The Rise in Inequality: The Honest Broker

Event – Income and Wealth Inequality in the United States: Evidence, Causes and Solutions | Rice University’s Baker Institute:

The policy debate on the sources, causes and potential solutions to rising income and wealth inequality has intensified in the past few years. Recently, French economist Thomas Piketty’s popular book ‘Capital in the Twenty-First Century’ garnered much attention and ignited further debate about these issues. Piketty argues that wealth will inevitably become more concentrated under capitalism because the returns to wealth are larger than economic growth rates. The solution he proposes is a coordinated global tax on wealth. The Baker Institute’s Tax and Expenditure Policy Program will host two renowned economists to discuss the underlying causes and consequences of inequality, evaluate the empirical evidence of rising inequality, and examine potential solutions for dealing with these problems in the United States.

• WELCOME AND INTRODUCTION: John W. Diamond, Ph.D., Edward A. and Hermena Hancock Kelly Fellow in Public Finance, Baker Institute
• PANELISTS
  • R. Glenn Hubbard, Ph.D.: Dean and Russell L. Carson Professor of Finance and Economics, Columbia Business School
  • J. Bradford DeLong, Ph.D.: Professor of Economics, University of California, Berkeley
• MODERATOR: George R. Zodrow, Ph.D., Allyn R. and Gladys M. Cline Chair of Economics; and Baker Institute Rice Faculty Scholar.

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As prepared for delivery:

The Rise in Income and Wealth Inequality: Evidence, Causes, and Solutions

J. Bradford DeLong :: U.C. Berkeley, NBER, WCEG, INET :: February 3, 2015 :: http://tinyurl.com/dl20150202a

I am very happy to be here, especially as Texas is a state I get to relatively rarely. I have unusually few relatives in it, you see. When the DeLongs got to Wichita they decided to turn north rather than south and wound up in DeKalb County, Illinois. And those who did end up here decamped to North Carolina, leaving me with none until last year when my cousin Annie and her husband moved to Dallas. The last time my wife and I spent any extended time in Texas was on our honeymoon, when we were washed out of our campsite in a swamp near the Louisiana border by a midnight mid-June thunderstorm, so we bypassed Galveston and Houston and then spent a week and a half going Austin-San Antonio-Permian Basin-El Paso.

We are here today because of a problem in the American economy, a problem that emerged back at the end of the 1970s. Since 1980 our rate of productivity growth in the American economy has been little more than half what it was before. Americans used to expect living standards in the country to double every generation. Not since 1980. in fact, standards of living at the median–with half the workers above and half the workers below–pretty much stopped growing around 1980 and are still stuck.

Now you can and probably should paint a more optimistic picture of how the American economy has done since 1980 then the standard rapidly growing wealth at the very top and stagnation everywhere else. Women are much better off economically with the decline in discrimination–if, that is, work burdens both outside and inside the household are fairly shared.

African Americans are better off economically with the decline and discrimination–although the overwhelming proportion of the African-American population has been caught up in the negative parts of broader trends. Our standard indices of what prices really are are biased upwards by about an extra half a percentage point per year which means that our standard indices of real incomes are biased downward by about the same amount. And the value each of us receives from what the buy is greater than its price–if it were not, we would not buy it. For information-type virtual goods the ratio of true user value to market price is bigger, and as more of our economy shifts the information goods this factor pays an extra dividend. Plus how people live is different from what they receive an income because of progressive taxes and the safety net.

Nevertheless:

2/5 of the measured productivity growth we reasonably expected back in the late 1970s that we would have seen by now in the American economy is simply not there.

Effectively all of the growth and measured living standards at the median of the population that we reasonably expected we would have seen by now is simply not there.

And that is a big problem–at least, that is a big problem if you believe in American exceptionalism an American progress.

Why has productivity growth done so much worse than previous generations? That is not a topic for tonight: and if he were to start there, we could never get anywhere else.

Why has the median done so much worse than the average since the late 1970s? Arithmetically, it is not because the bottom has caught up via some leveling process but because the top has leaped ahead. America’s best educated, best positioned, and most fortunate tenth looks no better educated or entrepreneurial relatively speaking now then its predecessor did in 1980. Yet it receives half of all income now while it only received one-third of all income then. That is what is given us a lower 85% little better than stagnant since 1980 in their real incomes, and 85th percentile to 95th percentile upper-middle-class with incomes growing roughly with economy wide productivity, and with an upper-class of households–a fortunate twentieth–with their incomes outstripping everyone else’s. The incomes of the top 1% slots in the distribution are the only ones to have grown faster since 1980 then before–economy why productivity +3% growth and income as per year for the top 1%.

And by the time you get up to the top 0.01%–The richest earning 260 households in Houston, in the rarefied air that only 1300 households now in Houston will ever breathe at any point in their lives–well, the incomes of those 260 start at $7 million a year and average $50 million a year. Back in the late 1970s would have started at, in today’s prices, $900K and averaged $6M. Fur people in that slice, The past generation has been a wonderful era of the American dream coming true.

What has happened has not been a tilting of the income distribution as globalization or the race between education and technology shifts the skill and education premium. What has happened, instead, has been a great hollowing out.

Below the 80%-ile–below roughly $90,000/year in household income–the slots in the distribution have had a hard time holding their own in real terms. Above that we have an upper middle class–from the 80% to the 95%-ile, with household income in the $90-$160,000/year level-—where the slots are more or less holding its own in relative terms and with income levels rising at the rate of growth of productivity.

And above that we have:

• At the 99%-ile, income from 1978-2013 up from $200 to $375,000/year.
• At the 99.9%-ile, up from $500,000 to $1,400,000/year.
• At the 99.99%-ile, up from $900,000 to $7,000,000/year

Why has this happened?

Why the enormous surge in wealth at the top and relative disappointment and stagnation everywhere below the upper-middle-class? 15 years ago when we talked about rising inequality we talked about the decision in the 1970s to stop increasing relative spending on public higher education. We talked about how thereafter technology kept creating more high-skill jobs and removing low-skill jobs and so college graduates and the well-trained found themselves in a sellers’ market and others in a buyers’.

Add onto that globalization, plus something title weird going on at the very top, and we thought we had a handle on it. We did not. The lion’s share of the gains are not being distributed in proportion to education or skill, but simply to those at the top.

There are a bunch of hypotheses. Larry Summers likes to muse on how George Eastman and Steve Jobs were both master technologist entrepreneurs, but one’s inventions supported middle-class prosperity in Rochester for decades, while the other’s created a few Silicon Valley millionaires. Some point to the decline of the union movement: it used to be overpaying your executives handed the UAW a powerful organizing tool, hence George Romney lived in a “normal” house, albeit in Grosse Point.

I tend to focus on the rise of finance–from 3% to 8% of total incomes, a very steeply-peaked sector indeed, and yet does the increase in the share of income it receives reflect anything more than modern high finance is much better at convincing individual middle-class investors and trustees of pension funds to take risks that they shouldn’t?

I tend to focus on the extra 5% of total income we spend on health care that other countries with health-care systems that outperform ours do not–and how much of that money flows to those who have gotten legislatures to bar nurse-practitioners from offering to treat their patients and who have figured out that the way to really make money in health is to collect insurance premiums and then figure out a way not to pay for the treatment of sick people, for sick people are expensive. I tend to focus on how with falling marginal tax rates and much higher pay levels for financiers who top executives regard as their peers, it is much much harder for directors and bosses who are part of the same social networks as bosses and immediate reports to hold the line, especially in the interest of shareholders given our well-known and longstanding flaws in corporate governance.

And then there are the hypotheses that suggest that rising inequality is relatively benign. There is the focus on winner-take-all information-goods industries. Fifty years ago it would have really raised the quality of life of three women to have been able to spend their afternoons hanging out laundry and gossiping with Oprah Winfrey over the back fence. In today’s world she manages to talk to not three people over the fence but to millions via the TV, and to turn her skill into a job, and to make $3 billion. That’s a big plus.

Back at the end of the 1970s it was promised that we would get better corporate governance and more time and energy devoted to invention and production management and less to tax avoidance if we lowered tax rates. We lowered them. But the productivity-growth benefits that were expected–well, I cannot see them in the data, and the only people who can are those with much more faith than St. Thomas ever had. And the argument that entrepreurship can only be spurred by the hope of a few very big prizes–well, Glenn Hubbard’s successor Greg Mankiw in the George W. Bush administration points to Steven Spielberg, Steven Jobs, and J.K. Rowling–all of whom would have been extremely happy to work like the dogs they worked like for 1/100 of the compensation.

Thinking about policies to remedy the situation is very difficult if we do not have a secure diagnosis of the causes of the problem, and we do not have a secure diagnosis of the causes of the problem. But I can say that making our income tax and our safety-net transfer system less progressive is not a rational policy reaction to the market economy’s having become a more unequal place.

And then there is the possibility that it is the old America, the America from 1933-1979, that was the anomaly. America before 1880 is the free-land America of the frontier, but as the frontier closed and the Gilded Age began income and wealth inequality rapidly became like it was today. Perhaps it is not what is going on now that is unusual, but what went on in the shadow of the Great Depression and the New Deal.

That is certainly what Thomas Piketty thinks. He points out that, historically:

1. Wealth is nearly always highly concentrated.
2. The era of wars, revolutions, progressive taxes, depressions, and social democracy that began in the 1910s quickly saw economy-wide wealth-to-annual-income ratios in the North Atlantic fall from about 7 to about 3.
3. And now it simply looks like we are going back to the old pre-World War I Belle-Époque Gilded-Age pattern.

Now this might be a benefit for the rest of us. After all, if the rich are rich because their ability to compound wealth is undisturbed, then they have to invest their wealth in something. And if they invest their wealth in useful buildings and productive machines, well then the rest of us who want to rent those buildings and work in businesses equipped with those machines find that we are in a buyers’ market: our wages go up, interest rates and dividend yields go down, and we have what John Maynard Keynes called the euthanization of the rentier, as the super-rich have immense wealth but because of low rates of profit derive only modest incomes from it.

It’s possible. But, as Thomas Piketty points out, when we look in history for the negative relationship between wealth-to-annual-income ratios and rates of return, we do not find it. Societies in which the rich are richer in relative terms appear to be societies in which the political-economic system is tuned to protect the profits of the rich as well.

So perhaps our grandchildren’s destiny will be to live in a world once again like that of Jane Austen or Honoré de Balzac–one in which marrying well after choosing the right parents are the roads to success as the world measures it…

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The Rise in Income and Wealth Inequality: Evidence, Causes, and Solutions

• J. Bradford DeLong :: U.C. Berkeley, NBER, WCEG, INET :: February 3, 2015
• http://tinyurl.com/dl20150202a

The Problem

• Americans used to expect living standards to double every generation…
• That stopped at the end of the 1970s—productivity growth halved…
• And stagnant real hourly median compensation tells us standards of living at the median stopped growing much, if at all…

Things Wrong with This Graph

• Misses decline in discrimination against women…
• Misses decline in discrimination against African-Americans…
• Denominator in real compensation still mostly a price index rather than a cost-of-living index (bias of 0.5%/year?)…
• Misses consumer surplus…
  • A lot more consumer surplus from “information goods” than from physical commodities…
• Misses progressive taxes
  • Misses safety net

Nevertheless…

• 2/5 of the total productivity growth we reasonably expected back in the late 1970s to see by now is not there…
• Effectively all of the growth in measured living standards at the median we expected to see is not there…

Why Has the Median Done so Much Worse than the Average?

• Arithmetically, top 10% up from 34% to 50%…
  • Reduction in 90% share by 1/4—from 2/3 to 1/2—accounts for the median…
  • Lower 85% little better than stagnant…
  • 85-95% growing with productivity…
  • 95-99% at productivity +0.8%/year…
• Top 1% at productivity + 3.0%/year—better than pre-1980…
• These are incomes of slots, not of people

And Look at the Top 0.01%

• From 1% to 5%…
• From 100 to 500 times average…
• 13,000 households at any point in time…
  • 260 households in Houston…
  • 1300 households now in Houston will make it there at some point in their lives…
  • Average income $50 million/year…
    • Back in the late 1970s their then-counterparts averaged $6 million/year…

What Has Happened?

• A “hollowing out”:
  • Below 80%—below $90K in household income—roughly holding its own in real terms…
  • An upper middle class—80%-95%, household income, $90K-$160K/year—holding its own in relative terms…
  • At the 99%-ile, income from 78-13 up from $200-375K/year…
  • At the 99.9%-ile, up from $500K-1.4M…
  • At the 99.99%-ile, up from $900K-$7M…

Why Has This Happened?

• Used to think:
  • Race between education and technology…
  • Plus “globalization”…
  • With something weird but less important going on at the top and the very top…
• That’s much harder a belief to hold on to now,
  • The lion’s share of the gains aren’t going to the educated, but to the top…

Hypotheses…

• Negative:
  • Something to do with the character of “technology”?
    • Kodak vs. Facebook
  • Decline of “union threat”:
    *It used to be that overpaying your boss gave your unions an excellent organizing tool…
    • George Romney lived in a “normal” house in Grosse Point…
  • Rise of finance: from 3% to 8% of total income…
  • Rise of health-care excess: another 5% of total income…
  • NIMBYism/congestion…
  • “Because they can”—lowered marginal tax rates, could afford to…
• Positive:
  • The rise of winner-take-all information-goods industries:
    • Oprah Winfrey, estimated net worth $3B, as America’s best friend…
  • Beneficial spur for innovation:
    • Greg Mankiw’s faux pas: “Steve Jobs as he develops the iPod, J.K. Rowling as she writes…Harry Potter… or Steven Spielberg as he directs…”
  • It didn’t work: we haven’t gotten faster productivity growth or better corporate control as a benefit of the 1980s reduction in marginal tax rates…
• Worrisome:
  • Great Depression and after as an unusual and anomalous era—it’s not what is going on now that is unusual, it is 1933-1979…

Thomas Piketty’s Take

• Wealth nearly always concentrated…
• Wealth-to-income falls from 7x to 3x annual income…
• Now it is simply going back…
• Will this be a bonanza for the rest of us? Keynes’s euthanasization of the rentier?…
  • No: wealth is very good at protecting itself and its returns…
• Your grandchildren will live, once again, in a world in which marrying well and choosing the right parents are the roads to success as the world measures it…

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