"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.

The sharp concentration of the increase in the 50-10 ratio for both men and women on the 1979–86 interval provides strong circumstantial evidence for declining unionization as a cause for men and the declining real minimum wage as a cause for women. The timing of the subsequent post-1986 evolution of the real minimum wage is also consistent with the stable 50-10 ratio for women. Our examination of quantitative evidence in the academic literature finds a small role for the decline in unionization, but only for men. The evidence on trade suggests that low-paid foreign workers do compete with domestic workers, and that the increased penetration of imports pushed wages downward in the middle by an amount that is difficult to quantify.

The immigration literature is contentious, but we were convinced by a recent paper showing negligible impact of increased immigration on domestic workers but rather a big downward impact on foreign-born workers who specialize in particular occupations traditionally dominated by immigrants.

Section 5 reviews the SBTC hypothesis and potential objections to it, particularly the slow wage increases of apparently skilled occupations like engineers and computer programmers, compared to the rapid income gains of managers. We endorse the effort by Autor and co-authors to broaden the skill distinction to three or more categories; their polarization hypothesis makes a lot of sense in explaining the facts about rising inequality and also the occupations most prone to outsourcing. The key distinction is between interactive work at the top, whether lawyers in courtrooms or investment bankers making deals in person, and interactive work at the bottom, whether attendants in nursing homes or immigrant workers mowing the lawns of well-off people. These jobs at the top and bottom cannot be outsourced. But jobs in the middle can be outsourced in the broad middle where people do routine, easily duplicated jobs such as airline reservations agents or workers at technical call centers.

Section 6 finds ample evidence that SBTC is a major explanation of increased skewness of labor incomes at the top. We distinguish three different types of top incomes. Superstars include the top members of any occupation that provides disproportionate rewards to the first-best as contrasted with the second-best. The pure superstar phenomenon has at its core the magnification of audiences, the fact that a single performance can be witnessed by an audience of one person or ten million people, depending on the perceived attraction and talent. A second category of top incomes is market-driven and includes law partnerships, investment bankers, and hedge fund managers, where there is no obvious analogy to audience magnification.

The most contentious question regards the third category, that is, the sources of enormous increases in the ratio of top executive compensation to that of average workers, both over time and between the United States and other developed nations. The core distinction is that superstars and other market-driven occupations have their incomes chosen by the market, whereas CEO compensation is chosen by their peers in a system that gives CEOs and their hand-picked boards of directors, rather than the market, control over top incomes. This idea that managers have power over stockholders is nothing new; the idea that managers control stockholders rather than vice versa goes back to Berle and Means (1932) and R. A. Gordon (1945). This idea that the principal-agent control of stockholders should be reversed has been applied fruitfully by such authors as Bebchuk and Fried (2004). We endorse their idea that managerial power lies behind some of the outsized gains in CEO pay, while also recognizing that stock options created an automatic spillover from the stock market gains of the 1990s directly into executive pay.

Has consumption inequality also risen as much as income inequality? If increased cross-sectional income inequality is simply the result of larger transitory shocks to income, and if financial markets are sufficiently well developed (assuming, against substantial evidence to the contrary, that liquidity constraints are not a major impediment), then consumption and welfare inequality could have stayed constant. In reviewing the evidence, it is clear that consumption data in the US does not measure exactly what we might hope for. While authors have found parts of the Consumer Expenditure Survey (CEX) revealing little increase in consumption inequality, other more believable parts of the CEX show consumption inequality to rise at roughly the same rate as income inequality. This evidence is consistent with that of Kopczuk, Saez, and Song (2007) who find that there has been no increase in income mobility associated with the rise in income inequality.

Our survey introduces two new issues into the discussion of consumption inequality. First, we connect with the literature on price index bias and argue that the price deflator for goods consumed by the poor has increased less rapidly than for goods consumed by the rich. This difference reflects the slower inflation rates of food, clothing, and electronics as well as the "Wal-Mart effect" that is not captured by official price data such as the CPI. Part is a compositional effect, that the relative prices of services increase over time due to relatively slow productivity increases, and the rich consume relatively more of the high-inflation services.

While the poor may do better when price indexes are corrected, they do much worse when their health outcomes are considered. Recent evidence suggests that between 1980 and 2000 the life expectancy of the bottom 10 percent increased at only half the rate of the top 10 percent. This translates into an increase in health welfare (using a method developed by Nordhaus) that is roughly 1.5 percent per year faster for the rich than the poor, expressed as a ratio to initial market consumption. This may be the most important single source of the increase in inequality in the United States, and it combines not only unequal access to medical care services and insurance, but also to differences in personal habits and environment related to education and income.

An aspect of inequality rarely discussed in the literature is the divergent evolution of relative per-capita incomes (compared to the US average) across US major metropolitan areas. We present two new results for the 37 largest broadly-defined US metropolitan areas. The first is that most of the areas have converged toward the national mean as the southern states have risen from sub-par toward the average, and the old Midwest industrial cities have regressed from above-average toward the mean. The striking exception is the set of bicoastal metropolitan areas that have been called "superstar cities," with both levels and rates of change of per-capita income that significantly exceed the US average. We link this rise in geographical inequality both to constraints in the supply of land for housing and to the desire by superstar scientists and other top-income professionals to live near each other in these bicoastal superstar cities.

Some of the most interesting remaining issues in the area of increased inequality involve cross-country differences. The post-1970 upsurge in US inequality, particularly the relative rise of top incomes, is much greater than in continental Europe or Japan, with the UK and Canada somewhere in between. We propose a mix of institutional and market-driven explanations. Institutional differences between the US and Europe include the earlier and more pervasive introduction of stock options in the US, the tradition of corporatism and cooperative bargaining in Europe that creates constraints on management compensation excess, and the larger role of unions and a higher real minimum wage in some European countries. But the market matters also; gains in profits and price-earnings ratios in the US stock market in the 1990s spilled over to executive compensation, interacting with the large increase in the share of executive compensation taking the form of stock options.

The study of income inequality is of fundamental importance to economics. The most obvious reason is that if economics is at all concerned with understanding the development of the economy over time, we must understand not only changes in means, but also changes in distributions. Second, changes in inequality can be indicative of changes in the structure of the economy that may favor one group or another, e.g. skill-biased technical change. Third, variation in inequality can tell us how well our theories about risk sharing and consumption smoothing actually fit with peoples’ experiences. Fourth, we can learn about the effects of various institutions on inequality by studying the experiences of different countries. This allows informed policy choices to be made in the future. What these policy choices should be, if any, are beyond the reach of this paper. We have attempted to link facts and hypotheses, and some of these links are clearly robust. These facts should be taken into account in policy discussions, and some, simply by being aired, may improve outcomes in the economy.