Category: Human Capital

Understanding economic inequality and growth at the top of the income ladder

Posted on by Heather Boushey

Thanks in large part to the ground-breaking work of Paris School of Economics professor Thomas Piketty, and his co-authors, including University of California-Berkley economics professor Emmanuel Saez, we know that we are living in an era of widening inequality. The share of post-tax-and-transfer income going to the top 1 percent of earners increased from nearly 8 percent in 1979 to about 17 percent in 2007. Over the course of the current economic recovery, the top 1 percent has received 95 percent of all pre-tax income gains—seeing a 31 percent increase in their incomes—while the bottom 99 percent saw a meager 0.4 percent increase.

Economists hypothesize several reasons for this sharp increase in income inequality, among them rising pay for chief executives and other senior executives, increasing returns to superstar workers, the rise of the financial industry, and the decline in top-income tax rates.But this debate is far from over. And the issue is not just income inequality. Economic inequality is on the rise across a variety of dimensions, including wealth. According to research by Saez and Gabriel Zucman, assistant professor of economics at the London School of Economics, the share of wealth owned by the top 0.01 percent has increased 4-fold over in the past 35 years.

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Piketty’s data makes the case that the steady accumulation of wealth at the top of the income spectrum is one of the most important ways that income inequality affects our economy. While there may be a theoretical argument for why higher incomes provide greater incentives for individual effort or inventing the next “big thing,” it may also be that, beyond a certain point, income and wealth inequality dampens incentives as the wealthy increasingly seek to preserve their wealth rather than risk it in potentially productive endeavors while the non-wealthy are locked out due to “opportunity hoarding” by those at the top.

One fundamental issue that Piketty’s book, “Capital in the 21st Century,” compels us to consider is the interaction between the flow of income and the stock of wealth. Does today’s flow of income to the very top of the economic ladder calcify into tomorrow’s wealth inequality? After all, the very high incomes that some people earn will allow them to build larger and larger stocks of capital over time.

Do we need to address rising income or wealth inequality in order to save our capitalist economy? How can we do so without hurting the vibrancy of today’s economy? The three essays in this section of our conference report—by UC-Berkeley economist Emmanuel Saez, Michael Ettlinger, founding director of the University of New Hampshire Carsey School of Public Policy, and Northwestern University sociology PhD candidate Fiona Chin—discuss the state of top incomes, the consequences of their rise, and possible policies to promote more widely shared economic growth. —Heather Boushey

Download the full 2014 conference booklet, with full citations included for all of the essays, including those addressing the top of the income ladder on this page

The Explosion of U.S. Income and Wealth Inequality

by Emmanuel Saez

In the United States today, the share of total pre-tax income accruing to the top 1 percent has more than doubled over the past five decades. The wealthy among us (families with incomes above $400,000) pulled in 22 percent of pre-tax income in 2012, the last year for which complete data are available, compared to less than 10 percent in the 1970s. What’s more, by 2012 the top 1 percent income earners had regained almost all the ground lost during the Great Recession of 2007-2009. In contrast, the remaining 99 percent experienced stagnated real income growth—after factoring in inflation—after the Great Recession.

Another less documented but equally alarming trend has been the surge in wealth inequality in the United States since the 1970s. In a new working paper published by the National Bureau of Economic Research, Gabriel Zucman at the London School of Economics and I examined information on capital income from individual tax return data to construct measures of U.S. wealth concentration since 1913. We find that the share of total household wealth accrued by the top 1 percent of families— those with wealth of more than $4 million in 2012—increased to almost 42 percent in 2012 from less than 25 percent in the late 1970s. Almost all of this increase is due to gains among the top 0 .1 percent of families with wealth of more than $20 million in 2012. The wealth of these families surged to 22 percent of total household wealth in the United States in 2012 from around 7.5 percent in the late 1970s.

The flip side of such rising wealth concentration is the stagnation in middle-class wealth. Although average wealth per family grew by about 60 percent between 1986 and 2012, the average wealth of families in the bottom 90 percent essentially stagnated. In particu­lar, the Great Recession reduced their average family wealth to $85,000 in 2009 from $130,000 in 2006. By 2012, average family wealth for the bottom 90 percent was still only $83,000. In contrast, wealth among the top 1 percent increased substantially over the same period, regaining most of the wealth lost during the Great Recession.

For both wealth and income, then, there is a very uneven recovery from the losses of the Great Recession, with almost no gains for the bottom 90 percent, and all the gains concentrated among the top 10 percent, and especially the top 1 percent. How can we explain such large increases in income and wealth concentration in the United States and what should be done about it?

Contrary to the widely held view, we cannot blame everything on globalization and new technologies. While large increases in income concentration occurred in other English-speaking countries such as the United Kingdom or Canada, other developed-nation members of the Organisation for Economic Cooperation and Development, such as those in continental Europe or Japan, experienced far smaller increases in income concentration. At the same time, income tax rates on upper income earners have declined significantly since the 1970s in many OECD countries, particularly in English-speaking ones. Case in point: Top marginal income tax rates in the United States and the United Kingdom were above 70 percent in the 1970s before President Ronald Reagan’s administration and Prime Minister Margaret Thatcher’s government drastically cut them by 40 percentage points within a decade.

New research I published this year with Paris School of Economics profes­sor Thomas Piketty and Stefanie Stantcheva at the Massachusetts Institute of Technology shows that, across 18 OECD countries with sufficient data, there is indeed a strong correlation between reductions in top tax rates and increases in the top 1 percent’s share of pre-tax income from the 1960s to the present. Our research shows that the United States experienced a 35-percentage point reduc­tion in its top income tax rate and a ten-percentage point increase in the share of pre-tax income earned by the top 1 percent. In contrast, France and Germany saw very little change in their top tax rates and the share of pre-tax income accrued by the top 1 percent over the same period.

The evolution of top tax rates is a good predictor of changes in pre-tax income concentration. There are three scenarios to explain the strong response of top pre-tax incomes to top tax rates. They have very different policy implications and can be tested in the data.

First, higher top tax rates may discourage work effort and business creation among the most talented—the so-called supply-side effect of higher taxes. In this scenario, lower top tax rates would lead to more economic activity by the rich and hence more economic growth. Yet the overwhelming evidence shows that there is no correlation between cuts in top tax rates and average annual real (inflation-adjusted) GDP-per-capita growth since the 1960s. Countries that made large cuts in top tax rates, such as the United Kingdom and the United States, have not grown significantly faster than countries that did not, such as Germany and Denmark.

Second, higher top tax rates could increase tax avoidance. In that scenario, increas­ing top rates in a tax system riddled with loopholes and tax avoidance opportuni­ties is not productive. A better policy would be first to close loopholes in order to eliminate most opportunities for tax avoidance and only then increase top tax rates. Conservative commentators argue that the surge in pre-tax incomes discussed above could be indicative of tax avoidance in the 1970s, when top earners were presumably hiding a large fraction of their income amid high taxes.

If this tax avoidance scenario were true, then charitable giving among top earners should have decreased once top tax rates were cut. After all, charitable giving is tax deductible and thus is more advantageous precisely when top tax rates are high. In fact, charitable giving among the rich surged pretty much in the same proportion as their reported incomes over the past several decades. If the rich are able to give so much more today than in the 1970s, it must be the case that they are truly richer.

Third, while standard economic models assume that pay reflects productivity, there are strong reasons to be skeptical, especially at the top of the income ladder where the actual economic contribution of managers working in complex organizations is particularly difficult to measure. In this scenario, top earners might be able partly to set their own pay by bargaining harder or influencing executive compensation com­mittees. Naturally, the incentives for such “rent-seeking” are much stronger when top tax rates are low.

In this scenario, cuts in top tax rates can still increase the share of total household income going to the top 1 percent at the expense of the remaining 99 percent. In other words, tax cuts for the wealthiest stimulate rent-seeking at the top but not overall economic growth—the key difference from the supply-side scenario that justified tax cuts for high income earners in the first place.

Up until the 1970s, policymakers and public opinion probably considered—rightly or wrongly—that at the very top of the income ladder pay increases reflected mostly greed or other socially wasteful activities rather than productive work. This is why poli­cymakers were able to set marginal tax rates as high as 80 percent in the United States and the United Kingdom. The Reagan-Thatcher supply side revolutions succeeded in making such top tax rate levels unthinkable, yet after decades of increasing income concentration alongside mediocre economic growth since the 1970s followed by the Great Recession, a rethinking of that supply side narrative is now underway.

Zucman and I show in our new working paper that the surge in wealth concentra­tion and the erosion of middle class wealth can be explained by two factors. First, differences in the ability to save by the middle class and the wealthy means that more income inequality will translate into more inequality in savings. Upper earners will nat­urally save relatively more and accumulate more wealth as income inequality widens.

Second, the saving rate among the middle class has plummeted since the 1980s, in large part due to a surge in debt, in particular mortgage debt and student loans. With such low savings rates, middle class wealth formation is bound to stall. In contrast, the savings rate of the rich has remained substantial.

If such trends of growing income inequality and growing disparity in savings rates between the middle class and rich persist, then U.S. wealth inequality will continue to increase. The rich will be able to leave large estates to their heirs and the United States could find itself becoming a patrimonial society where inheritors dominate the top of the income and wealth distribution as famously pointed out by Piketty in his new book “Capital in the 21st Century.”

What should be done about the rise of income and wealth concentration in the United States? More progressive taxation would help on several fronts. Increasing the tax rate as incomes rise helps curb excessive and wasteful compensation of top income earners. Progressive taxation of capital income also reduces the rate of return on wealth, making it more difficult for large family fortunes to perpetuate themselves over generations. Progressive estate taxation is the most natural tool to prevent self-made wealth from becoming inherited wealth. At the same time, complementary policies are needed to encourage middle class wealth forma­tion. Recent work in behavioral economics by Richard Thaler at the University of Chicago and Cass Sunstein at Harvard University shows that it is possible to encourage savings and wealth formation through well-designed programs that nudge people into savings. –Emmanuel Saez is a professor of economics  and Director of the Center for Equitable Growth at the University of California-Berkeley

Addressing Economic Inequality Requires a Broad Set of Policies and Cooperation

by Michael Ettlinger

There are any number of policies suggested by policymakers, academics and commentators for addressing economic inequality. A representative sample would include tax redistribution, improving education, raising the minimum wage, direct government job creation, employer hiring incentives, subsidized child care, better retirement security, a stronger social safety net, direct middle- and low-income subsidies, ending the socialization of environmental degra­dation, aggressive financial market regulation, stronger trade unions, more invest­ment in public goods (paid for by the better off), socially responsible trade policy, immigration reform, corporate governance changes, and campaign finance reform.

That’s certainly a formidable list, but interestingly most analysts and advocates who care about economic inequality focus on just one or two of these—typically offer­ing a concise, but ultimately unsatisfying recipe. Given the rapidly rising levels of inequality, when one reads the typical, short, policy agenda, it’s hard not to have a feeling of ennui—a sense that the solution offered falls well short of what’s needed to solve the problem or is completely impractical.

It is, for example, hard to believe that better educational opportunities is the com­plete answer. Improving education has huge virtue in terms of economic advance­ment at the individual level, creating opportunity, personal fulfillment, and overall economic growth. But, aside from anything else, at the rate we’re going, we’ll have again doubled our level of inequality by the time substantial numbers of people are likely to benefit from improved education. And it’s not like we’ve licked how exactly to improve education or that it’s clear that improved education solves the problem.

After all, if the result of boosting educational attainment is simply more competi­tion for a slowly increasing number of jobs that require further education, then the effect might primarily be that different people are on the winning and losing ends of inequality, not a lessening of inequality itself—at least from a global perspective. And the historical record is not encouraging. So, we should improve education, but we shouldn’t count on it as the silver bullet for addressing inequality.

There are other policies, of course, that are blunter instruments and clearly could fundamentally change the distribution of income and wealth. Taxes are the most clear cut example. If we take a sizable portion of the income of the wealthy and, one-way-or-another, distribute it to everyone else, inequality would, unequivocally, be reduced (call this the Sherwood Forest approach). But redistribution on that scale is unlikely and, at truly the scale that would be needed to reduce the levels inequal­ity to what it was even a few years ago, would probably be damaging to the overall economy. While there is ample evidence that the moderately higher levels of income tax on the well off are not the economic disaster sometimes claimed, addressing extreme economic inequality exclusively through the income tax could get us to the point at which higher taxes do cause harm. As with education, raising income taxes on the wealthy is not, alone, the answer.

“Wealth” or “capital” taxes on the assets of the better off, another favored approach, face a number of practical limitations. One problem in the United States is that a federal wealth tax would almost certainly require an amendment to the constitution. But even aside from that “technicality,” there is a limit to what one could reasonably expect to accomplish with a wealth tax.

One of the virtues of an income tax is that it taxes money going between two parties who both are typically required to inform the tax authorities of the transaction—so to outright cheat on taxes requires the complicity of at least two people. It happens, but the requirement of trust limits it. Wealth, in contrast, can be held without active engagement of another party.

Another virtue of an income tax is that if the transaction is honest then the dollar amount involved is usually clear-cut. That is less true for a tax on wealth. Assets held in publicly traded corporations or real estate in areas where there are frequent land deals are relatively easy. But the valuation of closely held corporations, let alone art and obscure intellectual property rights, can be extremely difficult—and one can count on more wealth ending up in those forms if a substantial wealth tax were put in place. A very small wealth tax would not necessarily spark this sort of tax avoid­ance. A substantial one would.

I can make similar arguments for almost the entire list I started with. Even if one believes that the minimum wage is too low, most everyone would agree that it can be too high. Even if one believes that our trade regimes are a factor in increasing inequality and that reforms are needed, overly restrictive policies would be coun­terproductive. Even if you believe that the outsized incomes from Wall Street are a consequence of power and influence—not genuine contributions to our overall prosperity—the national economy would surely be hurt if we tried to address eco­nomic inequality purely through restraints on the financial sector.

If you didn’t have ennui when you started reading this you probably do now. But the point isn’t that it’s impossible to address income inequality. The point is that it’s going to take a range of approaches. And, arguably, a range of approaches is easier to accomplish than trying to put all of one’s eggs in a single basket. If the whole solution doesn’t depend on a confiscatory tax on the wealthy, or vastly increasing educational attainment, or world-wide consensus on a socially responsible, equi­table, trade agreement—but instead on incremental change in range of areas—that is a much less daunting task.

There are agreements to be had in many of these areas. None of those individual policies will be at the scale needed to address inequality in a meaningful way, but together they can add up to make a difference.

There are reasons to do this. Extreme inequality leaves many people having harder lives than is necessary while, at the other end of the spectrum, personal wealth can reach a point where its growth does little to improve the lives of its beneficiaries—with the overall result being a net reduction in the aggregate quality of life. And there are real dangers to our society of such severe stratification. It’s an issue that is going to require a broad range of effort and cooperation around the world to address. But it’s achievable if we don’t try to accomplish it with just one or two highly contested policies. — Michael Ettlinger is the founding director of the Carsey School of Public Policy at the University of new Hampshire

What the Wealthy Know and Believe About Economic Inequality

by Fiona Chin

The wealthiest one percent among us in the United States are pulling away from everyone else, a trend documented by numerous economists and highlighted often by the media. Despite all this attention on inequality, there is a dearth of empirical research on what the wealthy know and believe to be true about this trend.

Recent research on social stratification and mobility in our country examines the beliefs of ordinary Americans about the growing wealth and income gaps, but few academics are talking directly to the wealthiest Americans about their own per­ceptions. It is notoriously difficult to interview wealthy subjects. It is hard to find them, given their scarcity in the population. Once you identify possible subjects, it is hard to gain their cooperation, particularly when discussing topics they find uncomfortable, such as income and wealth inequality.

How the very affluent view economic inequality is important because what they know and think influences how they interact with our political leaders responsible for translating these views into public policies. If policymakers respond disproportionately to the affluent and the majority of the wealthy do not favor government programs to ameliorate inequality then it is especially important for scholars and policy experts to learn what ideas and preferences the wealthy embrace. In contrast, if the majority of the very affluent favor steps to rectify the wealth and income gaps, then policymakers can consider enacting programs that are favored more by the general public.

I study wealthy Americans to find out what they believe about income and wealth inequality.1 My data come from two sources. The first is the Survey of Economically Successful Americans and the Common Good, or SESA, which was pioneered by Northwestern University political science professor Benjamin Page and Vanderbilt University political science professor Larry Bartels and funded by the Russell Sage Foundation.2 NORC at the University of Chicago conducted the survey in 2011. Respondents had an average of $14 million in household wealth (median of $7.5 million), making the sample representative of the wealthiest one-to-two percent of Chicago-area residents.

Most national surveys with representative samples capture very few respondents from the top of the wealth distribution. While it targets the Chicago metropolitan area, SESA is among the very few data sets on the wealthy and includes questions on a variety of topics, from economic mobility to taxes, retirement, philanthropic and charitable volunteering and giving, and other areas. As a survey, however, SESA was limited in the depth to which respondents could answer any particular question.

Upon reviewing the original survey sheets with interviewer notations in the margins, I found that the wealthy were eager to express more nuance than closed-ended survey responses provided. To complement the survey data with more detail, I am compiling a second source of information by conducting in-depth interviews with economically successful Americans from across the country. These interviews focus much more specifically on subjects’ beliefs about eco­nomic inequality and mobility, politics, and public policy.

As of August 2014, I have conducted 89 interviews ranging from 45 minutes to three hours in length. I spoke with top income earners and top wealth hold­ers, who I recruited based on the chain-referral method. Although my sample is not statistically representative, this methodology has allowed me to collect data on the beliefs of wealthy Americans from different geographic regions and backgrounds. Interview respondents had an average of $8.2 million in household wealth (median of $4.7 million). The interview sample was not as wealthy as the SESA sample overall, but more than half of my interviewees were within the top one percent of the income or wealth distributions. Interview subjects were from 18 different metropolitan areas across 15 states and the District of Columbia and worked in a variety of occupations and industries.

Despite the methodological differences, the interview questions that duplicated SESA questions yielded very similar patterns of answers. My research is on-going, but I have some preliminary results to share, with the important caveat that I am continuing to analyze my data and hope to conduct approximately ten more interviews.

The wealthy are aware of economic inequality and recognize that it has grown in recent decades. In the SESA data and my own in-depth interviews, the vast majority of respondents knew that income inequality is larger today than it was 20 years ago. They also tended to express a desire for a lower level of income inequality. Approximately two-thirds of respondents believed that income differences in our society are too large.

The wealthy also recognize that the distribution of wealth across society is very skewed. In fact, they tend to overestimate the proportion of wealth held by the top one percent. Based on the SESA data and my preliminary interviews, the median perception of the respondents so far was that the top one percent hold approxi­mately half of all U.S. wealth. (According to New York University economist Edward Wolff, the wealthiest one percent held a 35 percent share of the country’s household net worth, as of 2007.3) In my interviews, I also probe subjects about how large a share the wealthiest one percent “ought” to hold. Only about two-fifths of interview respondents believed that the wealthiest one percent ought to hold less.

In short, both survey and interview respondents tended to agree that income inequality is too high. But my interview data show that the wealthy did not neces­sarily believe that there should be less wealth inequality.

As much as the wealthy appear to be aware of growing economic inequality, they did not necessarily favor any kind of public intervention to remedy or ameliorate the trend. In fact, the wealthiest SESA respondents favored cutting back federal government programs such as Social Security, job programs, health care, and food stamps. Only 17 percent of SESA respondents thought that the government should “redistribute wealth by heavy taxes on the rich.”

Among my interviewees, very few were in favor of raising taxes to redress eco­nomic disparities, although a minority supported public intervention in the form of job training and other programs aimed at increasing economic opportunity. In general, many interview subjects were very pessimistic about the future of inequality trends and did not foresee any slow down in the growing bifurcation between the wealthy and the rest of society.

As a group, then, the wealthy are well informed about current events and public affairs, according to my preliminary interviews and the SESA data. They pay atten­tion to the news and are very politically active, so understanding and considering their preferences are important. My preliminary findings indicate two emerging patterns: The wealthy know that economic inequality is rising, but they do not agree that anything should or can be done to reverse the trend. My analysis is at an early stage, and much more research must be done in this arena in order to inform a productive dialogue between scholars and policymakers. –Fiona Chin is Ph.D. candidate in sociology at Northwestern University and a graduate research assistant at the Institute for Policy Research

 

How are economic inequality and growth connected?

Posted on by Ed Paisley

In the mid-20th century, economists began witnessing inequality’s decline in the developed world. Prior to the two World Wars and Great Depression, rising inequality was characteristic of most of the developed world, but in the aftermath of the upheavals, the trend reversed. At the time, many reasoned that declining inequality was a natural outgrowth of the development process: As countries become more economically mature, inequality would fall. This trend led Nobel Laureate economist Simon Kuznets to write:

 “One might thus assume a long swing in the inequality characterizing the secular income structure: widening in the early phases of economic growth when the transition from the pre-industrial to the industrial civilization was most rapid; becoming stabilized for a while; and then narrowing in the later phases.”

Given the narrowing of inequality in the more economically developed nations, Kuznets’ analysis suggested that the inequality in poorer countries was a transitional phase that would reverse itself once these nations became more economically developed. Thus, similar to how the level of inequality was decreasing in wealthy nations, inequality would eventually decline in poorer countries as they became richer. In fact, some economists theorized that inequality in the less developed world was actually good for growth because it meant that the economy was generating select individuals wealthy enough to provide the savings necessary for investment-led growth.

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Today, the world looks very different than it did in 1955 when Kuznets made his famous assertion. In the past several decades, economic inequality in the United States and other wealthy nations has risen sharply, spurring renewed interest in the question of whether and how changes in income distributions affect economic wellbeing. Over the same time period, economic inequality has persisted and even grown in many poorer economies.

These trends have sparked economists to conduct empirical studies, analyzing data across states and countries, to see if there is a direct relationship between economic inequality, and economic growth and stability. Early empirical work on this question generally found inequality is harmful for economic growth. Improved data and techniques added to this body of research, but the newer literature was generally inconclusive, with some finding a negative relationship between economic growth and inequality while others finding the opposite.

The latest research, however, provides nuance that can explain many of the conflicting trends within the earlier body of research. There is growing evidence that inequality is bad for growth in the long run. Specifically, a number of studies show that higher inequality is associated with slower income gains among those not at the top of the income and wealth spectrum.

Economists and policymakers today should not be surprised that empirical studies were inconclusive given the broad theoretical (and sometimes contradictory) reasons that hypothesized inequality would both promote growth and inhibit growth. On the one hand, hundreds of years of economic theory has been built on the hypothesis that inequality in outcomes creates incentives for individuals to work hard or be more productive than others in order to receive greater incomes—activity that spurs growth. In addition, many theorized that inequality would help individuals become rich enough to save some of their earnings and fund investments necessary to produce economic growth.

On the other hand, economic theory also suggests the opposite—that inequality may inhibit the ability of some talented but less fortunate individuals to access opportunities or credit, dampen demand, create instabilities, and undermine incentives to work hard, all of which may reduce economic growth. Growing inequality could also generate a relatively larger group of low-income individuals who are less able to invest in their health, education, and training, thereby retarding economic growth.

In this paper, we review the recent empirical economic literature that specifically examines the effect inequality has on economic growth, wellbeing, or stability. This newly available research looks across developing and advanced countries and within the United States. Most research shows that, in the long term, inequality is negatively related to economic growth and that countries with less disparity and a larger middle class boast stronger and more stable growth. Some studies do suggest that in the short run, inequality may spur growth before hindering it over the longer term, but overall there is growing evidence that, in the long run, more equitable societies are associated with higher rates of growth.

In looking at studies that directly estimate the effect of inequality on growth, there are concerns about data quality and statistical methodology. The purpose of these studies is to establish whether economic inequality has some effect on economic growth or stability. For researchers, there are important two questions: is there a causal relationship between inequality and growth? If so, can researchers actually identify this factor, or are they actually measuring the effect of some other factor. Establishing causality is exceptionally difficult in the social sciences and the standard approach employed for studying relationships between inequality and growth has been to look at the level of inequality preceding the growth period being measured. This does not firmly establish causality but can be indicative of it. On the other hand, the approaches for detecting the relationship vary widely by the statistical design, the data, controls included. Given enough time and flexibility in their specifications, economists have demonstrated an ability to draw a variety of conclusions. The best practices in this area are evolving and so it is important to look at the breadth of the literature, rather than focus on a single paper or approach.

Important as well for the purposes of this paper is this—the latest economic research we reviewed only examines the outcome of whether there are results for regressions that demonstrate positive or negative relationships between inequality and economic growth and stability. This means the paper cannot provide clear guidance for policymakers on exactly how to address inequality or mitigate its effects on growth. In other words, the research examined in this paper generally does not identify the channels or mechanisms by which inequality affects growth.

An additional issue (above and beyond the challenges of how to specify a model) is the paucity of data to evaluate questions about inequality and growth. Ideally, economists would want a variety of measures for inequality, including earnings, income, and wealth, that can be compared across a large number of countries over a long period of time. Sadly, such a perfect data set does not exist. Therefore, econ- omists are left to do the best estimates with the data at hand. Over time, though, the data sets that have been used to perform these analyses have been improving.

Other scholars who have examined this literature have also come to the conclu- sion that to inform policymaking, we need to do more than search for a mechanis- tic relationship between inequality and growth. Dani Rodrik, the former Harvard University professor now at the Institute of Advanced Studies, underscores the limitations of this kind of research, arguing that methods for analyzing data that span across places and time are ill-suited to address the fundamental questions about the relationship of government policy and inequality with growth outcomes. This conclusion is echoed by University of Melbourne economist Sarah Voitchovsky in her recent review of the literature in the “Oxford Handbook on Economic Inequality,” where she says:

 “While data constraints continue to limit the type of empirical analyses that can be undertaken, investigations that focus on specific channels generally provide more robust conclusions than evidence from reduced form analyses.”

This paper does not contain policy advice. Instead, it contains analysis that largely demonstrates there are direct, and possibly causal, relationships between economic inequality and growth—places that begin with a lower level of inequality subsequently tend to grow faster and have longer periods of growth than those with a higher level of inequality. In future research, we will focus on the channels through which inequality could or does affect economic growth.

All American youth need opportunities to grow our economy

Posted on by Ed Paisley

Fast forward to 2030, when the last baby boomers are moving into retirement, the millennials are middle aged, and within 10 years about 50 percent of the U.S. population will be people of color.  This demographic destiny—coming our way amid rising economic inequality and inadequate investments for growth—will define our nation’s economic strength in the 21st century.  In 15 years, the needs of an aging population and the earnings power and capacity of our workforce to drive growth and support a thriving U.S. economy will simply not match up.

Unless we do something about it now.

Economic research on the overall earnings of young people entering the workforce in the teeth of the recessions indicates their future earnings power will be stunted by their poor job prospects and low starting wages. These adverse economic conditions further constrict the already limited employment prospects for 16-to-24 year olds—disproportionately individuals of color—who are neither in school nor in the workforce.

There are at least 6.7 million Opportunity Youth nationwide, or about one-sixth of the U.S. youth population. These youth do not have the skills and education they need to productively contribute in our society. Their disconnection—often precipitated or exacerbated by the failure of critical education, training, and social service systems—places an enormous and unnecessary economic burden on our nation. The direct service costs and the losses that will accrue in the form of forgone earnings and taxes over their lifetime are estimated at $4.75 trillion.

Yet this same segment of the population is expected to help generate wealth to maintain the intergenerational social contract encapsulated in Social Security, Medicare and Medicaid.  To ensure a productive workforce that can also shoulder the costs associated with an aging population, we need to invest in our talent pipeline. And because people of color will account for all of net workforce growth in the United States by 2030, our economic vitality demands that the education and workforce systems meet their needs—not just the “talented tenth,” but all American youth.

Improving life outcomes for future generations of children is a moral imperative and an economic necessity. We need to ensure opportunity youth become productive, active members of society— and in doing so, eliminate the inevitable societal loss if we continue down our current path. These youth are a vital but as yet untapped source of intellectual energy, cultural vitality, and innovation. But for their talents to achieve escape velocity, we must work with them to overcome significant barriers.

We should start by making sure our education system meets their needs. Innovative models that bridge high school and postsecondary education have demonstrated success at increasing completion rates of students from backgrounds underrepresented in higher education. Early college high schools, for example, provide opportunities for students to earn an Associate’s degree or significant college credits while still in high school. There is variation—some early college high schools are located on a college campus while others bring college faculty to high schools—but the main idea is the same: exposing students to a college environment early and providing support while setting high expectations.

These programs are based on the need for every student to continue their education after high school and a belief that students’ past failures do not define their educational potential. This design has produced dramatic outcomes for students including our opportunity youth. One in three early college students complete an Associate’s degree or other credential prior to graduating high school, whereas nationally only 10 percent of students earn any college credit in high school.  Early college high school students are also more likely to graduate from high school, enroll in college, and persist for a second year.

Despite impressive results, the availability of these types of programs remains limited. According to analysis by Jobs for the Future, there are 280 early college high schools in 32 states, with an additional 56 new schools under development. In order to ensure that our opportunity youth have a chance to participate in high-growth occupational sectors and realize their full potential, we must move beyond our current status, which is best described as “program rich but system poor.” Instead, we must retool our education systems at the local, state, and federal level to help scale successful models of early college high schools.

We have examples of young people beating the odds, but that’s not enough. To continue to drive growth in the economy, we need to change the odds so that we capture the overlooked and underutilized talent of a significant portion of those 6.7 million opportunity youth. Smart education and workforce training policies, enacted now, can change the earning power and career trajectories for millions of these youth. That’s the America we must create in order to secure our economic future in 2030 and beyond.

Melody Barnes is the former Domestic Policy Advisor to President Obama and now Vice Provost for Global Student Leadership Initiatives at New York University, Chair of the Aspen Institute Forum for Community Solutions, a member of the Year Up national board of directors, and a steering committee member of the Washington Center for Equitable Growth, a new grantmaking and research institution. 

 

U.S. Census highlights rising economic inequality

Posted on by Ed Paisley

The U.S. Census Bureau’s latest set of annual reports on income, poverty, and health insurance coverage in the United States demonstrates that economists and policy makers alike need to come to grips with the short- and long-term affects of economic inequality on economic growth and prosperity. The two reports present data for 2013, four and half years after the official start of the economic recovery from the Great Recession that began in December 2007 and ended in June 2009. Although there are a few bright spots, most of the data reported are dismal and the implications for income inequality are disturbing.

Most tellingly, the long-term trend lines in rising income inequality are essentially unchanged over more than four decades—across several business cycles—which means we need to understand the short- and long-term factors that result in stagnant incomes for all but the most wealthy. So let’s parse the numbers.

The first report deals with income and poverty while the second report describes health insurance coverage. The first report found that real median household income (the income of the household in the middle of the income distribution) in 2013 was stagnant for the second year in a row after having fallen for the four consecutive years after 2007. At $51,900, median household income was still 8 percent, or nearly $4,500, below its level in 2007, roughly equal to what it was nearly 20 years ago in 1995, and less than what it was in 1989. The only racial or ethnic group to experience a statistically significant increase in annual income last year was members of Hispanic households, who earned 3.5 percent more in 2013 than in 2012.

The median earnings of full-time, year-round workers did not improve, though the number of such workers increased by 2.8 million, which reflects the growth in jobs in 2013 and the gradual shift from part-time to full-time work that has been ongoing since 2010. The gap between the median earnings of men and women who worked full time, year round, was slightly reduced, but the gap was not statistically different from what it was in 2012—meaning that the data are not precise enough for the Census Bureau to state unequivocally that the earnings gap had narrowed.

Moreover, the reported improvement in the female-to-male earnings ratio, from 77 cents on the dollar in 2012 to 78 cents last year, was not just a function of an increase in the earnings of women, something we could all celebrate, but also a function of the long-term continuing stagnation in the earnings of full-time, year-round, male workers. This is a worrisome phenomenon. In fact, the median earnings of full-time, year-round male workers were no higher in 2013 than they were more than 40 years ago in 1972.

One positive finding in this year’s poverty-and-income report is that the overall poverty rate declined from 15 percent in 2012 to 14.5 percent in 2013. As the report notes, this was the first decrease in the poverty rate since 2006. However, the report cannot tell us how much of the reduction in poverty was due to an improvement in the economy and in earnings versus an increase in government transfer payments to low income households or other factors.

Almost the entire decline in poverty is attributable to a reduction in the poverty of children under the age of 18 alongside a reduction in the poverty rate of Hispanics. The poverty rate for children fell from 21.8 percent to 19.9 percent, and an estimated 1.4 million fewer children lived in poverty. The poverty rate among Hispanics dropped from 25.6 percent to 23.5 percent, indicating that nearly 900,000 Hispanics (almost 600,000 of whom were children under age18) were no longer living in poverty.

Still, some 45.3 million people were living in poverty in 2013, including 14.7 million children. And, as was true in prior years, those with the highest poverty rates include women, children, people of color, and the disabled.

The Census bureau report measures income inequality in a wide variety of ways. They include:

  • Six different income ratios such as the 90th/10th ratio, which is the income of the household that is earning more than 90 percent of other households (i.e. the household at the 90th percentile) divided by the income of the household earning less than 90 percent of households (i.e. the household at the 10th percentile).
  • The Gini coefficient, which summarizes the income dispersion in a number that varies from 0 to 1 and indicates greater inequality as it approaches 1.
  • The Mean logarithmic deviation of income, which is a measure of the gap between the median and average income.
  • The Theil index, which summarizes the dispersion of income in a number that varies from 0 to 1 with higher numbers indicating more inequality.
  • The Atkinson measure, which suggests the end of the income distribution that contributed most to inequality.

None of the measures in the report indicates any reduction in income inequality in 2013 relative to 2012. By every measure, income inequality in 2013 was higher than in previous years or equally as high as has ever been reported by the Census bureau since it started collecting these data in 1967.

Here are just two cases in point. The household income at the high earning 90th percentile was 12.1 times greater than the income of the household at the low earning 10th percentile—the widest gap ever reported by the Census Bureau. Similarly, the Gini index of income inequality, one of the most commonly used measures of income inequality, was 0.476 and indistinguishable from the record high of 0.477 reported in 2012 and 2011.

It should be noted, too, that the income data reported by the Census Bureau understate the degree of income inequality. The reason: research shows that the data, derived from a survey of people, tends to overstate the incomes of low earners and understate the incomes of high earners. Thus, the true distribution of income is more uneven than indicated by the reported data.

The bottom line is that after nearly five years of economic recovery and growth in national income most Americans have not experienced an increase in their earnings while the earnings of those at the top have largely returned to their pre-recession level. The wages of men in particular have stagnated while women, children, and people of color have suffered in disproportionate numbers from the ravages of poverty. By every measure, income inequality is at a record high or on par with the record highs reported by Census in 2012 and 2011.

The second report, which deals with health insurance coverage, provides additional data that confirm the high degree of inequality revealed in the first report. Unfortunately, because of a redesign in the questions asked of respondents, it is not possible to compare results from this year’s report to prior years.  Thus, the second report does not provide a perspective on whether or not inequality in health insurance coverage is growing. A different Census Bureau study, the American Community Survey, provides annual estimates of health insurance coverage that have closely followed trends in the Current Population Survey Annual Social and Economic Supplement, also commonly known as the March CPS. The American Community Survey data suggest that there have been recent improvements in health insurance: the percent of the population without health insurance fell from 15.5 percent in 2010 to 14.5 percent in 2013.

 

The most recent Census Bureau survey found that nearly 42 million residents, or 13.4 percent of the population, did not have health insurance coverage for the entire 2013 calendar year. The lower a household’s income, the more likely they were to lack health insurance. For example, 24.9 percent of households living in poverty had no health insurance during the year while only 5.3 percent of households earning more than $150,000 lacked insurance in 2013. Those most eligible for government provided health insurance typically had the highest insurance coverage. For instance, only 1.6 percent of those over age 65 and 7.6 percent of those under age 19 lacked insurance compared to 18.4 percent of the rest of the population. Race and ethnicity also influence coverage as nearly a quarter of all Hispanics and 1 in 6 blacks lacked health insurance coverage compared to just 1 in 10 non-Hispanic whites.

 

The quality of health care that people get tends to be a function of both insurance coverage and the quality of health insurance. While these data provide information about coverage, they tell us nothing about the quality of health insurance. But, from other sources we know that lower income households, blacks, and Hispanics tend to have poorer quality insurance even when they are covered which further exacerbates inequality in health care services.

A central concern of the Washington Center on Equitable Growth is that these high and persistent levels of income inequality and other forms of inequality, such as in health care, may have detrimental effects on long-term economic growth and the well-being of most Americans. Though the Census Bureau data provide a useful snapshot at a particular moment in time of the levels of income, poverty, health insurance, and income inequality, they do not tell us what is causing these levels or their economic implications.

To promote rapid and widely shared growth may require attention to both short and long-run demand and supply factors. For instance, we may need to better understand the role that demand plays in promoting business sales, creating jobs, and boosting wages. Likewise, we may need to better comprehend the productivity or long-term supply side effects of investments in the health, education, and training of people. In the coming years, Equitable Growth will analyze the data ourselves and provide annual grants to other academics across an array of social sciences in an attempt to provide answers.

Building a strong foundation for the U.S. economy

Posted on by Ed Paisley

The U.S. economy experienced several structural shifts over the past several decades, including a large increase in inequality across a variety of dimensions. Despite headlines about inequality as a single issue, there are several aspects to the phenomenon. To be sure, incomes are skyrocketing among the top earners, income growth for the middle class is slower than in the past, and income growth is all but stagnant for those at the bottom.

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Yet income isn’t the only dimension of inequality. We have seen increases in inequality in wages and salaries, access to quality jobs, educational attainment, family and household workplace policies, and, of course, wealth. Considered together, the top members of our society are quickly pulling away from the rest of us across a variety of dimensions, with those in the middle and the bottom of our society experiencing little to no gains.

We are not the only ones to notice these trends. Nor are we the only ones to be asking what this means for our society and for our economy. Last year, just after we launched the Washington Center for Equitable Growth, President Obama argued that inequality was “the defining challenge of our times.” Soon after, Sen. Marco Rubio (R-FL) and Rep. Raul Ryan (R-WI) called on policymakers to grapple with specific aspects of inequality and what it means for our nation.

A robust set of academic research seeks to understand how the changes in income inequality affect our economy. Looking at the overall picture, this research suggests that in cases of extreme inequality, such as prior to the Great Depression in the 1920s as well as today in the United States, inequality is negatively associated with economic growth and stability. But this research on the overall relationship between inequality and growth does not necessarily help us understand why or how inequality affects the economy or provide policymakers with solutions to address these challenges.

Then, last spring, Paris School of Economics professor Thomas Piketty spurred an international debate with his book, “Capital in the 21st Century.”4 He sought to understand the interrelations between rising inequality and economic growth. The publication of his book led to many an econo-geek sporting t-shirts with the now-famous, but still cryptic “r>g” equation. One of Piketty’s fundamental conclusions is that so long as the rate of return on capital continues to be greater than the rate of economic growth—or, wage growth—then capital will become ever more concentrated.

There are for a variety of reasons to think that this calcification of wealth is not in the interest of long-term economic growth, which brings us to a set of empirical questions that Equitable Growth seeks to understand:

  • What are the mechanisms through which inequality affects the economy?
  • Which ones play out in the short term and which play out in the long term?
  • Are they mostly on the supply side or on the demand side, or both?

We have prepared this report for our second annual conference on September 19, 2014, and have asked a diverse array of scholars and policymakers with expertise in issues such as human capital development, productivity growth, entrepreneurship, and wage growth to examine these developments across our economy. Because the trends—and their implications—play out differently across the income spectrum, we have organized our discussion around trends and policies focused on the bottom, the middle, and the very top of the income ladder.

We seek to begin a conversation that not only accelerates analysis on whether and how these factors affect economic growth and stability but also inspires policy solutions that reduce inequality and expand economic growth, mobility and opportunity for all.

—Heather Boushey, executive director and chief economist, Washington Center for Equitable Growth

Income inequality affects our children’s educational opportunities

Posted on by David Evans

One of the clearest manifestations of growing economic inequality in our nation today is the widening educational achievement gap between the children of the wealthiest and the children of everyone else. At first glance, this sounds like an obvious outcome. After all, wealthier families are able to afford expensive private schools, or homes in wealthy public school districts with more educational resources.

But a closer look at this education achievement gap over the past 50 years or so shows that the gap only began to widen in the 1970s, right about the time that wealth and income inequality in our nation also began to grow. The past 30 years have seen a sustained rise in inequality in wages, incomes, and wealth, leading to more and more income and wealth accruing to those at the top of the economic ladder, pulling the rich further away from those on the other rungs.1

At the same time, the growing educational gap became ever more apparent. In the 1980s, the gap between the reading and math skills of the wealthiest 10 percent of kids and poorest 10 percent was about 90 points on an 800-point SAT-type scale.2 Three decades later, the gap has grown to 125 points. This widening gap is largely due to differences in how well prepared children are for school before they enter kindergarten or even pre-kindergarten.3 In this era of economic inequality, wealthier parents have far more resources, both in terms of time and money, to better prepare their children to succeed in school and later in life.

This widening educational achievement gap may threaten our future economic growth. With only a select few individuals receiving the best education and enrichment, we are not effectively developing the economic potential of our future workforce. To grow our economy we must provide educational and enrichment opportunities for children across the income spectrum, rather than only a select few at the top.

Wealth and income largely define the educational gap today, more so than race and ethnicity. In the 1950s and 1960s, the opposite was true. Back then, racial discrimination in all aspects of life led to deep racial inequality. Economic inequality, in contrast, was lower than at any time in U.S. history, according to extensive research done by economists Thomas Piketty at the Paris School of Economics and Emmanuel Saez at the University of California, Berkeley.4 But anti-discrimination and civil rights legislation and school desegregation led to improved economic, social, and educational conditions for African Americans and other minorities beginning in the late 1960s. As a result, the gap today between white and black children is about 70 points on an 800-point SAT-type scale, 40 percent smaller than it was in the 1970s, and about half the size of the gap between rich and poor children, but still unacceptable.5

The growth of the socioeconomic achievement gap appears to be largely because more affluent parents are increasingly investing more time and money in their kids’ educational enrichment—and at earlier periods in their children’s lives—than hard-pressed low-income and middle class families.6 Indeed, surveys show that the amount of time and money parents invest in their children has grown sharply over the past four decades among both affluent and non-affluent parents. But the increase in these investments has been two to three times greater among high-income families.7 Economists Richard Murnane of Harvard University and Greg Duncan at the University of California-Irvine find that between 1972 and 2006 the amount high-income families spent on their children’s enrichment activities grew by 150 percent, while the amount spent by low-income families grew by 57 percent.8 In part, parents are spending more on their kids because they understand that educational success is increasingly important in today’s uncertain economic times, a point that sociologist Marianne Cooper at the Clayman Institute makes in her recent book “Cut Adrift.”9 But low- and middle-income families can’t match the resources—both the money and flexible time—of the rich.

As a result, rich and poor children score very differently on school readiness tests before they enter kindergarten. Once they are in school, however, the gap grows very little—by less than 10 percent between kindergarten and high school.10 Thus, it appears that the academic gap is widening because rich students are increasingly entering kindergarten much better prepared to succeed in school than low- and middle-class students. To be sure, there are important differences in the quality of schools serving low- and high-income students, but these differences do not appear to be as salient as the differences in children’s experiences prior to kindergarten.

The socioeconomic education gap is likely to affect us for decades to come. Think of it as a leading indicator of disparities in civic engagement, college enrollment, and adult success. Indeed, family income and wealth have become increasingly correlated with a variety of positive adolescent activities, such as sports participation, school leadership, extracurricular activities, and volunteer work, according to research conducted by Harvard University political scientist Robert D. Putnam and his colleagues.11

Not only are the children of the rich doing better in elementary and high school than the children of the poor, they also are cornering the market on the seats in the best colleges. In a study that I conducted with several of my graduate students, we found that 15 percent of high-income students from the 2004 graduating class of high school enrolled in a highly selective college or university compared to only 5 percent of middle-income graduates and 2 percent of low-income graduates.12 Because these colleges provide educational opportunities and access to social networks that often lead to high-paying jobs, children from low-income families risk are being locked out of the upper end of the economic spectrum. For low-income children, the American Dream is further out of reach.

This is bad news for our future economy and society because we need well-educated workers in order to sustainably boost economic productivity and grow the economy. So how can we prepare every child, not just those most affluent ones, to be productive members of society? First of all, we must acknowledge that educational problems cannot be resolved by school alone. The achievement gap begins at an early age. To close it, we must invest in children’s early childhood educational opportunities. This means investing not only in preschool but also in parents. Specifically, we need to:

  • Invest in high-quality early childhood education programs (pre-schools, day care) and make them affordable for all families.
  • Invest in programs that help parents become their children’s first and best teacher.
  • Provide policy solutions to help all parents have the time to be teachers through paid leave, paid sick days, workplace flexibility, and income support programs that ensure that families can focus on their children even in hard economic times.

In short, we can narrow the socioeconomic education gap through public policies that help parents of all incomes provide enriching educational opportunities for their children in the way that only affluent parents can do today.

The prison boom and black-white economic inequality

Posted on by Ed Paisley

Over the past 40 years, the observed earnings gap between African American men and their white counterparts closed slowly but steadily. The average black employed worker earned about a quarter less than the average white employed worker with similar experience in 2010 compared to about a third less in 1970. Such enduring earnings inequality is nothing to celebrate, but at least the trend line is encouraging.

Or is it?

Those reported earnings gains among black men fail to take account of different trends in incarceration and employment, which not only skews labor market statistics but also masks the debilitating economic consequences of the mass incarceration of African American men over the past several decades. When properly accounted, there is little reason to believe that the labor market prospects for black men relative to white men have improved over the past 40 years.

Let’s start with the “prison boom,” or more precisely, the trend in incarceration rates, which have more than doubled over the past 30 years. Today, more than 2.3 million people are locked up in local jails, state prisons, or federal prisons. Although this prison boom affected all racial and ethnic groups, it has had a disproportionate effect on African American men. In the 2010 Census, almost one in ten African American men ages 20 to 34 were institutionalized, while the corresponding rate for white men was only about one in fifty.

Further, on any given day in 2010, about one third of African American men who were high school drop-outs between the ages 20 and 34 lived in jails, prisons, mental health institutions, or nursing homes, and there is good reason to believe that the fraction in prison or jail exceeded the employment rate for this group. Of course, this is just at any given point in time. The fraction incarcerated at some point in life is even higher—about two-thirds by age 34, according to a recent book by sociologist Becky Pettit from the University of Washington.

While these statistics are not new to criminologists, they imply that a growing share of the U.S. population is missing from the government’s main source of information about the labor market: the Current Population Survey. The CPS only covers the non-institutionalized population, but the federal government uses it to calculate important measures of labor market outcomes such as wages, labor force participation, and unemployment rates as well as official poverty statistics, including the Census Bureau’s new Supplemental Poverty Measure.

As the missing data problem has become more severe, these measures have become more distorted, in particular with respect to trends in racial inequality. In a recent NBER working paper, economist Derek Neal and I argue that since 1970, the economic progress of African American men relative to white men has been quite anemic. We reach this conclusion by properly accounting for the growth of the prison population over this period, and hence the misleading picture derived from average labor market earnings for employed workers.

In our paper, we treat the median weekly wages of men in their prime working years as a proxy for their overall labor market prospects. Among the employed, the ratio of median weekly wages for African Americans relative to whites increased steadily from around 65 percent in 1970 to well over 75 percent in 2010, the most recent census year. Yet this statistic substantially overstates the recent relative progress of African Americans for two reasons. First, employment rates for working age men have declined much more among blacks than among whites, and growing numbers among the non-employed are incarcerated. Second, earnings prospects are now and have always been worse for those who are not currently employed.

Thus, we estimate what we call median potential wages for blacks and whites, making adjustments for changes in the numbers of non-employed and institutionalized persons over time. We find that the labor market prospects of black men relative to white men have not improved over the past 40 years. There have been slight ups and downs (with some noteworthy progress in the 1990s), but in 2010, the ratios of median potential wages among African American men to the median potential wages of their white peers were roughly at 1970 levels, across groups with different levels of experience.

Black-white economic convergence, then, has come to a halt after substantial progress throughout most of the past century, as documented in a seminal 1989 study by James Smith of the Rand Corporation and Finis Welch, then an economics professor at the University of California-Los Angeles. While it is difficult to quantify the exact contribution of mass incarceration to the lack of black relative progress in recent decades, some studies do find suggestive evidence that incarceration harms employment and earnings opportunities long after prisoners serve their time.

Our results concerning stalled relative progress for African American men are particularly noteworthy because we are also able to demonstrate that the prison boom was primarily the result of policy choices. At first glance, one might suspect that rising incarceration rates reflect increased criminal activity as a consequence of deteriorating legal labor market opportunities for people with little formal education. But the boom in crime is long over. Criminal activity and arrests for all non-drug-related offenses peaked in the early to mid-1990s and have been on the decline ever since. Drug-related arrests increased well into the late 2000s, but due to short average sentences, drug offenses on their own contributed relatively little to the overall boom in incarceration.

Instead, the main driver of the prison boom has been a move toward more punitive corrections policies across all offense categories, not just drug crimes. Such policies include so-called Truth-in-Sentencing laws, “Three Strikes” policies, and mandatory minimum sentences. As a result, arrested alleged offenders in each violent crime category are now at least twice as likely to spend more than five years in prison then they were in the mid-1980s. The pattern is perhaps even more striking for non-violent offenses: conditional on arrest, the probability of any given sentence length has increased—often by a factor of two or more.

Overall, an alleged offender in the 2000s can expect to spend about twice as long in prison as in the 1980s, conditional on the severity of the crime. Of course, not all of this shift necessarily reflects a change in policy. In particular, technological advances such as the use of DNA evidence may have increased the probability that an alleged offender is found guilty. But these new investigative methods have been adopted by other developed countries—and none of them have experienced changes in distributions of time-served among offenders that are even remotely similar to those we have seen in the United States. Therefore, it is hard to avoid the conclusion that sentencing and parole release policies have played the leading role. We estimate that the overall shift toward more punitive corrections policies probably accounts for between 70 and 85 percent of the growth in incarceration rates since 1985.

There is now substantial evidence that the boom in incarceration had an adverse effect on the relative economic progress of African American men, and that this prison boom was primarily a policy choice and not a result of deteriorating labor market conditions. Supporters of tougher corrections policies may argue that these policies have contributed to the decline in criminal activity over the past two decades. But even with our study, the costs of that crime reduction have not been fully counted and may not have been fully realized yet.

Some recent studies provide evidence that more punitive treatment of first offenders increases recidivism rates and prolongs criminal careers, and recent trends in the demographic characteristics of prisoners are consistent with this claim. Crime in our country was once almost exclusively a young man’s game, but arrest rates and prison admission rates for men ages 40 to 49 have risen disproportionately in recent years. In addition, we have not yet seen how policies that promote mass incarceration within particular communities will impact future generations from those communities.

—Armin Rick is Assistant Professor of Economics at Cornell University’s Johnson School of Management. His collaborator on this project is Professor Derek Neal of the University of Chicago Economics Department. Their paper, “The Prison Boom and the Lack of Black Progress after Smith and Welch,” was recently released by the National Bureau of Economic Research.

Nothing new under the labor market sun

Posted on by Ed Paisley

The Bureau of Labor Statistics released new labor market data today showing that the U.S. economy added 209,000 jobs and that the unemployed rate ticked up slightly to 6.2 percent. Overall, the data show an economy continuing on its path of the past several years—a moderate recovery that is inadequate in light of the severity of job losses during the Great Recession.

The slight increase in the unemployment rate was due to an increase in the labor force and not a decline in the number of employed workers. According to the BLS household survey, the number of employed workers increased by 131,000 while the overall labor force increased by 329,000. This resulted in an increase in the labor-force participation rate to 62.9 percent in July from 62.8 percent in June.

The share of the population with a job, the employment-to-population ratio, was unchanged from 59 percent, still 4 percentage points below the most recent peak in December 2006. The ratio for the working age population (workers ages 25 to 54) slightly decreased to 76.6 percent from 76.7 percent.

The number of long-term unemployed workers (those without a job for 27 weeks or more) was essentially unchanged, according to BLS. This group continues to be a large share of the unemployed at 32.9 percent of all unemployed workers. The debate about the future of the long-term unemployed will continue. Some analysts, including economists at the Board of Governors of the Federal Reserve, claim that the long-term unemployed are getting jobs while others remain quite skeptical of the evidence.

Businesses added 209,000 total jobs during July, 198,000 coming from the private sector. The employment gains were less broadly based than in recent months. The diffusion index for private industries, a measure of how many industries added jobs, was only 61.9 percent in July compared to 65.3 percent in June and 64.4 percent in May.

Manufacturing added 28,000 jobs, and all of the gains (30,000) came from industries that manufacture durable goods. Specifically, 14,600 jobs came from the auto industry. Nondurable manufacturing industries shed 2,000 jobs in July led by food manufacturing (a loss of 3,600 jobs).

The data on wage growth, relevant to the current debate about slack in the labor market and the future of Federal Reserve policy, also showed little change. The year-on-year change in the average wage for all workers was 2 percent. Wage growth has hovered around this rate for the last year and shows no sign of acceleration. And the rate is well below its pre-recession level in 2007, which was closer to 3.5 percent.

080114-wage-growth-01

The data released today show a labor market that continues to heal from the Great Recession. But the recovery continues to come up short given the damage done in the past. With wage growth still subdued and no sign that the long-term unemployed are locked out from jobs gains, policy makers should be skeptical of calls to pull back on growth-boosting measures. Overly cautious policy would not only leave our economy weaker in the short run but undermine our long-term economic growth potential as well.

A post-war history of U.S. economic growth

Posted on by Ed Paisley

Five years removed from the end of the Great Recession, economists, policymakers, investors, business leaders, and everyday Americans from all walks of life remain concerned about the future of economic growth in the United States. The severity of that two-year recession and the lackluster recovery ever since sparks fear among economists and policymakers that the U.S. economy is in for a perhaps new and long period of slow growth. Economist Tyler Cowen of George Mason University raised this concern in his book “The Great Stagnation.” And Harvard University economist and former Treasury Secretary Larry Summers recently warned about secular stagnation where the economy suffers from a prolonged period of inadequate demand.

Read a PDF of the full document with all citations

While these fears are surfacing today, the anemic economic conditions that prevail at present and from which these concerns spring may be the result of structural changes in the U.S. economy over the past 40 years. Since the mid-1970s, the U.S. economy has undergone a variety of changes that may help or hinder economic growth over the long-term, among them:

  • An employment shift from manufacturing to services
  • The advent of the Internet
  • The entrance of women into the paid labor force
  • The greater participation of people of color in all sectors of the economy
  • The greater openness of the economy to international trade
  • The ever-evolving role of government
  • A rapid increase in income inequality

The mission of the Washington Center for Equitable Growth is to understand whether and how these structural changes, particularly the rise in inequality, affect economic growth and stability. But before we can understand how these forces may affect economic growth, we need a baseline understanding of how the U.S. economy grew in the past.

This report helps in that endeavor by looking at the past 65 years of economic growth in the United States—measured by examining our country’s Gross Domestic Product, both its rate of growth and sources of growth, from 1948 to 2014. The starting point, of course, is what this oft-cited statistic GDP actually measures. GDP is comprised of aggregate statistics based upon four major components: consumption, investment, government expenditures, and net exports.

The report then looks at the overall growth of real (inflation adjusted) per capita GDP as well as the contributions of each component to growth over time, specifically over business cycles, or patterns of economic recessions and expansions. (See graph.)

web-econgrowth01

Based on the overall trends, we divide the post-World War II into three eras of growth—the booming post-war period to the early 1970s (the fourth quarter of 1948 to the fourth quarter of 1973), the transition period to the early-1980s characterized by a series of economic shocks and high inflation (the fourth quarter of 1973 to the third quarter of 1981), and the ensuing period of low economic volatility and heightened growth known as the Great Moderation up until the start of the Great Recession in 2007 (the third quarter of 1981 to the fourth quarter of 2007).(See graph.)

web-econgrowth02

Specifically, economic growth in the third period, leading up to the Great Recession, was:

  • Not as brisk as it once was
  • More dependent upon consumption
  • Held back by net exports
  • Less driven by government expenditures and investment

The current business cycle, starting with the beginning of the Great Recession, appears to be the beginning of a new era—one tentatively defined by tepid consumer demand, stagnant real-wage gains, and growing economic inequality.

This report will have achieved its purpose if it spurs new thinking about how exactly we can and should promote economic growth in the United States.

Designing a research agenda to move the minimum wage forward

Posted on by Ed Paisley

During the most recent push to raise the federal minimum wage in the United States, more than 600 economists signed a letter encouraging Congress to do so, including seven Nobel laureates. This letter highlighted research that the minimum wage has little to no impact on the employment of minimum-wage workers and that a raise would provide a small stimulus effect on the economy. A few weeks later a letter opposing a rise in the minimum wage was released with the signatures of more than 500 economists, including three Nobel laureates. The opposing letter focused on the increase in labor costs and pointed to a Congressional Budget Office analysis that finds an increase would reduce overall employment, although the 90 percent confidence interval included a zero effect. These economists fundamentally disagree about the response of employment to minimum wage increases, contributing to the paralysis at the national level on the minimum wage, but both claim to point to “the research.”

Read a pdf of the full document.

We propose a series of research projects targeted at advancing the policy debate. In their February 2014 report the Congressional Budget Office highlighted several areas where they argued that there was not enough information or consensus to make strong assessments. We are reaching out to advocates and policymakers to better understand the questions about the minimum wage they want and need answered, with the intention of shaping a research agenda on the minimum wage that directly answers their questions.

Below we identify research questions that may be of interest to policymakers and advocates inspired by the existing academic research as well as the recent CBO paper. This discussion paper should be treated as the name implies—a jumping-off point for a conversation about a research agenda designed to move the policy process forward.

The 2014 Congressional Budget Office report, “The Effects of a Minimum-Wage Increase on Employment and Family Income,” addressed the questions posed to them by Congress on the impact of an increase in the minimum wage, and relied on the most up-to-date academic research in doing so.

Consequently, the CBO report had to adjudicate between a wide variety of studies on the minimum wage, not all of which pointed to the same conclusions. In many cases, the report splits the difference, such as when it cites “uncertainty about the responsiveness of employment to an increase in wages.” Given these inconsistencies, a minimum wage research agenda that addressed the following questions could help clarify and focus the empirical evidence:

  • How does the minimum wage affect production?
  • How do outputs, profits, and prices change?
  • Does a rise in the minimum change worker efficiency?
  • Do increases affect low- and high-productivity firms differently?
  • Are there changes to workforce composition or hours worked?
  • How does the minimum wage affect the overall wage distribution?
  • How large are“ripple effects”for workers who already earn more than the minimum wage?
  • How much does the minimum wage change income inequality?
  • Does the minimum wage affect the macroeconomy?
  • How much less is spent on government benefits for low-income people?
  • How do consumption patterns change from increased wages?
  • How does the structure of the minimum wage policy impact outcomes?
  • How do effects vary by the size of the minimum wage increase?
  • Do minimum wage changes have different short- and long-run effects?

Many of these questions have been addressed directly or indirectly in the economics literature, but work will be needed to synthesize and effectively communicate the results in a way that allow for a more direct, effective response to CBO’s analysis. Yet many
of these topics are under-researched or rely on older data, suggesting a need for new research. This discussion paper explores several of these questions as a starting point for encouraging new research.

How do employment effects vary by the size of the minimum wage increase?

While recent research suggests that modest increases in the minimum have strong effects on earnings and small effects on employment, little work exists on whether this pattern holds for larger raises. Economic theory suggests that the effects will vary by the “bite” of the minimum wage into the underlying wage or productivity distribution. In a study of the 1996 and 1997 federal minimum wage changes, Economist Jeffrey P. Thompson— now at the Federal Reserve Board and previously a professor at the University of Massachusetts, Amherst, found that in 2009, counties with low average earnings (where the minimum’s “bite” was greater) had larger falls in employment after the wage change. Offering an international perspective on the debate, economists Yi Huang, Prakash Loungani, and Gewei Wang estimated that after China strengthened minimum wage enforcement, firms with low profit margins reduced employment, but firms with high profit margins expanded.

Seattle has just passed legislation to increase the city minimum wage from $9.32 per hour today to $15 by 2017-2021, depending on the type of employer. San Francisco is now con- sidering following suit. Opponents of the minimum wage frequently respond by highlight- ing the arbitrariness of the levels proposed by legislators. Additional research could ground the levels in analysis and help policymakers identify the best targets.

Do minimum wage changes have different short-run and long-run effects?

In his review of the research fifteen years ago, University of Michigan economist Charles Brown emphasized that understanding the long-run effects of the minimum wage remains “the largest and most important gap in the literature.”  Perhaps the research overall found no short-term employment effects because firms are unable to modify production in response to a minimum wage increase in the short-run, but in the medium- to long-run, they are less constrained in terms of hiring patterns and substituting capital for labor.

More recently, Texas A&M University economists Jonathan Meer and Jeremy West argued that the minimum wage primarily influences employment growth, rather than the employment level. Therefore, an increase in the minimum wage has a small effect on employment levels in the short-run , but a large effect in the long-run. In contrast, economists Arindrajit Dube at the University of Massachusetts, Amherst, T. William Lester at the University of North Carolina, Chapel Hill, and Michael Reich at the University of California, Berkeley, failed to find effects on employment levels up to four years after minimum wage increases. Additional work must reconcile conflicting evidence on long-term effects of an increase in the minimum wage.

How does the minimum wage affect production?

To respond to a minimum wage increase, employers and workers may choose a variety of “channels of adjustment,” such as raising prices or improving efficiency. The most comprehensive evidence suggests that restaurants raise prices in response to a minimum wage increase, passing a portion of increased labor costs onto consumers. Unfortunately, the city-level data used in this analysis is almost two decades old, and has not been subjected to alternative specifications. With more recent but less comprehensive data, economists Emek Basker and Muhammad Khan at the University of Missouri, Columbia, find similar price increases for two out of three restaurant items. New research with better quality price data has a high probability of informing how much affected businesses raise prices after a minimum wage increase.

By improving worker and managerial efficiency, minimum wage increases may boost labor productivity. Productivity effects would be consistent with current research confirming that worker turnover falls sharply after a minimum wage increase, both in the United States and Canada.  In addition, restaurant managers’ survey responses suggest that minimum wage increases provide an opportunity to portray the “cost shock as ‘a challenge to the store’” in order “energize employees and to improve productivity,” according to a study by economists Barry Hirsch and Bruce Kaufman at Georgia State University. Similarly, using plant-level data in the United Kingdom, economists at the National Bureau of Economic Research find that revenue-per-worker increases in response to a minimum wage rise, but the effect is statistically insignificant.

Firms may also adjust production practices in the face of a minimum wage increase by hiring more highly skilled workers, or by reducing hours of the lower-skilled work- force. Existing high-quality studies do not generally find large effects on workforce composition and hours, but the estimates remain too statistically imprecise to rule out substantive effects. One recent study, for example, estimates that teen hours either fall somewhat or not much at all, depending on the specification.

More recent but preliminary work suggests that relatively small employment-level impacts of the minimum wage may conceal large changes in the mix of firms. The study finds that restaurants in three states that raised minimum wages during the 2000s experienced increases in employees’ hiring and departures from firms. New research must provide more comprehensive and precise evidence on how firm composition and output change in response to the minimum wage.

How does the minimum wage affect the overall wage distribution?

By raising the wage floor, the minimum wage reduces inequality, but current research has not settled on the size of these effects. One study in 1999 estimated that the falling real value of the minimum wage accounted for the entire increase in wage inequality between the median wage and the 10th percentile wage during 1979-1989. In contrast, a new study this year by economists David Autor and Christopher L. Smith at the Massachusetts Institute of Technology and Alan Manning at the London School of Economics finds that the falling real minimum wage accounted for about one-third of the inequality increase. Better data quality and more recent empirical techniques can improve estimates of the minimum wage’s impact on inequality.

In raising the minimum wage, workers just above the minimum wage will often see a wage increase. While many studies observe these “ripple effects” or wage spillovers, existing empirical work does not evaluate any underlying mechanisms. Do the spillovers occur within firms, as workers paid just above the minimum also demand raises? Or do they occur in the market, as firms are forced to raise wages to attract new workers? Or do they occur as employers attempt to maintain established wage structures (internal pay scales) within firms?

What are the macroeconomic effects of the minimum wage?

By lifting workers out of poverty, the minimum wage may reduce fiscal spending on income support and welfare programs. Two economists at the Institute for Research on Labor and Employment, Rachel West and Michael Reich, find that the minimum reduces the use of food stamps as well as state-level expenditures on that program. Additional empirical work could examine other needs-based programs and quantify state-level budget impacts.

Minimum wage raises likely translate into increased consumption, but little work exists
on directly measuring these effects. One recent study finds a minimum wage change leads to large increases in consumption; these expenditures seem concentrated in automobile purchases partially financed by debt. New research with high quality individual-level data will help to improve estimates of the consumption response to minimum wages.

A final related issue is whether minimum wage increases affect the economy differently during times of economic slack or expansion. One recent study finds that the minimum has large negative effects on employment when unemployment is high, but another one finds no such evidence. More work is needed to identify credible estimates of how the minimum wage interacts with the broader economy.