Where Does Inequality Come From?

Harvard macro-economist, Greg Mankiw growing economic inequality and its causes in the NY Times (pointed from Mark Thoma):

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 ...

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. ...

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

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...

Education can explain part of growing inequality: the fact that a household of two college-educated earners has gained considerably on a family of one blue-collar breadwinner or two service-economy workers. It explains the growing economic distance between the Northern Virgina suburbs and say western Pennsylvania. But it does not explain the difference between Central Park West or the Upper West Side in Manhattan, Beverly Hills or Malibu in greater LA, and Palo Alto and the upscale suburbs of Silicon Valley and everywhere else. The fact of the matter remains that a significant percentage of the self-made richest people in America and around the world do not have college degrees, Bill Gates being the most obvious case in point. So what accounts for the incredibly rising tail of the income distribution - the fact that Bill Gates and company are so much richer than a family with two college-degree wage earners? Education fails to explain this.

Periods of economic transformation, like the one we are going through from the industrial to the creative economy, or from agriculture to industry a century or two ago, are marked by rising economic inequality.  The reason is that the mechanisms for generating wealth change dramatically during such periods. MIT economists Frank Levy and Peter Temin make the important point that a key reason for rising economic inequality is the breakdown of old institutions (the New Deal broadly construed) that mitigated economic inequality.

But what most ignore is that the basis for economic wealth-creation and thus inequality have shifted massively today. That's Mankiw's main point, really - the massive growth not in the upper-middle class or even the growing numbers of "millionaires" but the incredible growth in the distance between the super-rich and everybody else.

In today's idea-driven, creative economy super-wealth comes increasingly from control over royalties derived from specialized intellectual property in one from or another (new technology, new forms of entertainment, new investment vehicles and so on). And it is the growing distance between those at the commanding heights of the royalty economy and the rest of us who derive income from wages that is a key dimension of growing economic inequality.

In my view, the key to mitigating economic inequality rests on a two part strategy. On the one hand, new institutions are needed that can generate less skewed distribution of the proceeds from royalties. On the other new mechanisms will have to be found to increase the earnings of those at the very bottom by improving the productivity and in turn the wages, benefits and working conditions of those who work in the low-wage service economy (as was done in the previous era for blue-collar work).

Your thoughts.

Comments

[Jared]

IANAE, but is it possible that what Mankiw means is that an educated upper-middle class takes money from the rich? Perhaps the rich as able to easily exploit the uneducated lower classes for gain, but educated workers have too much power to squeeze profits out of. So we shouldn't look at the income gap between the lower-middle class and the upper-middle class because they're not competing, the upper-middle class and the upper class are.

[Kevin Horgan]

The inequality is derived from the shape of the distribution curve of success - a power law that reflects the best selling books, best selling music, superstar athletes etc. How are you going to get Dan Brown, JK Rowling, U2, Madonna, Tiger Woods etc to share their wealth?

[Scott]

Alvin and Heidi Toffler point out exactly this phenomenon (eg how the large changes in economic structure increase inequality) in their most recent book called Powershift.

[Robert]

Actually the solution is not to spread the royalties from new products and services that are being developed in America but to spread the actual work that is done to create these new products and services to people in America if developing the American economy is the goal. Most of the start ups in Silicon Valley appear to offshore most of the engineering and actual creation of the new product and/or service. The solution would be a American dollar collapse that makes it uneconomical to offshore. Based on what I have read the American dollar is probably in the beginning of the collapse phase right now that will take it down around 40% to .52 on the dollar index from .72 now. From there if there is not a massive return of jobs from offshoring, especially high paying high tech jobs from overseas the dollar could go down alot farther, think Weimar Republic German Inflation where a person's life savings would not buy a cup of coffee or postage stamp. The Federal Reserve is inflating the money supply in hopes of creating jobs in America but most of this money is just going overseas in the form of offshore outsourcing and investment in foreign countries.

[Robert]

The following is an excerpt from an article from the International Herald Tribune called "Economic slowdown hits Silicon Valley" By Matt Richtel and Brad Stone published on Wednesday, April 9, 2008

"Upek has 30 employees in California and another 80 or so worldwide; it has manufacturing in Singapore, hardware development in Italy and software development in Prague. It also does 80 percent of its sales overseas.

Upek's global nature, which is shared by a growing number of start-ups in Silicon Valley, is cutting both ways in the economic downturn. On the positive side, the overseas sales are insulating the company from some of the tough economic conditions in the United States.

However, because it has workers outside the country, it is paying a hefty and unexpected price as a result of the dollar's decline.

"The biggest impact is the free fall of the dollar," Buatois said. He said costs for the company have risen 10 percent to 20 percent in the last three quarters. "But the price of the product is not going up."
"

The only way to stop the falling dollar is to turn around the trade deficit and the only way to do that is for more Americans to actually produce more of the goods domestically and export these goods overseas. That means a drastic reduction in offshore outsourcing. The bottom line is that there will be a dramatic reduction in offshore outsourcing either by jobs coming back to America or the America dollar becoming basically worthless and thus most people around the world will refuse to accept American dollars as payment for their engineering services or labor in general.

[Denis Drew]

Here is the scheme to reverse the trend: introduce the management power nullifying "scheme" into the USA that is used around the better paid OECD world: sector-wide (collective-collective) bargaining -- wherein everybody doing the same kind of job in the same geographic locale (the whole nation for something like airlines) works under one unified contract -- the one-stop flight to labor heaven IF ANYBODY EVER MAKES IT PART OF THE NATIONAL DISCUSSION.

For those who doubt they want to follow in the foot steps of the better paid Teamsters and other testosterone overloaded unions -- just look on collective-collective bargaining as akin to power steering and power brakes -- collective-collective bargaining shifts the locus of power so heavily to labor unions must take care not to put management out of business.

The "plutocracy" did not create itself -- it filled a vacuum left by American labor's (continuing) complacency. American overall has insufficient sense of the need to bargain in the free market and imagines that the free market somehow sets the fair and appropriate pay level on automatic pilot (the same delusion that afflicts the infamed "Chicago Boys").

First, we have to explain to people how far they have fallen (when they should have risen): 25% now earning less than LBJ's 1968 minimum wage ($10/hr) after a DOUBLING of average income (must always include eco growth to avoid being Malthusian -- being Malthusian is what makes the Repub nonsense work), AT LEAST* 25% of families now below a better worked out poverty line (up from 15% in LBJ's time -- notice the matching 25% numbers?), the median wage (about $15/hr) grew only 10% since 1973 as average income grew 70% (See NYT article** yesterday on the disappearing $20/hr wage).

*http://ontodayspage.blogspot.com/2008/02/are-38-of-american-families-living.html
**http://www.nytimes.com/2008/04/20/weekinreview/20uchitelle.html?_r=1&ref=business&oref=slogin

Once people understand what is happening to them -- and why (it is their own easily reversible fault for coming into the labor market powerless -- it is the supposed liberal media's fault for not informing them of the startling stats: I followed the books, mags and talking head since 1961 w/o ever encountering these stats OR THEIR SECTOR-WIDE SOLUTION; had to accidentally run into it all my high school educated cab driver self) then the legislative solution (that is how sector-wide is imposed -- French Canadian version is simplest of all and right near by to view) follows naturally.

[Brock]

I think these viewpoints are interesting. Another thing to consider is the overall level of wealth. What was the overall level of wealth, purchasing power, etc of a average blue collar worker in 1916 vs today.

[save_the_rustbelt]

Using Bill Gates, Tiger Woods, Madonna etc. as examples really distorts the picture, they are outliers. If all of the superstars disappeared tomorrow it would barely be a tick in the statistics.

The real issue is the shift toward Manhattan, Washington DC, Silicon Valley and etc., where a combination of brains and influence peddling has warped the economic model.

How to solve this? Dunno.

[cfw]

Suppose we wanted to set up a dream team (or teams) to deal with inequal wealth distribution, would we stock up with the most educated? Probably not first. What we want first are the most well connected and well heeled. The ones who network well, and continuously. The ones who lobby and work the system (Congress, Courts, Executive Agencies, State government bodies, Local governments). We then would branch out to ones with top international contacts, top language skills (Chinese, Arabic), top writers and speakers (eg Bill Clinton coming out of high school), top math students, and then the top engineers and scientists (genetics, biotech, computer science).

Education is part of the cure - including making good tutors available for good prices, adjusting for legacy wealth, toning down sports as education (or to way to get a college scholarship), and need-based scholarships for pre-college years.

But equally important is one's legacy (relatives or friends who can act as angel investors, help find jobs, write recommendations), and one's family finances (coming from a family with say $1 mm of net worth aside from the house).

We should look hard at the Asian and Jewish communities as they thrive in places like CA - ideally there is a holistic approach, not just focused on education, but also finances, contacts, cultural values, classical music, the best in modern culture.

Developing good manners and using them well or a daily basis - socializing regularly for fun and profit - will be key for those who go to law school and get the $160,000 job that lasts for three years.

We will be going (and are going) to a society that requires each college grad or
law grad or the like to be entrepreneurial and to develop his or her own portable book of business (a rolodex or contact list of people one can network with over time to find work and get projects completed). That kind of skill set is developed mostly on the job, and not in Minkiw's EC 10 classroom, yes?

[john trenouth]

I think you're touching on something really important here Rich -- something that might contradict your work on the creative class.

Accordig to the BBC, there are in the UK about 30,000 millionaires and about 50 billionaires. Virtually all of the billionaires are related to hedge funds or private equity firms -- in other words, they just broker deals.

(http://video.google.com/videoplay?docid=-4001834874264918973)

So from this perspecitve, unlike the gilded industrialists of the past (Eastman, Carnegie, Hurst, etc), today's calss of super rich are creatively inert -- they move wealth rather than create value. They are an absolutely un-creative class, and are rewarded fabulously for it.

So is the "creative economy" really just a middle class phenomenon, while the royalty and brokerage economies are what make up the upper classes? Meaning, is the "creative economy" as you talk about it, really a broad paradigmatic redefinition of how our economy creates and consumes value, or is it just the latest in a series of comfortable middle-class ghettos?

[Michael Wells]

John F,

Fascinating national difference. In the US, relatively few billionaires are in finances, and those that are seem to be creating some value rather than just moving wealth around (Warren Buffett, Carl Ichan). I wonder what accounts for the contrast of UK and US?
http://www.forbes.com/lists/2006/54/biz_06rich400_The-400-Richest-Americans_land.html/

[Robert]

Bill Gates got lucky with Microsoft in that IBM decided to outsource their personal computer operating system to Microsoft rather than develop their own system at first. IBM thought that the real future and money was in big mainframe computers instead of small PCs that could be networked. The key to Microsoft's success was that their operating systems were considered "IBM compatible" thus small and medium sized businesses automatically bought their operating system because of the prestigious IBM label not because of the quality of Microsoft's engineering. This allowed Microsoft to get that initial head start that was crucial to its success. Once all the small and medium sized businesses got their critical data on an IBM PC compatible computer then they would be very reluctant to change over to another operating system period no matter how much better that operating system might be.

I challenge anyone to argue convincingly that Microsoft is where it is based on merit instead of the factors I mention above. In fact I think this subject deserves another thread titled "Bill Gates's Billions - Merit or Luck?"

[Michael Wells]

Robert,

In terms of the basic operating system I agree totally. I've always been an Apple user and the Mac system has always been superior to DOS/Windows and so has Unix and probably some others.
But Gates didn't get where he is on luck alone. As a college kid he was able to convince IBM to choose his mediocre operating system over other competitors. Where he excels is as a business strategist and in his drive to dominate any field he enters. Without this combination, someone else would have taken over parts of Microsoft's market. The fact that he was able to keep user loyalty when ripping off the Mac format and shifting the entire DOS market to Windows is testimony to his skill.

[Robert]

TO: Mike Wells

So you are saying that key skills Bill Gates has is the ability to persuade or BS effectively, effectively defraud and deceive others and to have the "drive to dominate". Actually I agree however, these skill sets are not "creative class" skill sets as I understand it so I guess I wasn't thinking these skills were part of "merit". However, luck did play a key role in that IBM made a big key mistake in ignoring the development of the PC while putting all its resources in mainframes. Basically, someone at IBM had to make a big mistake in order for Bill Gates to have any chance of success. If Gates had to compete in the operating system market with IBM at the start his company would be bankrupt within 6 months. I don't believe any reasonable person can argue with that and I guess that is what I really meant by Gate's success being based on luck.

[Michael R. Bernstein]

Characterizing Bill Gates as a dropout (while literally true) is actually very misleading. He was also a scion of a wealthy and well-connected banking family, and had a million-dollar trust fund.

John Opel, the President of IBM in 1980 (he also became CEO about a year later) when they gave Gates the MS-DOS deal (royalties on each copy, and MS retained all IP rights) sat on the national United Way board with Gates' mom.

Few (if any) folks could have taken those early breaks and capitalized on them as successfully as Gates did (especially over the longer term), but he was a child of privilege and DID have quite a lot of unearned advantages right at the beginning.