Policy and Income Inequality

Dean Baker weighs in on the dispute over the sources of income inequality  (original Krugman article, follow up email, DeLong summary, Mankiw response) :

Income Inequality: Missing Mechanisms, by Dean Baker: There has been a raging blog debate, following in the wake of some recent Paul Krugman columns, as to whether the rise in income inequality is due to policy or the natural workings of the economy. While Krugman indicated that he believed the policy view (promising details later), many of the economists weighing in have said that they don't see any policy mechanism(s) that could explain the rise in inequality.

Perhaps I have different eyes (or maybe I don't have sufficient training in economics), but I see the mechanisms almost everywhere. There is a nice example in the news today. A judge ruled that Northwest's flight attendants can't go on strike to oppose the wage cuts that the airline is unilaterally imposing following in the wake of its bankruptcy.

In other words, a U.S. judge is telling workers that they will go to jail if they refuse to work for the wages that Northwest wants to pay them. (I know, I'm skipping some steps here.) Judges don't have to threaten workers with jail for refusing to agree to employers' demands. This is a policy decision.

For those who find the labor-management framework difficult to understand, imagine that Northwest purchased flight attendant services from the Flight Attendant Services Corporation (FASC), which is a corporation wholly owned by the workers it employs. Suppose that FASC tells Northwest that it will not provide services for the lower fee it is now offering. Would any judge threaten FASC with jail if it didn't agree to offer its services on Northwest's terms?

There are many other examples of rulings that have gone against labor in the last quarter century. For practical purposes, it is now legal to fire workers for organizing a union (the penalties are a joke). This is not the whole policy story; I have much more in my book, The Conservative Nanny State. It's short and free (and the summary is even shorter), so you have no excuse not to read it, unless you want to remain as ignorant as an NPR reporter your whole life.

Update: If "My sense" is a valid econometric estimator, then Brad DeLong believes 40% (one fifth plus two tenths) of income inequality is attributable to changes in policy and power relationships:

I agree with Dean: this is a bad decision. ... This is a judge who is not doing his job properly. But in a big country this is a (relatively) little decision. My sense (and it is just a guess) is that declining unionization and union power might account for perhaps a fifth of the widening in income inequality; that reductions in the value of the minimum wage might account for a tenth; and that legal changes that have shifted the balance of power within the corporation toward CEOs might account for another tenth. I have a hard time finding other policy changes that have a big impact--and only a portion of declining unionization and union power is due to changes in government policy since the 1970s.

Brad says "it is just a guess," so, with "My sense" plus or minus two wetware standard errors, my sense is that this could account well over half of the variation in income inequality.

Update: An email talks about the econometric evidence that does exist:

I'd add that estimates based on the union-nonunion wage differential, or on the time series effects of local changes in union density, aren't reliable ways of inferring the effects of a change from an economy in which unions are marginal to one in which they're dominant and back again.

Comments

[Bruce Wilder]

"Perhaps I have different eyes (or maybe I don't have sufficient training in economics), but I see the mechanisms almost everywhere."

That was exactly my reaction.

[save the rustbelt]

With both Rubinonomics and Bushonomics crony capitalism has risen to its peak, in my life time at least (Rubin/Clinton threw a few more crumbs toward working people).

Take a look at the sweetheart deal Frank Quatrone (sp?) got from the Justice Department, after Martha Stewart went to prison for essentially nothing.

Then there is the sweet heart deal Wal-MArt had with the Department of Labor.

And Halliburton, well..............

etc., etc., etc....

[Yuan]

I have been following the debate. It seems one can find examples to show that the rise in inequality is due to highly educated, and cases to support that the rising inequality is due to policy mechanism.

[realpc]

"a U.S. judge is telling workers that they will go to jail if they refuse to work for the wages that Northwest wants to pay them."

That can't be true. He can't prevent them from quitting.

Maybe the judge thought a strike would cause the already bankrupt airline to go out of business. Maybe the flight attendants were better off having their pay cut than losing their jobs and destroying the airline.

Now I would feel differently if it turned out high level management were not also having their pay cut. But the article doesn't say.

It does not help workers when their employer goes out of business. This should be too obvious to mention, but it doesn't seem to occur to Baker.

[sebastianguy99]

The issue isn't whether or not a judge can keep workers from quitting. The issue is that the judge's ruling is an open and notorious example of how inequality flows from policy.

The ruling took away the very leverage the workers had at their disposal in order to effect a change in pay and benefits.

The ruling fixes the games to the benefit of one party, in this case as well as too many others, the benefit accrues to the party that already has suffered the adverse effects of inequality.

[alex]

On this issue, Paul Krugman is correct. The New Gilded Age has been in the making for about 30 years, since the late 60's, early 70's. However, it has only been since the 80's, with the election of Ronald Reagan, that inequality has been increasing steadily, if not rapidly. So one has to inquire as to what policies, trends in the economy helped increase inequality in the 80's? Here are two components that I believe were important;

1) Falling tax rates. The top marginal tax rate on income fell from 70% in 1980 to 28% in 1987. The tax rate on capital gains fell from 35% to 20% in 1980 (although it was raised to 28% in 1987) The top estate tax rate fell from 77% to 55% during the 80's. And the top corporate tax rate fell from 45% to 35% or so. These tax cuts definitely allowed those at the top to keep more of their income. And since they could keep more of their income, the constraint on their income due to high tax rates fell as well. Although one cannot estimate how much of an impact this had, it definitely increased inequality.

2) De-regulation/the new American System. During the 80's, the Federal government allowed corporate mergers to procede at a great pace, and the federal government covered corporate America's ass, especially when the S&L crisis cost two to three hundred billion dollars of tax payer money to clean up. During the first gilded age in the 19th century, the federal government set up teriffs to imports and maintained the gold standard and deflationary policies. From the 80's on, the government has supported free trade for corporations, oligopolies, de-unionization (allowing union supporters to be illegally fired), Federal Reserve Policy that reigns in inflation at the expense of labor (i.e 80% of America at least), a falling minimum wage, and a drastic cut back in the welfare state.

These two major trends have continued since the 80's to the present.

Also check out Emmanuel Saez's site and look at Japanese inequality. Japan had great economic growth from the 50's to the 80's, but inequality decreased drastically, all because of government policies redistributing land, breaking up business cartels, enforcing life long employment at a firm, unionzing the workforce, high income and inheritance taxes, a strong pension system, and other government reforms. Since the 90's, inequality has increased in Japan. And of course it is just coincidence that,with the top tax rate haven fallen from 75% to 37% in the past ten years, capital gains taxes have fallen in half from 20% to 10%, the government has turned a blind eye to union busting, cut inheritance taxes, corporate taxes, par down the Japanese welfare state and begun privatizing services, inequality has increased along with these enlightened government policies.

Look at South Korea, China, Canada, Australia, Britain and Germany. In each of these countries, inequality has just happened to increase as these countries have cut corporate and income taxes and/or raised VAT's, cut back welfare state benefits, been more anti-union, etc. Even though other countries which did not follow such policies (such as France) have not seen such increases, and they have to cope with the same global environment as well.

There is a very clear connection between government policy and inequality.

[realpc]

"the top marginal tax rate on income fell from 70% in 1980 to 28% in 1987."

You don't think 70% was a little excessive???

[spencer]

In the 1940s -50s the top marginal tax rate was in the 90s.

[slink/js paine]

nice comments

my question really and old one

okay so the rules got changed
over the last 30 years or so

and the majority of america took a loss
from this set of changes

why are they not in a position to re change the rules to their advantage ???

they're the majority

[anne]

http://delong.typepad.com/sdj/2006/08/dean_baker_on_j.html#comment-21630735

August 28, 2006

Dean Baker on Judges Behaving Badly
By James Galbraith

I keep harping on a theme, but I can't help it.

The one thing missing from this discussion, at every level from Brad DeLong and Paul Krugman through the comments, is actual data.

D-A-T-A. Numbers. Measurement.

Everyone is talking about inequality, attributing 2/5ths to this cause and the rest to some other.

But what are you talking about, actually?

Income inequality? Earnings inequality? Wage inequality? They are not the same, and in the U.S. they sometimes don't even move in the same direction.

Income inequality soared in the late 1990s. Why? A decomposition by region and sector can tell you pretty much exactly: it was the tech bubble and the stock boom. Capital gains and stock options realizations. Much of it in just five places in the whole country: Manhattan, King County WA, and Santa Clara, San Francisco and San Mateo Counties, CA. Take out those five, as Travis Hale and I showed in a paper, and the between-counties component of income inequality (which isn't all of it, but it isn't chopped liver, either) doesn't go up at all.

Meanwhile, earnings inequality went down in the same time. Why? Full employment. This component of inequality is closely tied to utilization rates and unemployment. It varies with hours worked, and overtime earned, more than anything else. It is, in short, a macroeconomic phenomenon.

Most of the discussion here and elsewhere, sadly, is about a third concept -- inequality in hourly wage rates. That is the subject of Dean Baker's anecdote about Northwest airlines: the flight attendants do not wish to work for the wage rate the company is offering.

In a decade of working on this topic, I have yet to see any measure of inequality that is based exclusively on movements in relative hourly wage rates. Not one. No doubt, changes in the structure of hourly rates can affect inequality, in principle -- changes in the minimum wage do have a measurable effect in past data.

It is quite certain, however, that the effect of changes in relative hourly wage rates on income inequality is very, very small, compared to that of changes in non-wage income (such as capital gains), and changes in the macro and demand factors that cause variations in relative earnings.

Understanding the hierarchy of components of income is the first, small step toward a realistic grip on the inequality issue. Any takers?

[anne]

http://www.nytimes.com/2006/08/28/business/28wages.html

August 28, 2006

Real Wages Fail to Match a Rise in Productivity
By STEVEN GREENHOUSE and DAVID LEONHARDT

With the economy beginning to slow, the current expansion has a chance to become the first sustained period of economic growth since World War II that fails to offer a prolonged increase in real wages for most workers.

That situation is adding to fears among Republicans that the economy will hurt vulnerable incumbents in this year’s midterm elections even though overall growth has been healthy for much of the last five years.

The median hourly wage for American workers has declined 2 percent since 2003, after factoring in inflation. The drop has been especially notable, economists say, because productivity — the amount that an average worker produces in an hour and the basic wellspring of a nation’s living standards — has risen steadily over the same period.

As a result, wages and salaries now make up the lowest share of the nation’s gross domestic product since the government began recording the data in 1947, while corporate profits have climbed to their highest share since the 1960’s. UBS, the investment bank, recently described the current period as “the golden era of profitability.”

Until the last year, stagnating wages were somewhat offset by the rising value of benefits, especially health insurance, which caused overall compensation for most Americans to continue increasing. Since last summer, however, the value of workers’ benefits has also failed to keep pace with inflation, according to government data.

At the very top of the income spectrum, many workers have continued to receive raises that outpace inflation, and the gains have been large enough to keep average income and consumer spending rising....

[Mark Thoma]

I have plans to follow up on Galbraith's work, and I hope to do so - but I wanted to think about the mechanisms he talks about first. I actually had a post ready based upon the NY Times review and the post of the first chapter of his book, then decided to hold off until I'd thought more about it.

[anne]

James Galbraith:

"In a decade of working on this topic, I have yet to see any measure of inequality that is based exclusively on movements in relative hourly wage rates. Not one. No doubt, changes in the structure of hourly rates can affect inequality, in principle -- changes in the minimum wage do have a measurable effect in past data.

"It is quite certain, however, that the effect of changes in relative hourly wage rates on income inequality is very, very small, compared to that of changes in non-wage income (such as capital gains), and changes in the macro and demand factors that cause variations in relative earnings...."

Agreed completely. Attending to the tax analyses of David Cay Johnston is a step in this direction as well as looking at the startling change in the data of Piketty and Saez for 2004 when a dramatic effect in tax law favoring capital gains and dividend income becomes effective.

[anne]

Ah, Mark Thoma's comment just appeared. Comments I added recently from James Galbraith are interesting to me and seemingly germane to discussions on what must be rising income and wealth inequality. I add "must be" because inequality data are fiercely argued about with a design of showing the data meaningless though it is not so. Galbraith's work could be more compellingly presented, could be far more accessible, but I am much interested.

[anne]

http://utip.gov.utexas.edu/

What I wish is that James Galbith's inequality project, University of Texas, research could be more compellingly set, could be more accessible, but the work strikes me as quite important :)