Thursday, May 17, 2007

Income Inequality
So, one of the obvious political and economic issues of our day is the level of income inequality, which has been rising. The questions most people have are “why” and “what are the ramifications.”

There are two dominant theories right now. One describes income inequality as pretty benign: it reflects a greater of return on education.
The second is malignant: There has been a fall in taxes, allowing rich people to accumulate fortunes. CEOs can manipulate their pay and stock prices, unions have fallen, and outsourcing is taking a toll on wages. The rise in inequality is a very bad thing under this scenario, and not everyone is better off.

This argument, of course, is politicized. Most Republicans like to think that inequality is due to education and hard work, and Democrats are more likely to believe that CEOs are abusing the system.

In truth? It’s a little bit of both. The top 20% households as measured by income have been growing in share since the 1960s, but, within that segment of the population, households have been growing at different rates and at different times. The top .01%, in terms of total income, earned 50 times the median level of society in 1970. That same factor was 250 in 1998. On the other hand, a worker at the 90th percentile (we’re talking wages now, not total income) earned 3.7 times what the worker at the 10th percentile made in 1979. In 2006, that number was 4.7 times.

Obviously, different factors at work here.

Looking at the top 20% and top 10%, the story is pretty simple; the return to education has increased dramatically. In 1979, the median worker with a bachelor’s degree earned 38% more than a person with just a high school degree. That number was 75% on 2005. Numbers like this shouldn’t be too shocking too much to anyone; better educated workers are better able to take advantage of our dynamic economy and our growing level of technology. I’d also suggest that we’re more efficient in who we send to college; even though we’ve sent a lot more people to postsecondary education since the middle of the century, the average IQ of the college student has increased significantly. Since the two factors work together to increase wages, it’s not surprising to see their incomes rise.
It’s also important to note that our measures of inequality check for inequality of households. The fact that more women are working now implies greater inequality, as higher income households are more likely to have a well-educated father and well-educated mother.

But what the heck is going on at the VERY top? Their income share has risen dramatically, much more so than the rest of the population. Does this mean we’re returning an era of oligarchy?
Eh, not quite, but education doesn’t explain everything. Technology, however, does still a play a role.
For instance, technology enables actors and baseball players to be seen all around the world and quite easily; their services are now in much greater demand, and they can be paid higher wages. And I’d suggest American cultural imperialism has played a complementary role to that as well.
The other group at the top are, of course, the CEOs. This is the most profound change in the United States throughout the 20th century. Prior to the Great Depression, the top 1% made 70% of their income in dividends. The shocks of the Great Depression and World War II seemed to have completely destroyed many vast fortunes, and the capital income that the rich got was never the same. On the contrary, since then most of the top 1% has earned money by…well, by actually earning their money. In 1998, roughly half of their income came from labor, and another sizable chunk came from private business income. Dividends only composed about a quarter (compare this to France, where the rich still live off of dividends). Why has CEO pay risen?
Well, the top 1% (CEOs included) started having income share increases in the 1970s, about a decade after the rest of the top 20%. However, their income share rose much faster than the rest of the top 20%. In 1970, the top .1%, for example, had 1% of the wage share of the population. That was 2% in 1984, and has increased since then.
The reason corporate board pay has risen so much is a matter of much contention. In my opinion, the average corporate executive these days really does have it all; they posses a high level of education, put in many hours, typically have much experience, and are better connected socially. This productivity has been seen in the large increase in shareholder value since the 1970s, as well as in the numerous powerful corporations that have emerged over the past 30 years that have revolutionized the way we think about business; Wal-Mart and Microsoft are good examples.
However, does this explain the WHOLE story? Perhaps executive compensation has risen too dramatically to fully account for the new firms that been made that are, indeed, profitable. Marginal taxes, for instance, may play a role. The large reduction in taxes under Reagan may have made work more profitable for the rich, who then would work more and obviously make higher incomes. There is indeed a measured increase in the share of income for the top 1% after 1986, but this is probably due to the change in tax structure; before 1986, it made more sense to classify personal income as corporate income. It’s tough to say how much inequality rose in the Reagan years before that.
Another factor, as many on the left say, is corporate influence over their own pay, as well as social norms. Since I don’t know too much about influence over their own pay, I’ll save that for a future post.
The social norms basically suggest that no one has no idea how much executives should really be paid. Are they worth that much? It’s almost impossible to measure, but investors are willing to jump on the bandwagon simply because they don’t know any better. If true, it’s a big reason why executive pay has increased, and explains why executive pay doesn’t seem to be sensitive to things like oil shocks (which DO affect the wages of everyone else). .

So, do we have anything to worry about?
1. The higher income definitely enables the creation of an oligarchy. Tyler Cowan recently pointed out that the college premium is the same as it was in the Gilded Age. Although he was saying nothing about an oligarchy, I found it pretty interesting.
2. Consumption inequality is even more important than income inequality, and doesn’t appear to have been dramatically affected in recent years. Consumption inequality, of course, measures how much each household consumes as opposed to how much it makes. This is important because many households are at different stages of their lives; obviously, inequality exists if there are households that are run by the elderly and households that are run by people in the prime of their lives, even though the amount of goods that they have is more equal than the amount of income they make.
3. The increasing level of single mothers should disturb everyone.
4. There is still a lot of income mobility, mostly because the level of income is largely determined by what stage of life a household is in. For instance, between 1996 and 1999, slightly more than one-third of the population was impoverished for at least 2 consecutive months. Only 2% was impoverished the entire time. Indeed, even the super-rich .01% change every year as executives exercise stock options at different times. We may not all be in the top 10% now, but a lot of us will be at some point in our lives; with wise investments, we’ll be able to live well for a long time.
5. An important thing that I’m going to come back to; we should be worried about the fact that people don’t see opportunities. Part of what makes the top 1% so wealthy, in my opinion, is the fact that they recognize business opportunities more effectively than the rest of the population. Part of this is due to the fact that the top 1% has more connections and more experience. Part of this is also due to the fact that some people major in Gender studies and later join the private work force.
6. We should be confused that education is such a big problem because education reform is difficult to implement. We’re middle-of-the-road at best in k-12 education, and college education is getting quite expensive. Postgraduate education isn’t even considered by many.
7. One thing that is hopeful? Though implementation is tough, there is a lot of room for future growth in the United States. If we reformed education, if people became more perceptive of the business world, and if families in the US were more stable, economic growth would pick up considerably.

In the future:
-A post about unions will appear
-A post discussing solutions to inequality (or, rather, policies to make our economy grow faster)
-A lot more discussion on the gap in business knowledge and opportunity recognition

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