Economist's View

"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.

Mankiw: The Wealth Trajectory: Rewards for the Few

Greg Mankiw on the sources of rising inequality:

The Wealth Trajectory: Rewards for the Few, by N. Gregory Mankiw, Economic View, NY Times: If there is one thing about the United States economy in recent years that is beyond dispute, it is this: It’s a great time to be rich. ...

You see it in the daily headlines... Lloyd C. Blankfein, chief executive of Goldman Sachs, took home $68.5 million last year.... Bill and Hillary Clinton raked in $109 million. These stories are not mere aberrations. According to the economists who crunch the numbers, they reflect a long-term trend of increasing economic inequality.

The best data on the superrich comes from Thomas Piketty ... and Emmanuel Saez... They report that ... the superrich have been getting an increasing slice of the economic pie. In 1980, the top 0.01 percent of the population had 0.87 percent of total income. By 2006, their share had more than quadrupled to 3.89 percent, a level not seen since 1916.

Critics of the Piketty-Saez data argue, with some justification, that tax return data is unreliable. ... It is hard to escape the conclusion, however, that Professors Piketty and Saez are finding something real. ...

Offsetting this trend to some degree is the shrinking gender gap. Female workers started well below their male counterparts and have been catching up. But despite this equalizing force, the earnings ratio of the 90th to 10th percentiles, men and women combined, has risen 30 percent.

What accounts for rising inequality? Some pundits are tempted to look inside the Beltway for a cause, but the case is hard to make. Government policy makers do not have the tools to exert such a strong influence over pretax earnings, even if they wanted to do so.

Also, the trend toward increasing inequality has been fairly steady, despite changing political winds. The income share of the richest families increased substantially both during Ronald Reagan’s eight years in office and during Bill Clinton’s.

The best diagnosis so far comes from ... Claudia Goldin and Lawrence F. Katz... Their bottom line: “the sharp rise in inequality was largely due to an educational slowdown.”

According to Professors Goldin and Katz, for the past century technological progress has been a steady force not only increasing average living standards, but also increasing the demand for skilled workers relative to unskilled workers. ...

For much of the 20th century, however, skill-biased technological change was outpaced by advances in educational attainment. In other words, while technological progress increased the demand for skilled workers, our educational system increased the supply of them even faster. As a result, skilled workers did not benefit disproportionately from economic growth.

But recently things have changed. Over the last several decades, technology has kept up its pace, while educational advancement has slowed down. ...

Because growth in the supply of skilled workers has slowed, their wages have grown relative to those of the unskilled. This shows up in the estimates of the financial return to education made by Professors Goldin and Katz. In 1980, each year of college raised a person’s wage by 7.6 percent. In 2005, each year of college yielded an additional 12.9 percent. The rate of return from each year of graduate school has risen even more — from 7.3 to 14.2 percent.

While education is the key to understanding broad inequality trends, it is less obvious whether it can explain the incomes of the superrich. Simply going to college and graduate school is hardly enough to join the top echelons...

But neither is education irrelevant. If Mr. Blankfein had left the New York public school system and gone directly to work, instead of attending Harvard College and Law School, most likely he would not be the head of a major investment bank today.

If the Clintons had been content with high school diplomas and not attended Georgetown, Wellesley, Oxford and Yale, they most likely would not ... now be getting multimillion-dollar book deals and $100,000 speaking dates. A top education is no guarantee of great riches, but it often helps.

Maybe educational levels are like Willie Wonka’s chocolate bars. A few of them come with golden tickets that give you opportunities almost beyond imagination. But even if you aren’t lucky enough to get a golden ticket, you can still enjoy the chocolate, which by itself is well worth the price.

More from Goldin and Katz on this topic here (see also Krugman:  Graduates Versus Oligarchs, Acemoglu: The Source of Rising Inequality, Delong: Driving Forces Behind Rising Income Inequality: Tracking the Internet Debate, and Yellen: Economic Inequality in the United States).

Frank Levy and Peter Temin provide one counterargument:

Inequality and institutions in 20th century America, by Frank Levy and Peter Temin, Vox EU: A central feature of post-World War II America was mass upward mobility: individuals seeing sharply rising incomes through much of their careers, and each generation living better than the last. It therefore is problematic that recent productivity gains have not significantly raised incomes for most American workers. In the quarter century between 1980 and 2005, business productivity increased by 71%. Over the same quarter century, median weekly earnings of full-time workers rose from $613 to $705, a gain of only 14% (figures in 2005 dollars), as our recent research shows.[1] Detailed analysis of these years shows that college-educated women are the only large labour-force group for whom median compensation grew in line with labour productivity.

"Do People Care about Inequality?"

Lane Kenworthy says there is evidence suggesting "that inequality matters to people":

Do People Care About Inequality?, by Lane Kenworthy: A question in the International Social Survey Programme’s 1999 survey offered respondents pictorial illustrations of various income distributions and asked “What do you think the distribution in your country ought to be like — which do you prefer?” The choices were depicted as follows:

A relatively small share, fewer than 20% in most countries, said they preferred type A, B, or C. This isn’t surprising; each of those three has a large share of the population at the bottom. The bulk of respondents selected either type D or type E.

D and E are identical in their population shares at the bottom. The difference between them is that D has a larger share in the middle, whereas E has a larger share at the top. Average income is higher in E. Inequality is lower in D.

Interestingly, more respondents in the ISSP survey preferred D than preferred E. The results are strikingly similar across countries, even among nations that seemingly have very different orientations toward affluence and equality.

I wouldn’t go so far as to conclude from this that people tend to value low inequality over high incomes. Other ways of posing the question might yield different results. But it does suggest that inequality matters to people.

I chose E.

If You Didn't Hear It, Was It Really a Boom?

From 2000 to 2007, the typical household lost income:

For Many, a Boom That Wasn’t, by David Leonhardt, NY Times: ...The ... now-finished boom was, for most Americans, nothing of the sort. In 2000, at the end of the previous economic expansion, the median American family made about $61,000, according to ... inflation-adjusted numbers. In 2007, in what looks to have been the final year of the most recent expansion, the median family, amazingly, seems to have made less — about $60,500.

This has never happened before, at least not for as long as the government has been keeping records. In every other expansion since World War II, the buying power of most American families grew... You can think of this as the most basic test of an economy’s health: does it produce ever-rising living standards for its citizens? ...

“We have had expansions before where the bottom end didn’t do well,” said Lawrence F. Katz, a Harvard economist who studies the job market. “But we’ve never had an expansion in which the middle of income distribution had no wage growth.”

More than anything else — more than even the war in Iraq — the stagnation of the great American middle-class machine explains the glum national mood today. As part of a poll that will be released Wednesday, the Pew Research Center asked people how they had done over the last five years. During that time, remember, the overall economy grew every year, often at a good pace.

Yet most respondents said they had either been stuck in place or fallen backward. Pew says this is the most downbeat short-term assessment of personal progress in almost a half century of polling. ...

Anxiety about the income slowdown has flared at various times over the past three decades. It seemed to crescendo in the first half of the 1990s, when voters first threw George H. W. Bush out of office, then, two years later, did the same to the Democratic leaders of Congress. ...

Then came a technology bubble that made everything seem better, for a time. Record-low oil prices in the 1990s helped, too. So did the recent housing bubble, allowing families to supplement their incomes by taking equity out of their homes.

Now, though, we appear to be out of bubbles. It’s hard to see how the economy will get back on track without some fundamental changes. This, I think, can fairly be considered the No. 1 economic project awaiting the next president.

Fortunately, there is an obvious model waiting to be dusted off. The income gains of the postwar period didn’t just happen. They were the product of a deliberate program to build up the middle class, through the Interstate highway system, the G. I. Bill and other measures.

It’s easy enough to imagine a new version of that program, with job-creating investments in biomedical research, alternative energy, roads, railroads and education. ...

The tax code, meanwhile, has become far more favorable to high-income workers at the same time that they — and they alone — have received large pretax raises. ...

It’s a pretty big to-do list. But it’s a pretty big problem. Since the economy now seems to be in recession, and since recessions inevitably bring their own pay cuts, my guess is that the problem will look even bigger by the time the next president takes office.

The article also says:

The causes of the wage slowdown have been building for a long time. They have relatively little to do with President Bush or any other individual politician (though it is true that the Bush administration has shown scant interest in addressing the problem).

There are arguments about how the political environment could have affected wage growth, e.g. by changing rules and enforcement practices regarding unionization. But I want to focus on the second part of the statement, the lack of attention to domestic issues and the fortunes of lower and middle class households by this administration.

It could be that the administration's lack of attention to domestic issues and the troubles that working families face is one of the costs of war - there wasn't time to address these issues and run a war too. But there was plenty of time to cut taxes on capital gains and dividends, plenty of time to try and remove the estate tax (even in the aftermath of Katrina), there was plenty of time to do things that benefited those at the upper end of the income distribution, so that argument doesn't stand up to closer inspection. There was time to address these issues - there was time to find a way to share the gains from the boom across a wider swath of the population - but the administration and congress, a congress that was controlled by Republicans for most of this time period, had no desire to do so.

Update: Graph of the Pew survey results mentioned in the article (from the WSJ Economics Blog):

"Inequality and Meritocracy"

This is from a new blog that focuses, among a variety of other things, on inequality:

Inequality and meritocracy, by Kathy G.: Yesterday Atrios made this astute observation:

Lots of people in this country are basically born on 2nd and 3rd base and then manage to stay there for the rest of their lives. And many of them look down on those who start at home plate and fail to hit a home run.

This brought to mind an excellent essay about college admissions... The whole phenomenon of college admissions fascinates me, because college admissions is in many ways one of the few overt manifestations of the otherwise often invisible American class system. ...

One of the most pernicious effects of America's so-called meritocracy is ... the attitude of smug entitlement it often produces. ... A distressingly large number of people in our society seem to believe that going to college is proof that they're "smarter" than their non-college-educated fellow citizens, and therefore more deserving of respect, status, and the comforts of middle-class life.

Of course, not going to college is no cause for shame, any more than attending college should necessarily be a cause for pride. In the U.S., low income is likely to be a huge barrier  to going to college, even among the highest scoring students.

I saw this entitled attitude ... on display ... during the 2005 New York City transit strike.  I remember how some commenters ... expressed disgust and incredulity that people who didn't even go to college (i.e., transit workers) had job security, decent benefits, and salaries of 50 or 60K a year. How dare they! ...

The counterpart to the smug entitlement of the "winners" in our society is the shame and self-loathing of the losers. In her recent book about unemployment, Barbara Ehrenreich wrote about the feelings of inadequacy and self-blame of those who, through no fault of their own, lost their jobs. New York Times Louis Uchitelle reported similar attitudes in the laid off workers he interviewed for his book.

The left in this country has a huge task on its hands: to chip away decades of individualistic, right-wing, propagandistic bullshit and explain to Americans how power and the class system work in this country. We need to get through to them about how utterly arbitrary the whole process is, and how where one ends up on the economic ladder tends to be overwhelmingly a product of where one started out in the first place.

Above all, we desperately need to instill some humility and compassion into our overclass -- and some good old-fashioned pride and fighting spirit into the rest of us.

The President's Party Affiliation and Changes in Inequality

Will Wilkinson says he has questions about a result in Larry Bartels' new book concerning the relationship between changes in inequality and whether the president is Republican or Democrat:

Unequal Democracy, by Will Wilkinson: I’m three pages into the first chapter of Larry Bartels’ forthcoming Unequal Democracy: The Political Economy of the New Gilded Age and I have questions:

My examination of the partisan politics of economic in equality, in chapter 2, reveals that Democratic and Republican presidents over the past half-century have presided over dramatically different patterns of income growth. On average, the real incomes of middle- class families have grown twice as fast under Democrats as they have under Republicans, while the real incomes of working poor families have grown six times as fast under Democrats as they have under Republicans. These substantial partisan differences persist even after allowing for differences in economic circumstances and historical trends beyond the control of individual presidents. They suggest that escalating inequality is not simply an inevitable economic trend— and that a great deal of economic inequality in the contemporary United States is specifically attributable to the policies and priorities of Republican presidents.

Fascinating if true! But, congress writes the laws, not the president. So why not look at the party tilt of congresses rather than presidents? Or the alignments between the party controlling congress and the part in the White House. What happens under divided government, I wonder.

This is not to say that presidents don’t have a lot of policymaking power... The cabinet agencies’ considerable discretion in creating and enforcing regulations and their ability to selectively apply and enforce legislated mandates should be troubling — in itself and independent of issues of partisan slant — to those, like Bartels, who start with the Dahl’s “Who governs?” question.

Because growth effects, for good or ill, follow policy changes with a pretty long lag (in political time at least), I guess this effect is supposed to be largely a function of redistributive policy that can take effect within a president’s term?

I’m looking forward to reading pages 4 - n. ... I find that I’m completely convinced by the main premise .. that a great deal of the increase in inequality has been an effect of Republican approaches to taxation and redistribution. I’m simply not convinced that this is pernicious. I do think economic stratification is pernicious, but that has more to do with the Democratic Party standing in the way of fundamental structural reform in education as it has to do with Republican tax cuts for rich people, doesn’t it? ... Page 4, here I come!

Dani Rodrik has already read past page three, and he is quite convinced by what he has read:

American political economics in one picture, by Dani Rodrik: Look at the figure below, and then look at it again, and again, and again.  It is the most telling picture about the U.S. political economy I have ever seen.

...What it shows is the difference that the President's party affiliation makes to the distribution of income during the four years of the president's term. (The distributional outcomes are shown with one year's lag.)  When a Republican president is in power, people at the top of the income distribution experience much larger real income gains than those at the bottom--a difference of 1.5 percent per year going from the bottom to the top quintile in the income distribution. The situation is reversed when a Democrat is in power: those who benefit the most are the lower income groups. If you are in the bottom quintile, the difference between having a Democratic or a Republican president in office is an income gain (or loss) of more than 2 percent per year! Strikingly, compared to Republicans, Democratic presidents generate higher income gains for all income groups (although the difference is statistically significant only for lower income groups).

Bartels shows in his book that this difference is not a statistical artifact or a fluke.  It is not the result of Democrats coming to power during better economic times, or of Republicans reining in the unsustainable excesses of Democratic administrations they replace. (It turns out that the same pattern prevails even when a Republican president is succeeded by another Republican.) These numbers are real and they are the outcome of partisan differences in policy. So if you are one of those who have bought the story that income distribution is the result of pure market forces and technological changes, with politics playing no role--think again.

Bartels' findings raise an important puzzle: if Democrats produce better income results for everyone, and particularly for the more numerous lower-income groups, why do they not always win?  Bartels offers a rather complicated, but well-supported answer to this question having to do with voter myopia and psychology.  (You will have to wait to read his book to get the full story). But Bartels does demolish two of the standard arguments regarding Republican advantages at the polls: the idea that poor Americans vote Republican for cultural reasons, or that Americans do not care about inequality.

The Bush Tax Cuts Did Not Make Taxes More Progressive

In case you hear otherwise (and you will):

Have the 2001 and 2003 Tax Cuts Made the Tax Code More Progressive?, by Aviva Aron-Dine, CBPP: Summary Supporters of extending the 2001 and 2003 tax cuts claim that these tax cuts’ benefits have been broadly and fairly distributed. Some argue that the tax cuts have actually made the tax system more progressive, pointing to Congressional Budget Office (CBO) data showing that the share of total federal income taxes paid by the top 1 percent of households rose modestly after the tax cuts were enacted.

The claim that the tax cuts are fairly distributed and have made the tax code more progressive does not withstand scrutiny. Whether measured in dollar terms or as a share of household income, the tax cuts going to high-income households are much larger than those going to all other households.

When fully in effect, the tax cuts will boost after-tax income by more than 7 percent among households with incomes of more than $1 million, but just 2 percent among middle-income families... A progressive tax cut, like a progressive tax system, is one that reduces inequality. But, as these data show, the tax cuts enacted in 2001 and 2003 are widening the gap in after-tax incomes, which was historically large even before the tax cuts were enacted.

In 2010, when the tax cuts are fully in effect, the average household earning more than $1 million a year will receive $158,000 in tax cuts, according to the Tax Policy Center; the average middle-income household will receive $810.

The same CBO data cited by the tax cuts’ supporters show that the top 1 percent of households pay almost 5 percent less of their income in federal personal income taxes than they did in 2000, before the tax cuts. No other group got a tax cut nearly as large.

The CBO finding cited by the tax cuts’ supporters does not change these facts. High-income households now pay a modestly larger share of federal income taxes not because the tax cuts are somehow tilted against them — to the contrary, the tax cuts are tilted decisively in their favor — but instead because (1) their incomes have risen much faster than other households,’ and (2) the tax cuts have significantly shrunk the total revenue “pie.”

The Tax Cuts Widened Income Gaps

A progressive tax code is one that makes the distribution of after-tax income more equal than the distribution of pre-tax income.  (This definition is accepted by analysts across the political spectrum.)  Hence, one tax code is “more progressive” than another if it has a larger effect in reducing income inequality. For the 2001 and 2003 tax cuts to have made the tax code more progressive, after-tax incomes would have to be less unequal today than if the tax cuts had not occurred.  In fact, the tax cuts have made the distribution of after-tax income more unequal.

There's been quite a bit of denial about this from the crowd that believes that tax cuts for the wealthy are the answer to every problem. They want to believe - or want you to believe - that tax cuts pay for themselves and, at the same time, make taxes more progressive. Here's the entire report. [On changes in the distribution of income, see the graphs and discussion in this post from Lane Kenworthy.]

Income and Happiness

How are income and happiness related?

Income and Happiness: An Imperfect Link, by Robert H. Frank, Economic View, NY Times: ...This week, Senator Byron Dorgan, Democrat of North Dakota, will ... hold a hearing exploring whether traditional economic measures like per-capita income accurately capture people’s sense of well-being.

This has long been a contested issue. ... The debate is not just of philosophical interest; it also has important policy implications. Recent research findings offer support for specific arguments on both sides. Mounting evidence suggests, however, that per-capita income is a less reliable measure of well-being when income inequality has been rising rapidly, as it has in recent decades. ...

[The problem is]... the assumption, traditional in economic models, that absolute income levels are the primary determinant of individual well-being.

This assumption is contradicted by consistent survey findings that when everyone’s income grows at about the same rate, average levels of happiness remain the same. Yet at any given moment, the pattern is that wealthy people are happier, on average, than poor people. Together, these findings suggest that relative income is a much better predictor of well-being than absolute income.

In the three decades after World War II, the relationship between well-being and income distribution was not a big issue, because incomes were growing at about the same rate for all income groups. Since the mid-1970s, however, income growth has been confined almost entirely to top earners. Changes in per-capita G.D.P., which track only changes in average income, are completely silent about the effects of this shift.

When measuring the economic welfare of the typical family, the natural focus is on median, or 50th percentile, family earnings. Per-capita G.D.P. has grown by more than 85 percent since 1973, while median family earnings have grown by less than one-fifth that amount. Changing patterns of income growth have thus caused per-capita G.D.P. growth to vastly overstate the increase in the typical family’s standard of living during the past three decades.

Some economists have advanced an even stronger claim — that there is no link, at least in developed countries, between absolute spending and well-being. Recent work suggests that this is especially true for spending categories in which the link between well-being and relative consumption is strongest. For instance, when the rich spend more on larger mansions..., the apparent effect is merely to redefine what counts as adequate.

Evidence also suggests that higher spending at the top instigates expenditure cascades that pressure middle-income families to spend in mutually offsetting ways. Thus, when all spend more on interview suits, the same jobs go to the same applicants as before.

Yet in many other categories, greater levels of absolute income clearly promote well-being, even in the richest societies. The economist Benjamin Friedman has found that higher rates of G.D.P. growth are associated with increased levels of social tolerance and public support for the economically disadvantaged. Richer countries also typically have cleaner environments and healthier populations than their poorer counterparts.

That per-capita G.D.P. is an imperfect index of economic welfare is not news. The lesson of recent work is that its weaknesses are more serious than we previously realized.

And it is an especially uninformative metric when income inequality has been rising sharply, as it has been in recent decades. A society that aspires to improve needs a better measure of what counts as progress.

This would be a good place to note this from Will Wilkinson:

Better to Be Richer, The Fly Bottle: I just ran across Angus Deaton’s latest summary of his happiness findings at the Gallup website:

As the graph indicates, life satisfaction is higher in countries with higher GDP per head. The slope is steepest among the poorest countries, where income gains are associated with the largest increases in life satisfaction, but it remains positive and substantial even among the rich countries; it is not true that there is some critical level of GDP per capita above which income has no further effect on life satisfaction. ...

Please share this fact with friends at your next cocktail party. Here’s the graph:

Deaton conjectures that the consistent relationship between income and life satisfaction has to do with some kind of shared global standard for self-reporting — the Danes know how good they have it relative to the folks in Togo, and the folks in Togo know how bad they have it relative to Danes. I don’t know about that.

Here's more from Angus Deaton:

The link between money and contentment has been a question of considerable interest to researchers since Richard Easterlin noted in a seminal 1974 paper that average national happiness does not increase over long spans of time, despite large increases in per-capita income. ...

It is far from clear why questions of life satisfaction should be so closely related to national incomes. Much of the literature on the topic emphasizes the relative nature of such responses; when people answer such questions, they must surely assess their life satisfaction relative to some benchmark, such as their own life in the past, or the lives of those around them. Indeed, a recent study by Andrew Clark, Paul Frijters, and Michael Shields found that life satisfaction is sensitive to respondents' income relative to those with whom they most closely associate, which implies that there should be no relation between average national life satisfaction and national income, unless there is some other aspect of national income that raises everyone's life satisfaction together.

A simpler interpretation of the Gallup World Poll findings is that when asked to imagine the best and worst possible lives for themselves, points 10 and 0 on the scale, people use a global standard. Danes understand how bad life is in Togo and other poor places, and the Togolese, through television and newspapers, understand how good life is in Denmark or other high-income countries. ...

If this interpretation is correct, it would be an indication of how much the globalization of information has affected the perceptions of populations worldwide -- because the consistently high correlation between income and satisfaction could not have existed in its absence.

"Institutions and Income Inequality in 20’th Century America"

This is part of a talk given by Frank Levy in memory of Bernie Saffran. The talk discusses the interaction of institutions and income equality, and further develops the ideas in Levy and Temin:

Institutions and Income Inequality in 20’th Century America, by Frank Levy: I want to talk tonight about the role of institutions in achieving a fair distribution of the gains from economic growth. In labor economics today, institutions do not receive much attention. Most attention is reserved for market forces like the impacts of technology and international trade. The work I will discuss tonight does not deny the importance of market forces. But I will argue that institutions – unions, the minimum wage, the tax system, accounting conventions and ultimately the tone set by the government – have the power to either moderate or reinforce the underlying market. I will describe how U.S. institutions abandoned a moderating role sometime after 1975, when market forces were already tending toward greater inequality. In my story, the inequality we see today reflects continued market pressures unhampered by institutional restraint.

This story turns out to be subtle – it is not all Republicans versus Democrats, and inequality has more than one cause. In other words, the story requires you to walk and chew gum at the same time. But I believe it is reasonable description of where we are.

The story comes in four parts. ...

...

We now come to the third part of our story and another question: If these institutions were so great, why were they dismantled? The roots of the answer lie in the early 1970s when the economy stopped producing broad benefits.

Going back a little, the 1960s ended in a terrific boom – the result of Vietnam War deficits piled on top of an economy that was already at full employment. A byproduct of this boom was an increasing rate of inflation. Inflation was reinforced in the early 1970s by two big price shocks – one in food and the other, of course, in oil.

In this chaotic environment, labor productivity stopped growing. This further stimulated inflation since higher wages could only be paid for by price increases. From 1970 to 1980, the Consumer Price Index literally doubled and median family income increased only slowly.

By the mid-1970s, Republicans and many Democrats including Jimmy Carter and his advisor Fred Kahn were arguing that the economy’s inflationary bias reflected a lack of real price competition. The result was a bi-partisan push toward deregulation in airlines, telecommunications, trucking and other industries.

Once Ronald Reagan took office, support for unencumbered markets became more extreme – for example, the fiction that tax cuts would stimulate so much growth that they would be self-financing. Herb Stein ... on Richard Nixon’s Council of Economic Advisors ... once labeled Reaganomics as the shift from real supply side economics to punk supply side economics.

Reagan’s firing of the Air Traffic Controllers, his significant tax cuts and his general attitude that being rich was no crime all gave strong signals that employers could do whatever they wanted with their employees, and no salary, however high, would be subject to government scrutiny.

Two events from this time deserve special mention. One was Paul Volcker’s tight money policy and its impact on union membership. Volcker, an inflation hawk, was the new chairman of the Federal Reserve, reluctantly appointed by Jimmy Carter in 1979 to deal with accelerating inflation. In order to break inflation, Volcker sharply tightened the money supply leading to high interest rates and a deep recession. When Ronald Reagan assumed office, he gave Volcker’s anti-inflation policy his strong backing.

The tight money policy worked far better than most economists had predicted. Inflation fell from 12.5 percent per year in 1980 to 3.8 percent in 1982. But by 1982, Reagan’s tax cuts had led to projections of large future deficits. Financial markets, fearing the deficits would recreate inflation, kept interest rates high even as inflation fell. High interest rates increased global demand for U.S. securities and the dollars required to buy them. Between 1979 and 1984, the value of the dollar rose by 55 percent in international markets.

As a result, old line U.S. manufacturing firms – the heart of private sector unionization – were hit first by the deep recession and then by a high dollar that crippled export sales. More generally, high interest rates restricted investment opportunities for mature firms in all industries, making them targets for takeovers and restructuring. The loss of old line manufacturing jobs together with new employer boldness caused union membership to fall from 23 percent of private sector workers in 1979 to 16 percent in 1985.

The second event requiring comment was the increasing deregulation of financial markets and what we might call the financialization of the economy. ... When I asked my son Dave, currently studying for his MBA, how to get a grip on this period, he told me to reread Michael Lewis’ 1989 book Liar’s Poker. Dave was right. In that book, Lewis tells the story of Howie Rubin... Rubin was a chemical engineering major at Lafayette College who worked briefly as an engineer and soon went to Las Vegas to make his living as a gambler. He next went to Harvard Business School and then took a job at Salomon Brothers where he went through the firm’s bond trading program. In his first year on the trading floor, Rubin generated $25 million of revenue trading mortgage backed bonds. Quoting from Lewis:

…Rubin, like all trainees, was placed in a compensation bracket. In his first year, he was paid $90,000, the most permitted a first-year trader. In 1984, his second year, Rubin made $30 million trading. He was then paid $175,000. He recalls, “The rule of thumb at Harvard [Business School] had been that if you are really good, you’ll make a hundred thousand dollars three years out.” The rule of thumb no longer mattered. In the beginning of 1985 he quit Salomon Brothers and moved to Merrill Lynch for a three year guarantee: a minimum of $1 million a year plus a percentage of his trading profits (p. 126)

Many of Salomon’s other mortgage bond traders soon left for similar packages.

In another example, a friend of Peter Temin’s who I will call “Robert” wrote us the following description of his career:

Paul Krugman: Trade and Wages, Reconsidered

Paul Krugman posted a link to a very preliminary draft of a paper he is writing on the relationship between trade and wages. Here is the introduction and concluding paragraph:

Trade and Wages, Reconsidered, by Paul Krugman, February 2008: This is a very preliminary draft for the spring meeting of the Brookings Panel on Economic Activity. Comments welcome.

There has been a great transformation in the nature of world trade over the past three decades. Prior to the late 70s developing countries overwhelmingly exported primary products rather than manufactured goods; one relic of that era is that we still sometimes refer to wealthy nations as "industrial countries," when the fact is that industry currently accounts for almost twice as high a share of GDP in China as it does in the United States. Since then, however, developing countries have increasingly become major exporters of manufactured goods, and latterly selected services as well.

From the beginning of this transformation it was apparent to international economists that the new pattern of trade might pose problems for low-wage workers in wealthy nations. Standard textbook analysis tells us that to the extent that trade is driven by international differences in factor abundance, the classic analysis of Stolper and Samuelson (1941) – which says that trade can have very strong effects on income distribution – should apply. In particular, if trade with labor-abundant countries leads to a reduction in the relative price of labor-intensive goods, this should, other things equal, reduce the real wages of less-educated workers, both relative to other workers and in absolute terms. And in the 1980s, as the United States began to experience a marked rise in inequality, including a large rise in skill differentials, it was natural to think that growing imports of labor-intensive goods from low-wage countries might be a major culprit.

But is the effect of trade on wages quantitatively important? A number of studies conducted during the 1990s concluded that the effects of North-South trade on inequality were modest. Table 1 summarizes several well-known estimates, together with one crucial aspect of each: the date of the latest data incorporated in the estimate.

For a variety of reasons, possibly including the reduction in concerns about wages during the economic boom of the later 1990s, the focus of discussion in international economics then shifted away from the distributional effects of trade in manufactured goods with developing countries. When concerns about trade began to make headlines again, they tended to focus on the new and novel – in particular, the phenomenon of services outsourcing, which Alan Blinder (2006), in a much-quoted popular article, went so far as to call a second Industrial Revolution. Until recently, however, surprisingly little attention was given to the increasingly out-of-date nature of the data behind the reassuring consensus that trade has only modest effects on income distribution. Yet the problem is obvious, and was in fact noted by Ben Bernanke (2007) last year: "Unfortunately, much of the available empirical research on the influence of trade on earnings inequality dates from the 1980s and 1990s and thus does not address later developments." And there have been a lot of later developments.

Figure 1 shows U.S. imports of manufactured goods as a percentage of GDP since 1989, divided between imports from developing countries and imports from advanced countries.[1] It turns out that developing-country imports have roughly doubled as a share of the economy since the studies that concluded that the effect of trade on income inequality was modest. This seems, at first glance, to suggest that we should scale up our estimates accordingly. Bivens (2007) has done just that with the simple model I offered in 1995, concluding that the distributional effects of trade are now much larger.

And there’s another aspect to the change in trade: as we’ll see, the developing countries that account for most of the expansion in trade since the early 1990s are substantially lower-wage, relative to advanced countries, than the developing countries that were the main focus of concern in the original literature. China, in particular, is estimated by the Bureau of Labor Statistics (2006) to have hourly compensation in manufacturing that is equal to only 3 percent of the U.S. level. Again, this shift to lower-wage sources of imports seems to suggest that the distributional effects of trade may well be considerably larger now than they were in the early 1990s.

But should we jump to the conclusion that the effects of trade on distribution weren’t serious then, but that they are now? It turns out that there’s a problem: although the "macro" picture suggests that the distributional effects of trade should have gotten substantially larger, detailed calculations of the factor content of trade – which played a key role in some earlier analyses – do not seem to support the conclusion that the effects of trade on income distribution have grown larger. This result, in turn, rests on what appears, in the data, to be a marked increase in the sophistication of the goods the United States imports from developing countries – in particular, a sharp increase in imports of computers and electronic products compared with traditional labor-intensive goods such as apparel.

Lawrence (2008), in a study that shares the same motivation as this paper, essentially concludes from the evidence on factor content and apparent rising sophistication that the rapid growth of imports from developing countries has not, in fact, been a source of rising inequality. But this conclusion is, in my view, too quick to dismiss what seems like an important paradox. On one side, the United States and other advanced countries have seen a surge in imports from countries that are substantially poorer and more labor-abundant than the third-world exporters that created so much anxiety a dozen years ago. On the other side, we seem to be importing goods that are more skill-intensive and less labor-intensive than before. As we’ll see, the most important source of this paradox lies in the information technology sector: for the most part there is a clear tendency for developing countries to export labor-intensive products, but large third-world exports of computers and electronics stand out as a clear anomaly.

One possible resolution of this seeming paradox is that the data on which factor-content estimates are based suffer from severe aggregation problems – that developing countries are specializing in labor-intensive niches within otherwise skill-intensive sectors, especially in computers and electronics. I’ll make that case later in the paper, while admitting that the evidence is fragmentary. If this is the correct interpretation, however, the effect of rapid trade growth on wage inequality may indeed have been significant.

The remainder of this paper is in four parts. The first part offers an overview of changing U.S. trade with developing countries, in a way that sets the stage for the later puzzle. The second part describes the theoretical basis for analyzing the distributional effects of trade, then shows how macro-level calculations and factor content analysis yield divergent conclusions. The third part turns to the case for aggregation problems and the implications of vertical specialization within industries. A final part considers the implications both for further research and for policy.
...

Implications of the analysis

The starting point of this paper was the observation that the consensus that trade has only modest effects on inequality rests on relatively old data – that there has been a dramatic increase in manufactured imports from developing countries since the early 1990s. And it is probably true that this increase has been a force for greater inequality in the United States and other advanced countries.

What really comes through from the analysis here, however, is the extent to which the changing nature of world trade has outpaced our ability to engage in secure quantitative analysis—even though this paper sets to one side the growth in service outsourcing, which has created so much anxiety in recent years. Plain old trade in physical goods has become remarkably exotic.

In particular, the surge in developing-country exports of manufactures involves a peculiar concentration on apparently sophisticated products, which seems at first to put worries about distributional effects to rest. Yet there is good reason to believe that the apparent sophistication of developing country exports is, in reality, largely a statistical illusion, created by the phenomenon of vertical specialization in a world of low trade costs.

How can we quantify the actual effect of rising trade on wages? The answer, given the current state of the data, is that we can’t. As I’ve said, it’s likely that the rapid growth of trade since the early 1990s has had significant distributional effects. To put numbers to these effects, however, we need a much better understanding of the increasingly fine-grained nature of international specialization and trade.

Promoting Economic Mobility

Lane Kenworthy notes that most spending to enhance economic mobility does not reach those at the very bottom of the income distribution where it might do the most good. He has several ideas about how to change this:

Promoting Mobility, by Lane Kenworthy: Opportunity for upward mobility is key to the American dream. What does our government do to assist it?

A recent report (pdf) by the Economic Mobility Project attempts to answer this question. The report groups federal government spending into three broad categories: (1) expenditures aimed, at least in part, at promoting mobility; (2) expenditures on income maintenance, such as social security, health care, welfare, and housing support; (3) expenditures on public goods such as defense, environment, and transportation. As of 2006 about one fifth of federal spending — $740 billion, or 6% of GDP — was in the mobility-promotion category. Most of this takes the form of tax subsidies rather than direct expenditures.

The most striking of the report’s findings is how little of the federal government’s mobility expenditure goes to those with low incomes. This chart shows the estimated amounts that go to lower-income households (bottom two quintiles of the income distribution) versus middle-and-upper-income households (top three quintiles). In total, only about a quarter goes to the former group.

This seemingly-perverse distribution is not surprising. Spending decisions aren’t made by an omniscient policy czar seeking to maximize opportunity for upward mobility. They are a product of a political system characterized by clashing interests, ideologies, motives, and means.

Imagine, though, that we could move money around within the broad category of mobility-promoting expenditures — not increase spending, not take money from other areas of the federal budget, just shift funds from one type of (ostensibly) mobility-promoting program to another. What would help the most?

Let’s start with where to take the money from. By far the largest amount, about $240 billion, currently goes to employer-related work subsidies for pensions, health insurance, life insurance, and other fringe benefits. Surely some of this money could be better spent elsewhere, but I’m not sure it would be much.

A better target would be the $100 billion that goes to saving and investment incentives. The Economic Mobility Project report points out that almost all of this goes to households in the top fifth of the income distribution, and there is little evidence that it boosts saving.

I would favor also taking a large chunk from the roughly $160 billion currently spent on homeownership subsidies (after the current housing downturn abates). There is little indication that reducing or even fully removing the tax deduction for mortgage interest and property tax payments would lower the rate of homeownership in the United States. As the report notes, more than 80% of this tax break goes to the top quintile of households. And homeownership rates in several other rich countries are similar to ours despite the absence of a homeownership subsidy. Furthermore, homeownership’s contribution to upward mobility is ambiguous. On the one hand, it can help people accumulate assets. On the other hand, for those with low income it can be a risky and ineffective way of doing so, as this piece (written long before the recent downturn) rightly emphasizes. Moreover, homeownership discourages geographic mobility; it’s easier to pick up and move in search of better job opportunity if you don’t have to sell your home.

What would be more effective at fostering mobility? ...

1. Universal preschool for 4-year-olds and subsidized high-quality care for under-4s. ...

2. Improve K-12 public schooling by increasing teacher pay. ...

3. Encourage lifelong learning. ...

4. Make college more affordable. ...

5. Universal health care. ...

6. Expand the Earned Income Tax Credit. ...

7. Wage insurance. ...

8. Boost income maintenance. ...

9. Job placement assistance and public employment as a last resort. ... [...read Lane's discussion of the nine mobility policies...]

With respect to the income maintenance proposal, Stephen Gordon uses a set of graphs derived from a simulated macroeconomic model to analyze a guaranteed income proposal for Canada:

On the political economy of a basic income, by Stephen Gordon: The idea of a basic income - it's generally referred to as a Guaranteed Annual Income in Canada - has been floated again. My initial reaction was that this is such a good idea that it's hard to figure out why we don't have it already.

For some reason, there doesn't seem to much in the way of a formal modeling exercises that work through the general equilibrium implications of a BI (I will be happy to be corrected on this point), so I decided to set up a blog-sized version. It turns out that although the BI is still a good idea, it's not quite the slam-dunk I thought it was.

The gory details are below the fold. ...

It's hard to argue against equal opportunity, an important factor in economic mobility and in reducing economic inequality, but we are a long way from that ideal.

"Mr. Kristol"

Dani Rodrik has been waiting for this chance:

Mr Kristol, you get a C in economics, by Dani Rodrik: There! I said it, and I feel better already.  I have waited a really long time to do this, and ... Bill Kristol finally gave me an opportunity with his column in today's New York Times. ...

[H]e was my dreaded instructor long ago in two of the classes that I took as a Harvard undergraduate. He was a doctoral student at the time in the Government Department (no relation to the HKS)...  The first course was Harvey Mansfield's political theory course (for which Kristol served as teaching fellow), and the second was a sophomore tutorial (a required course for government concentrators). 

In each course, we had to write short papers once every couple of weeks. I can say that my performance on these papers, which Kristol graded, was fairly consistent.  The essay on Machiavelli? Here is a C-.  The essay on the Federalist Papers?  Here is a C.  John Stuart Mill?  Well, how about, yes you guessed it, another C.  You can say that Kristol did his best to discourage me from pursuing a career in political science...

I remember well the very first time I saw  him.  It was the first meeting of the discussion session in Mansfield's course...  He walked into the classroom and his first words were: "Hello, my name is Mr. Kristol."  To underscore the point that he was that, and not Bill or any other friendly appellations by which we students may have chosen to address him, he went to the board and wrote "Mr. Kristol." I may have been a poorly adjusted Turk in my first year in the U.S., but this still struck me as odd. He was certainly the only graduate student I met in my four years as an undergraduate who insisted on being called by his last name.   

Well, Mr. Kristol's column today takes aim at Barack (and Michelle) Obama, and does so quite unfairly in my view.  ...  What caught my attention was this passage:

Michelle Obama, in the course of a stump speech, remarked...: “Life for regular folks has gotten worse over the course of my lifetime, through Republican and Democratic administrations. It hasn’t gotten much better.”

Now in almost every empirical respect, American lives have in fact gotten better over the last quarter-century.

Really? Look at the chart below, which comes from Frank Levy... It shows the median compensation since 1980 of different groups of prime-aged men, alongside productivity. ...

People like me with graduate degrees have done great.  But the median compensation (that includes fringe benefits, by the way) of high school graduate men has declined by about 10 percent since 1980!  Mr. Kristol: that means that for a high-school graduate, the odds that his compensation would have fallen by more than 10% is 50-50.  Note that even college graduates have not seen any income gains since around 2000. ...

What is special about the last quarter century, as Frank Levy makes clear, is that it followed a period when productivity increases were broadly shared by different groups in society. That is no longer the case...

So statistics aside, who do you think has a better sense of what has happened to "regular folk" since 1980? Michelle Obama or Mr. Kristol?

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Update: Different topic: Dani Rodrik and Arvind Subramanian have an article in the Financial Times arguing that we need to limit the flow of financial capital on international markets:

We must curb international flows of capital, by Dani Rodrik and Arvind Subramanian, Commentary, Financial Times: First large downhill flows of capital – from rich countries to poor countries – led to the Latin American debt crisis of the early 1980s. In the 1990s similar flows begat the Asian financial crisis.

Since 2002 the flows have been uphill, from emerging markets and oil-exporting countries to the developed world, especially the US. But the outcome has not been very different. So, it does not seem to matter how capital flows. That it flows in sufficiently large quantities across borders – the celebrated phenomenon of financial globalisation – seems to spell trouble.

"Childhood Poverty and Labour Market Exclusion"

Paul Krugman's column today prompted memory of this paper:

Sweden: Childhood poverty has a negative impact on attainment in adulthood, by aplefebvre: In a new Working Paper two researchers shows that living conditions during childhood and adolescence structure socio-economic circumstances in midlife. It is not a surprise, but it is a new proof coming from 2 researchers and the Swedish prospective institute:

Childhood Poverty and Labour Market Exclusion. Findings from a Swedish Birth Cohort., Bäckman, Olof & Anders Nilsson
Arbetsrapport/Institutet för Framtidstudier; 2007:13: Abstract Research has consistently shown that poverty and economic hardship have negative consequences for children. Few studies, however, have examined whether these consequences persists into adulthood. In the present paper we broaden the focus and analyse how living conditions during childhood and adolescence structure socio-economic circumstances also in midlife. How does exposure to poverty during childhood and adolescence affect future probabilities for labour market exclusion and inclusion in early adulthood and in midlife?

"The Only Way to Keep the Economy Going Over The Long Run is to Increase the Wages of the Bottom Two-Thirds of Americans"

Robert Reich:

Totally Spent, by Robert Reich, Commentary, NY Times: We're sliding into recession, or worse, and Washington is turning to the normal remedies for economic downturns. But the normal remedies are not likely to work this time, because this isn’t a normal downturn.

The problem lies deeper. It is the culmination of three decades during which American consumers have spent beyond their means. That era is now coming to an end. Consumers have run out of ways to keep the spending binge going. ...

The underlying problem has been building for decades. America’s median hourly wage is barely higher than it was 35 years ago, adjusted for inflation. The income of a man in his 30s is now 12 percent below that of a man his age three decades ago. Most of what’s been earned in America since then has gone to the richest 5 percent.

Yet the rich devote a smaller percentage of their earnings to buying things than the rest of us... They already have most of what they want. Instead of buying, and thus stimulating the American economy, the rich are more likely to invest their earnings wherever around the world they can get the highest return.

The problem has been masked for years as middle- and lower-income Americans found ways to live beyond their paychecks. But now they have run out of ways.

The first way was to send more women into paid work. Most women streamed into the work force in the 1970s less because new professional opportunities opened up to them than because they had to prop up family incomes. ... But there’s a limit...

So Americans turned to a second way of spending beyond their hourly wages. They worked more hours. The typical American now works more each year than he or she did three decades ago. Americans became veritable workaholics, putting in 350 more hours a year than the average European, more even than the notoriously industrious Japanese.

But there’s also a limit to how many hours Americans can put into work, so Americans turned to a third way of spending beyond their wages. They began to borrow. With housing prices rising briskly through the 1990s and even faster from 2002 to 2006, they turned their homes into piggy banks... But this third strategy also had a built-in limit. With the bursting of the housing bubble, the piggy banks are closing.

The binge seems to be over. We’re finally reaping the whirlwind of widening inequality and ever more concentrated wealth.

The only way to keep the economy going over the long run is to increase the wages of the bottom two-thirds of Americans. The answer is not to protect jobs through trade protection. ... Most routine jobs are being automated anyway.

A larger earned-income tax credit, financed by a higher marginal income tax on top earners, is required. The tax credit functions like a reverse income tax. Enlarging it would mean giving workers at the bottom a bigger wage supplement, as well as phasing it out at a higher wage. ... We also need stronger unions, especially in the local service sector that’s sheltered from global competition. ...

Over the longer term, inequality can be reversed only through better schools for children in lower- and moderate-income communities. This will require, at the least, good preschools, fewer students per classroom and better pay for teachers in such schools, in order to attract the teaching talent these students need.

These measures are necessary to give Americans enough buying power to keep the American economy going. They are also needed to overcome widening inequality, and thereby keep America in one piece.

The idea that the rich need to spend lavishly to prevent a recession is an old one, see for example the debate over the corn laws and the possibility/impossibility of gluts between Malthus and Ricardo. Later classical economists argued economy-wide gluts were impossible because the interest rate would move to equate saving and investment and, since all saving is converted into investment and investment is part of aggregate demand, there could be no loss of demand from saving (and hence no gluts: supply creates its own demand). Keynes, of course, had something to say about all this, and it's partly a difference in the propensity to consume at the margin (the mpc) that is behind the argument above. But it's easy to anticipate objections to the idea that transfers from rich to poor are needed to maintain a healthy, growing economy, or objections based upon the notion that transfers from rich to poor would harm economic growth.

But here's how I see it. Expanding the EITC is a good idea in any case, so none of that really matters.