Economist's View

The "Silver Spoon" in Ancient Societies

The intergenerational transfer of wealth and advantage is nothing new, but what causes it?:

Inequality, 'silver spoon' effect found in ancient societies, EurekAlert: The so-called "silver spoon" effect -- in which wealth is passed down from one generation to another -- is well established in some of the world's most ancient economies, according to an international study coordinated by a UC Davis anthropologist.

The study, to be reported in the Oct. 30 issue of Science, expands economists' conventional focus on material riches, and looks at various kinds of wealth, such as hunting success, food sharing partners, and kinship networks.

The team found that some kinds of wealth, like material possessions, are much more easily passed on than social networks or foraging abilities. Societies where material wealth is most valued are therefore the most unequal, said Monique Borgerhoff Mulder, the UC Davis anthropology professor who coordinated the study with economist Samuel Bowles of the Santa Fe Institute.

The researchers also showed that levels of inequality are influenced both by the types of wealth important to a society and the governing rules and regulations.

The study may offer some insight into the not-too-distant future.

"An interesting implication of this is that the Internet Age will not necessarily assure equality, despite the fact that its knowledge-based capital is quite difficult to restrict and less readily transmitted only from parents to offspring," Borgerhoff Mulder said.

"Whether the greater importance of networks and knowledge, together with the lesser importance of material wealth, will weaken the link between parental and next-generation wealth, and thus provide opportunities for a more egalitarian society, will depend on the institutions and norms prevailing in a society," she said.

For years, studies of economic inequality have been limited by a lack of data on all but contemporary, market-based societies. To broaden the scope of that knowledge, Borgerhoff Mulder, Bowles and 24 other anthropologists, economists and statisticians from more than a dozen institutions analyzed patterns of inherited wealth and economic inequality around the world.

The team included three others from UC Davis - economics professor Gregory Clark, anthropology professor Richard McElreath and Adrian Bell, a doctoral candidate in the Graduate Group in Ecology.

They focused not on nations, but on types of societies - hunter gatherers such as those found in Africa and South America; horticulturalists, or small, low-tech slash-and-burn farming communities typical of South America, Africa and Asia; pastoralists, the herders of East Africa and Central Asia; and land-owning farmers and peasants who use ploughs and were studied in India, pre-modern Europe and parts of Africa.

"Labor's Share"

Spencer at Angry Bear on the "secular decline in labor's share of the pie":

Labor's Share, by Spencer: The issue of a jobless recovery is getting a lot of attention recently.

I've found the best way to look at the issue is to compare the change in real growth and productivity over the long run. There have been three periods of different productivity trends in modern US economic history.

Prior to about 1973 productivity growth averaged 2.8%. In the second or low productivity era, running from 1974 to 1995, productivity growth slowed to 1.5% before rebounding to 2.4% since 1995.

But real GDP growth also slowed over this period. ... Basically, real GDP growth equals productivity growth plus hours worked or employment growth. A consequence of stronger productivity in an era of weaker GDP growth this suggests that each percentage point increase in real GDP growth generates a much weaker increase in hours worked or employment. ...

But to a certain extent comparing productivity and real GDP is comparing apples to oranges. To be accurate one should look at productivity versus output in the nonfarm sector. GDP includes the farm sector of course, but also the nonprofit and government sectors where productivity is assumed to be zero.

If you look at what happened in the 1990s and early 2000s recoveries in the nonfarm business sector, you see that productivity growth significantly outpaced output growth in the early recovery phase of the cycle. As a consequence hours worked or employment fell, generating the jobless recoveries. It looks like the problem in these two cycles was much weaker growth rather than strong productivity. ... This shift to an environment of stronger productivity and weaker real growth generated an interesting development that has received little attention among economists or in the business press.

This development was a secular decline in labor's share of the pie. Prior to the 1982 recession there was a strong cyclical pattern of labor's but it was around a long term or secular flat trend. But since the early 1980s labor's share of the pie has fallen sharply by about ten percentage points. Note that the chart is of labor compensation divided by nominal output indexed to 1992 = 100. That is because the data for each series is reported as an index number at 1992=100 rather than in dollar terms. So the scale is set to 1992 =100 rather than in percentage points. But it still shows that labor payments as a share of nonfarm business total output has declined sharply over the last 20 years and prior to the latest cycle we did not even see the normal late cycle uptick in labor's share.

If this chart gets a lot of attention it will be interesting to see how the libertarian and/or conservative analysts who keep coming up with all types of excuses to explain away the weakness in real labor compensation in recent years explain this away. If you really want to raise a stink you could look at this as a great example of the Marxist immiseration of labor that Marx believed was one of the internal contradictions of capitalism that would eventually lead to its self destruction.

I'll just add that the point at which the decline begins (in the early 1980s) is generally associated with the onset of the Great Moderation.

"Increasing the Social Mix"

Why do some countries exhibit more social mobility than others?:

Getting ahead of ourselves, by Peter Browne, Inside Story: Last month, after Barack Obama invoked the American Dream at Wakefield High School in Virginia, Inside Story looked at what the statistics show about social mobility in western countries. ... In France, Italy, Britain and the United States, family background plays a very significant role in determining adult income; in Denmark, Norway, Finland and Canada the effect is much smaller. ... This puts the United States among a group of countries that are regarded as class-bound and stifling of individual initiative.

Our main source was a report by Anna Cristina d’Addio, a researcher in the OECD’s Directorate for Employment, Labour and Social Affairs. Now, two researchers in the organisation’s Economics Department, Orsetta Causa and Asa Johansson, have released a new report... Their broad conclusion is very similar to d’Addio’s. The more equal the socioeconomic and educational backgrounds of children in a given country, the greater the degree of social mobility...

Causa and Johansson identify education as the key factor. “Across European OECD countries covered by the analysis there is a substantial wage premium associated with growing up in a higher-educated family, whereas there is a penalty with growing up in a less-educated family, even after controlling for a number of individual characteristics.”...

But parents’ socioeconomic status obviously plays a vital role in school performance. ... Interestingly, it’s not necessarily only the child’s parents’ status that counts: “In over half of the OECD countries, including all the large continental European ones, students’ cognitive skills are more strongly influenced by the average socioeconomic status of parents of other students in the same school… than by their own parents’ socioeconomic status.”

This leads into what seems to me the most interesting of the report’s findings. According to the authors, the evidence suggests that “increasing the social mix within schools may increase performance of disadvantaged students with neutral or in some cases with positive effects on overall performance. Thus, policies aimed at encouraging such mix in neighborhoods may, therefore, play a role in mitigating inequalities.” This means that policies to encourage students from a range of backgrounds to attend the same schools ... will not only improve the performance of the least able students without lowering average performance, but could increase the overall performance of a classroom or a school. ...

Government policies have added to the problem in some cases, and helped to alleviate it in others, and not necessarily intentionally. Where enrolments in childcare and early childhood education are high, for instance,... students are less bound by their socioeconomic background. On the other hand, grouping students into different programs according to their proficiency correlates ... with less mobility. ...

Causa and Johansson ... see a role for urban planning and housing. “...policies aimed at increasing the social mix in neighbourhoods (for instance, by improving housing quality in deprived areas in order to attract middle-class families) could be instrumental for improving social mobility, especially in countries where the influence of the school socioeconomic environment on student performance is relatively large.”

Finally, two more observations that might be causing consternation among the authors’ colleagues in the OECD Economic Department:

More progressive income taxation and higher short-term unemployment benefits are associated with a looser link between parental background and both teenager’s cognitive skills and wages. This may reflect the tendency of well-targeted redistributive and income support policies to lower cross-sectional income inequality and poverty rates.

Labour market institutions that tend to compress wage distributions, such as a higher degree of unionisation and a greater coverage of collective wage agreements, appear to be associated with a looser link between parental educational achievement and children’s wages.

Causa and Johansson are saying that any measure that reduces inequality will make it easier for individuals to break free of the constraints of their backgrounds. It’s an enormous challenge for the United States and another warning for Australia.

"Will Economic Inequality Lead to Terrorism?"

Bruce Judson with a description of a "chilling call" that occurred while he "was a guest on OnPoint which is distributed nationally by NPR." As he notes in an email, "the post raises an important issue. All of the discussion of economic inequality essentially presumes that people continue to view the existing economic system as legitimate. As foreclosure rise, jobs disappear, and the divide between the have's and have not's increases, our ability to take this for granted becomes less clear":

Will Economic Inequality Lead to Terrorism? A Chilling Moment on NPR, by Bruce Judson: Last week, It Could Happen Here was the subject of a 45-minute segment of Tom Asbrook’s OnPoint, which airs nationally on NPR. To demonstrate, how inequality can divide a nation, It Could Happen Here, which is a nonfiction book, opens with a fictional scenario involving American terrorists who threaten the nation with dirty bombs demanding an end to foreclosures by “vulture banks,” and free access to healthcare and higher education for all. Tom Ashbrook asked hard questions about this scenario. I said to him think of a laid off engineer who works with radioactivity to create medical devices…

Here’s the transcript of the discussion:

BRUCE JUDSON: First off, here’s a flash point for you. In the scenario, in the fictional scenario, I talk about…It is very easy to imagine that an engineer, or someone else with the necessary knowledge who works on, let’s say, medical devices and has used radioactivity to create a better world…. to save lives, is laid off. You can imagine that he suddenly is facing foreclosure. He’s an educated person unable to put his kids through college.

A few minutes later the show took calls. The show received a chilling call from an out of work nuclear engineer–who had helped to build 13 nuclear power plants but had not worked in two years. You can read the transcript of his call below, or click to listen to his call here.

Click player below to listen to out of work Nuclear Engineer:

TOM ASHBROOK: Certainly inequality’s a big issue. Let me get a call right here from New London, Connecticut. And

Don. Hi, Don. You’re on the air.

CALLER: Hi.

TOM ASHBROOK: Hi.

CALLER: I think you should be listening to this guy, Judson. I’m an unemployed nuclear engineer. I’ve worked on 13 nuclear power plants. Making a dirty bomb is not a big deal. I’m not going to go out and tell everybody now to do it, but I’m just saying things like that can happen. And it sounds like you’re just being dismissive of all his ideas and what he’s saying. Because there’s a lot of anger out here, and there are a lot of people who feel that the American Dream is slipping away from them, they don’t have a chance. And the only entrepreneurial opportunity for them is to sell drugs and to be an outlaw. It’s happening.

TOM ASHBROOK: [OVERLAPPING] I hear you, [PH] Don. We’ve got Bruce on for an hour. So, I can’t say we’re not listening to him. But let me ask you, you’ve got a lot of expertise in your field, nuclear engineering. But does that mean you’re unhappy if you’re unemployed? Do you really feel like the country’s ready to revolt?

CALLER: I’m not an expert in revolution, and I don’t really know how they happen. All I know is I’m 60 years old. There’s not a lot of people who want to hire a nuclear engineer who’s 60 years old. And there are a lot of people out there like me who are out there who, you know, once you have so much gray hair, you’re out of here. And there’s just a lot of people that are just not happy with the way that the country’s going right now. And I don’t know…where it’s going to take it, or what’s going to be its spark, or what’s going to be the event. But people feel like there’s just no way to climb out of the hole. Like there’s just nothing that’s going to get them out. This attitude, that I’ve seen, over 60 years, I’ve never seen anything like it. It scares me.

TOM ASHBROOK: Up against it. And with an education, a particular education. Don, thank you for your call.

You can listen to the full OnPoint segment by clicking the player below:

In ... today’s New York Times column Safety Nets for the Rich, Bob Herbert, details our emerging have and have not society, where two-thirds of  the entire income gains of the nation between 2002 and 2007 went to the top 1% of Americans. Herbert writes:

And we still don’t seem to have learned the proper lessons. We’ve allowed so many people to fall into the terrible abyss of unemployment that no one — not the Obama administration, not the labor unions and most certainly no one in the Republican Party — has a clue about how to put them back to work.

Meanwhile, Wall Street is living it up. I’m amazed at how passive the population has remained in the face of this sustained outrage.

Unfortunately if we do not change course, Herbert’s amazement may end in circumstances that we do not want to contemplate.  We are witnessing the unfolding of a chain of dangerous events associated with our collapsing middle class and increasingly two-tier economy. Sadly, the dynamics outlined in It Could Happen Here that lead to political instability are occurring  with increasing ferocity. More on this in my next post...

"Is The American Dream A Myth?"

We've known for some time that the degree of social mobility in the US is much less than people believe. But given how widespread the mobility myth is -- the false perception that there is equal (enough) opportunity allows us to be more accepting of unequal outcomes than we would be if we knew how stagnant social outcomes actually are -- the evidence that rebuts this belief is worth repeating:

Is The American Dream A Myth?, by Ronald Brownstein, National Journal: One tenet that separates the United States from other countries is our belief in upward mobility. A study of attitudes in 27 countries found that Americans, more than people elsewhere, tend to believe that intelligence, skill, and effort will be rewarded with success. This faith is vibrant even among groups to which opportunity has often been denied:... African-Americans and Hispanics were more likely than whites to believe that children of all races had adequate chances to succeed in America.

But as Brookings Institution scholars Ron Haskins and Isabel Sawhill demonstrate in a compelling new book, America's record doesn't entirely justify this optimism. ... In the generation after World War II, the median income roughly doubled, increasing faster for those on the lower rungs of the ladder than for those at the top. Since 1979, the median income has advanced much more slowly overall, and it has grown much faster for the affluent than for those below them. Today,... family incomes are higher than in the 1970s almost entirely because women are working...; men in their 30s today earn less than their fathers did at the same age. In this environment, upward mobility becomes tougher. ...

More than 60 percent of Americans whose parents scaled the top fifth of the income ladder have reached the top two-fifths themselves, Haskins and Sawhill found. By contrast, 65 percent of Americans with parents from the lowest fifth of earners remain stuck in the bottom two-fifths. Though we venerate the American Dream, studies show that children born to low-income parents in the United States are more likely to remain trapped near the bottom than their counterparts in Europe...

Many factors constrain upward mobility in America, including the decline of the two-parent family and bad personal decisions... But another reason the escalator is slowing ... is that income is now so dependent on education. Today, four-year college graduates earn about 80 percent more than workers with high school degrees. That's more than double the gap in the 1960s.

Young people who begin with the most advantages are considerably more likely than the less well-off to add the advantage of advanced education. Sawhill and Haskins report that children of parents in the top fifth of income are now more than twice as likely to attend college, and nearly five times as likely to graduate, as are children of parents in the bottom fifth. Separate research from Thomas Mortenson ... shows that this income gap in college completion has widened substantially since the 1970s. ...

These are deeply unhealthy, even destabilizing, patterns. If advanced education is the key to economic success, it's dangerous to reserve it primarily for those who start out on top. Such ossification is a recipe for class and racial conflict...

He and Sawhill see several keys to expanding college access. Although affordability remains a challenge, they say that enough financial aid is available for needy students that money is not the principal obstacle. ...

The two believe that less progress has been made in developing programs that effectively prepare lower-income students to apply to college or help them succeed once they arrive. Most important, too few public schools in poor neighborhoods academically equip students to handle college work.

There is no simple answer to these challenges. But the nation is inviting conflict if it apportions opportunity primarily to the children with the good sense to be born where it is already within reach.

"Is Consumption the Grail for Inequality Skeptics?"

Lane Kenworthy responds to Will Wilkinson's Cato Unbound essay on inequality:

Is Consumption the Grail for Inequality Skeptics?, by Lane Kenworthy: ...Over [the 1979 to 2006 time] period the share of total income going to the top 1% of households jumped from 7% to 16%, while the share for the bottom three quintiles fell from 36% to 28%.[2] This is a substantial rise in income inequality. Very few social scientists deny its existence. The debate among them focuses on its characteristics, timing, magnitude, and causes.[3]

But there is far less consensus about whether, and if so to what extent, we should worry about this development. Inequality skeptics have offered a number of reasons for downplaying its significance: inequality is the product of free choices, what really matters is equality of opportunity, measures of income inequality ignore upward mobility, higher inequality boosts economic growth, focusing on a single country fetishizes national borders, and others.

Will Wilkinson emphasizes the distinction between income and consumption:

As far as I can tell, when most people are worried about economic inequality, they’re usually worried about inequalities in ... the real material conditions of life. . . An individual’s or household’s standard of living is determined rather more directly by the level of consumption than by the level of income. . . Different datasets and analytical methods produce somewhat different results, but most stories of consumption inequality are stories of stability or a relatively mild rise.

Wilkinson makes other arguments in his piece, and additional ones in his earlier Cato essay. But I want to focus on this point. I don’t find it compelling.

"New Income Inequality Data: Surprising and Frightening"

Bruce Judson is worried about what the latest reports on economic inequality say about our future:

New Income Inequality Data: Surprising and Frightening, by Bruce Judson: The newest economic inequality numbers ... are frightening. Yesterday, the Associated Press released an article titled, US income gap widens as poor take hit in recession. The opening paragraph of the article, based on recent census data, reads:

The recession has hit middle-income and poor families hardest, widening the economic gap between the richest and poorest Americans as rippling job layoffs ravaged household budgets.

The article ... failed to mention that the Census Bureau considered the differences between 2007 and 2008, with regard to economic inequality, statistically insignificant. But, whether the Census Data shows a meaningful increase, or not is irrelevant. The Census Data reports that, contrary to the almost universal expectations of economists, economic inequality most likely did not decrease in 2008. Experts had anticipated that the declines in income of the rich would lead to a reversal in this groups ever–widening share of our national income. Instead, the Census reported that the 2008 income losses by the top 10% of Americans were offset by larger losses among middle class and poorer Americans. ...

Early next week, my new book It Could Happen Here will be released... The book is an in-depth look , based on a historical analysis, of the implications of our historically high levels of economic inequality for the nation’s ultimate, long-term political stability. As economic inequality grows, nations invariably become increasingly politically unstable: Should we complacently believe that America will be different?

A central conclusion of the book is that once economic inequality reaches a self-reinforcing cycle it is halted only by inevitably controversial, hard-fought, bitterly opposed government action. ... In 1928, economic inequality was near today’s levels. Franklin Roosevelt succeeded in reversing the trend toward the continuing concentration of wealth, but it was a turbulent battle. ...

In FDR’s era and in our own, money brings power: both explicitly and implicitly, in hundreds of different ways, both large and small. Today, the wealthiest Americans, together with a number of financial and corporate interests that act on their behalf, protect their ever-increasing influence through activities that include, among others, lobbying, supplying expertise to the councils of government, casual conversation at dinner parties, the potential for jobs after government service, the power to run media advertisements that influence public opinion. Indeed, MIT economist Simon Johnston, writing in The Atlantic asserted that the U.S. is now run by an oligarchy...

The new inequality data suggests that the potential problems for the nation associated with the concentration of wealth and power are even more severe than previously recognized. Two weeks ago, I wrote that “Once income concentration becomes a reinforcing cycle of the kind we are witnessing, it is never stopped by pure market forces.” This mechanism is now in full swing. ...

The great strength of American democracy has always been its capacity for self-correction. However, Robert Dahl, the eminent political scientist, recognized that political power fueled by wealth may ultimately neutralize this central aspect of our democracy. In his 2006 book, On Political Equality, Dahl wrote:

As numerous studies have shown, inequalities in income and wealth are likely to produce other inequalities..

The unequal accumulation of political resources points to an ominous possibility: political inequalities may be ratcheted up, so to speak, to a level from which they cannot be ratcheted down. The cumulative advantages in power, influence, and authority of the more privileged strata may become so great that even if less privileged Americans compose a majority of citizens they are simply unable, and perhaps even unwilling, to make the effort it would require to overcome the forces of inequality arrayed against them.

In the chapter following this quote, Dahl notes “that we should not assume this future is inevitable.” He’s right. But he was clearly concerned. ...

Many current Executive Branch initiatives deserve our support and praise: However, nothing proposed to date will effectively halt growing economic inequality, and its corrosive impact on our economy and the long-term future of the nation. ...

My analysis in It Could Happen Here concludes that without a vibrant middle class, the the American democracy as we know it, is not sustainable. Before the Great Recession, the middle class was in far worse shape than was generally acknowledged. In an economy with a record number of job seekers for every available job, the potential for nearly one-half of all home mortgages to be underwater, and increasing foreclosures, the collapse of the middle class will accelerate. With each job loss and each foreclosure, another family becomes a member of the former middle class.

America has never been a society sharply divided between have’s and have not’s. Unfortunately, this new data says to me we continue to head in that direction. Economists assumed that the Great Recession would be a circuit breaker that would halt this advance, at least temporarily. It did not. ...

Could our democracy survive a transformation into a nation composed principally of a privileged upper class and an underclass that struggles from paycheck to paycheck that lacks basic economic security. My analysis of a broad sweep of history, suggests it could not.

We will only stop the growth of economic inequality if the President and the Congress are ready to fight in the style of Franklin Roosevelt. FDR was a divider not a conciliator. Before World War II, he fought an all-out war at home. Today, “There’s class warfare, all right,” as Warren Buffett said, “but it’s my class, the rich class, that’s making war, and we’re winning.”

I fervently hoped that we have not passed the point of no return, described by Professor Dahl. The recent news shows we are one step further on this road. If we continue down it, our nation may be on the path to becoming a House divided against itself, which ultimately cannot stand.

Are you as concerned as he is? I don't know if we are headed down the path of no return or not, but the part that concerns me is that recent changes in inequality do not seem to be driven by market forces that properly evaluate and reward productive activity.

Republicans worry a lot about the effect that small changes in tax rates would have on economic activity (something there's not a lot of evidence to support) because taxes distort the relationship between effort and reward. But if the rewards have become generally separated from productive effort, particularly the large rewards at the very top of the income distribution where the Republicans argue these incentive effects are the strongest, then there are large distortions in the system that have nothing to do with taxes. That is what Republicans ought to be worried about if they are truly concerned with ensuring that the rewards people receive match their productive effort.

Social Mobility

Andrew Leigh says this is a "a terrific piece on social mobility":

American dreams, by Peter Browne: When Barack Obama spoke to schoolchildren at Wakefield High School in Virginia last week, he drew on his own experiences to argue that all young Americans, regardless of their family’s wealth and income – even kids who “goofed off” at high school, like he did – have the potential to rise to the top. ...

But how typical is [this]? ... The seductive idea that anyone can move up the income scale might mean that Americans are more tolerant of a degree of inequality that would cause much deeper unease in many other western countries. ...

[R]ecent research drawing on a series of studies from Europe, the United States and Australia ... has concluded ... that among comparable countries, the United States has an unusually rigid social system and limited possibilities for mobility. ...

President Obama is no doubt aware of this research, and has made oblique references to the problems facing low-income families and neighborhoods in speeches and interviews. But the mobility myth is so widely believed and so deep-seated that it’s not surprising he hasn’t tried to confront the problem head on. When the Economic Mobility Project [2] surveyed 2100 adults and ran ten focus groups earlier this year it found that respondents overwhelmingly believe that personal attributes – “like hard work and drive” – are the prime determinants of how economically successful an individual can be. A smaller majority also disagreed with the statement that “In the United States, a child’s chances of achieving financial success is tied to the income of his or her parent.”

As the studies show, that statement is true for ... a higher proportion of American children than in most comparable countries. Among the twelve countries analyzed by economist Anna Cristina d’Addio in a 2007 OECD report,... the United States was in a group of four – with France, Italy and Britain – where family background plays the greatest role in influencing adult income. Children born into a poor family in any of these countries had a much lower chance of breaking into a higher income group than in any of the other countries in the study. ...

Britain came out worst, with around 50 per cent of a person’s income explained by his or her parents’ income. ... Italy and the United States weren’t far behind, at around 47 per cent. At the other end of the range were Denmark, Norway, Finland and Canada, where parental income explained less than 20 per cent of the child’s eventual earnings. ...[I]t’s those four countries, rather than the United States, that come closest to realizing the American Dream.

Some studies have found that mobility is not only limited in the United States but has worsened in recent decades. ...

Why do some countries fare so badly...? The OECD report offers the most comprehensive list of likely factors, but its conclusions are tentative. ... But looking at the factors that the OECD believes contribute “significantly” to differences in mobility, it isn’t hard to see why the United States performs badly...

First, there’s the problem of entrenched income inequality. “In general,” says d’Addio..., “the countries with the most equal distributions of income at a given point in time exhibit the highest mobility across generations.” Among the twelve countries examined in the report, the United States has the most unequal distribution of income. ...

Equally interesting is the role of immigration in pushing up mobility. Overall, immigrants tend to be more upwardly mobile than the broader population. ... Yet the United States doesn’t seem to have gained the ... benefits from migration... This clearly has something to do with how well migrant students perform at school. ...

The other key factor identified indirectly by the OECD, and more explicitly in a new Economic Mobility Project [8] report, is a strikingly low level of mobility among black Americans. ... The author of the Project’s report, New York University sociologist Patrick Sharkey, finds that growing up in a high-poverty neighborhood “increases the risk of experiencing downward mobility and explains a sizable portion of the black-white downward mobility gap.”

These neighborhoods usually suffer from other warning signs for low mobility identified in the OECD report, including a high rate of male unemployment at the time of a child’s birth and a high rate of relationship breakdown. ...

For Barack Obama, the ... reform that’s causing him the most difficulty at the moment – healthcare – also has implications for economic mobility. Child birth-weight is a “significant” factor in explaining low mobility, and the child’s mental health and parents’ physical health are “significant and large” factors, according to the OECD. Like any measures designed to break down the rigidity that keeps many Americans poor, improvements in health will take some time to influence overall mobility. But a system of health insurance for all Americans would certainly have an impact in the long term.

Ironically, the remarkable rise of Barack Obama could make it harder for Americans to recognize the shaky foundations of the American Dream. And the fact that so many people continue to believe the myth could make the problem worse. As the American researcher Isabel Sawhill writes, “When those who are relatively poor believe that they or their children will rise in status over time, they are less likely to complain about the status quo and more likely to accept the prevailing system.” ...

Is it true that we tolerate inequality because we believe we are highly mobile, and that merit rather than family background is the most important factor in determining social outcomes? Even if it were true that merit is the most determinant of social mobility, that is not enough. The opportunity must be present before those with merit can take advantage of it, and ensuring that everyone has a chance to succeed is an important step in fixing the mobility problem. Nothing will ever be completely equal, some people will always have more opportunity than others to get ahead, but we could do a whole lot better than we are doing now at creating the opportunity for people to reach their full potential.

I am not generally predisposed to redistributive policies, and the best solution to the mobility problem is to ensure everyone has an equal chance to succeed. But since equal opportunity is a long way from reality, I believe that redistribution that compensates for differences in opportunity is justified.

Economic Inequality: The Wall Street Journal is Just Wrong

Many of the same people who argue that inequality is caused by the market rewarding highly productive people for their efforts -- that it's a good thing because it encourages productive effort -- also deny that inequality is increasing. If inequality is predominately the result of rewarding people for hard work that benefits everyone, you'd think they'd be eager to point out that inequality has been growing, and will likely continue to do so.

Recently, the Wall Street Journal claimed, as it has in the past, that inequality hasn't really been growing like just about everyone else says it has. And in any case, the WSJ says, the recession will take care of it. Bruce Judson explains why this is "just plain wrong" (there's more detail on the data and other issues in the full article):

Economic Inequality: The Wall Street Journal is Just Wrong, by Bruce Judson: For anyone with even a passing familiarity with issues associated with economic inequality, The Wall Street Journal front page story last week was shocking. Its use of bad data was a misuse of this important forum. In effect, the article says that economic inequality was never really a problem, and even if it is we no longer have to worry about it. These conclusions are just plain wrong.

The Journal article effectively leads the reader to two conclusions: First, any issues that may exist around economic inequality are disappearing, because of the likely decline in the outsize incomes of the top 1% of Americans... Second, the problem was never really that bad in the first place. ...

Unfortunately, few conclusions could be further off the mark.

"The Savings Rate Has Recovered…if You Ignore the Bottom 99%"

Yves Smith suggested this. I don't know if it's correct or not, as noted below most of the numbers are speculative due to data limitations, but the question of how recent changes in saving vary with income does seem like a question worth asking:

Guest Post: The Savings Rate Has Recovered…if You Ignore the Bottom 99%, by By Andrew Kaplan, a hedge fund manager: It has become fashionable among equities managers of the bullish persuasion to argue that a strong recovery in GDP will occur in 2010 because the “structural adjustment period” of moving back to a more normal savings rate has been completed. We’ve gone from a savings rate of barely 1% in 2008 up to 4.2% in July (ok, so the argument sounded better when the number was 6.2% in May, but still…).

The story goes something like, “consumers took a little time to recognize that their home equity had disappeared, but now they’ve adjusted their savings rates toward the desired level to reflect the fact that they need to save a larger proportion of income for retirement…so this effect will no longer be a drag on growth in coming quarters.”

This is the kind of conventional wisdom which could only emerge among folks in the 99^th income percentile who spend their time primarily with other folks in the 99^th income percentile. You don’t have to look at the data (mortgage delinquencies, foreclosures, credit card defaults, bankruptcies) all that hard to see a very different picture. In fact, it is almost certainly true that the savings rate for 99% of the US population is negative. These people (a/k/a “all of us”) are drowning. And to the extent that our savings rate is less negative than it was one or two years ago, that simply reflects the reality of reduced home equity and unsecured credit lines rather than any conscious effort to reach a “desired level” of savings.

"Social Mobility"

The U.S. does not have as much social mobility as Horatio Alger would have you believe. Equal opportunity is an important social goal, at least it is to me, and to the extent that this indicates unequal opportunity, it is of concern. Why is social mobility within the U.S. lower than in many other countries?:

Social mobility, by Daniel Little?: We often think of the United States as a place with a lot of social mobility. What exactly does this mean? And is it true? Ironically, the answer appears to be a fairly decisive "no." In fact, here's a graph from a 2005 New York Times series on income mobility that shows that the United States ranks second to last among Great Britain, US, France, Canada, and Denmark when it comes to the rate of income improvement over four generations for poor families. And here are two very interesting recent studies that come to similar conclusions -- a report on social mobility by the Center for American Progress and a 2007 academic study by researchers at Kent State, Wisconsin and Syracuse. Here is how Professor Kathryn Wilson, associate professor of economics at Kent State University, summarizes the main finding of the latter study: “People like to think of America as the land of opportunities. The irony is that our country actually has less social mobility and more inequality than most developed countries” (link).

Basically social mobility refers to the likelihood that a child will grow up into adulthood and attain a higher level of economic and social wellbeing than his/her family of origin. Is there a correlation between the socioeconomic status (SES) of an adult and his/her family of origin? Do poor people tend to have poor parents? And do poor parents tend to have children who end up as poor adults later in life? Does low SES in the parents' circumstances at a certain time in life -- say, the age of 30 -- serve to predict the SES of the child at the same age?

The fact of social mobility is closely tied to facts about social inequality and facts about social class. In a highly egalitarian society there would be little need for social mobility. And in a society with a fairly persistent class structure there is also relatively little social mobility -- because there is some set of mechanisms that limit entry and exit into the various classes. In the simplest terms, a social class is a sub-population within a society in which parents and their adult children tend to share similar occupations and economic circumstances of life. It is possible for a society to have substantial inequalities but also a substantial degree of social mobility. But there are good sociological reasons to suspect that this is a fairly unstable situation; groups with a significant degree of wealth and power are also likely to be in a position to arrange social institutions in such a way that privilege is transmitted across generations. (Here are several earlier postings on class; post, post, post.)

A crucial question to pose as we think about class and social mobility, is the issue of the social mechanisms through which children are launched into careers and economic positions in society. A pure meritocracy is a society in which specific social mechanisms distinguish between high-achieving and low-achieving individuals, assigning high-achieving individuals to desirable positions in society. A pure plutocracy is a society in which holders of wealth provide advantages to their children, ensuring that their adult children become the wealth-holders of the next generation. A caste system assigns children and young adults to occupations based on their ascriptive status. In each case there are fairly visible social mechanisms through which children from specific social environments are tracked into specific groups of roles in society. The sociological question is how these mechanisms work; in other words, we want to know about the "microfoundations" of the system of economic and social placement across generations.

The Trickle-Up Economy

Paul Krugman notes the latest inequality numbers:

Even more gilded, by Paul Krugman: With everything else going on, the latest inequality numbers from Emmanuel Saez, now updated to 2007, didn’t get much attention. But they’re truly amazing:

How will the crisis change these numbers, if at all?

Update: Brad DeLong:

That means that the top 1-10,000 of the American income distribution receives 6% of pretax household income--meaning that their average income is 600 times that of the average.

Time for a more progressive income taz, is what I am saying...

Machine-Sourcing

Gregory Clark sees a bleak future for the unskilled:

Tax and Spend, or Face The Consequences, by Gregory Clark, Commentary, Washington Post: At some point, the Great Recession will end. ... Whenever it happens, we will see that the downturn was but a minor blip in the long story of the economy. In the next chapter, abundance beckons -- for some. Advances in technology drive economic growth, and there is no sign that they are slackening. The American economy is likely to continue unabated on the upward path that began with the Industrial Revolution.

No, the economic problems of the future will not be about growth but about something more nettlesome: the ineluctable increase in the number of people with no marketable skills, and technology's role not as the antidote to social conflict, but as its instigator.

The battle will be over how to get the economy's winners to pay for an increasingly costly poor. ... In a future with higher taxes, the divide between rich and poor would be the central economic challenge.

For much of the past 200 years, unskilled workers benefited greatly from capitalism. Before the Industrial Revolution, for example, skilled construction workers earned 50 to 100 percent more than unskilled laborers; today, that premium has fallen to 33 percent in the United States. ...

Why have the unskilled fared so well? ...[M]achines ... even today ... cannot replace many of people's manipulative abilities, language skills and social awareness. The hamburger you eat at McDonald's is still put together and delivered to you by human hands; even a fast-food "associate" deploys an astonishing repertoire of spatial and language skills.

But in more recent decades, when average U.S. incomes roughly doubled, there has been little gain in the real earnings of the unskilled. And, more darkly, computer advances suggest these redoubts of human skill will sooner or later fall to machines. We may have already reached the historical peak in the earning power of low-skilled workers, and may look back on the mid-20th century as the great era of the common man.

I recently carried out a complicated phone transaction with United Airlines but never once spoke to a human; my mechanical interlocutor seemed no less capable than the Indian call-center operatives it replaced. Outsourcing to India and China may be only a brief historical interlude before the great outsourcing yet to come -- to machines. And as machines expand their domain, basic wages could easily fall so low that families cannot support themselves without public assistance. ...

So, how do we operate a society in which a large share of the population is socially needy but economically redundant? There is only one answer. You tax the winners ... to provide for the losers. ...

The United States was founded, essentially, on resistance to taxes, and to this day, an aversion to the grasping hand of the state seems fundamental to the American psyche. ... The conflicts to come are foreshadowed in California, where popular anti-tax sentiment has forced substantial reductions in medical care for the state's poorest children.

How can we avoid or minimize such conflicts? The Obama administration seeks to do so in part through a more cost-effective health-care system. ... But ... this will at best buy time before an inevitable crunch.

Others see education as a way out of this dystopia. The root problem is, after all, the widening of the income gap between the skilled and the unskilled. Can expanded education give the poorest the tools to resist the march of the machines? I'm skeptical. Already, much of the supposed improvement in high school and college graduation rates has come by asking less of graduates. ...

 In the end, we may be forced to learn to live in a United States where, by stealth, "from each according to his ability, to each according to his need" becomes the guiding principle of government -- or else confront growing, unattended poverty.

As the world develops in the long, long run, and as countries move from "developing" to "developed," I still see a chance that the growth in the demand for the services that the unskilled provide will outstrip the growth in the supply. That doesn't mean that the wealth gap won't continue to increase, and that there won't be any problems associated with the growing gap between those at the top and those at the bottom, but I'm not so sure that wages will fall such that absolute living standards will decline as predicted above. But nobody knows for sure what will happen, so what do you foresee?

"Education and Technology: Supply, Demand, and Income Inequality"

Claudia Goldin and Lawrence Katz say that "the educational slowdown caused much of the recent rise in economic inequality," and that "the future of inequality and this nation depend on increasing the supply of highly educated workers," [An alternative view is here: Krugman vs Mankiw: The 80-20 Fallacy]:

Education and technology: Supply, demand, and income inequality, by Claudia Goldin and Lawrence F. Katz, Vox EU: The American Dream has been placed on hold. Putting aside the recent financial meltdown and the current recession – if you can – the main reason is an educational slowdown. For most of American history, the average American child was far more educated and better off financially than his parents. But ever since the 1970s, US growth in educational attainment for successive generations has substantially slowed. The slowdown in education spells trouble for economic growth and economic inequality, as many authors have noted, e.g. Heckman (2008).

An educated populace is a key source of economic growth directly, through the improved productivity of workers, and indirectly, by spurring innovation and aiding the diffusion of advanced technologies. Broad access to education was a major factor in US economic ascendancy and in the creation of a broad middle class. The American Dream of upward mobility both within and across generations has been tied to educational access.

Ever since the beginning of the twentieth century, technological change has operated to increase the relative demand for educated and skilled workers. In academic parlance, technological change has been “skill-biased” – smart machines require smart workers. Technological change increases the relative demand for skilled and educated workers, but educational advance increases their relative supply. This “race” between education and technology can produce rising, declining, or stable levels of economic inequality.

US economic inequality has been on a roller coaster ride during the past century. Wage inequality and educational wage differentials decreased from around 1910 to 1950. They remained fairly stable until about 1980, after which economic inequality soared. The contrasting descent and rise of economic inequality in the twentieth century is linked to the history of educational attainment.

Our book shows that the educational slowdown caused much of the recent rise in economic inequality. Similarly, the large increase in educational attainment earlier in the twentieth century produced greater economic equality and shared prosperity. Slowdowns and speedups in skill-biased technological change are far less important in accounting for the large swings in inequality than changes in the supply of skills. The rise and decline of unions plays a supporting role in the story, but it is rarely a major player. Immigration and international trade also do not play starring roles in explaining changes in economic inequality.

"Do Schools Make Inequality Worse?"

Lane Kenworthy:

Do schools make inequality worse?, by Lane Kenworthy: “Far from leaning against economic inequality, U.S. schools make it worse.” This sentiment, from a recent Clive Crook op-ed, expresses a view that’s commonplace on both the left and the right, and among both proponents and opponents of school reform.

It’s wrong. Americans do leave the schooling system more unequal in cognitive and noncognitive skills than when they enter it. Yet that inequality is less — probably much less — than it would be in the absence of schools. Schools don’t increase inequality; they just don’t do enough to overcome the inequality produced throughout childhood by differences in families, neighborhoods, peers, and other influences.

How do we know that? First, children are vastly unequal in ability when they enter the school system at age five or six. This is due partly to genetics and partly to environmental differences.

Second, we have evidence from the natural experiment that is summer vacation. During those three months out of school, the cognitive skills of children in lower socioeconomic status (SES) households tend to stall or actually regress. Kids in high-SES households fare much better during the summer, as they’re more likely to spend it engaged in stimulating activities. In his book Intelligence and How to Get It, cognitive psychologist Richard Nisbett concludes that “much, if not most, of the gap in academic achievement between lower- and higher-SES children, in fact, is due to the greater summer slump for lower-SES children” (p. 40).

Without schools this pattern would be magnified, and the gap in cognitive and noncognitive abilities at age 18 almost certainly would be much greater than it now is.

This by no means implies that our educational system is doing fine. It could and should do much better at helping children from disadvantaged environments. But saying it currently makes things worse suggests the situation is hopeless. Instead of promoting reform, that undercuts it.

Inequality and Residential Segregation

According to this research, inequality raises residential segregation. This is worrisome in part because the increase in segregation can cause problems that feedback to both amplify and perpetuate the inequality:

Inequality and the Measurement of Residential Segregation by Income In American Neighborhoods, by Tara Watson,  NBER Working Paper No. 14908, April 2009: Abstract American metropolitan areas have experienced rising residential segregation by income since 1970. One potential explanation for this change is growing income inequality. However, measures of residential sorting are typically mechanically related to the income distribution, making it difficult to identify the impact of inequality on residential choice. This paper presents a measure of residential segregation by income, the Centile Gap Index (CGI) which is based on income percentiles. Using the CGI, I find that a one standard deviation increase in income inequality raises residential segregation by income by 0.4-0.9 standard deviations. Inequality at the top of the distribution is associated with more segregation of the rich, while inequality at the bottom and declines in labor demand for less-skilled men are associated with residential isolation of the poor. Inequality can fully explain the rise in income segregation between 1970 and 2000. ...

"The Crisis, Reduced Inequality, and Soak-the-Rich Populism"

Alberto Alesina and Paola Giuliano ask, "Will Americans turn into 'inequality intolerant' Europeans?" They use the word intolerant because they believe that "The increase in income inequality of the last three decades in the US is not extraordinary if viewed from a very long-term perspective," therefore the recent increase in inequality and social immobility shouldn't be viewed as unfair. But I don't see why the distribution or degree of immobility in the past was necessarily fair just because it prevailed, nor why the recent increase in inequality - which we know was based in large part upon false valuations and hence false rewards - should be viewed as justifiable in any case:

Preferences for redistribution: The crisis, reduced inequality, and soak-the-rich populism, by Alberto Alesina and Paola Giuliano, voxeu.org: The current financial crisis will reduce income and wealth inequality. The rich who heavily invested in financial and stock markets have lost much more than the less wealthy. The relatively poor “young” may face the sale of the century. Go and tell a young (and poor) just-married couple that the collapse of housing prices is a problem; mention to a young worker just beginning to accumulate retirement money that low stock prices are a problem!

Many will consider this reduction in inequality the silver lining of the crisis and a welcome development. This is especially the case because many people are acutely aware of the increase in income inequality that occurred in many (especially English-speaking) countries in the last three decades and perhaps tend to think of it as “unfair”. Those who became rich from complicated financial instruments and sophisticated investments in derivatives are now seen as undeserving of their wealth. The extraordinary bonuses of certain incompetent managers, especially those bailed out by the taxpayers, have certainly not helped gain them sympathy. Nevertheless, a frontal attack on the finance world is pure populism; finance serves a very productive purpose. One cannot mix criminals like Bernie Madoff with unlucky or even excessively leveraged, overly risk-taking, sometimes incompetent, and overpaid managers. Politicians should not throw fuel on any anti-finance or anti-Wall Street sentiments. There is enough anger against “unfairly” accumulated wealth; we do not need more.

"The Asset Bubble Theory of Income Inequality"

Awhile back, I asked "Do large bubbles cause income to become more concentrated, or does the concentration of income cause the bubbles?" There are other possibilities too, causation could be simultaneously and run in both directions, or it could be that there is no causation at all and both bubbles and inequality are driven by a third factor. Justin Fox says he's looked at the data, and the answer is that inequality is driven by bubbles:

The asset bubble theory of income inequality, by Justin Fox: There's been a debate going on for a few years about whether the big rise in income inequality in the U.S. over the past three decades has been at least partly a political phenomenon or purely an economic one. The first camp, whose members include political scientist Larry Bartels and economists Thomas Piketty and Emmanuel Saez (pdf), argues that decisions about taxing and government spending made since the early 1980s have increased the disparity of incomes. The second ... contends that globalization and technological advance have increased the rewards to the most skilled and reduced pay for those whose work can be done by machines or lower-paid workers overseas. Since globalization and technological advance are good things, the increase in inequality thus isn't really something we'd want to stop.

Well now, after looking at the data about the country's 400 highest earners and reading the comments by pneogy and shepherdwong, I am ready to offer an important new theory (well, not entirely new): The rise in income inequality over the past 30 years has to a significant extent been the product of a series of asset-price bubbles. Whenever the market (be it the market in stocks, junk bonds, real estate, whatever) booms, the share of income going to those at the very top increases. When the boom goes bust, that share drops somewhat, but then it comes roaring back even higher with the next asset bubble. It's not the same people raking it in every time—there's lots of turnover in the top 400—but skimming the top off of asset bubbles appears to have become the leading way to get rich in these United States in the past three decades. ...

"Immigration and Inequality"

David Card:

Immigration and Inequality, by David Card, NBER WP No. 14683, January 2009 [open link]: Abstract Immigration is often viewed as a proximate cause of the rising wage gap between high- and low-skilled workers. Nevertheless, there is controversy over the appropriate framework for measuring the presumed effect, and over the magnitudes involved. This paper offers an overview and synthesis of existing knowledge on the relationship between immigration and inequality, focusing on evidence from cross-city comparisons in the U.S. Although some researchers have argued that a cross-city research design is inherently flawed, I show that evidence from cross-city comparisons is remarkably consistent with recent findings from aggregate time series data. Both designs provide support for three key conclusions: (1) workers with below high school education are perfect substitutes for those with a high school education; (2) "high school equivalent" and "college equivalent" workers are imperfect substitutes; (3) within education groups, immigrants and natives are imperfect substitutes. Together these results imply that the impacts of recent immigrant inflows on the relative wages of U.S. natives are small. The effects on overall wage inequality (including natives and immigrants) are larger, reflecting the concentration of immigrants in the tails of the skill distribution and higher residual inequality among immigrants than natives. Even so, immigration accounts for a small share (5%) of the increase in U.S. wage inequality between 1980 and 2000.

We'll see the same close the doors response to immigration we are seeing with trade, and there are short-run and long-run considerations to responding in this way similar to those discussed here.

"Creating Jobs and Closing the Income Gap"

Can policy create jobs and reduce income inequality at the same time?:

Creating new US jobs and closing income gap, by Edward N. Wolff, Commentary, Project Syndicate: With unemployment climbing..., job creation is a key objective for policy makers. ...President Barack Obama recently proposed to increase public spending by about US$600 billion over the next two years to create an additional 4 million jobs.

But Obama is also concerned with reversing a sharp rise in income inequality, which is now at an 80-year high. Is it possible for leaders to do both at the same time? The answer is unequivocally yes, but only if they focus on government spending rather than reforming their tax systems.

America's tax system has surprisingly little redistributional punch. ... Total personal taxes are mildly progressive, increasing steadily as a share of income from 14 percent at the 10th percentile to 28 percent at the 90th percentile. But then they fall off sharply to 22 percent at the top, owing to the favorable treatment of capital gains and investment income.

On the other hand, total transfers have a much bigger equalizing effect on incomes. Cash transfers, like Social Security and unemployment insurance, are highly equalizing. When the value of non-cash government benefits, like Medicaid, Medicare, and food stamps, are also included, total transfers become extremely progressive.

Government spending on goods and services, like education, highways, police, and sanitation, has distributional consequences, too. Public consumption is just as progressive as transfer payments. ...

When you add together government transfers and public consumption and subtract taxes paid, you get a figure for net government expenditures.

This is extremely progressive. As a share of income, it declines sharply from 70 percent at the 10th percentile to -16 percent at the top (in other words, the top bracket pays more in taxes than it receives in government benefits).

The extremely progressive nature of net government expenditures comes about equally from government transfers and public spending; very little is contributed by taxes.

It is not just the poor who benefit from net governmental expenditures. The middle class is also a big beneficiary.

As Obama and other leaders around the world implement stimulus packages in the months ahead, they should recognize that the question of who benefits goes beyond the number of jobs created.

If these packages target education (very redistributive) or sanitation, fire, police, and highways (mildly redistributive), they can create jobs and reduce inequality.

This seems to take the existing tax structure and its suprisingly small "redistributional punch" as fixed, or nearly so, but I don't think we should. A revenue neutral increase in progressivity would not impede recovery, it would provide a mild stimulus as money moves from households with higher savings rates to households with lower savings rates. So the need for stimulus is not, per se, an argument against redistribution.

Cyclists versus Structuralists

Robert Reich:

Once the Stimulus Kicks In, the Real Fight Begins, by Robert B. Reich, Commentary, Washington Post: The real stimulus debate hasn't even started yet. Congress will pass President Obama's stimulus package in the next two weeks... But when the economy starts to turn up again, perhaps as early as next year, the president will have the real tough decisions to make. He'll have to choose which spending will continue -- or whether any of it will continue at all. ...

Those who support the stimulus as a desperate measure to arrest the downward plunge in the business cycle might be called cyclists. Others, including me, see the stimulus as the first step toward addressing deep structural flaws in the economy. We are the structuralists. These two camps are united behind the current stimulus, but may not be for long. Cyclists blame the current crisis on a speculative bubble that threw the economy's self-regulating mechanisms out of whack. They say that we can avoid future downturns if the Fed pops bubbles earlier by raising interest rates when speculation heats up.

But structuralists see it very differently. The bursting of the housing bubble caused the current crisis, but the underlying problem began much earlier -- in the late 1970s, when median U.S. incomes began to stall. Because wages got hit then by the double-whammy of global competition and new technologies, the typical American family was able to maintain its living standard only if women went into the workforce in larger numbers, and later, only if everyone worked longer hours.

When even these coping mechanisms were exhausted, families went into debt -- a strategy that was viable as long as home values continued to rise. But when the housing bubble burst, families were no longer able to easily refinance and take out home-equity loans. The result: Americans no longer have the money to keep consuming. When you consider that consumers make up 70 percent of the economy, the magnitude of the problem becomes apparent.

What happened to the money? According to researchers Thomas Piketty and Emmanuel Saez, since the late 1970s, a greater and greater share of national income has gone to people at the top of the earnings ladder. ... But the rich don't spend as much of their income as the middle class and the poor do... That's why the concentration of income at the top can lead to a big shortfall in overall demand and send the economy into a tailspin. ...

Other structural problems are growing as well. One is climate change and our dependence on oil. Another is the United States' growing reliance on foreign capital, mostly from China, Japan and the Middle East. Neither is sustainable.

Meanwhile, our broken health-care system drains more of our dollars yet delivers less care. ... Most cyclists acknowledge these problems, but they tend to think of them as separate from the current crisis -- issues to be tackled after the economy has recovered, and then only to the extent that we can afford to do so.

But structuralists like myself don't believe that the economy can fully recover unless these underlying problems are addressed. Without policies that put the nation on the path to higher median incomes, higher productivity, renewable energy and a more accessible and efficient health-care system, we'll face deeper and more prolonged recessions...

As early as next year, the business cycle may hit bottom and begin climbing. At that point, cyclists and structuralists will want two different things -- and which side the president chooses will be ... the "central drama" of the Obama administration. ...

There's also another type of structuralist found on the conservative side of debate who focuses almost exclusively on economic growth (though some see that as a facade for upward redistribution of income). Curiously, however, the only way to get growth is tax cuts, government investments in infrastructure - something the left sees as productive investment in public goods - are not generally favored by this group.

However, I want to make a different point that doesn't deal directly with Reich's arguments, but it's a point that is being overlooked too often in the debate about the recovery package. Most observers are marking the turnaround in the economy as the point where GDP begins to turn upward, i.e. after the trough in GDP, and expressing worry that the stimulus package might extend beyond that point.

But looking to the last two recessions for guidance, the trough in employment came much later than the trough in output, the traditional one quarter lag between the upturn in GDP and the upturn in employment was extended considerably, and once employment did turnaround, the recovery of employment was sluggish relative to the recovery in GDP (overall job growth during the Bush years was relatively weak).

So marking the turnaround in GDP as the turning point in the economy rather than looking at the behavior of GDP in conjunction with other measures such as the behavior of employment can lead policymakers to pull back on the recovery effort too fast. If employment follows same path it followed in the last two recessions and lags GDP considerably, the need for stimulus in employment will extend far beyond the point where GDP begins to recover. Thus, if some infrastructure projects cannot be completed before GDP turns upward, and instead take a year or longer to complete - something we're hearing a lot of worry about - that won't be a problem, just the opposite as it will provide a helpful and needed boost to employment.

"The Union Way Up"

Robert Reich argues for unions:

The union way up, by Robert B. Reich, Commentary, LA Times: ...Go back about 50 years, when America's middle class was expanding and the economy was soaring. Paychecks were big enough to allow ... a virtuous circle. Good pay meant more purchases, and more purchases meant more jobs.

At the center of this virtuous circle were unions. In 1955, more than a third of working Americans belonged to one. ... So many Americans were unionized that wage agreements spilled over to nonunionized workplaces as well. ...

Fast forward to a new century. Now, fewer than 8% of private-sector workers are unionized. Corporate opponents argue that Americans no longer want unions. But public opinion surveys ... suggest that a majority of workers would like to have a union to bargain for better wages, benefits and working conditions. ...

One point is clear: ... As our economy grew between 2001 and the start of 2007, most Americans didn't share in the prosperity. ... Home-equity loans and refinancing made up for declining paychecks. But that's over. ...

The way to get the economy back on track is to boost the purchasing power of the middle class. One major way to do this is to expand the percentage of working Americans in unions. ... According to the Department of Labor, workers in unions earn 30% higher wages ... and are 59% more likely to have employer-provided health insurance...

Although America and its economy need unions, it's become nearly impossible for employees to form one. ... The reason? Most of the time, employees who want to form a union are threatened and intimidated by their employers. And all too often, if they don't heed the warnings, they're fired, even though that's illegal. I saw this when I was secretary of Labor... We tried to penalize employers..., but the fines are minuscule. Too many employers consider them a cost of doing business.

This isn't right. The most important feature of the Employee Free Choice Act, which will be considered by ... Congress, toughens penalties against companies that violate their workers' rights. The sooner it's enacted, the better...

The American middle class isn't looking for a bailout or a handout. Most people just want a chance to share in the success of the companies they help to prosper. ...

The Pursuit of Wealth

Tim Duy:

For A Sunday Morning, by Tim Duy: An unusually quiet Sunday morning – the kids are with their grandparents, leaving me with a chance to think of something beyond the immediate economic data. This morning that meant a stream of thoughts triggered by Paul Krugman’s most recent op-ed, particularly this:

Most of all, the vast riches being earned — or maybe that should be “earned” — in our bloated financial industry undermined our sense of reality and degraded our judgment.

Think of the way almost everyone important missed the warning signs of an impending crisis. How was that possible? How, for example, could Alan Greenspan have declared, just a few years ago, that “the financial system as a whole has become more resilient” — thanks to derivatives, no less? The answer, I believe, is that there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing.

In this paragraph, Krugman sounds less like an economist and more like a philosopher. But I am not complaining in the least; economists lost a sense of the essential humanity of their topic when they gravitated down a path of sanitized mathematical and statistical methodology. Indeed, I often think that economists share no small blame for our current economic challenges, as the profession provided the intellectual basis for free markets but often failed to place that ideology in a larger social perspective. It is as if the profession followed the path of The Wealth of Nations but forgot The Theory of Moral Sentiments. The latter is Adam Smith’s philosophical tome, and if you can only read one of these two, it is my recommendation. I suspect that Krugman had TMS in mind when he wrote the above paragraphs. An excerpt from Smith:

Paul Krugman: The Madoff Economy

The costs of "America's Ponzi Era":

The Madoff Economy, by Paul Krugman, Commentary, NY Times: The revelation that Bernard Madoff — brilliant investor (or so almost everyone thought), philanthropist, pillar of the community — was a phony has shocked the world, and understandably so. The scale of his alleged $50 billion Ponzi scheme is hard to comprehend.

Yet surely I’m not the only person to ask the obvious question: How different, really, is Mr. Madoff’s tale from the story of the investment industry as a whole?

The financial services industry has claimed an ever-growing share of the nation’s income over the past generation, making the people who run the industry incredibly rich. Yet, at this point, it looks as if much of the industry has been destroying value, not creating it. And it’s ... had a corrupting effect on our society as a whole.

Let’s start with those paychecks. ... The incomes of the richest Americans have exploded over the past generation, even as wages of ordinary workers have stagnated; high pay on Wall Street was a major cause of that divergence.

But surely those financial superstars must have been earning their millions, right? No, not necessarily. The pay system on Wall Street lavishly rewards the appearance of profit, even if that appearance later turns out to have been an illusion.

Consider the hypothetical example of a money manager who leverages up his clients’ money..., then invests the bulked-up total in high-yielding but risky assets... For a while — say, as long as a housing bubble continues to inflate — he (it’s almost always a he) will make big profits and receive big bonuses. Then, when the bubble bursts and his investments turn into toxic waste, his investors will lose big — but he’ll keep those bonuses.

O.K., maybe my example wasn’t hypothetical after all.

So, how different is what Wall Street in general did from the Madoff affair? Well, Mr. Madoff allegedly skipped a few steps, simply stealing his clients’ money rather than collecting big fees while exposing investors to risks they didn’t understand. ... Still, the end result was the same (except for the house arrest): the money managers got rich; the investors saw their money disappear.

We’re talking about a lot of money here. In recent years the finance sector accounted for 8 percent of America’s G.D.P., up from less than 5 percent a generation earlier. If that extra 3 percent was money for nothing — and it probably was — we’re talking about $400 billion a year in waste, fraud and abuse.

But the costs of America’s Ponzi era surely went beyond the direct waste of dollars and cents.

At the crudest level, Wall Street’s ill-gotten gains corrupted and continue to corrupt politics... Meanwhile, how much has our nation’s future been damaged by the magnetic pull of quick personal wealth, which for years has drawn many of our best and brightest young people into investment banking, at the expense of science, public service and just about everything else?

Most of all, the vast riches ... undermined our sense of reality and degraded our judgment. Think of the way almost everyone important missed the warning signs of an impending crisis. How was that possible? ... The answer, I believe, is that there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing.

After all, that’s why so many people trusted Mr. Madoff.

Now, as we survey the wreckage and try to understand how things can have gone so wrong, so fast, the answer is actually quite simple: What we’re looking at now are the consequences of a world gone Madoff.

"The Rising Tide Tax System"

This is one of the entries in the NY Times Magazine's annual Year in Ideas:

The Rising-Tide Tax System, by Stephen Mihm, NY Times: In the last 20-plus years, overall economic growth in the United States has come at a cost: rising income inequality, which in the past few years has hit levels not seen since the late 1920s. A more progressive income tax, introduced during the New Deal, helped mitigate the problem, and it remains a likely prescription today. Yet a team of economists that includes Robert Shiller of Yale University and Leonard Burman of the Tax Policy Center recently released a paper in which they propose another way of “spreading the wealth”...

Under the proposal, the tax code would automatically be rewritten at the end of each year to reflect any changes in the relative share of national income earned by each income bracket. For example, if one year the nation's top earners saw their share of national income rise while people at the bottom saw their share grow at a slower rate (or decline), the following year's tax rates would be automatically rewritten to compensate for the new inequality. This would keep everyone's share of after-tax income at the earlier level.

The ... proposal would work both ways: if the rich saw their share of the nation's income grow more slowly relative to people lower down the economic ladder, the tax system would become less progressive...

The name of the proposal — the Rising-Tide Tax System — is an allusion to John F. Kennedy's claim in 1962 that “a rising tide lifts all boats,” a promise that general economic growth would benefit all members of society. Shiller argues that it's still possible to turn Kennedy's vision into a reality. “It's something we can engineer,” he says.

This has attractive properties, and it may help us to avoid the concentration of bubble-inducing excess liquidity in the hands of relatively few people, but how do we know which baseline level of inequality to target?

Also, this approach leads to the idea that the only reason for progressive taxation is redistribution, but that's not the case. Concepts such as equal marginal sacrifice can be used to support a progressive structure, so even if there is no redistribution at all we may still want to have progressive taxes. Thus, before we can use this approach we'd have to decide (at least) two things - what is the level of inequality we are targeting, and what is the base level of progressiveness that we use. For example, if there is no change in inequality from previous years, does that mean taxes should be flat?

"Presidents and Income Inequality"

Do Democratic administrations reduce income inequality?:

Presidents and Income Inequality, by Lane Kenworthy: With an incoming Democratic president, should we expect some reversal of the rise in income inequality that has characterized much of the past generation? ...Larry Bartels’ book Unequal Democracy, suggests reason for optimism. Using Census Bureau data covering the period from 1948 to 2005, Bartels finds a much more egalitarian pattern of income growth under Democratic presidents than under Republican ones. [chart] ...

That finding seems to have become accepted as an empirical fact by economic and political commentators. A sampling: Dan Balz, Alan Blinder, Tyler Cowen, Kevin Drum, Andrew Gelman, Ezra Klein, Paul Krugman, Andrew Leigh, Brendan Nyhan, Dani Rodrik, Theda Skocpol, Michael Tomasky, Will Wilkinson, Matthew Yglesias, Julian Zelizer.

Is it correct? The story struck me as convincing for the period through the end of the 1970s, but less so for the years since then. So I went to the data. Here’s a summary of my conclusions:

Bartels’ account of the first portion of the post-World War II era seems to me compelling. From the late 1940s through the 1970s, Democratic and Republican presidents tended to have sharply contrasting fiscal and monetary policy orientations. This difference in policies appears to have contributed to sizable differences in income growth for families at various points in the income distribution. Families near the top tended to do equally well irrespective of the president’s party, but families in the bottom 80% fared better under Democrats. Income inequality in the United States changed little over the period as a whole, as increases under Republican presidents were balanced by declines under Democratic presidents.

Since the 1970s the story has been very different. Income inequality has risen sharply, and the correlation between president’s party and movement in inequality has been much weaker.

If we focus on the bottom 95% of the income distribution, as Bartels does, we observe a notable partisan difference in inequality trends and in patterns of income growth in the lower half of the distribution during this period. Contrary to Bartels’ conclusion, this partisan difference exists mainly for pretransfer-pretax income, suggesting that transfer and/or tax policy differences have not been a key driver. To the extent presidents have mattered, the effect seems more likely to have operated via union strength and/or the minimum wage.

To fully understand post-1970s trends in income inequality in the United States, it is critical to include developments at the top of the distribution, which Bartels does not do. If we turn to data that include the top 1%, we find only a weak association between president’s party and changes in inequality since the 1970s. Republican and Democratic presidents have pursued contrasting tax policies, and those policies appear to have made a difference for inequality. But their impact has been swamped by trends in pretax income. At the moment we know relatively little about the factors driving the dramatic increase in the share of economic growth going to those at the top of the distribution, and even less about what role presidents have played.

The following chart is, I think, the best representation of what’s happened since the late 1970s:

The full paper is here.

Update: Follow-up from Andrew Gelman.

Equitable and Efficient Redistribution

Before there can be redistribution, there must be distribution, and if the initial distribution is unfair - and it's hard to argue that, for example, financial executives were paid their marginal products over the last decade instead of being paid inflated, bubble based incomes - then there's no reason to suppose that redistribution necessarily makes us worse off.

If we accept that being paid the value of your marginal product is fair - and not everyone would agree that it is - but if we do take this as our standard, then we need competitive markets to assure that wages are held to this level. Without the discipline of competition to regulate the marketplace, profits, and hence the income of those at the top of the income distribution, will be larger than can be justified by the contribution those individuals make to output. If that is the case, if markets are not ideal and there are significant departures from pure competition, then redistribution can improve the outcome in terms of providing the correct incentives in the marketplace. Redistribution is not necessarily harmful (that is why, for example, modern macromodels with monopolistically competitive agents often assume that the government imposes a set of lump-sum taxes and transfers to correct any distortions arising from the presence of pricing power).

The point is that those who argue against redistribution are implicitly assuming that markets are competitive and that people are paid accordingly. Thus, any interference is a distortion. But if that is not how a typical market functions, and I'm not convinced earnings at the top end of the income distribution are set in anything approaching a perfectly competitive marketplace, then interference can take away distortions rather than create them.

If people want to make the argument that incomes at the top are, in fact, equal to the contributions these individuals make to output at the margin, then they should make this argument explicit. Tell us why you believe this is true. But I suspect that a lot of the people who would be tempted to do so are the same individuals who were, not too long ago, arguing that financial executives were paid according to their contributions at the margin. They may still want to make that argument, but I think it's pretty clear the incomes these individuals earned were excessive, and that redistributing part of it would not have created bad incentives. In fact, it's easy to see how redistributing the excessive gains might have helped to temper the recent mania and improved the economic outcome.

Redistribution of Opportunity

What if we redistribute opportunity instead of redistributing wealth?:

Equal Chances for Equal Talent, by Will Wilkinson: The first part of Rawls’ Second Principle of Justice says, in Joshua Cohen’s words, “people who are are equally talented and motivated are to have equal chances to attain desirable positions, so far as this is consistent with maintaining equal basic liberties…”

This has always thrown me for a loop. ...

Maybe this is how you approach it, and I do wonder why we don’t see more proposals like the following from those egalitarians who do tend to see the desirable positions as more or less fixed… How about a quota system for firms that limits hiring from high-status schools and mandates a certain number from low-status schools, so that it’s better to be the best kid from the University of North Dakota than the median kid at Princeton? Radical high school-quality affirmative action quotas for college admissions. No Supreme Court justice can have more than one clerk from a top-ten law school. It is illegal ever to hire someone who is a relative, or a friend, or a friend of a friend. Randomized assignments to a vast network of national boarding schools. Combat self-reinforcing prestige by picking an athletic conference at random and then mandating that all Federal Reserve governors for the next ten years be professors at schools from that conference. (So Harvard and MIT econ depopulates as everyone rushes to Creighton and Indiana State. Etc.) Examples of this sort can be multiplied. So would these strategies be “consistent with maintaining equal basic liberties”? Are they necessary for maintaining equal basic liberties, but egalitarians are simply missing the real issue by going on and on about income redistribution? ...

"Urban Inequality"

Glaeser, Resseger, and Tobio:

Urban Inequality, by Edward L. Glaeser, Matthew G. Resseger, and Kristina Tobio, NBER Working Paper No. 14419, October 2008 [Open link]: Abstract What impact does inequality have on metropolitan areas? Crime rates are higher in places with more inequality, and people in unequal cities are more likely to say that they are unhappy. There is also a negative association between local inequality and the growth of both income and population, once we control for the initial distribution of skills. What determines the degree of inequality across metropolitan areas? Twenty years ago, metropolitan inequality was strongly associated with poverty, but today, inequality is more strongly linked to the presence of the wealthy. Inequality in skills can explain about one third of the variation in income inequality, and that skill inequality is itself explained by historical schooling patterns and immigration. There are also substantial differences in the returns to skill, related to local concentrations in different industries, and these too are strongly correlated with inequality.

The paper concludes with:

Area-level income inequality does not create the same policy implications as national income inequality. At the nation level, an egalitarian, Rawlsian social welfare function implies the need to reduce income inequality. However, egalitarianism does not provide the same implications about local inequality. Shuffling people across the country in a way that creates more homogeneity at the local level would not seem like a natural means of increasing social welfare given standard social welfare functions. Instead, such functions would instead push towards a focus on policies like human capital development that would promote equality nationwide. We concluded by noting that localities are poorly poised to reduce inequality on their own. Any attempt at local redistribution is likely to lead to out-migration of the wealthy. Poor localities don’t have the resources to improve failing schools. However, if national policies are going to try to reduce inequality by making the distribution of human capital more equal, then inevitably localities must be involved. Schools are run at the local level. The combination of national resources and local operation seems most likely to improve the quality of the poorly performing schools. Unfortunately, bringing together such different levels of government is inevitably quite difficult. Moreover, the strong correlation between human capital today and human 34 capital more than fifty years ago suggests that any change will not happen overnight.

"Taxes, Bailouts and Socialism"

Is it socialism?

Taxes, Bailouts and Socialism, by James Edward Maule: ...When Senator Barack Obama replied to the question ... about his tax plan by noting that "I think when you spread the wealth around, it's good for everybody," he opened the floodgates of accusations that his tax proposals would amount to socialism. ...

Obama's tax plan is to increase taxes for individuals with incomes exceeding $250,000. Most Americans do not fall into that category, and 95 percent are unaffected by this particular proposal. Americans in that category are paying taxes at lower rates than they were paying a decade ago. The theory was that reducing rates on the rich would generate benefits not only for the rich, but also for everyone else. This "trickle down" theory turned out to be a failed experiment. All that trickled down was the economic pain inflicted on America by the casino capitalist gamblers. Technically, Obama proposes revocation of tax cuts for the wealthy. They had their chance. It failed, other than to make the wealthy wealthier, the middle class smaller, and the gap between the haves and have-nots wider. ...

Will Obama's tax plan redistribute wealth? Hardly. The additional revenue generated by the revocation of tax cuts for the wealthy very well may end up paying the interest on the national debt that was incurred because taxes were cut and kept too low during wartime. One could consider those tax cuts to have been a loan to the wealthy, and the events of the past month have demonstrated what they did with it.

But perhaps there's some wealth redistribution involved. One reasonably can argue that the revenue raised by revoking the tax cuts for the wealthy will be used to fund government programs that help only the poor or only the middle class or only the poor and middle class. Does that make it socialism? More important, does that make it bad policy? ...

Colin Powell has suggested that "Taxes are always a redistribution of money. Most of the taxes that are redistributed go back to those who pay them -- in roads and airports and hospitals and schools. And taxes are necessary for the common good, and there's nothing wrong with examining what our tax structure is or who should be paying more, who should be paying less. For us to say that makes you a socialist, I think, is an unfortunate characterization that isn't accurate." Hooray for Colin Powell. I might disagree that taxes always are a redistribution, because to the extent that they pay for services being rendered to the paying taxpayer, they do not transfer wealth. They simply represent an exchange of cash for services or property. But that articulation technicality aside, there are, and have been for decades, valid arguments for imposing higher taxes on those on whom America has bestowed better opportunities and greater fortune. Undoing the mistaken tax cuts, and fixing the problems caused by trying to fight a war without raising taxes, isn't socialism. It's an attempt to undo the problems caused by welfare for the wealthy. ...

A total ban on wealth redistribution would mean tens of millions of people in need would not get assistance, and in many instances would die. Social Security is wealth redistribution. So, too, is Medicare. So, too, are food stamps. So, too, is the program that provides breakfasts and lunches to school children who would otherwise go unfed. So, too, are all sorts of other programs. If these programs are socialism, and if support for these programs make someone a socialist, then here's some news: by that definition, America has been a socialist nation for decades, and most of its Presidents and legislators have been socialists. So what would it mean to purge "socialism" from public policy? What then would life in America be?

Income Shares and Bubbles - Part 1

Not too long ago, I wondered if there was any connection between bubbles and the concentration of income, and if there is, which way causality runs, i.e. if it is causal, does income concentration lead to bubbles, or is it the other way around, that bubbles cause income to become more concentrated.

James Livingston, an historian at Rutgers, thinks he has the answer:

Their Great Depression and Ours: Part I, by James Livingston: Now that everybody is accustomed to citing the precedent of the Great Depression in diagnosing the current economic turmoil—and now that the Congress has agreed on a bail-out package—it may be useful to treat these episodes as historical events rather than theoretical puzzles. The key question that frames all others is simple: Are these comparable moments in the development of American capitalism?  To answer it is to explain their causes and consequences.

Income Shares and Bubbles - Part 2

James Livingston continues. [Note: For another view, see Anna Schwartz who says, "If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset."]:

Their Great Depression and Ours: Part 2, by James Livingston: Last time out, I asked five questions that would allow us to answer this one: Does the current economic turmoil bear the comparisons to the Great Depression we hear every day, every hour? On my way to these questions, I noticed that mainstream economists’ explanations of the Great Depression converge on the idea that a “credit contraction” engineered by the hapless Fed was the “underlying cause” of that debacle. They converge, that is, on the explanation offered by Milton Friedman and Anna Jacobson Schwartz in 1963 in A Monetary History of the United States, 1867-1960. In this sense, the presiding spirit of contemporary thinking about our current economic plight—from Niall Ferguson to Henry Paulson and Ben Bernanke—is Friedman’s passionate faith in free markets.

How Republicans Equalize Pay between Men and Women

A recent op-ed in the WSJ argues that people should vote Republican if they want equal pay between men and women. Lane Kenworthy explains why women's pay has caught up with men's more during Republican administrations. When Republicans are in power, women don't do a whole lot better relative to when Democrats are in power, men do worse:

Vote Republican if You Want Equal Pay?, by Lane Kenworthy: In a Wall Street Journal op-ed, Casey Mulligan points out that over the past half century the pay gap between women and men has shrunk more under Republican presidents than under Democratic ones. The following chart shows this. The data are from the Census Bureau.

Mulligan argues that the best way to achieve equal pay is therefore “to work for a labor market that creates opportunities for women like it did during the Reagan and the Bush years.” But as the next two charts indicate, the Republican advantage in closing the gender pay gap owes mainly to slow earnings growth for men during Republican administrations, rather than rapid earnings growth for women.

More here and here.

The reminds me of when students come in and say something like "I have the same answer as my roommate, but he/she got four points more than I did." They then argue it's not fair. Ah, the response goes, "we'll have to fix that and make it equal. Have your friend bring their exam to my office, and I'll lower their grade by four points. Who was it again?" That's the same mechanism that equalizes the pay of men and women under Republican administrations.

"Where has US Household Income Gone?"

John Quiggin has a puzzle for you:

Where has US household income gone?, by John Quiggin: I was at a seminar ... on inequality in US household income, and I asked the speaker about something that’s puzzled me for a while. I didn’t really get an answer, so rather than do a lot of work myself, I thought I’d try this crowdsourcing all the cool kids are talking about. Here’s the puzzle.

Over the past 40 years or so, real median US household income has risen by about 30 per cent. [graph] But real US GDP per person has more than doubled. How can this be ?

I’ve done enough work to rule out a couple of easy answers. Average household size has fallen from around 3 to 2.6, but that’s not enough to account for more than a small part of the gap. And inequality as measured by the ratio of mean to median household income has gone up, but again, not enough to account for the gap. In fact, even top quintile income hasn’t quite kept up with GDP per person. [graph]

So it seems as if the ratio of total household income to GDP must have fallen. Where has the extra income gone?

My candidate answers:
(1) A big chunk of income goes to the top 1 per cent of households and isn’t captured by the survey. The seminar gave some support to this idea, at least insofar as this group seems to have a big enough share of the total that the choice of the point where the Census Bureau stops measuring income makes a big difference
(2) A lot of income is flowing to the corporate sector and never being recorded as household income, perhaps because it is distributed in the form of capital gains, which aren’t counted. Again, a very large chunk of these would go to the top 1 per cent.

"The Dream for a Human Capital Agenda"

Ed Glaeser says education is the answer:

The dream for a human capital agenda, by Edward L. Glaeser, Commentary, Boston Globe: ...[I]n this hopeful season of presidential change, even economists need to be for something. Some of my colleagues labor to improve healthcare; others fight for tax reform. My dream is that one, or both, candidates will make human capital the centerpiece of their campaign. ...

America's future will ... depend on the skills of its citizens. In a remarkable new book,... Claudia Goldin and Lawrence Katz make a compelling case that America's 20th-century achievements owed much to our nation's once-robust investment in education, and that since the 1970s the growth in that investment has slowed dramatically.

Also since the mid-1970s, America has become much more unequal. ...[M]illions of Americans seem to have reaped, at best, modest benefits from the past 30 years of technological change.

Scrooge-like economists stress that most means of fighting inequality carry large costs. Progressive taxation reduces the incentives for entrepreneurship. Taxes on capital gains reduce investment. Allegedly redistributive regulations, like rent control, restrict the supply of things, like apartments, that should be abundant. Large welfare programs create the prospect of a permanent, government-funded underclass.

By contrast, investing in human capital offers the potential for permanent increases in earnings that encourage work. Education increases the ability to deal with innovation, so that investing in skills today will make Americans better able to weather the storms of future technological changes. ...

A national human capital agenda requires investing in all children, not just those who might be left behind... Such spending needs to be justified by more than just a desire to reduce inequality. The case for governmental investment in education reflects the fact all of us become more productive when our neighbors know more. ... As the share of adults in a metropolitan area with college degrees increases by 10 percent, the wages of a worker with a fixed education level increases by 8 percent. Area level education also seems to increase the production of innovations and speed economic growth.

American education is not just another arrow in a quiver of policy proposals, but it is the primary weapon ... to fight a host of public ills. One can make a plausible case that improving American education would ... improve health outcomes... People with more years of schooling are less obese, smoke less, and live longer. Better-educated people are also more likely to vote and to build social capital by investing in civic organizations. ...

Because education is both important and difficult, it should be at the center of the presidential political debates.

I also support education and believe a better educated workforce is one of the keys to remaining competitive in the global economy. People with more education will, in general, do better than people with less. But I'm not sure that education alone, particularly in the short-run, is enough to ensure that gains are more equitably distributed. And while I believe education can help with the problem, it's not at all clear that differences in education alone can explain the growth in inequality we have experienced since the growth is concentrated at the very top of the income distribution, and returns associated with a college education have stalled while inequality has risen.

GDP per Capita versus Median Family Income

Here's a nice way to picture the growth in inequality in recent decades from Lane Kenworthy:

Slow Income Growth for Middle America, by Lane Kenworthy: The economic challenges and strains facing middle-class Americans are likely to get a good bit of attention between now and election day, at least from the Obama campaign. They include sluggish income growth, heightened financial insecurity, rising health care and college costs, and falling home values. Each of these is important, but the most critical in my view is slow growth of incomes.

The following chart tells the story.

"Is the U.S. a High-Inequality Country if Mobility Is Taken into Account?"

The U.S. exhibits considerable inequality relative to other countries - it ranks last in the sample of countries in the first graph in the link below. But the data shown in the graph are for a point in time, a single year - the usual measure of inequality - and thus do not capture income mobility. If there are differences in mobility across countries, then perhaps looking at a longer timeframe that allows for mobility will change the picture. Lane Kenworthy, Markus Gangl, and Joakim Palme look at this issue and find that while longer timeframes are associated with lower Gini coefficients, looking at longer timeframes does not improve the position of the U.S. relative to other countries:

Is the U.S. a High-Inequality Country if Mobility Is Taken into Account?, Consider the Evidence

Mobility and Inequality

In his last post, Lane Kenworthy asked: Can Mobility Offset an Increase in Inequality?. His answer, which included a series of graphs to illustrate his point, was that:

...[as] Milton Friedman ... suggested...Income mobility helps to reduce income inequality. ...

Single-point-in-time income inequality has risen sharply in the United States since the 1970s. Has mobility increased too? Stay tuned.

I did stay tuned, and here's the next installment:

Rising Inequality Has Not Been Offset by Mobility, by Lane Kenworthy: Income inequality in the United States is typically measured with data from a survey that asks around 50,000 households what their income was in the previous year. According to these data, inequality has increased sharply since the 1970s (see the second chart here).

But this survey includes different households each year. It therefore misses any mobility — movement of households up and down in the distribution over time — that occurs. If mobility has increased, the conclusion that there is more inequality might be misleading. ...

The type of mobility at issue here is relative intragenerational income mobility. Has it increased in recent decades?

To find out, we need panel data — data for the same households (or individuals) over a number of years. There are three main sources of such data. Each suggests the same conclusion: relative intragenerational income mobility in the United States has not increased.

"China and Wal-Mart: Champions of Equality"

Christian Broda argues that globalization has not increased inequality. The argument is that "China and Wal-Mart have increased the purchasing power of the poor more than the rich," and this offsets unequal changes in income. [My response is here and here. The response argues that a full assessment of the change in worker circumstances should include factors such as changes in economic security (see recent headlines about job layoffs), employer based health care and retirement programs, debt burdens, etc., "and when you do that, it is far less clear that workers have benefited overall even if you take the Broda and Romalis result as given."] [Update: Brad Delong says "Like many people, I am still somewhat puzzled and confused by Christian Broda and John Romalis." See his discussion, and his Multisector Stolper-Samuelson Finger Exercise]:

China and Wal-Mart: Champions of equality, by Christian Broda, Vox EU: The U.S. presidential campaign has sometimes sounded like a contest to prove who despises trade the most, as Willem Buiter and Anne Sibert point out in their recent Vox column. Media reports of job losses to China and the destructive effect of Wal-Mart on local business are ubiquitous. In recent weeks, Lawrence Summers and Martin Wolf have highlighted the dangers of having high-income countries turn against globalisation. This public debate has taken for granted that inequality in these countries has risen as a result of globalisation.

But has it really? In a recent paper, co-authored with John Romalis from the University of Chicago, I argue that it hasn’t.[1] The reason is simple. How rich you are depends on two things: how much money you have and how much the goods you buy cost. If your income doubles but the prices of the goods you consume also double, then you are no better off. Unfortunately, the conventional wisdom on US inequality is based on official measures that only look at the first half, the income differential. National statistics ignore the fact that inflation affects people in different income groups unevenly because the rich and poor consume different baskets of goods.

Inflation differentials between the rich and poor dramatically change our view of the evolution of inequality in America. Inflation of the richest 10 percent of American households has been 6 percentage points higher than that of the poorest 10 percent over the period 1994 – 2005. This means that real inequality in America, if you measure it correctly, has been roughly unchanged. And the reason is just as dramatic as the result. Why has inflation for the poor been lower than that for the rich? In large part it is because of China and Wal-Mart!

"The Income-Inequality Denialists"

Speaking of "the George W. Bush administration ... quest to win the class war by making America’s income distribution more unequal," Justin Fox finds out what happens if you say the inequality in the U.S. has been increasing. I've been down this road:

The strange fantasy world of the income-inequality denialists, by Justin Fox: One of the more interesting developments in the U.S. economy over the past few decades has been the dramatic rise in incomes at the very top of the scale. There's all sorts of anecdotal evidence for this... But the most exhaustive empirical evidence for this income explosion at the top has come from the work of economists Thomas Piketty and Emanuel Saez...

Certain elements among the right-wing economic chattering classes ... have honed an interesting response to this rise in income inequality: They deny that it exists. My economic policy cover story of a while back, which cited Piketty and Saez, seems to be drawing these denialists out of the woodwork. Gary North is one, and now David Gitlitz joins in at National Review Online:

On income inequality, Fox accepts as fact the findings of economists Thomas Piketty and Emanuel Saez that “75% of all income gains from 2002 to ’06 went to the top 1% — households making more than $382,600 a year.” But as Piketty and Saez have acknowledged, these results are significantly skewed by the fact that their data only includes income reported on individual tax returns.

Following cuts in individual tax rates in 1986 (under Ronald Reagan) and 2003 (under George W. Bush), many of the businesses that had been reporting income under the corporate tax switched to the lower individual rate. In 1986, business income accounted for only 11 percent of the income reported by the top 1 percent of earners. By 2005 that share jumped to more than 29 percent. Clearly, much of the reported gain of the top 1 percent is accounted for in this bookkeeping shift.

Uh, no it's not. That purported problem, raised by Alan Reynolds, was swatted down pretty convincingly by Piketty and Saez:

Most of the scenarios described by Alan Reynolds, such as a shift from corporate income to individual income or from qualified stock-options to non-qualified stock options, would imply that high incomes used to receive capital gains instead of ordinary income. For example, a closely held C-corporation which does not distribute its profits increases in value and those accumulated profits would appear as realized capital gains on the owner individual tax return when the business is sold. Yet, our top 1% income share series including realized capital gains has also doubled from 10.0% in 1980 to 19.8% in 2004.

A fair description of the current state of knowledge on the income distribution is that members of the economics establishment (from right-wingers to left) more or less unanimously accept the Piketty and Saez data as a more or less accurate representation of reality. There are big debates about what it all means, and why it's happening, but the only major objections that I know of to the Piketty-Saez data itself have been those raised on the op-ed page of the Wall Street Journal by Reynolds, a senior fellow at the libertarian Cato Institute who doesn't appear to have an advanced degree in economics or in anything else.

It's a case where the scientific consensus says one thing, and this one guy says the opposite. I don't have an advanced degree in anything either, and I like to think that on occasion the scientific consensus will turn out to be wrong and the lone outsider right. But I'm pretty sure this isn't one of those cases.

Why not? First, there's all that anecdotal evidence of vast new fortunes being created.

Second, Piketty and Saez have pretty convincing answers to all of Reynolds' objections to their data.

Third, Piketty and Saez come across as data jockeys with no particular axe to grind, while Reynolds is an overt ideologue.

Finally, when Reynolds strays into an area that I actually know something about--the use of stock options in compensation--he is so clearly blowing smoke that it becomes difficult for me to trust anything else he says....

So here's where all that leaves me. I'm going to keep "accept[ing] as fact the findings of economists Thomas Piketty and Emanuel Saez." And anyone who says I shouldn't do so, without raising some major objections beyond the feeble array already trotted out by Reynolds, goes down in my book as something of a joker.

Adam Smith on Poverty

Gavin Kennedy finds Don Arthur at Club Troppo asking "What if Adam Smith was Right about Poverty?" This relates to the idea often heard in debates about poverty that since the material well-being of the poor has increased over time, there's no need to worry about inequality:

Adam Smith on Poverty, by Gavin Kennedy: A post by Don Arthur in the Australian Blog, Club Troppo, (here) which has been quoted on Lost Legacy in the past when I referred to articles by Nicholas Gruen, opens an interesting and important discussion on poverty in societies and Adam Smith’s expressed view on the issue. I only quote some parts of it, and I have deleted several excellent references and discussions of recent work by academics on related matters. Check the link and read them for yourself:

What if Adam Smith was right about poverty? Don Arthur,  June 22: Well-being isn’t just about our relationship with things, it’s also about our relationships with each other. Poverty hurts, not just because it can leave you feeling hungry, cold and sick, but because it can also leave you feeling ignored, excluded and ashamed. In The Theory of Moral Sentiments Adam Smith argued that all of us want others to pay attention to us and treat us with respect. And "it is chiefly from this regard to the sentiments of mankind, that we pursue riches and avoid poverty."

Recent research confirms Smith’s intuitions — social pain is every bit as aversive as physical pain. ...

So if Smith is right then what should we do about involuntary poverty? Is it enough to provide state subsidised goods such as housing and healthcare and to dole out money for necessities?

Adam Smith — Poverty as social exclusion
According to Adam Smith, human beings are by nature social creatures. In The Theory of Moral Sentiments, he wrote:

Nature, when she formed man for society, endowed him with an original desire to please, and an original aversion to offend his brethren. She taught him to feel pleasure in their favourable, and pain in their unfavourable regard. 

The reason poverty causes pain is not just because it can leave people feeling hungry, cold and sick, but because it is associated with unfavourable regard. As he explains:

"The Rise in American inequality"

Ian Dew-Becker and Robert Gordon discuss possible explanations for the rise in inequality in recent decades, and they conclude that "for top corporate executives, there is strong evidence that incomes have been driven by non-market forces. This is where policy can have the most positive impact on inequality; increased disclosure and improved corporate governance laws can not only raise firm value but help distribute economic gains more evenly across society":

The rise in American inequality, by Ian Dew-Becker and Robert J. Gordon, Vox EU: Of all the economic debates with broad political implications, none competes with the puzzling rise in American income inequality since the late 1970s. Both economists and politicians disagree about the forest and the trees – the overall interpretation of rising inequality and the importance of individual causes. People argue about differences between data sources, about the causes of sinking relative incomes in the middle and bottom percentiles, and have especially contentious disagreements about the interpretation of the leap of relative incomes at the top end. Goldin and Katz (2007) and Piketty and Saez (2003) describe changes in the income distribution over time. In this column we focus on possible explanations for the observed changes at both the bottom and top of the income distribution.

The data

Our initial work on inequality (Dew-Becker and Gordon, 2005) started from an attempt to understand the differential between the growth of mean and median labour income. We documented an important and simple fact: over the period 1966–2001 only the top 10 percent of the income distribution had real compensation growth equal to or above productivity growth. Accordingly here we refer to the lower 90 percent of the distribution as “the bottom” and the top 10 percent as “the top.”

If real compensation growth is roughly equal to productivity growth, then labour’s share of national income will be constant. Figure 1 shows that in fact, over the full period 1950–2006 labour’s share has risen, not fallen. The dotted line adds in the labour portion of proprietors’ income, and shows that labour’s share has been almost exactly flat for more than 50 years. This implies that the growth of mean labour income has been roughly equal to the growth in productivity. But our finding that the bottom 90 percent did not enjoy real income gains equal to productivity growth implies that the growth rate of median income has lagged significantly behind growth in the mean.

"Stolper-Samuelson for the Real World"

Dani Rodrik says that trade with other nations may not cause the wages of unskilled workers to fall as predicted by generalizations of the Stolper-Samuelson theorem. Instead, the main impact may be the losses associated with the displacement of workers as the least efficient firms are driven out of business. Here's a shortened version:

Stolper-Samuelson for the real world, by Dani Rodrik: (Warning: This is a long and wonkish entry, aiming at self-comprehension...)

The Stolper-Samuelson theorem is a remarkable theorem... But the theorem is also quite limited in its applicability. ...

But there is a version of the theorem that is remarkably general and powerful. It says that regardless of the number of goods and factors, at least one factor of production must experience a decline in real income [as a result of opening up to international trade]... All that this result requires is a very mild assumption... The stark implication is that someone will lose, even if the nation as a whole becomes richer. (Here is the proof. ...)

The theorem does not identify who exactly will lose out. The loser in question could be the wealthiest group in the land. But if the good in question is highly intensive in unskilled labor, there is a strong presumption that it is unskilled workers who will be worse off. ...

I have been thinking about this result in connection with Broda and Romalis's remarkable finding that

the rise of Chinese trade has helped reduce the relative price index of the poor by around 0.3 percentage points per year. This effect alone can offset around 30 percent of the rise in official inequality we have seen over this period.

The puzzle here, at least on the face of it, is that one would expect China's trade to have had the largest price impact on labor-intensive goods. And if so, wages of unskilled workers must have fallen even more, along the lines of the Stolper-Samuelson logic sketched out above. Can we still say that trade with China has helped reduce U.S. inequality? ...

What gives? The Auer and Fischer paper underlines another important result. What lies behind the decline in U.S. producer prices in trade-affected sectors is not wage or other input price reductions but mostly increases in total factor productivity. So perhaps what is going is that the Stolper-Samuelson logic is defeated by increases in sectoral productivity induced by import competition. The ... proof of the generalized S-S theorem ... breaks down whenever there is productivity change. After all, if TFP increases, employers can afford to pay unchanged wages even if the prices they face decline.

The next question inquiring minds will want to know is how and why this TFP improvement comes about. The available economic theory on the impact of market competition on firm-level efficiency is notoriously inconclusive and ambiguous. (Profit-maximizing firms should want to minimize costs regardless of how tough competition is.) Perhaps what is happening is a kind of industry rationalization--exit of the least efficient firms--in which case we should see this restructuring and the associated layoffs in the data as well. Moreover, labor does not exactly come out unharmed in this case either. It is after all job loss, and the threat thereof, that workers complain about.

But if this line of reasoning is correct, the main threat to workers is not a Stolper-Samuelson type permanent compression in wages, but the more temporary (and limited) wage losses incurred by displaced workers. This is the kind of problem that wage insurance is ideally suited for.

Stay tuned--if you managed to read this far...

[Note: Richard Serlin responds here.]

Coming Up Short

People in other countries used to look up to Americans, but that is changing:

Economist traces height trends, by Tom Hundley, Chicago Tribune: When John Komlos wants to take the measure of a nation's economic well-being, he doesn't check its gross domestic product or consumer price index. He ignores ... unemployment figures. Instead, Komlos takes a look at how tall its people have grown.

"Height is a very good overall indicator of how well the human organism thrives in its socioeconomic environment," he explained.

Komlos, a professor in the economics department at the University of Munich, Germany, has dedicated his professional life to the study of anthropometric history—his own coinage for the academic field that studies the links between a population's height and general well-being.

What Komlos has learned is that Americans, despite their nation's prosperity, abundance of food and cutting-edge medical technology, stopped getting taller in the 1950s and have now been passed by their European cousins.

"Americans were head and shoulders above Europeans in the 18th Century, and it stayed that way for two centuries," he said. "Now it's the other way around."

This, according to Komlos, suggests that Europeans eat better, have better access to health care and enjoy a more equitable distribution of national wealth. They will almost certainly live longer than their American counterparts. ...

Genetics determines an individual's height—whether a person is shorter or taller than the national norm—but external factors determine a population's height.

While the media quickly latched onto the height rankings, Komlos and other economists were more interested in the external factors that were causing the startling disparity between American and European growth rates.

In the 2004 paper, Komlos fingered two likely suspects: the growing gap between rich and poor in the U.S., and its lack of universal health care.

Although the U.S. has been the dominant economic power since the end of World War II, its wealth has not been very evenly distributed. According to standard measures, countries such as the Netherlands and the Scandinavian nations are at the top of the list; the U.S. ranks near the bottom, tied with Ghana and Turkmenistan, according to UN figures.

When income is distributed more evenly, it follows that access to health care also is evenly and equitably distributed, Komlos said.

He noted that a high number of Americans are without health insurance (a U.S. Census Bureau report put the figure at 47 million for 2006), meaning that millions of American children do not get top-notch medical care during the critical growth years. Meanwhile, the "tall" countries of the world have been providing their citizens with cradle-to-grave health care for generations.

Komlos does not claim that his research has established a causal link between a nation's height and its health care delivery system, only that "height is a pretty good indicator of how well a society treats its children and young people."

Komlos is struck by two things when he visits the U.S.: the alarming proportion of the population that is overweight, and the shortfall in height—especially among females.

Could America's diminished stature have something to do with its expanding girth?

Very likely, Komlos said. "The tremendous amount of fast food consumed by Americans ... has to have an impact," he said. ...

The latest national height data contains some good news and some bad, Komlos said.

The good news is that there are indications that Americans may have started to grow again. The bad news is that this growth trend appears to be bypassing black females. "This is an uncomfortable finding, especially at a time when Europeans and other developed countries are not only catching up but exceeding us," Komlos said.

Here's Paul Krugman on the same topic. He says:

We seem to be left with two main possible explanations... One is that America really has turned into 'Fast Food Nation.'

A broader explanation would be that contemporary America ... doesn’t take very good care of its children. ... Whatever the full explanation..., our relative shortness, like our low life expectancy, suggests that something is amiss with our way of life. A critical European might say that America is a land of harried parents and neglected children, of expensive health care that misses those who need it most, a society that for all its wealth somehow manages to be nasty, brutish — and short.

Update: Eric at Edge of the American West has a brief follow-up on whether this is due to immigration (it's not). Free Exchange weighs in here.

Inexpensive, Low-Quality Goods and Inequality

A paper by Christian Broda and John Romalis implies that inequality may not have changed as much as we thought in recent decades, and the result is getting lots of publicity. But Lane Kenworthy doesn't think the claim about inequality is very compelling:

Inequality and Prices, by Lane Kenworthy: Steven Levitt and Will Wilkinson point to a new paper that Levitt says “shatters the conventional wisdom on growing inequality” in the United States. The paper is by Christian Broda and John Romalis, economists at the University of Chicago.

Here’s their argument: Income inequality has increased over time. But analysis of consumption data indicates that people with low incomes are more likely than those with high incomes to buy inexpensive, low-quality goods. In part because those goods increasingly are produced in China, their prices rose less between 1994 and 2005 than did the prices of goods the rich tend to consume. Hence the standard measure of inequality, which is based on income rather than consumption, greatly overstates the degree to which inequality increased. The incomes of the rich rose more than those of the poor, but because the cost of living increased more for the rich than for the poor, things more or less evened out.

Their point that the prices of some goods have risen less than the overall inflation rate, and that this is due in large part to imports from China, seems perfectly valid and worth making. It has important implications for our understanding of how absolute living standards for America’s poor have changed over time.

But I’m not sure why Broda and Romalis, or Levitt and Wilkinson, think this should alter our assessment of the trend in inequality. Do they mean to suggest that the revealed preference of the poor for cheap goods is exogenous to their income? In other words, people with low incomes simply like buying inexpensive lower-quality goods, and they would continue to do so even if they had the same income as the rich. Likewise, the rich simply have a taste for better-quality but pricier goods, and they would continue to purchase them even if they suddenly became income-poor. If this is the assumption, I guess the conclusion follows. But I can’t imagine the authors, or anyone else, really believe that.

Actually, Levitt may believe it. “How rich you are,” he says, “depends on two things: how much money you have, and how much the stuff you want to buy costs” (my emphasis).

Consumption is worth paying attention to. But income is important in its own right because it confers capabilities to make choices. What matters, in this view, is what you are able to buy rather than what you want to buy. If a rich person with expensive tastes gets an extra $100,000, she can continue buying high-end clothes and gadgets. Or she can choose to purchase low-end Chinese-made products and save the difference. Suggesting that if she opts for the former there has been no rise in inequality is not very compelling.

And on the consumption data, recall Gordon and Dew-Becker's statement:

The paper concludes that data on consumption inequality are too fragile to reach firm conclusions...

[Felix Salmon also responds in "Rich-Poor Inflation Differentials: Smaller Than You Might Think" (there's a rebuttal comment from James Surowiecki), and my indirect response is here. My point was that an assessment of how imports of low-priced manufactured goods impacts the welfare of the working class has to include all of the changes that have hit labor and product markets as a consequence of increased international trade, and when you do that, it is far less clear that workers have benefited overall even if you take the Broda and Romalis result as given.]

"The Canary in the Mine?"

I have a hard time picturing Larry Summers as a canary:

Is Larry Summers the canary in the mine?, by By Devesh Kapur, Pratap Mehta and Arvind Subramanian, Commentary, Financial Times: Is a liberal international economic order losing intellectual support? Should developing economies be worried? If Larry Summers is the canary in the intellectual mine, his two columns in the Financial Times suggest that the answers to both questions are yes.

The liberal economic order of the last several decades was premised on two assumptions. First, that the proliferation of prosperity across countries was a good thing. Second, there would be winners and losers but, on balance, a majority of people in both developing and developed countries would benefit. Mr Summers now appears to be questioning both assumptions ..., his columns ... suggest that globalisation creates competition for America.

This is an obvious fact. For the first time since the 17th century the west’s economic pre-eminence is being seriously challenged. But he goes on to draw the disturbing conclusion that the process of globalisation should be attenuated, precisely because it poses potential threats to the US. In doing so he, perhaps unwittingly, presents the rise of the poorer parts of the world ... more as a threat than an opportunity to the US. In effect, globalisation is justified only when it serves American interests.

This apparently nationalist argument is couched in appealing distributional terms. The losers in the process are US workers. The structure of globalisation is such that their bargaining power is considerably weakened, while mobile capital reaps all the benefits.

Mr Summers is right to worry that US workers have not benefited as much from globalisation... He is also right to assert that globalisation requires democratic legitimation.

But the ... terms of what constitutes just globalisation cannot be determined unilaterally from the standpoint of the gains and losses within the US. It has to be determined co-operatively, involving discussions over the costs and benefits to all, especially those least able to defend their interests in both rich and poor countries. ...

That globalisation needs appropriate regulation is hardly in doubt. But blaming globalisation preponderantly for the ills of American workers runs the risk of providing an alibi for the sins of omission in domestic policy that have had a much bigger impact.

It is undeniable that the best line of defence for protecting workers has to be overwhelmingly domestic – through progressive taxation, improving education, strengthening the bargaining position of labour and improving the safety nets. Since the Ronald Reagan years, the headlong embrace of market solutions has systematically undermined each of these policy responses.

One reading is that Mr Summers’ angst about globalisation is motivated by desire to maintain the environment for the continuing spread of prosperity: a need to tweak the rules – through regulatory harmonisation – to bolster the fraying consensus among the US middle class in favour of globalisation.

But the manner in which his position is framed, the inconsistencies of the arguments across time, the inappropriate transferring of the burden of any response from domestic actions to international ones, and the susceptibility of the proposed remedies to protectionist misuse point to a more alarming prospect for developing countries. The ground is shifting under their feet. They would do well to take notice.

"Controversies about the Rise of American Inequality: A Survey"

Robert Gordon and Ian Dew-Becker survey "seven aspects of rising inequality":

Controversies about the Rise of American Inequality: A Survey, by Robert J. Gordon and Ian Dew-Becker,  NBER WP 13982, April 2008 [Open Link to Paper]: Abstract This paper provides a comprehensive survey of seven aspects of rising inequality that are usually discussed separately: changes in labor's share of income; inequality at the bottom of the income distribution, including labor mobility; skill-biased technical change; inequality among high incomes; consumption inequality; geographical inequality; and international differences in the income distribution, particularly at the top. We conclude that changes in labor's share play no role in rising inequality of labor income; by one measure labor's income share was almost the same in 2007 as in 1950. Within the bottom 90 percent as documented by CPS data, movements in the 50-10 ratio are consistent with a role of decreased union density for men and of a decrease in the real minimum wage for women, particularly in 1980-86. There is little evidence on the effects of imports, and an ambiguous literature on immigration which implies a small overall impact on the wages of the average native American, a significant downward effect on high-school dropouts, and potentially a large impact on previous immigrants working in occupations in which immigrants specialize. The literature on skill-biased technical change (SBTC) has been valuably enriched by a finer grid of skills, switching from a two-dimension to a three- or five-dimensional breakdown of skills. We endorse the three-way "polarization" hypothesis that seems a plausible way of explaining differentials in wage changes and also in outsourcing. To explain increased skewness at the top, we introduce a three-way distinction between market-driven superstars where audience magnification allows a performance to reach one or ten million people, a second market-driven segment consisting of occupations like lawyers and investment bankers, and a third segment consisting of top corporate officers. Our review of the CEO debate places equal emphasis on the market in showering capital gains through stock options and an arbitrary management power hypothesis based on numerous non-market aspects of executive pay. Data on consumption inequality are too fragile to reach firm conclusions. We introduce two new issues, disparities in the growth of price indexes and also of life expectancy between the rich and the poor. We conclude with a perspective on international differences that blends institutional and market-driven explanations. ...

9. Conclusion ...We argued in section 2 that there have been no interesting changes in labor’s share of national income over the last two decades, once a consistent cyclical chronology is applied. Over the full period 1950–2006 labor’s share has risen, not fallen, but once the labor portion of proprietor’s income is added in, labor’s share has been almost exactly flat for more than 50 years. Further, we point out that labor’s share in national income is not related to the current debate about increased inequality. If the labor income of the highest-paid workers increased enough, we could observe simultaneously an increase in labor’s share and a decline in the real income of the median worker.

Section 3 documents the evolution since the late 1970s of the 90-50-10 ratios from CPS data for men, for women, and for both together. Our most important finding is that all discussions of income by percentile below the 90th must distinguish carefully between men and women. We were surprised to learn that the 90-10 income ratio for women has increased by fully double the increase for men. While the 90-50 ratio for both men and women increased slowly and steadily from 1979 to 2005, the 50-10 ratio showed a sharp jump in 1979–86 that was twice as large for women as for men. Then the 50-10 ratio remained on a high plateau for women about 20 percent above its 1979 value, while for men the 50-10 ratio gradually slipped back to its 1979 value.

In examining causes for these changes, we focus in section 4 on five elements, the decline of unionization, the increase of trade, the increase of immigration, the decline in the real minimum wage, and the drop in top-bracket income tax rates.

"How Big a Deal is Trade?"

A recent article in The Economist states:

Krugman's conundrum, The Economist: "This paper is the manifestation of a guilty conscience." With those words, Paul Krugman began the recent presentation of his new study of trade and wages at the Brookings Institution. Mr Krugman ... had concluded in a 1995 Brookings paper that trade with poor countries played only a small role in America's rising wage inequality... Mr Krugman's paper convinced economists that trade was a bit-part player in causing inequality. Other factors, particularly technological innovation..., were much more important.  ...

In recent years ... the issue has returned. ...Mr Krugman has become more sceptical. “It's no longer safe to assert that trade's impact on the income distribution in wealthy countries is fairly minor,” he wrote on the VoxEU blog last year. “There's a good case that it is big and getting bigger.” .... His new paper set out to substantiate these assertions.

That proved hard. ... If you simply update the approach used in Mr Krugman's 1995 paper to take into account today's trade patterns, you find that the effect on wages has increased. Josh Bivens, of the Economic Policy Institute, a Washington, DC, think-tank, did just that and found that trade widened wage inequality between skilled and unskilled workers by 6.9% in 2006 and 4.8% in 1995. But even with that increase, trade is still far from being the main cause of wage inequality. Lawrence Katz, a Harvard economist who discussed Mr Krugman's paper at Brookings, estimates that, using Mr Bivens's approach, trade with poor countries can account for about 15% of the growth in the wage gap between skilled and unskilled workers since 1979. ...

While the New York Times says:

There is also no question that life for many American workers has gotten tougher since the 1970s. Paychecks have failed to keep pace with productivity as most of the spoils of growth have gone to a tiny elite.

Still, critics’ charges that trade is to blame are misguided. While trade can hurt some workers, most economists believe it plays a modest role compared with other forces in the economy, including advances in technology, the decline of trade unions and mushrooming executive pay. ...

No matter how hard economists look for trade’s fingerprints on these inequities, they find it plays only a bit part. Josh Bivens of the Economic Policy Institute estimated that rising trade with poor countries increased wage inequality between college and high school graduates by about 7 percent over the past quarter-century — but the wage gap has widened by more than six times that amount over that period. And many economists think Mr. Bivens overstates trade’s impact. Robert Lawrence of Harvard, who was an adviser to President Bill Clinton, concluded that the increase in wage inequality since the 1990s had little to do with trade. ...

Josh Bivens would like a chance to set the record straight:

How Big a Deal is Trade?, by Josh Bivens: The campaign to exonerate trade from any role in pressuring American living standards proceeded this weekend with a Sunday editorial in the New York Times. This time, my own research was dragooned into service.

This is the second time in recent weeks this research was referenced in media outlets, and, in both cases the writers claimed that what it showed was that trade's contribution to the wage problems of American workers just isn't that big a deal.

The method for arguing a de minimus effect of trade is tried and true: scale trade's impact against the sum total of all influences that have wedged wages apart in the US economy since the late 1970s. This total rise in wage inequality has been so large, and, its causes so varied, that any single influence looks pretty small when scaled against it.

In my paper referenced by the Economist and the New York Times, I explicitly refused to make this (misleading in my mind) calculation. Instead, I translated trade's impact into dollars lost per year by workers on the losing end of trade - those without a 4-year college degree.

While I continue to maintain this calculation has more real-world relevance, I guess it was hubris to think I could change an old chestnut in the trade debate, and, others decided to do the exercise of scaling trade's contribution to the total rise in inequality for me. Along the way, some errors of fact and interpretation have been made, so, I'll try to correct them here.

First, we need to agree on two things: (1) the relevant time-period to look at, and, (2) the total rise in the metric of inequality we're arguing about.

1979 is a popular year to start from, mostly because it is the high-point of wage equality in the last generation. However, a little-known fact is that the importance of trade in the US economy actually grew faster in the 1970s than the 1980s. Starting from 1979 implicitly says that the damage trade had inflicted on wages by then should be totally discounted.

1973 is a better choice for a starting year. It is the year that the Bretton Woods system finally disintegrated and the US exchange rate began to float, it is a business cycle peak, and, it is the year that sees imports from low-wage nations begin register in their importance to the broad US economy.

A popular metric of inequality is the wage of college graduates relative to non-graduates. Below I'm pasting the relevant wage measures for this comparison. The upshot is that this relative wage has risen by just under 20% since 1973.

It feels strange for an avowed inequality pessimist to chastise others for overestimating inequality, but, in the trade and wages debate (if nowhere else), those with a sanguine outlook on trade often inflate the total rise in inequality in an effort to make trade's contribution look small.

The New York Times, for example, wrote that wage inequality rose "six times as much" as my estimate of trade's contribution. This is flat-wrong - nobody thinks the relative wage of graduates has risen by 42% over any stretch of time in the past 50 years. I'm not sure how they got this wrong, but, there are some common errors people make in this debate.

Sometimes people reference the percentage point change in the relative wage of college graduates between 1973 and 2007 was around thirty (still not 42, but, closer). However, this relative wage didn't start from 100, so, the percent change in the relative wage was less (both percentage point and percent changes are shown below). My 7% number is a percent change, and, in percentage point terms would be closer to 11.

If one accepts 1973 as the starting point, and, accepts the correct numbers on the rise in the relative wage of college graduates, this implies that my research shows that trade has contributed roughly a third of the entire increase in this measure of inequality. No, international trade flows don't dominate all other sources of wage growth and/or decline in the American economy, but, their impact just isn't trivial.

I still submit that this "share of inequality" metric is a profoundly misleading benchmark, useful only for minimizing the impact of trade (or, actually, any other single influence upon wage inequality). The 7% swing in relative wages translates into more than a $1,000 cut in annual earnings for these workers, about double the wage-loss they experienced due to the last recession. And, unlike wage losses stemming from movements in the business cycle, those stemming from trade are permanent, and, promise only to grow.

"The Cost of Rising Inequality"

If the gains from economic growth since 19779 had been shared equally instead of flowing disproportionately toward the top of the income distribution, how would more income would the bottom 80% of the distribution have had?:

The Cost of Rising Inequality, by Lane Kenworthy: Income inequality in the U.S. has increased sharply in the past generation. Those who worry about this development do so partly on grounds of fairness and partly because inequality may have adverse effects on politics, health, and crime. Sometimes overlooked is a more immediate cost: slow income growth for a large chunk of the population.

The following chart shows average inflation-adjusted incomes in 1979 and 2005 for various groups of households: the bottom 20%, the lower-middle 20%, the middle 20%, the upper-middle 20%, the next 10%, the next 9%, and the top 1%. The incomes include government transfers and subtract taxes. The data, from the Congressional Budget Office (here), are the best available for this purpose.

The average income among all households rose at a rate of 1.5% per year over these two and a half decades. But as the chart makes plain, much of that increase went to households at the top of the distribution, especially those at the very top. Households in the bottom three quintiles experienced very slow income growth — 0.2% per year for the poorest quintile, 0.6% for the next, and 0.7% for the middle.

What would 2005 incomes have looked like if income growth had been proportionate rather than heavily skewed in favor of the top — in other words, if all incomes had increased at a pace of 1.5% per year? The dashed line in the next chart shows the answer. To make it easier to see the effect, I include only the bottom 80% of households here. All of them would have been a good bit better off.

It’s often said that progressives focus too much on the distribution of income and don’t pay enough attention to absolute income levels. In fact, its impact on absolute incomes is one of the chief reasons to be concerned about rising inequality.

Tax Progressivity and Inequality

Is reduced progressivity of taxes responsible for the rise in inequality in recent decades?

Tax Progressivity and the Rise in Inequality, by Lane Kenworthy: Income inequality in the United States has increased sharply since the 1970s. How much of this is due to reduced tax progressivity?

A key element of the rise in inequality has been the dramatic jump in incomes among the top 1% of the population. According to calculations from IRS data by Thomas Piketty and Emmanuel Saez (available here), this group’s share of total income more than doubled during the 1980s and 1990s.

This is due in part to the fact that in recent decades taxes have done less to reduce the top 1%’s income share. The following chart shows the pretax and posttax income share of this group from 1960 to 2001, according to the Piketty-Saez calculations. Between 1960 and 1979, its posttax income share was 70% of its pretax share. In the period from 1980 to 2001 that increased to 84%.

(Note: The Piketty-Saez data end in 2001, so they don’t reflect the Bush tax cuts. Calculations by the Congressional Budget Office suggest that from 2002 to 2005 the top 1%’s posttax income share was 85% of its pretax share, very similar to what the Picketty-Saez data indicate for 1980-2001. I don’t use the CBO data here because they go back only to 1979.)

What effect has this had on inequality?

The chart makes clear that most of the rise in the top 1%’s posttax income share is due to the increase in its pretax share rather than to changes in tax progressivity. The next chart offers another way to see this. The solid line in the chart shows the top 1%’s share of after-tax income since 1960. The dashed line shows what the top 1%’s share of income would have been had taxes reduced it to the same degree as in the 1960s and 1970s. It’s lower, but not massively so. Changes in taxation have mattered, but they have not been the main reason for the rise in the top 1%’s income share.

If reducing inequality is an aim of the next administration, increasing the progressivity of our tax system would surely help. But this is only one piece of the puzzle.