Archive for the 'Inequality' Category

Should income inequality be the central issue for the American left?

December 26, 2013

This has become a hot topic, prompted by, among other things, the launch in November of the Washington Center for Equitable Growth, President Obama’s inequality and mobility speech in early December, and Ezra Klein’s recent comments. My current thinking is here.

America’s social democratic future

December 19, 2013

That’s the title of my essay in the January-February 2014 issue of Foreign Affairs. You can read it at foreignaffairs.com. It’s free; you simply have to register. Here’s the opening:

Since March 2010, when U.S. President Barack Obama signed the Affordable Care Act into law, the ACA has been at the center of American politics. Tea Party activists and their allies in the Republican Party have tried to stymie the law at nearly every turn. The Republican-controlled House of Representatives has voted more than 40 times in favor of repealing or defunding it, and last October the House allowed a partial shutdown of the federal government in an attempt to block or delay the law. The controversy surrounding the ACA shows no sign of ending anytime soon.

Obamacare, as the law is commonly known, is the most significant reform of the U.S. health-care system in half a century. It aims to increase the share of Americans who have health insurance, improve the quality of health insurance plans, and slow the growth of health-care spending. But the fight over the law is about more than just health-care policy, and the bitterness of the conflict is driven by more than just partisan polarization. Obamacare has become the central battleground in an ongoing war between liberals and conservatives over the size and scope of the U.S. government, a fight whose origins stretch back to the Great Depression and the New Deal….

The ACA represents another step on a long, slow, but steady journey away from the classical liberal capitalist state and toward a peculiarly American version of social democracy. Unlike in, say, northern Europe, where social democracy has been enacted deliberately and comprehensively over the years by ideologically self-aware political movements, in the United States, a more modest and patchy social safety net has been pieced together by pragmatic politicians and technocrats tackling individual problems. Powerful forces will continue to fight those efforts, and the resulting social insurance policies will emerge more gradually and be less universal, less efficient, and less effective than they would otherwise have been. But the opponents are fighting a losing battle and can only slow down and distort the final outcome rather than stop it. Thanks to a combination of popular demand, technocratic supply, and gradually increasing national wealth, social democracy is the future of the United States.

Income inequality and its effects

September 18, 2013

Over the past several years a large group of researchers in Europe, the U.S., and a few other countries have been looking at the rise of income inequality and its social, cultural, and political impacts. A number of working papers are available from the project’s webpage. One on the United States is here.

How to achieve shared prosperity even if wages aren’t rising

April 13, 2013

See here. This is a framing essay I prepared for a conference on progressive governance organized by Policy Network and Global Progress. The full set of conference essays is here.

Will everyone be worse off if the United States turns social democratic?

September 29, 2012

Daron Acemoglu, James Robinson, and Thierry Verdier have a new paper that asks “Can’t We All Be More Like Scandinavians?” Their answer is no. The answer follows from a model they develop in which

  1. Countries choose between two types of capitalism. “Cutthroat” capitalism provides large financial rewards to successful entrepreneurship. This yields high income inequality, but it stimulates lots of entrepreneurial effort and hence is conducive to innovation. “Cuddly” capitalism features less financial payoff to entrepreneurs and more generous cushions against risk. This yields modest income inequality but less innovation.
  2. Because of the difference in innovation, economic growth initially is faster in cutthroat-capitalism nations. But technological advance spills over from cutthroat nations to cuddly ones, so growth rates then equalize. Over the long run, GDP per capita is higher in cutthroat-capitalism nations (due to the initial burst) while economic growth rates are similar across the two types.
  3. Average well-being may be higher in cuddly countries because the more egalitarian distribution of economic output more than compensates for the lower level of output.
  4. Nevertheless, it would be bad for all countries if cutthroat-capitalism nations switched to cuddly capitalism. That would reduce innovation in the (formerly) cutthroat nations, which would reduce economic growth in all nations.

Acemoglu, Robinson, and Verdier say the model might help us understand patterns of economic growth and well-being in the United States and the Nordic countries — Denmark, Finland, Norway, and Sweden. The United States chose cutthroat capitalism, while the Nordics chose cuddly capitalism. The U.S. grew faster for a short time, but since then all five countries have grown at the roughly same pace. America’s high inequality encourages innovation. The Nordics can be cuddly and still grow rapidly because of technological spillover. If the U.S. were to decide to go cuddly, innovation would slow. Both sets of nations would grow less rapidly.

Incentives, innovation, and economic growth in the U.S. and Sweden

I won’t provide the “detailed empirical study of these issues” that Acemoglu and colleagues say they hope their paper will inspire, but I can offer a little data. To keep things simple, I’ll compare the United States with just one of the Nordic countries: Sweden.

An indicator of financial incentives for entrepreneurs is the top 1%’s share of household income. An indicator of the extent of cushions against risk is government expenditures’ share of GDP. What we see in the data is a lot of similarity between the U.S. and Sweden until the second half of the twentieth century. Government spending begins to diverge in the 1960s, income inequality in the 1970s.

Though Sweden’s top 1% get a smaller share of the total income than their American counterparts, are incentives for entrepreneurs really much weaker in Sweden? Swedish CEOs and financial players don’t pull in American-style paychecks and bonuses in the tens of millions, but there is little to prevent an entrepreneur from accumulating large sums. In the 1990s Sweden undertook a significant tax reform, reducing marginal rates and eliminating loopholes and deductions. Corporate income and capital gains tax rates were lowered to 30%, and the personal income tax rate to 50%. Later the wealth tax was done away with. In the early 2000s a writer for Forbes magazine mused that Sweden had transformed itself from a “bloated welfare state” into a “people’s republic of entrepreneurs.”

But set this aside for the moment. Suppose the incentives for entrepreneurs did begin to differ in the two countries around 1960 or 1970. The model predicts innovation will subsequently diverge. Acemoglu, Robinson, and Verdier refer to one measure of patent applications per capita that has the U.S. leading Sweden beginning in the late 1990s. That timing perhaps is consistent with the model’s prediction if we allow a substantial lag. But they cite another measure that is available starting in 1980 and has the U.S. well ahead of Sweden already by then. This suggests America’s innovation advantage might have preceded rather than followed the two countries’ type-of-capitalism choice.

The final outcome is GDP per capita. Here the model stumbles. The gap between the two countries isn’t recent; it dates back to more than a century ago. Apart from a few hiccups, each country has stayed on its long-run growth path throughout the past 100 years, with Sweden slowly catching up to the United States.

So the U.S. and Sweden have chosen different styles of capitalism, at least as measured by income inequality and public spending. That choice looks to have occurred around 1960 at the earliest. The U.S. may be the more innovative of the two nations, and that advantage may have come after the type-of-capitalism choice. But the model doesn’t seem to help in explaining the gap between the two countries in per capita GDP.

Will American innovation slow if we go “cuddly”?

The really interesting question posed by Acemoglu, Robinson, and Verdier is whether innovation would slow in the United States if we strengthened our safety net and/or reduced the relative financial payoff to entrepreneurial success. I’m skeptical, for three reasons.

The first flows from America’s past experience. According to Acemoglu et al’s logic, incentives for innovation in the U.S. were weakest in the 1960s and 1970s. In 1960 the top 1%’s share of pretax income had been falling steadily for several decades and had nearly reached its low point. Government spending, meanwhile, had been rising steadily and was close to its peak level. Yet there was plenty of innovation in the 1960s and 1970s, including notable advances in computers, medical technology, and other fields.

Second, the Nordic countries, with their low income inequality and generous safety nets, currently are among the world’s most innovative countries. The World Economic Forum’s Global Competitiveness Index has consistently ranked them close to the United States in innovation. The most recent report, for 2012-13, rates Sweden as the world’s most innovative nation, followed by Finland. The U.S. ranks sixth. The 2012 WIPO-Insead Global Innovation Index ranks Sweden second and the United States tenth. Whether or not this lasts, it suggests reason to doubt that modest inequality and generous cushions are significant obstacles to innovation.

Third, if Acemoglu and colleagues are correct about the value of financial incentives in spurring innovation, we should see this reflected not only in the United States but also in other nations with relatively high income inequality and low-to-moderate government spending, such as Australia, Canada, Ireland, New Zealand, and the United Kingdom. But we don’t.

There’s one additional possibility worth considering. If financial incentives truly are critical for spurring innovation, it could be the opportunity for large gains that matters, rather than the absence of cushions. Suppose we were to increase government revenues in the United States via higher taxes on everyone — steeper income taxes on the top 1% or 5% plus a new national consumption tax. And imagine we used those revenues to expand public insurance and services — fully universal health insurance, universal early education, a beefed-up Earned Income Tax Credit, a new wage insurance program, more individualized assistance with training and job placement. These changes wouldn’t alter income inequality much, but they would enhance economic security and opportunity. Would innovation decline? I doubt it.

We may get a test of this moderate-to-high inequality with generous cushions scenario at some point. I suspect this is where America is heading, albeit slowly. Interestingly, the Nordic countries, where the top 1%’s income share has been trending upward (see figure 10 here), might end up there first.

Disability is the human condition

September 2, 2012

See here, here, and here.

Is rising obesity a product of income inequality and economic insecurity?

June 10, 2012

Three decades ago, 15% of American adults were obese. Today 35% are. Obesity has increased in many other rich nations too. Why?

Although we burn fewer calories now than in the past, reduced physical activity likely played only a minor role in obesity’s rise. Instead, the main cause was a sharp increase in the number of calories we consume. Why did that happen? The most common story focuses changes in the supply of food. Tasty, high-calorie food became cheaper and more easily accessible in larger quantities, so we began eating more of it.

In the past several years some researchers have advanced an alternative hypothesis that blames rising income inequality and/or economic insecurity (see here, herehere, here). These are said to increase stress, which in turn prompts overeating. How well does this square with the evidence?

OVER TIME IN THE UNITED STATES

Begin with the over-time trend in the United States. The obesity rate was flat in the 1960s and 1970s and then shot up in the 1980s. The timing fits for income inequality, which has increased significantly since the 1970s. Economic insecurity, too, has risen during this period, though I’m not sure its increase has been large enough to have produced the massive jump in obesity that occurred.

Note that for the over-time story to work, we need to assume little or no time lag. There was a large rise in obesity during the 1980s. Income inequality and economic insecurity began to rise in the late 1970s at the earliest. If it takes a long time for them to have an impact on obesity, they probably can’t have caused the 1980s obesity increase.

Given that for both hypotheses the key mechanism is stress, we might ask whether stress has increased, and whether the timing fits with the rise in income inequality, economic insecurity, and obesity. None of the research I’ve seen looks into this, but some cite a paper published a decade ago that finds evidence of a rise in anxiety in the U.S. Curiously, though, that study concluded that anxiety rose steadily from the 1950s through the early 1990s. This doesn’t match up well at all with the over-time trends in income inequality, economic insecurity, or obesity.

ACROSS THE RICH COUNTRIES

The chief empirical evidence cited in support of the income inequality and economic insecurity hypotheses is the pattern across affluent countries. However, there’s a problem with the country-level obesity data. In most of these nations the only available data are from interviewees’ self-reports of their height and weight, which are likely to underestimate the true obesity rate. If the degree of bias is similar in all countries, this wouldn’t pose much of a problem for an analysis of cross-country differences. But we don’t know whether the bias is similar across countries or not.

The following chart shows the data we have for the late 2000s. For a few countries — the U.S., Australia, Canada, Ireland, and Finland — there are obesity estimates both from self-reports and from actual measurements of people’s height and weight. The latter are likely to be quite accurate. In each of these five countries the obesity rate based on self-reports is lower. But in the U.S., Canada, and Ireland it’s quite a bit lower, whereas in Finland it’s somewhat lower and in Australia it’s only slightly lower.

This leads me to worry a good bit about the degree of bias for many of the countries. It’s certain that that the U.S. has the highest obesity rate and that Japan has the lowest. But apart from those two nations it’s difficult to be confident. In almost all of the other countries, the obesity rate according to the self-reported data is within a fairly narrow band, between 10% and 16%. Maybe these countries’ true obesity rates line up in the same way they appear in the chart. But maybe not. Bottom line: we should be very cautious in drawing inferences from the cross-country data.

Okay, with that caveat, what does the cross-country evidence suggest? Let’s start with the simple cross-section. (I’ll come to over-time patterns in a moment.) The next chart shows the association between obesity and income inequality as of the mid-to-late 2000s. I’ve used obesity rates based on self-reports for most of the countries and the true rate minus a few percentage points for the others. As the solid line indicates, the association is positive; nations with higher income inequality tend to have higher obesity rates.

But the positive association is driven entirely by the group of six English-speaking nations in the upper-right portion of the chart: Australia, Canada, Ireland, New Zealand, the United Kingdom, and the United States. If we exclude them, the association disappears entirely (dashed line). That’s not due to lack of variation in income inequality among the remaining nations. The Nordic countries are well over to the left with low inequality, while Portugal, Spain, Italy, and Japan are well over to the right. But there is no relationship between income inequality and obesity among these 14 non-English-speaking countries.

Maybe there’s something about the English-speaking nations, other than high income inequality, that has resulted in high obesity. Here is where the economic insecurity hypothesis comes in. In a recent paper in the journal Economics and Human Biology, Avner Offer, Rachel Pechey, and Stanley Ulijaszek write “Among affluent countries, those with market-liberal welfare regimes (which are also English-speaking) tend to have the highest prevalence of obesity. The impact of cheap, accessible high-energy food is often invoked in explanation. An alternative approach is that overeating is a response to stress, … that market-liberal countries have an environment of greater economic insecurity, and that this is the source of the stress that drives higher levels of obesity.” Offer and his colleagues conclude that economic insecurity is a good predictor of the cross-country variation in obesity, much better than income inequality.

I suspect it’s true that the English-speaking countries tend to have more economic insecurity than other rich nations. But I have limited faith in the insecurity measures Offer and his coauthors use in their analyses. To be economically secure is to have sufficient resources to cover one’s expenses. Economic insecurity is a product of low income, of significant income decline coupled with lack of private or public insurance and lack of assets, or of inadequate insurance to head off large unexpected expenses. At the moment I don’t think we have an especially valid and reliable measure of economic insecurity for cross-country analysis.

What do the over-time patterns in obesity tell us? They’re shown in the following chart, with data based on measured height and weight shown in solid lines and data based on self-reports shown in dashed lines. Note the similarity between the trend for the U.S. and the trends for Australia, New Zealand, and the U.K. The pace of increase since the 1970s has been about the same in all four of these countries. This suggests that there is indeed something different not just about the United States but about the English-speaking nations as a group.

And yet, the differing data sources should give us pause. The data for the other two English-speaking countries, Canada and Ireland, are from self-reports, and their over-time trends look very much like those of the non-English-speaking nations with self-report data. Maybe the apparent difference between the English-speaking countries and other rich countries (apart from Japan) in the pace of obesity’s rise is simply a function of data source. Unfortunately, we can’t be sure.

If the English-speaking countries do in fact stand apart in their obesity rates or trends, there is an alternative hypothesis that ought to be considered. Rather than being driven by income inequality or economic insecurity, it might owe to these countries’ weak regulation of food and restaurants and to their lack of a well-entrenched healthy eating culture. Large-portion restaurants, particularly fast-food ones, may have proliferated more rapidly in the English-speaking nations. Junk food may have become available in grocery and convenience stores sooner and in larger quantities. And the shift away from home cooking and limited snacking may have occurred more quickly and decisively. This strikes me as more plausible than the suggestion that Americans and their counterparts in other English-speaking nations suddenly began eating more due to heightened stress. It’s also consistent with my own anecdotal impressions, though I haven’t seen any hard data.

Offer and colleagues include a measure of the price of a McDonald’s Big Mac relative to per capita GDP. This is likely to capture only part of what I’m referring to, and in their analysis it doesn’t account for much of the cross-country variation. A better measure, though still only a partial one, might be something like the number of restaurants per capita. One study finds that within the United States this correlates strongly with the prevalence of obesity over time.

ACROSS THE STATES

To my knowledge there are no state-level studies of the impact of economic insecurity on obesity, perhaps because we lack good state-level data on economic insecurity. Income inequality has received more attention, and some researchers have concluded that there is a positive association between inequality and obesity across the states (e.g. chapter 7 here).

Obesity data for the U.S. states are available from 1995 to 2010. The data are from self-reports, so here too we should be wary. But we can hope that the degree of bias is similar in each state.

Here is the cross-sectional pattern as of the late 2000s. The predicted positive association is there (solid line). But it is driven by eight southern states in the upper-right portion of the chart: Alabama, Arkansas, Kentucky, Louisiana, Mississippi, Oklahoma, Tennessee, and West Virginia. (Four other deep-south states — Georgia, North Carolina, South Carolina, and Texas — are close by.) Without these states there is no correlation (dashed line). It’s not difficult to think of plausible alternative causes of these states’ high obesity rates, most notably diet.

Indeed, since the states differ in a slew of ways that might affect obesity — from food preferences to education to affluence to physical activity — our best bet is to compare changes over time. If income inequality is an important determinant of obesity, we would expect states in which income inequality has increased most rapidly to have experienced the fastest rise in obesity. Have they? As the next chart shows, the answer is no.

(Two technical details: First, do we need to allow a longer time lag for the effect to show up? Perhaps, but if so the case for inequality as a major contributor to the rise in obesity is, as I suggested earlier, much less compelling. Second, is there a positive association between the level of income inequality in the mid-1990s and subsequent changes in obesity? The answer again is no.)

Now, it’s possible that analyzing the period from the mid-1990s through the late 2000s isn’t very informative. It could be that the strong causal effects are visible only in the 1980s, when the obesity rise began, and patterns since then don’t shed much light. Unfortunately, there’s no way to know, because we don’t have 1980s obesity data for many of the states. What can be said is that given the available data, the case for income inequality as a key determinant looks weak.

ACROSS INDIVIDUALS IN THE U.S.

Another piece of evidence sometimes cited as supporting the economic insecurity hypothesis is the social gradient in obesity in the United States — the fact that obesity rates have tended to be highest among the poor, those who are least secure economically.

Of course, there are reasons other than stress why poor people might be more vulnerable to obesity, such as less education, less ability to afford healthy food, and less access to such food. Here too, then, it’s helpful to examine changes over time rather than just levels. One potentially useful piece of information is changes in obesity among women after the mid-1990s welfare reform. That reform placed strict time limits on receipt of cash assistance for women with low income. If there is any change in recent decades that ought to have heightened stress among low-income women, welfare reform is it. According to the economic insecurity hypothesis, obesity rates in the period after the mid-1990s should have risen more rapidly among low-income women than among other women.

But that isn’t what happened, as the next chart shows. Obesity rates actually increased a bit more rapidly among middle-income and high-income women than among those with low incomes.

WHAT SHOULD WE DO?

About a third of American adults are obese. Obesity tends to have adverse financial and mental and physical health consequences for these individuals, and it’s estimated to cost the country about 1% of GDP in medical expenses each year. It’s a significant social and economic problem.

What’s the best strategy for reducing obesity? Some scholars have come to believe that reducing income inequality and/or economic insecurity is a key part of the cure. I’m not persuaded that the evidence supports this view. Though there’s a lot of uncertainty due to data limitations, my best guess is that inequality and insecurity have played a minor role, if any, in obesity’s rise.

Inequality, mobility, opportunity

January 31, 2012

Alan Krueger, Chair of President Obama’s Council of Economic Advisers, gave a talk a few weeks ago on inequality. Krueger described the sharp increase in income inequality in the United States since the 1970s and discussed some undesirable consequences it may have. One of those consequences is reduced intergenerational mobility (relative intergenerational income mobility, to be more precise). Krueger provided a graph showing that nations with greater income inequality tend to have a stronger correlation between the earnings of parents and their children (less mobility). This has sparked a wide-ranging discussion about the link between income inequality and mobility (Winship, Corak, Winship, Corak, Cowen, Yglesias, Wolfers, Smith, Winship, Quiggin, Cowen, Quiggin, Bernstein).

Here’s what the pattern looks like according to Miles Corak, the source of Krueger’s data (enlarged version here). The vertical axis in the chart is immobility; lower means more mobility. The horizontal axis is income inequality a few decades earlier.

Nations with lower income inequality tend to have more intergenerational mobility, and the association is quite strong. There are concerns about the data. But suppose the data are accurate, and suitable for testing this link. What does the association depicted in this chart tell us about the magnitude of inequality’s impact? How much would reducing income inequality in the United States help?

For most, the aim isn’t high intergenerational mobility per se; it’s low inequality of opportunity. Mobility serves as an indicator (not perfect, but not bad) of equality of opportunity.

Money ought to be good for children’s opportunity. Kids growing up in households with higher incomes are more likely to have good health care, low stress, learning-centered preschools, good elementary and secondary schools, extracurricular activities that promote cognitive skills and earnings-enhancing noncognitive traits, and access to a strong university. It would be surprising, therefore, if inequality of parents’ incomes did not contribute to inequality of opportunity among their children.

But how large is the effect? After all, money isn’t the only thing that matters; a good bit of our abilities and motivations when we reach adulthood stem from nonmonetary influences such as genetics, in-utero developments, our parents’ habits and behaviors, and peers. Also, there are diminishing returns to money; beyond a certain point, more parental income probably helps only a little, if at all.

Yet the graph suggests a large impact. Apart from data concerns, is there any reason to question this? I think so. First, let’s set aside the low- and middle-income countries (Argentina, Brazil, Chile, China, Pakistan, Peru, Singapore). Mobility processes in these countries may or may not be comparable to those in the rich nations. Next, notice that inhabiting the lower-left corner of the chart are the four Nordic nations: Denmark, Finland, Norway, and Sweden. These countries have been providing affordable high-quality early education to a substantial portion of children age 1 to 5 for roughly a generation. James Heckman and Gøsta Esping-Andersen, among others, have argued that early education is perhaps the single most valuable thing a society can do to equalize opportunity. These countries also feature late tracking in elementary and secondary schools and heavy subsidies to ensure college is affordable for all. These public services, rather than low income inequality, might be the chief reason the Nordic countries have such high intergenerational mobility.

What would that imply for the cross-country association between income inequality and intergenerational mobility? As the following chart shows, if we leave out the Nordic nations the association is still there, but the countries are widely dispersed around the line, suggesting weaker grounds for confidence that the association is a strong one. (For the statistically inclined, the r-squared is .47 with the Nordics included and .16 without them.)

Is it possible, then, for a country to have high income inequality but also low inequality of opportunity? John Quiggin is skeptical. He suggests the UK experience has debunked this “third way” notion. I’m not so sure. Imagine a rich nation with America’s income inequality and Nordic public services: affordable high-quality early education, K-12 schooling with late tracking and equal funding, and widespread access to good-quality universities. And perhaps also comprehensive prenatal care. Would its opportunity (mobility) structure look more like America’s or more like Sweden’s?

But, some will respond, you can’t get those services if income inequality is high. The rich will block the heavy taxation needed to fund them. Maybe. But income inequality has been rising in Sweden. In fact, in the late 1990s and mid 2000s the top 1%’s share of income (including capital gains) in Sweden was about the same as in the 1970s United States (see figure 7 in this paper by Atkinson, Piketty, and Saez). So far this hasn’t undermined Swedish taxation, though it’s probably too soon to draw any firm conclusions.

Suppose income inequality continues to rise in Sweden but its public services hold up. Will Sweden’s intergenerational mobility a few decades from now look like ours does today? I’d predict no. I suspect opportunity-enhancing programs can overcome a good bit of the harm done by income inequality.

That’s not to say we shouldn’t also try to reduce income inequality. I think we should. The point is that if we want to reduce inequality of opportunity, reducing income inequality isn’t the only way, and perhaps not even the best way, to do it.

How rich countries lift up the poor

December 11, 2011

That’s the title of a short article of mine in the current Pathways magazine. Pathways ought to be on the reading list of anyone interested in living standards, poverty, inequality, and mobility. And it’s free.

A few other worthwhile recent reads on these topics:

Jared Bernstein’s blog

CBO, Trends in the distribution of household income

Center on Budget and Policy Priorities, A guide to statistics on historical trends in income inequality

OECD, Divided we stand: why inequality keeps rising

Scott Winship, Mobility impaired

Miles Corak, The decline of the American dream

Reihan Salam, Understanding America’s income mobility problem

Mike Brewer and Liam Wren-Lewis, Why did Britain’s households get richer?

James Plunkett, The potential for female employment to raise living standards in low to middle income Britain

Winner-take-all financial incentives, Steve Jobs, and the living standards of ordinary Americans

December 3, 2011

I’ve just finished Walter Isaacson’s fascinating book on Steve Jobs’ fascinating life. Among the many intriguing things about Jobs’ story is that it may shed some light on a particular interpretation of America’s economic performance over the past generation.

Between 1979 and 2007, inflation-adjusted hourly wages for Americans at the median and below were essentially flat. Household incomes in the lower half increased, but not very much. Both wages and incomes for many ordinary Americans trailed far behind growth of the economy. At the same time, the earnings and incomes of those at the top exploded (see here, here, here, here).

One story sometimes told about the 1980s, 1990s, and pre-crash 2000s links these two developments to offer an optimistic verdict on the evolution of living standards for America’s lower half. The story goes something like this: A winner-take-all economy reduces income growth for low-to-middle Americans. But it nevertheless produces a substantial rise in living standards for them. It does so by increasing financial incentives for inventiveness and hard work, which yields leaps in consumption that aren’t reflected in the price data used to measure changes in the cost of living.

To put it more precisely, the story has four parts:

1. Returns to success soared in fields such as entertainment, athletics, finance, and high tech, as well as for CEOs. These markets became “winner-take-all,” and the amounts reaped by the winners mushroomed.

2. For those with a shot at being the best in their field, this increased the financial incentive to work harder or longer or to be more creative.

3. This rise in financial incentives produced a rise in excellence — new products and services and enhanced quality.

4. These improvements haven’t been satisfactorily captured in the price index by which we assess changes in the cost of living. Watching Michael Jordan or LeBron James play basketball is a qualitatively superior experience relative to what came before in a way that isn’t reflected in the price of a ticket or of a cable TV subscription. Similarly, the Macintosh, iPod, iTunes, iPhone, and iPad are so different from and superior to anything that preceded them that what they add to living standards isn’t likely to be adequately measured.

I think there’s a good bit of truth to parts 1, 2, and 4 of this story. But I’m skeptical about part 3.

This brings me to Steve Jobs. Apple and its delightful, user-friendly, (eventually) affordable gadgets play a key role in this story. The question is: Would Jobs and his teams of engineers, designers, and others at Apple have worked as hard as they did to create these new products and bring them to market in the absence of massive winner-take-all financial incentives?

In the things-have-improved-more-than-the-income-data-make-it-seem story, the answer is no. The financial incentive is the critical spur to inventiveness and hard work.

But I don’t find anything in Isaacson’s account of Jobs that supports this view. Jobs himself seems to have been driven mainly by a passion for the products, for winning the competitive battle, and perhaps for status among peers. The satisfaction of achieving excellence and of beating one’s opponents appears to have been far more important than monetary compensation. Excellence and victory were their own reward, rather than a means to the end of financial riches. In this respect Jobs was little different from scores of inventors and entrepreneurs over the ages, or for that matter from Bill Russell, Larry Bird, and Michael Jordan.

The rise of winner-take-all compensation occurred simultaneously with surges in innovation and productivity in certain fields, but that doesn’t mean it was the cause of those surges.

Reducing relative poverty

June 5, 2011

Reducing poverty is widely viewed as a key objective of a good society. The U.K.’s Labour government set a formal poverty reduction target in the late 1990s, and the European Union recently did so as well. In the United States, public opinion surveys consistently find a solid majority saying government spends too little money on assistance to the poor.

The standard poverty measure in comparisons of rich nations is a “relative” one. The poverty line for each country is set at a percentage, usually 60% or 50%, of that country’s median household income.

Which countries have been most successful in reducing relative poverty in recent decades? And how have they done it? Here’s what the picture looks like for twenty affluent nontiny longstanding democracies. The data are from three sources: the Luxembourg Income Study (LIS), considered the most reliable for comparative purposes; the European Union’s Statistics on Income and Living Conditions (EU SILC), which covers recent years for EU countries; and the OECD.

As it turns out, there is hardly any success to explain. In almost every one of these nations the relative poverty rate was no lower in 2007, the peak year of the pre-crash business cycle, than at the end of the 1970s. The only clear exception is Ireland. Denmark also reduced poverty according to the LIS data, but the OECD data suggest little or no change. Portugal is another possibility. A few countries succeeded in reducing relative poverty during certain portions of this period, such as the U.K. in the early 2000s.

What accounts for this near-universal failure?

A relative measure of poverty is essentially a measure of inequality in the lower half of the income distribution. A nation’s relative poverty rate is determined largely by three things: wage inequality among individuals in the bottom half of the distribution, employment inequality among households in the bottom half, and the generosity of the public safety net. The wage distribution has become more unequal in many countries, though by no means all. This owes to a host of developments, including globalization, deregulation of product and labor markets, manufacturing decline, weakening of collective bargaining, and increased immigration of people with language barriers and/or limited job skills. The trend in employment likewise has tended to be inegalitarian, depending on the magnitude and character of the rise in single-adult households, the movement of women into jobs, and government efforts to promote employment. Government transfers have increased in a number of countries, but often only enough to offset the rise in market inequality. And in a few nations transfers have stagnated or decreased. (More discussion here, here, here, here, and here.)

I prefer a focus on absolute incomes and living standards rather than on relative poverty, and that approach yields a very different conclusion about progress in recent decades. Still, the widespread failure of rich countries to make any headway in reducing relative poverty rates is striking.

Inequality and mobility at the top

March 8, 2011

Income inequality in America has soared over the past generation. But some see little cause for concern. One reason is that our inequality statistics — Gini coefficient, share of income going to the top 1%, and so on — are calculated based on households’ income in a single year. This misses the fact that people move up and down over time. Our incomes in any given year may be more dispersed now than several decades ago, but if many of us are switching places from year to year, why the fuss?

Two claims need to be distinguished here. One says there’s enough movement up and down in the income distribution over time (in technical lingo, relative intragenerational income mobility) that we needn’t worry about single-year inequality at all. It doesn’t matter whether inequality is high or low; it doesn’t matter whether it’s rising or falling. Single-year income inequality is simply irrelevant, on this view, because there is a lot of mobility. Since “a lot” and “enough” are in the eye of the beholder, evidence can’t confirm or refute this claim.

A second claim says that the rise in income inequality has been offset by a rise in mobility. Here we can look to the data for a verdict. Has income mobility increased?

For the bulk of the population — everyone but the richest — we have multiple sources of mobility data. One is the Panel Study of Income Dynamics (PSID); another is earnings records from the Social Security Administration. Both indicate that there has been no increase in income mobility in recent decades (see also here).

What about at the top? A good bit of the past generation’s rise in inequality consists of growing separation between the rich, especially the top 1%, and the rest of America. But has this been accompanied by increased churn among those at the top? In 2007 the Treasury Department released a study based on analysis of tax records. It included data on movement out of the top 1% over two nine-year periods: 1987-1996 and 1996-2005.

Single-year income inequality rose sharply during these two periods. The share of income going to the top 1% of households jumped from 11% in 1987 to 14% in 1996 to 18% in 2005. The Treasury study found that mobility, by contrast, was essentially unchanged.

The large increase in income inequality has not been offset by a rise in mobility at the top.

Is winner-take-all bad or good for the middle class? Evidence from baseball

January 11, 2011

A “winner-take-all” market is one in which the top stars get paid much more than anyone else. It’s an apt description of the American economy in recent decades. Top financiers, CEOs, entertainers, and athletes now routinely earn more than ten million dollars a year, and the share of all income (after taxes) going to the top 1% of households jumped from 8% in 1979 to 17% in 2007.

What impact does the rise in the share taken by those at the top have on the incomes of those in the middle? On one view it’s bad: if the additional millions going to the “winners” had instead been spread among those in the middle, the latter would have been better off. Others suggest the impact is good: winner-take-all markets help make the pie bigger than it otherwise would have been, and a larger pie means a larger slice for the middle class in absolute terms, even if that slice has shrunk relative to the slice of those at the top.*

Pay in major league baseball is a good test case. Since the 1970s professional baseball has had the two defining characteristics of a winner-take-all market: owners’ and/or consumers’ judgment that top stars are much more valuable than the next best, and stars’ ability to exit if offered better pay elsewhere. Salaries for baseball’s top players have skyrocketed. Also helpful: unlike in pro football and basketball, baseball teams’ total pay is not limited by a salary cap.

Here are the two contending hypotheses:

1. Winner-take-all is bad for middle-pay players. Stars’ big paychecks come largely at the expense of their teams’ mid-level players.

2. Winner-take-all is good for middle-pay players. Teams that pay big money for top stars enjoy greater revenue growth via higher game attendance, richer TV deals, better jersey and hat sales, and so on. The stars collect a growing share of these teams’ total payroll, but this is more than offset by the degree to which they help boost the payroll. As a result, salaries for the middle players on these teams increase more than on other teams.

Baseball-almanac.com has data on the salaries of all major league players since the mid-1980s. I’ll examine change from 1989 to 2007, as both are business-cycle-peak years. (I exclude the four teams created after 1989. The Cincinnati Reds also are left out, due to missing 1989 salary data.)

Does paying big money for top stars enlarge the pie? On the horizontal axis of the following chart is change in the share of each team’s total pay that goes to its top three players. Consistent with what we would expect in a winner-take-all market, for most teams that share rose. For example, in 1989 the best-paid trio of players on the San Francisco Giants got 22% of the team’s total pay. In 2007 the Giants’ top three got 40% of the total pay, an increase of 18 percentage points. On the chart’s vertical axis is 1989-to-2007 change in each team’s total pay, in millions of inflation-adjusted dollars. The hypothesized positive association isn’t there. Teams that increased the portion of their pie going to their top three players haven’t gotten a faster-growing pie in return.

That points us toward hypothesis 1, which says a rising share of a team’s pay going to its top stars is bad for those in the middle. As the next chart shows, that’s indeed how things have played out. The chart plots the change in pay for each team’s middle five players from 1989 to 2007 by the change in the top three players’ share of the team’s total pay. Middle-player salaries have tended to grow less rapidly on teams in which the top three’s share has risen more.

The following set of charts elaborates a bit. It shows changes in top players’ pay and changes in middle players’ pay for four teams. The first two teams, the San Francisco Giants and Toronto Blue Jays, are on the right side of the second chart above. Pay for their top three players exploded. It rose for their middle players too, but much more modestly. The next two teams, the Baltimore Orioles and Milwaukee Brewers, are on the left side of the second chart above. Pay for their top three players rose sharply, but less than for their counterparts on the Giants and Blue Jays. Their middle players, by contrast, did better.

But that’s not the full story. To the two hypotheses listed above we should add a third:

3. Winner-take-all is bad for middle-pay players, but its harm is outweighed by other developments.

The “other” development that has mattered most is the growth in team payrolls. Total pay for the median team soared from $23 million in 1989 to $89 million in 2007. This has been the key determinant of salary growth for middle-pay major league players. On average, the pay of the middle five players rose by $300,000 less on a team with a ten-percentage-point increase in the top three players’ pay share than on a comparable team with no change in the top three’s share.** But salaries for the middle five players nevertheless increased on almost all teams, in many instances handsomely so. Across all teams, the average increase for the middle five between 1989 and 2007 was $1 million, nearly a 200% rise. Even among the six teams on which the top three players’ share of pay rose the most — those to the right in the second chart: Houston, Pittsburgh, San Francisco, Toronto, Oakland, and the L.A. Angels — the average increase for the middle five players was $540,000.

What accounts for the sharp jump in team payrolls? One element is enhanced revenues due to expanded demand for tickets, TV rights, and team paraphernalia. Another is a shift in the balance of power away from owners in favor of players. These developments have enabled some teams — the New York Yankees are the paramount example, as you can see in the second chart above — to concentrate a growing share of pay on their top three ballplayers and simultaneously provide a large rise in pay for their “middle-class” players.

Implications for the broader economy probably are limited. One, though, is that even if winner-take-all hurts middle-class incomes, if we had very rapid economic growth it might not matter much. Alas, figuring out how to get that isn’t so easy. A good substitute might be moderately strong growth coupled with strong unions (as in the 1950s and 1960s) or low unemployment (as in the late 1990s). But I’m not too optimistic about that either.

__________

* Some recent analysis and commentary: Andrews-Jencks-Leigh, Cowen, Drum, Kenworthy, Klein, Thoma, Yglesias.

** This is based on a regression of change in middle-five players’ pay on change in top-three players’ share of team pay, change in total team pay, and 1989 level of middle-five players’ pay.

Has rising inequality been bad for the poor?

December 14, 2010

Income inequality has risen sharply in the United States and some other affluent countries since late 1970s, with much of the increase consisting of growing separation between the top 1% and the rest of the population.

Has this been bad for the incomes of the poor?

In a relative sense, the answer is yes, at least in the United States. According to the best available U.S. data, from the Congressional Budget Office, the share of income going to households at the bottom has decreased.

What about in an absolute sense? Would the incomes of low-end households have grown more rapidly in the absence of the top-heavy rise in inequality? If we look across the rich nations, it turns out that there is no relationship between changes in income inequality and changes in the absolute incomes of low-end households. The reason is that income growth for poor households has come almost entirely via increases in net government transfers, and the degree to which governments have increased transfers seems to have been unaffected by changes in income inequality. (For more detail, see my piece in the November-December issue of Challenge.)

In some countries with little or no rise in income inequality, such as Sweden, government transfers increased and so did the incomes of poor households. In others, such as Germany, transfers and the incomes of low-end households did not increase.

Among nations with sharp increases in top-heavy inequality, we observe a similar disjunction. Here the U.S. and the U.K. offer an especially revealing contrast. The top 1%’s income share soared in both countries, and through the mid-1990s poor households made little progress, as the following chart shows. But over the next decade low-end American households advanced only slightly, whereas their British counterparts experienced sizable gains. The New Labour governments under Tony Blair and Gordon Brown increased benefits and/or reduced taxes for low earners, single parents, and pensioners. As Jane Waldfogel documents in her book Britain’s War on Poverty, these were big policy shifts, even if not always high-profile ones. They produced a significant rise in the real disposable incomes of poor households.

Rising income inequality has a number of potential consequences — some of them, perhaps many, undesirable. Its apparent lack of impact on the absolute incomes of the poor over the past generation ought not lead us to overlook this. Still, it is noteworthy that some affluent countries have managed to engineer income growth for low-end households despite a significant top-heavy rise in inequality. For American policy makers, that might serve as welcome inspiration.

Roundtable on Larry Bartels’ book “Unequal Democracy”

December 6, 2010

At The Monkey Cage over the next few days. It includes comments on the book by Paul Pierson and Jacob Hacker, by Will Wilkinson, and by me, with responses from Bartels.

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