That is an ugly chart. It is from economist Emmanuel Saez, and what it depicts is a historic surge in inequality at the very top of the income scale. The very rich (1 in 10,000 rich) command six times more income than they did 30 years ago. Another 30 years like that and I figure we all will pretty much be living like peasants--or at least 9,999 out of 10,000 will.
So, even aside from fairness, this raises many questions. Is it just a coincidence that inequality spiked to all time highs in 1929 and 2007, just before major macroeconomic disruptions? Is inequality harmful to macroeconomic growth? What does this kind of inequality mean in terms of law and justice? What can and should be done to address such raising inequality? Is the US in an inequality trap?
Let me be clear: It is not a coincidence that inequality soared right before economic collapses because excessive concentration of economic power is as problematic as excessive concentration of political power. Either way the law is likely to serve the narrow interests of the powerful at the expense of any rational rule of law. While inequality is not inherently harmful to macroeconomic performance, particularly if it reflects rational incentives and disincentives at play, inequality may reflect elite entrenchment or the marginalization of disempowered groups. An entrenched elite or significant economic marginalization will lead to retarded macroeconomic growth everywhere and always. An entrenched elite simply does not face appropriate incentives to produce and is far more apt to use excessive economic resources to seek rents--that is money payments or government subsidies without production. Entrenched elites are unlikely to assure appropriate human capital formation (which is critical to growth), and are much more likely to exploit marginalized populations for political or economic profit. Marginalized minorities always reflect wasted human potential and the destruction of human capital. The US passed the tipping point of inequality and faces entrenched political subversion of the rule of law, and dangerous marginalization of disempowered populations.
So what does economics say of my view? Well, identifying the key drivers of macroeconomic growth can be complicated. Nevertheless, the economic evidence does fairly suggest that my conclusions are sound.
The Injustice of Inequality (by Edward Glaeser, Jose Scheinkman and Andrei Shleifer) shows that during the Gilded Age in the United States and during the transition from communism in Russia, inequality soared. In both instances elites used their newly accumulated wealth to subvert the rule of law and entrench themselves from competition. Macroeconomic growth suffered. Glaeser, Scheinkman and Shleifer also present cross country evidence consistent with their findings from the Gilded Age and transitional Russia.
Dietrich Vollrath of the University of Houston recently posted a paper showing the pernicious impact of inequality on the funding of education. He found that higher wealth inequality in the US was associated with diminished funding for public education (at the county level) in 1890. "The effect of inequality was dramatic. The difference between the county at the 90th and the 10th percentile of the inequality distribution was a decrease in tax rates by one half." Moreover, this effect was driven almost entirely by the effect of inequality on school funding, while there was no effect of inequality on non-school funding.
In Human Capital Inequality and Economic Growth: Some New Evidence, Amparo Castello and Raphael Domenech show that inequality in human capital attainment drives differences in economic growth trans-nationally. More recently, they showed that human capital inequality begets human capital inequality as investment decisions regarding human capital formation are tainted by factors such as life expectancy.
The World Bank in its 2006 Development Report: Equity and Development also links high inequality to stunted economic growth:
high levels of economic and political inequality tend to lead to economic institutions and social arrangements that systematically favor the interests of those with more influence. Such inequitable institutions can generate economic costs. When personal and property rights are enforced only selectively, when budgetary allocations benefit mainly the politically influential, and when the distribution of public services favors the wealthy, both middle and poorer groups end up with unexploited talent. Society, as a whole, is then likely to be more inefficient and to miss out on opportunities for innovation and investment.
In short, distribution matters to growth and there is powerful empirical evidence demonstrating the impact of inequality. Inequality may corrode the rule of law and impairs human capital formation.
We already knew this. Can any American in 2009 really argue that the US exploits all the talent of all of its people. Does anyone really believe that legacy admits at Harvard or admits based upon star-power at Brown does not operate to allocate economic opportunity based upon privilege instead of merit?
As long as the neo-classical paradigm ignores distributional concerns it cannot deliver maximum economic growth. The neo-classical paradigm ignores the reality that inequality can be excessive.
... inequality may reflect elite entrenchment or the marginalization of disempowered groups ... An entrenched elite simply does not face appropriate incentives to produce and is far more apt to use excessive economic resources to seek rents--that is money payments or government subsidies without production ... The US passed the tipping point of inequality and faces entrenched political subversion of the rule of law, and dangerous marginalization of disempowered populations.
ReplyDeleteYou cannot have an "entrenched elite" when those who comprise the upper wealth quintiles are in constant flux. As the findings of this study by the National Tax Journal, using large panels of income tax returns, demonstrates:
The composition of the very top income groups changed dramatically over time. Less than half (39 percent or 42 percent depending on the measure) of those in the top 1 percent in 1996 were still in the top 1 percent in 2005. Less than one-fourth of the individuals in the top 1/100th percent in 1996 remained in that group in 2005.
... the median incomes of those initially in the lowest income groups increased more in percentage terms than the median incomes of those in the higher income groups. In contrast, the real median incomes of taxpayers who were in the highest income groups in 1996 declined by 2005.
The degree of relative income mobility among income groups over the 1996-2005 period was very similar to that over the prior decade (1987-1996). To the extent that increasing income inequality widened income gaps, this was offset by increased absolute income mobility so that relative income mobility neither increased nor decreased over the past 20 years.
Robert Gordon, of the National Bureau of Economic Research, found that, "The rise in American inequality has been exaggerated both in magnitude and timing ... a conceptually consistent measure of this growth gap over 1979 to 2007 is only one-tenth of the conventional measure. The study finds that:
By some measures inequality stopped growing after 2000 and by others inequality has not grown since 1993. This cessation of inequality’s secular rise in 2000 is evident from the growth of Census mean vs. median income, and in the income share of the top one percent of the income distribution. The income share of the 91st to 95th percentile has not increased since 1983, and the income ratio of the 90th to 10th percentile has barely increased since 1986...
Directly supporting our theme of prior exaggeration of the rise of inequality is new research showing that price indexes for the poor rise more slowly than for the rich, causing most empirical measures of inequality to overstate the growth of real income of the rich vs. the poor.
Further, as much as two-thirds of the post-1980 increase in the college wage premium disappears when allowance is made for the faster rise in the cost of living in cities where the college educated congregate and for the lower quality of housing in those cities...
As Thomas Sowell reminds us, Comparing the top income bracket with the bottom income bracket over a period of years tells you nothing about what is happening to the actual flesh-and-blood human beings who are moving between brackets during those years. Following trends among income brackets over the years creates the illusion of following people over time. But the only way to follow people is to follow people.
... during the Gilded Age in the United States and during the transition from communism in Russia, inequality soared. In both instances elites used their newly accumulated wealth to subvert the rule of law and entrench themselves from competition.
ReplyDeleteThe more socialist the system, the greater the real inequality, and the more opportunity for corruption and elite entrenchment. The Russian transition is a perfect example. Entrenched party elites used their positions to capture key economic assets and further enriching themselves at the expense of general population. In a competitive, free market system political elites must satisfy themselves with extorting money from the private sector, while economic elites struggle to maintain their position in the economic order.
The "Gilded Age" was a time of prosperity for ALL Americans. Again, comparing the top income bracket to the bottom tells you nothing about what was happening to individual Americans. This piece, from The American Institute for Economic Research, delves briefly into the period from 1865-1900:
The decades between 1865 and 1900 were the years of America’s industrial revolution. Before this time, America had an economy of primarily light industry and farming. By the beginning of the 20th century, however, the United States had surpassed all of the European nations in manufacturing, including Great Britain and Imperial Germany, the industrial giants of the time.
Mass immigration from Europe, huge capital investments, and technological improvements provided the means for America’s growth and rising standards of living that soon became the envy of the rest of the world.
During the years after 1865 prices in general slowly fell from their Civil War highs. A Consumer Price Index that stood at 100 in 1865 had declined to 57 by 1900, or a 43 percent decrease in prices over a 35 year period. On average prices went down around 1.2 percent each year over three and a half decades.
At the same time, indices of money wages in agricultural and manufacturing employment both rose during this period as labor was becoming more productive due to capital investments, even with a rising population resulting from millions of immigrants joining the American work force.
The index of money wages in agriculture rose by almost 40 percent between 1866 and 1900, while money wages in manufacturing went up 20 percent during this period. Thus, on average, money wages in general increased by about 30 percent for workers as a whole.
In combination with the productivity gains and the capital investments that resulted in the 43 percent decrease in the price level, this meant that in the last 35 years of the 19th century the real standard of living of the American people increased by almost 75 percent as measured by the positive change in the average American’s buying power in the market place.
Gilded Age elites drove an economic boom that led to America's future industrial might lifting millions out of poverty, something that no socialist system has ever accomplished.
... high levels of economic and political inequality tend to lead to economic institutions and social arrangements that systematically favor the interests of those with more influence ... When personal and property rights are enforced only selectively, when budgetary allocations benefit mainly the politically influential, and when the distribution of public services favors the wealthy, both middle and poorer groups end up with unexploited talent.
ReplyDeleteThe claim that our, "economic institutions and social arrangements systematically favor the interests of those with more influence" ( i.e., the rich), does not jibe with evidence. Consider the following:
The tax burden of the top 1 percent exceeds that of the bottom 95 percent.
The U.S. corporate tax rate is the second highest in the industrialized world. As an example, U.S. oil companies pay more in taxes than they earn in profits.
This chart shows that those in the upper quintiles pay much higher taxes and receive fewer benefits than those in the lower quintiles showing that budgetary allocations do not benefit mainly the politically influential and wealthy. The distribution of public services definitely favors those in the lower quintiles.
Can any American in 2009 really argue that the US exploits all the talent of all of its people.
No, but not for the reasons that you address in this post. As this story from the Detroit News outlines, teachers unions and political elites have conspired to deny our kids the education that they deserve and that we as taxpayers have paid generously for:
Detroit -- Impassioned parents demanded jail time for educators and district officials Saturday following the release of test scores that showed fourth- and eighth-graders had the worst math scores in the nation.
City students took the National Assessment of Educational Progress test this year, and 69 percent of fourth-graders scored below the basic level in math and 77 percent of eighth-graders scored below basic.
The Detroit scores on the progress test were the lowest in its 40-year history. The sample of students included 900 of Detroit's 6,000 fourth-graders and 1,000 of the district's 6,000 eighth-graders.
The current state of public education denies America's children the future they are entitled too. From the L.A. public school systems 50 plus percent drop out rate to the denial of Hope scholarships in Washington D.C., entrenched political elites are putting their interests and the unions interests ahead of America's children. It's time for a little HOPE, it's time for a little CHANGE.
I agree that some of our economic and social institutions favor the rich, to a certain extent. However, it would seem logical for a bank to favor someone who is in a better position to pay back a loan. Where it becomes problematic is when there is a discrepancy between the treatment by economic institutions towards different individuals in the same or similar position who meet the institution's requirements. Social institutions, on the other hand, should have different motiviations than those of an economic institution. Social institutions in some aspects favor those with little money, but that does not seem odd or unfair to me because they are the ones who need to be favored. I do not believe that because the poor pay less in taxes, they are being favored. You're not doing somoene a favor because you tax them less than someone who makes more money; You're doing what makes sense.
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