's spending does government tend to 'crowd out' when there is severe inequality?

When government decides to spend, is all spending equal or which spending creates the largest optimal increase in potential GDP, is it education? Is there a point of diminishing return or is there a rising premium? If there is a rising premium, all of us including Mankiw should be heavily pushing for more educational spending. If inequality is the result of corruption, perhaps we should be taxing campaign contributions as another poster stated.

[Kevin Carson]

The skill premium and the two-tier labor force result, in large measure, from state intervention in the economy. The U.S. government has subsidized the most capital- and skill-intensive forms of production (subsidized technical education, R&D subsidies, depreciation allowances, interest deduction for corporate debt), and created deskilling technologies on a massive scale and transferred them for free or damn near to the private sector (see David Noble on digital control systems for machine tools, developed at Air Force expense and first introduced in military contractors).

[Bruce Wilder]

May I second Anne in complementing our host on superb editing? There should be a skill premium awarded here.

I would just add my standard demur against reasoning from a "marginal product" framework. One really does need a credible theory of production, to have any foundation for even the vaguest hand-waving about changes in technology. The "production function" is not such a theory; it is silly, and wrong on its face.

Tymbrimi and Winslow wonder why it matters. Why prefer egalitarianism? If you believe the technologically determined, marginal product, frame, that seems like more of a legitimate question, than if, like me, you are more of an institutionalist "risk and power" kind of guy.

[Bruce Webb]

Winslow I think is missing the point. And of course Tymbrinni's only point is on the top of his head (matching the two on the end of his ears (I guess you have to read the book)).

If the strategy of the Economic Right is to sell the message "Some of us are winners, the rest of you are losers, too bad, so sad" well good luck. The problem is that they have to find some way of winning elections which last I heard required 50% plus 1 vote (plus or minus Diebold effect).

The Reagan Revolution was not sold to the majority of Americans by promising to make the rich even richer, it was sold with the message that "a rising tide lifts all boats", that supply side tax cuts would ultimately "trickle down" to everybody. Well that rising tide in fact is not lifting those boats and that trickle down is suspiciously yellow and warm. Yet Republicans are still confident they can go to the polls and sell bigger, ever more succulent pie to the vast majority of voters who are locked outside the pie shop wistfully looking in hoping they could have more than a crumb.

The entire model of the Economic Right is structured around the notion that individuals should maximize their own gain, that is seek the biggest pie slice they can possibly cut from the pie. Yet their electoral hopes rest on everyone else ignoring pie slices in favor of overall pie.

"What is in it for me?" is not only a legitimate economic question, for the Economic Right it is THE legitimate question. Yet they like to argue that the millions who would personally benefit from say an increase in minimum wage should forgo it because of minor (and theoretical) job losses at the margin. Well screw that. Why does the slogan "Greed is good" lose all legitimacy once you get outside the boardroom door?

Why SHOULD a majority of Americans care about pie size in the absense of any meaningful slice for themselves?

[hj]

Again I ask why all these factors don't seem to affect the income distribution in numerous European nations. I would think a comparative perspective might help to sort out the reasons for the growing and extreme inequality in the USA.
What is so different about the USA? Are high skills valued highly only here?

[hj]

Here are some Gini indices to compare to the USA's 45.

Austria...31
Canada...33.1
Denmark...23.2
EU...32
France...32.7
Germany...28.3
Netherlands...30.9
Norway....25.8

Is one to gather that these nations don't reward high education?

[Bruce Webb]

And to repeat Movie Guy's point:

"The frequent glossing over of capital income growth and spread is also a significant error of omission."

That Paris Hilton's portfolio grew in 2005 is not proof that higher education is the key to income inequality, quite the opposite. Mankiw's assertion that all of these gains are flowing to doctors and lawyers would need to be corrected by an examination of how much of this is simple returns on capital, capital mind you that may or may not have been based on the enterprise of the capital holder. Is Bill Frist a multi-millionaire because he was a talented heart surgeon? Or because his father and brother run Hospital Corporation of America (HCA Inc)? Is Ted Kennedy a millionaire because he has a JD from the U of VA?

Even a correction based on correlation between higher degrees and wealth doesn't serve us well here. That millionaires' and billionaires' kids go to college and subsequently get MBAs and JDs in a lot of cases just means Dad springing for a couple extra years of college for Junior before elevating him to the executive suite.

It is one of the dirty secrets of American higher education that anyone can ultimately get any professional credential they want, simply by moving down the food chain of colleges. Doesn't mean you'll pass the Bar exam or get licensed by the State Medical Board, but you will still have that JD or MD after your name.

[save_the_rustbelt]

tymbrini:

Are you this year's summer intern with The Club for Growth?

If you belive in free markets you should be outraged at the Bush administration and the GOP Congress, both of which have prostituted themselves to big business interests, which tends ot protect them from the free market.

[Movie Guy]

hj - "Again I ask why all these factors don't seem to affect the income distribution in numerous European nations. I would think a comparative perspective might help to sort out the reasons for the growing and extreme inequality in the USA.

What is so different about the USA? Are high skills valued highly only here?"

I agree that with your point. The differences are worthy of further discussion.

A sound analysis might help provide the answer for identifying those changes needed to stem and reverse the growing income inequality in the USA. Aside from the howls of those only interested in extremist greed, others may move forward in straightening out this mess before we witness a coup d'etat in the streets.

[Movie Guy]

Bruce Webb and Bruce Wilder are internet treasures. We would be smaller thinkers without their fine contributions.

[Bruce Wilder]

excellent points from Movie Guy, Bruce Webb, hj.

I think I am following Movie Guy in bemoaning the naivete, evidenced in Brad Delong's comments:

"Oh yes, in the event that it is neither luck nor talent, but instead industriousness, things become harder to evaluate. Organizations adopt winner-take-all compensation policies because they see a benefit,"

Well, I'm sure someone sees a benefit, but in what way is analysis made sharper by adopting the impersonal, "Organization" as an abstract actor?

"My second reaction depends on whether victory in the winner-take-all tournaments is due to luck, talent, or industriousness."

I can think of a couple of ways to win a game, which don't involve luck, talent or industriousness, but simply ruthlessness and the absence of scruples. In other words, if you make the stakes very large, you are just encouaging people to cheat shamelessly.

""Do you really trust the American government to manage a major downward redistribution of wealth without doing immense harm?"

Some very rich people trusted the government to manage a major >upward< redistribution of wealth, and some of us think it did do immense harm.

[Winslow R.]

Perhaps I've missed the point as I am still developing my framework.

It seems there are three suspects for rising inequality in income:

1) Corruption - return on political connections
2) Return on education
3) Return on capital

Number 2 and 3, though perhaps imbalanced, in and of themselves do not cause an insolvable problem as they increase the size of the pie. The problem is the corruption that 'overly' concentrates the slices into the hand of a few.

It is number 1 that is capable of destroying our society. But the 'problem' has currently been solved.

How much of this growing economic pie turns out to be illusionary financial assets which can be created with zero labor? How much of the wealthy's income is going to purchase these types of ephemeral assets while 'less fortunate' citizens purchase tangible assets in exchange for the creation of newly minted financial assets? As long as both parties are agreeable, why does this have to end?

Much 'inequal' income is not being spent on consumption but is rather being 'saved'. It is not being saved in tangible assets but rather in tsy secs and the like. The 'problem' is not an issue until the bargain changes which it look like may be happening as income is funneled into commodities. It is ironic that 'inflation' is not coming from excess consumption but through excess hoarding through the various commodity indicies.

The Fed must hope saving intangible assets becomes more valuable than tangible assets before they crush the economy with increasing interest rate hikes. Something that may require the government clean up corruption in the commodity markets.

[baileyman]

The extra take for the top 1%, amounting to some 5% of total income, would seem to act like a 5% recession to the rest of the economy. Like a 5% tax where the proceeds are wasted. The loss of the 5% to the lower 99% would seem to be acutely felt.

[Movie Guy]

Winslow R.,

I'll repost the following from another thread just for you:

We're watching a white collar crime in progress every time the Congress passes another 'give more to the wealthy' tax bill.

That we haven't witnessed a "coup d'etat" among the general population over such 'extreme greed is good' tax bills demonstrates the political and economic weakness of 80 percent of the American population.

We're headed back to the 1929 income inequality scenario.

Wonder what happens this time?

Bruce Webb captured the governing class mentality driving the growing income inequality - "Some of us are winners, the rest of you are losers, too bad, so sad, well, good luck."

We have one political party saying, "What is in it for me?" (another Bruce Webb quote).

The other political party is saying, "Wait a minute, you self-centered and self-serving pigs. There are 298 million people in our nation. We have responsibilities that extend far beyond making the top 10%, top 5%, and top 0.03% five times richer. There is more at stake in creating and sustaining a great nation. Wake the hell up."

And, here we are.

[Dave Schuler]

Mark, every time you post on this subject I've asked the same question: what's the prescription?

Taxation per se would not seem to correct the problem. Education per se would not seem to correct the problem.

So what would correct the problem?

My intuition is that there need to be substantially higher incentives for domestic investment. But that's only an intuition.

What are your thoughts?

[piglet]

Mankiw: "To some extent, the returns to human capital are random (as is true of physical capital). Getting an MBA gives you a shot at being CEO, but it is not a guarantee."

Gosh! This is being presented as an argument! Put it on the head. If the income of CEOs has risen without any proportion, and most CEOs qualify as "highly educated", does that make CEO pay rises a "higher education premium"? Or does it just mean that CEOs have found a way to enrich themselves? Whatever class society you are studying, in most (not all) cases you will find that those at the top are "highly educated", according to the standards of that society. Does that mean that any measure of income inequality is justified as long as a mere correlation between education and income can be established? Capitalism must really be in bad shape if you can't find better arguments than that.

[piglet]

"The extra take for the top 1%, amounting to some 5% of total income, would seem to act like a 5% recession to the rest of the economy."

Good point, baileyman. Iow, the famous economic growth of the past years has gone to the top 1%. For the rest, the recession has simply continued.

[Winslow R.]

In general I agree with your post, corruption extends into our political system but in the end what is being corrupted is our unit of account.

I am able to purchase almost anything I desire through borrowing (not that I have). My kids are not denied health care, food, shelter, or private schools, etc. as long as I am willing to borrow. Access to financial assets has increased access to nonfinancial assets. Perhaps I live in a 'gilded cage' as Mankiw but I see American access to wealth has increased not decreased over the last 30 years even if it is 'borrowed'.

The 'corruption' that brings down the system of 'borrow now, pay later' may reside in commodity markets. The commodity markets may reflect the need for a safe haven from the effects of political corruption induced inflation more than a corruption of the market itself. I am calling 'corruption' the breaking of 'the bargain' that has allowed the lower 80% to still prosper while inequality in income has increased.

From: PAUL MUOIO, CITIGROUP GLOBAL MAR At: 3/30 7:32

I will take nat gas to task. The chart shows
US nat gas storage and it will end the winter in the next few weeks
with
more gas than any time in the past 10+ years. Even a lousy injection
season would give the US 3.4trillion bcf, or capacity, at the start of
the next winter. A normal injection season will require that gas bid
for storage in the marketplace ie be sold at Nymex. The only thing
holding up natgas is crude and index flows. Draw today is seen -79 to
-85.

COMMODITIES AS ASSET CLASS A CONTRIBUTING
FACTOR BEHIND ENERGY PRICE VOLATILITY
Over $605 billion dollars were added to commodity derivatives during the first
9 months of 2005, which is almost 13-times the total value of the US Strategic
Petroleum Reserve based on today s WTI crude price. This inflow of assets
has raised major questions about whether the upward movement in energy
prices has been purely a function of changes in underlying fundamentals. We
have noticed, for instance, that crude futures rallied on the 1st business day of
the month more than 70% of the time over the past two years (by an average
of $1.33/barrel), a pattern which suggest some sort of ratable fund flow from
investors

[Mark Thoma]

This isn't going to be very well thought out - kind of rushed - but I'll throw some thoughts down as they come to me. You all will set me straight anyway...

What should we do about globalization and growing inequality? Making a comparison to the medical profession, it may be that while we can diagnose some conditions clearly, we have no effective cure for them (though there are economists hard at work daily hoping to change that, just as medical researchers are trying to find cures for their set of ills), it requires waiting for the system to "heal" itself over time.

Economists can suggest healthy diets (e.g. monetary and fiscal policy), but that is no guarantee that the economy will not get sick anyway and when it does, we don't always have the cure at hand, though I do think we have, for the most parts, prescriptions to help the economy heal faster. But people want instant cures, a pill to take that makes it better now, not a long difficult road to recovery.

Education, worker retraining, those sorts of things aren't cures, they simply (hopefully) speed the healing process along, and sometimes that can be a much longer process than any of us like.

I know a lot of you like to beat us up because we don't have the answer, and it's useful to motivate us to look all that much harder, but I'm not any more embarrassed for our profession because of it than doctors are who can't cure the common cold. And (this will make some of you mad) they, like us, have to listen to a lot of folk remedies that supposedly work, be told they are idiots, etc. And though every once in awhile the folk remedy is valid, generally the suggestions come from people who really don't understand all facets of the problem. You can't argue with them, they really believe their folk remedies work, so it's best to listen to them attentively, smile and nod, and not engage.

But that's pessimistic. My economics tells me that there will be winners and losers from things like free trade and that the winners will have enough to compensate the losers and still be better off themselves. So my solution would recognize this reality and, along with all the things we need to do to help the economy heal, it would also redistribute income in a way that produces far more winners and far fewer losers. But I don't think we have the political will to do that yet, the understanding that everyone will still be better off, though the the GOP's change of heart to allow consideration of a vote on the minimum wage is one sign that this is being recognized.

Policies can protect people from losing jobs, but I think that's a recipe for stagnation in the long-run; policy can help people get new jobs faster, that's where education, retraining, etc. come in, but that hasn't worked as well as we would like (but that's not an excuse to stop trying and my solution involves these things even though so many of you object to such policies); policy can raise income for lower income groups, that's where minimum wage, negative income taxes, redistribution policy, etc. come in. These help ease the transition by transferring income and hence make it easier to accept politically, but it's not clear they make the transition occur any faster.

Finally, we can hope the electoral process results in a change in the use of political power to bring about transfers of income toward higher levels. We have enough trouble dealing with the economics driving such changes, we don't need legislation that makes it even worse.

I think part of the silence is that economists have no instant cure for problems that occur with globalization. We think it's necessary for our long-run health, and we can recommend policies that aid the recovery process, but perhaps our silence is because we've been waiting for some economist working hard to have a "Eureka" moment and announce to all of us a cure is at hand. Until that happens, we will be stuck with less satisfying rehabilitative solutions.

[Movie Guy]

Dave Schuler - "My intuition is that there need to be substantially higher incentives for domestic investment."

What types of domestic investment? Business, other, or a combination?

What types of incentives and for what purpose?

If you're primarily discussing business investments, then we have a few problems.

There isn't an apparent shortage of domestic business investment money flows, though the Fed Reserve would like to see the more growth in this area. As importantly, by the Fed Reserve's own continuing admission, its leadership still doesn't understand advanced global trade outcomes. This, in turn, raises questions as to why the Fed Reserve doesn't understand how GDP growth is not aligned with domestic business investment levels.

It appears that the Fed Reserve still doesn't understand the effects of offshoring and other trade globalization actions as related to U.S. GDP, including global investment trends. Some of the answers should be obvious, as they are clear to corporate interests and business owners. The Fed needs to catch up.

Remarks by Governor Donald L. Kohn
Federal Reserve Board
At the Forecasters Club of New York Luncheon, New York, New York
April 27, 2006
Business Capital Spending

"Business fixed investment has risen at a robust annual rate of nearly 9 percent on average over the past two years, and the real level of investment at the end of last year, $1.3 trillion, was nearly 6 percent higher than the peak reached five years earlier. However, real gross domestic product (GDP) expanded nearly 14 percent over the same period. To be sure, the investment peak in 2000 was unusually high; still, the nominal share of business fixed investment in GDP, at 10-3/4 percent at the end of 2005, was well below its forty-year average."

"Business financial statements also reflect evidence of restrained business spending behavior. Normally, businesses are heavy net users of savings generated by the rest of the economy. The financing gap--the level of capital spending over the level of internal funds--is a measure of that reliance. But it was close to zero in 2002 and 2003 and remained unusually low last year (after adjustment for tax-induced flows of repatriated foreign earnings), which suggests that businesses didn't see enough profitable investment projects to warrant tapping the markets for external financing, even at low long-term interest rates. To be sure, profit margins and cash flow have been high, but that would also seem to be an environment that should encourage expansion. In fact, businesses appear to be using some of their very large holdings of cash for other purposes. Corporations have increased their share repurchases, which hit a record level last year. They have also increased share retirements through cash-financed mergers and acquisitions, which have been boosted by a surge in buyouts. Evidently, corporate managers view prospective returns from these uses of cash flow as comparing favorably with those from new capital spending projects."

The Effects of Globalization on Inflation and Their Implications for Monetary Policy
Remarks by Governor Donald L. Kohn
At the Federal Reserve Bank of Boston's 51st Economic Conference, Chatham, Massachusetts
June 16, 2006

"One challenge in assessing the effect of increased globalization is the lack of research on this issue. At a research conference on modeling inflation held at the Federal Reserve Board last fall, none of the papers even touched on issues related to globalization. And, although some new and interesting research is emerging from places like the International Monetary Fund and the Bank for International Settlements, much of this work is still quite preliminary."

[piglet]

"I think part of the silence is that economists have no instant cure for problems that occur with globalization. We think it's necessary for our long-run health, and we can recommend policies that aid the recovery process, but we've been waiting for some economist working hard to have a "Eureka" moment and announce to all of us a cure is at hand."

I appreciate your thinking hard about solutions, but frankly, I'm not hoping for some economist crying Eureka! Haven't economists been crying "Eureka" and announcing their cure-all solutions for decades? "Washington consensus", "Free Trade", "Liberalization"? Am I the only one to remember our bright economists "curing" Chile in the 1970s, later "curing" the Soviet Union from 1990? You remember that 50% slump in the Russian economy, the dramatic increase in poverty rates and dramatic decrease in life expectancy? That was called "shock therapy", prescribed by our brightest economists, is there nobody out there to remember that?? You remember the Argentinian and other crises, suffered by countries who had taken literally the snake-oil economic advice of the "Eureka" gang? And closer to home, what about those economists cring "Eureka" to the tune of the Bush tax cuts, explaining away budget deficits after having spent decades warning of the debt burden incurred by progressive redistributive policy?

What I'm hoping for from the economist community is not a cure announcement but the acknowledgment that economists themselves are part of the problem.

[Live Wire]

Economists won't have the answers because the answers are to be found in our national psychology, specifically the ability or inability of the wealthy to identify with the other 95% of Americans.

hj asked in this thread or another why Europe was different. It's different because European elites can still taste the effects of the mass hysteria that gripped the continent during the 20th Century. European elites know what happens when the masses are radicalized and set upon by forces far beyond their control. People turn violent, nationalistic and racist. American elites have no direct knowledge of such behavior. Republicans think they're being clever for pursuing their various election strategies. They line the pockets of the rich even while abusing the very working class and religious who brought them to power. But those Republican pundits have no idea how easily that fire can burn them.

The answer to income inequality is fear. Once the upper 5% really and truly fear the rest of us the path will be miraculously cleared for every sort of economic change imaginable. Minimum wage, universal health care, educational opportunities, you name it... the wealthy will be falling over themselves to help out their fellow man... once they fear him.

[Mark Thoma]

Sticking with the analogy, I fully understand that it undermines the faith in the medical profession when they issue studies reversing advice they once gave. There was a time doctors recommended that people smoke.

That may stop me from following the fad of the day, but it won't stop me from going to the doctor, or from following time tested, proven advice. And there are lots of places to point if you want to find successful implementations of economic policy at both the micro and macro levels, i.e. such time tested advice does in fact exist. But we surely can't claim a 100% success rate for every problem we've recommended.

[Movie Guy]

Good points, Mark. Including the darts I am pulling from my chest (ha).

Seriously, though, embarking on an economic path that really reduces standards of living for the lower 60 to 80 percent of American citizens isn't the best economic policy for the nation.

While advanced global trade will enormously benefit developing countries, it wasn't necessary to lower the flood gates that far. There were other ways to improve the economies of the developing nations without creating rules and conditions that create larger income inequality in developed nations.

Whenever a nation engages in trade practices that are built around the concept of improving standards of living of its citizens (as required by law), and the outcome is that the upper income earners run away with the vast majority of the rewards and prizes of such exercise, then it's time to sit down and reevaluate the practices in play.

We're not improving standards of living for the majority of American citizens with our revised trade practices. That doesn't appear to be one of the goals of advanced global trade.

[Dave Schuler]

Movie guy, as best as I can tell the article you've cited doesn't address whether American companies are investing overseas or domestically. My intuition (when I say “intuition” I mean that I don't have hard figures to back it up nor any particular desire to round any up ;-) ) is that American companies are doing a lot of overseas investment, particularly companies in the technology sector.

Mark, my reservation about the efficacy of education is that when you subsidize a specific sector massively and then limit entry education ain't going to do much.

[Movie Guy]

Dave,

My reference wasn't an article. It was a speech by the Vice Chair of the Federal Reserve.

Second, Don Kohn is acknowledging that U.S. businesses are generally flush with cash. And he (the Fed) doesn't understand why investment isn't higher than its existing levels. If there is a shortfall in domestic investment needs (and I question that point), the corporations have the means to fulfill those investments. So, U.S. business investments in domestic operations aren't being held up due to a lack of available cash or cheap loans. That's not the problem unless there is pressure to change the operating environment prior to commitment of new investments.

The Fed doesn't understand the effects of advanced global trade with the possible exception of Richard Fisher, Dallas Fed.

Moreover, GDP growth suggests that the U.S. is in good shape. That's questionable if considering the GDP losses suffered due to offshoring. Dr. Peter Morici puts those losses at $1 trillion or more per year.

What are your investment goals and incentives, by the way?

[anne]

"There was a time doctors recommended that people smoke."

When I was in high school, I decame interested in statistics and decided to learn theoretical statistics on my own. I found several library works on statistics, that were both old and repeatedly revised, and the works turned out to be classics by an American and British developer of theory in the field. Nice stuff, indeed. The pioneer work in data collection and analysis was in smoking related illnesses and deaths. Anyone, especially any doctor, who wished to notice should have noticed how destructive smoking was in the 1920s and 1930s. Now, why do you suppose so many doctors and others did not notice?

[anne]

Similarly sticking with the metaphor of noticing and not noticing, Benjamin Friedman has noticed the social or political effects of movements to and away from income equality. While the effects are there to be noticed, I am wondering why seemingly few are noticing :)

[slink/js paine]

insider slice offs of profit are a much more straight forward explanation
cultural change in ceo circles from ike to ronnie seem a better trail to sniff down
if less gyrop gearloose fetching
as
"The implicit model... thanks to revolutions in computer and communications technology,
leverage their symbolic-analyst skills
over a much larger base of routine manufacturing, marketing, and distribution workers
than they could have a generation ago..."

though none can fault this kicker:

" we have become much more of a "winner take all" economy than we used to be"

" Much more income is distributed
in the form of winner-take-all tournaments
than used to be the case"

but its profit grab opportunity by insiders
at the top of the greasy pole
not ...skilled symbol clasher
lottery winners

f the rentiers !!!!!!!

[Winslow R.]

"Anyone, especially any doctor, who wished to notice should have noticed how destructive smoking was in the 1920s and 1930s. Now, why do you suppose so many doctors and others did not notice?"

As Anne hints many economists are on 'the take',
perhaps it is possible to extend the analogy further.

What ended a disinformation campaign aimed at creating a profitable trade in the death and illness of millions of American smokers but trial lawyers? Will we end up suing our way to economic justice? Just as the threat of lawsuits is preempetively removing trans fats from french fries perhaps a few lawsuits against oil companies regarding global warming are needed. Maybe a few worker lawsuits against various trade agreements could bring about improved income equality. What jury would deny such a suit in Ohio or Detroit? I am no lawyer:)

[slink/js paine]

"My economics tells me that there will be winners and losers from things like free trade and that the winners will have enough to compensate the losers and still be better off themselves"

not so mark as you well know

thats a hope maybe even a sensible hope
but no certainty

vide locus classicus
paul the samuel - son paper (circa 1972)

not to mention that
re- distribution from winners to losers
has a very very poor history
of sufficient enactment

a classic case of airy wouldn't it be swell promises
are not contracts

thus
not contract violations thus not enforced

the case would need
to come under the statute of frauds anyway

since it would be without " consideration"

ie "what did the loser do to earn the comp "

hence
it can only be pursued
as a fraud
ie
inducing harmful aquiesence
by the loser(jobsters)
in a policy( free trade)
with knowingly false promises
(we'll make you whole if your job goes under)

but class action suits
with vaguely hooked in defendants
get no where

contingency lawyers
taking one of these on spec
has to figure
they can't get
a fair hearing

"unprecedented"

[anne]

Winslow, has interestingly lighted a course of redress I would otherwise have forgotten. Eskimos or the Inuit are trying to change the nature of the debate on recourses to global warming. After all, the effects of global warming are magnified closer to the poles, and especiaaly so close to the north pole. So, the Inuit have planned for and are filing civil rights suits to ask redress as they argue existence of the Inuit is at risk.

[slink/js paine]

piglet

not all economists
are trans nat hacks
paving the road to the grim reeper
with glowing algebraic contentions

just most of em are

but as an example

mark here
is not now nor ever has he ever been
part of that elite party
of at the markets margin guyz

panglossians for private profit max

[anne]

Winslow:

"Will we end up suing our way to economic justice?"

Interesting; I must ask my sister. At the least, the question suggests just how important true balances are in our government structure and the danger of loss of such balances.

[slink/js paine]

lest my profit grab line sound too folk remedy like

lets call it a agency problem gone wild

legal or quasi legal
Expropriation of the stockholders profits

ie .
a transfer of another's property to oneself
by the inner corporate clique
and their colluding outside confederates

among other manifestations of degenration and lust for the main chance
its why good rentier folks
( sporting their ever so feeble remedies)
scream about
a public corporation
"gubnitz" problem

am I right here gang ???

or just left ???

[Mark Thoma]

always appreciate slink's (and his new name's) comments.

"the winners will have enough to compensate the losers"

I probably should have said "generally," the standard cop-out.

[Winslow R.]

As slink was posting I was thinking about this quote as well...

"But that's pessimistic. My economics tells me that there will be winners and losers from things like free trade and that the winners will have enough to compensate the losers and still be better off themselves. "

Say there are two economies one economy which includes a subsistance farmer and the other economy which includes a factory owner and a worker.

The factory owner currently pays the worker $50 to produce a widget which he sells for $100 but not decides to offshore his production to the subsistance farmer for $30. Yes the factory owner has gained by saving $20 on production costs but is it enough to compensate his newly unemployed worker through a government redistribution program and still have an overall gain? How is it possible to replace the $50 that the former worker made?

The miracle of financial wealth creation is our current answer. Government created wealth through deficit spending creates any displacement benefits. Only if the subsistance farmer or factory owner leverage their profit through the miracle of financial wealth creation and the proceedes to purchase some product from the former worker does everyone come out ahead without government intervention.

[piglet]

"There were other ways to improve the economies of the developing nations without creating rules and conditions that create larger income inequality in developed nations."

This would almost be true, except that the economies of those developing nations were in many cases not improved at all by following the advice of mainstream economists.

[piglet]

"Sticking with the analogy, I fully understand that it undermines the faith in the medical profession when they issue studies reversing advice they once gave. There was a time doctors recommended that people smoke."

My understanding is that many mainstream economic "doctors" still recommend smoking, plus having three Big Mac and large Coke a day, plus driving SUVs and avoiding physical exercise. Some economic doctors are saying that the cholesterol level is the key to a healthy life and should at any cost be controlled, if necessary by administering drugs that may cause cancer, while blood pressure and other parameters are irrelevant. Some are saying that physical health is not connected with mental well-being while others recommend taking on as much weight as possible.

A few economic doctors have started questioning some of their colleagues' advice. They claim it hasn't been proven that smoking really reduces the risk of heart disease, and one dissident recently called on his colleagues to wash their hands before doing surgery (of course, he was laughed out of the room). Some economic doctors are now promoting what they call a "healthy life style", but most of their colleagues are upset by what they see as irresponsible propaganda undermining the public's trust in the profession. To be sure, this is yet only a marginal phenomenon, but who knows how the econo-medical profession will change over the next hundred years or so?

[Mark Thoma]

Are you saying we shouldn't try to get better, shouldn't give the best advice we have at the time? Just stop trying, do nothing? Even though doctors advice is far from perfect, and has been flat wrong at times, overall people are healthier.

Rant away, I don't mind, because I think the same is true of the economy. For all our faults, our net contribution is clearly positive.

[Mark Thoma]

One more comment. We are specialists (though bloggers need to be generalists too which can be a tough requirement at times).

If you ask me what monetary policy should be after a supply or demand shock, you will probably begin looking at your watch before I am done talking. But when it comes to international trade or intergenerational wealth transfers, I simply do not have the depth of knowledge to call myself a specialist in the area. I don't mean I don't know a whole lot about it down to some of the finer points, I hope I do, but I would never have the same degree of knowledge as someone who specializes in these areas.

So sometimes my hesitation is one of professional courtesy (if that's the right term), I should defer to those who know the area best and evaluate their policy prescriptions (not accept them on faith, but let them set the table). You don't go to an dermatologist when you have a brain tumor or heart disease, and you don't usually ask a heart surgeon to diagnose and prescribe solutions to skin ailments (though chances are they would recognize the vast majority of such diseases).

So sometimes, out of necessity, we wait for others to address the problems, see what the specialists think should be done, and go from there. What I try to do is learn enough about these issues as they come up to talk intelligently about them and, if it's outside my areas and I don't know, present what specialists are saying, specialists I've come to trust.

[Dave Schuler]

What are your investment goals and incentives, by the way?

My personal ones? So small as to be irrelevant. If you're asking whether I have a vested interest in some particular outcome, the answer is no.

If you're asking what I have in mind, I don't have a fleshed out idea—I'm grasping at straws.

As I mentioned in an earlier comment thread on this subject, I can see clearly how to reduce income inequality by reducing the income of the highest earners but I don't think that's as desireable an objective as increasing the real income of average people.

The beneficial secondary effects of that latter goal are many and from my point of view highly desireable. My ideal picture of America's future is quite Jeffersonian.

[Jeffrey Miller]

Mankiw hazards a guess for why the distribution of income is becoming more skewed: that the returns to education are becoming more non-linear (more convex). Krugman doesn't address this. Is there any evidence for such an effect?

[Mark Thoma]

He said something along the lines of friends in the Department had told him there was some evidence of this. But he didn't say who or mention papers.

[piglet]

"Are you saying we shouldn't try to get better, shouldn't give the best advice we have at the time?"

Sigh. I really don't know how I can make myself any clearer. But I find consolation in slink's poetry (Jul 17, 2006 2:13:49 PM) ;-)

"For all our faults, our net contribution is clearly positive." If I asked you about scientific evidence for this claim, do you think you'd be able to provide it? I am curious how you'd measure the "net contribution" of Paul Krugman and Greg Mankiw ;-)

[camperman]

camperman's quick summary:

Problem: see anne says...
Solution: see Live Wire says...

all the rest is just hot air (highly entertaining hot air mind)

[skeptonomist]

I think it is long past time to evaluate the effects of the power of corporate executives. This has a bearing on several current problems, notably income inequality and globalization.

The moral and societal role of corporations is not set out in Adam Smith (he disapproved of corporations), the Constitution, or the Bible. Shouldn't capitalist society try to take a rational approach to how this power must be limited?

[Michael Bishop]

Thoma Rocks!
This summary post is fantastic!