Inequality: how'd that happen?!

In a recent post, Mickey Kaus attacks Barack Obama for blaming the middle-class squeeze on, in Obama's words, "a corporate culture rife with inside dealing, questionable accounting practices, and short-term greed; a Washington dominated by lobbyists and special interests." But Kaus attributes inequality to something entirely different. Sayeth Mickey:

I would tend to blame ... increasing returns to skill produced by trade and technological change! They are hard to personify and demonize--they're just problematic trends we all need to confront.

That is a deeply problematic statement. Yes, a decade or so ago most economists probably would have attributed ever-growing levels of inequality to increasing returns to skill produced by trade and technology. But Mickey, the World's Most Annoying Democratic Concern Troll™, obviously hasn't been paying much attention lately, which is not surprising.

Kaus, whose brain seemed to stop functioning sometime during the Reagan era, is not exactly doing a lot of intellectual heavy lifting these days. Because if he were, he'd know that more and more economists and policy types are coming around to the view that something other than "increasing returns to skill" is going on here. The short answer to why our society is experiencing near-record levels of economic inequality? It's the politics, stupid.

It's not that the "increasing returns to skill" hypothesis is wrong, exactly. But it's woefully incomplete. The increasing returns to skill hypothesis posits that technological change, trade, and the outsourcing of low-skill labor has led to an increase in demand for skilled workers relative to unskilled workers. And since the supply of low-skill workers is large relative to demand, their wages have declined, while at the same time, wages of college-educated workers have increased (at least relative to non-college educated workers), because demand is outpacing supply.

That scenario is not wildly implausible, and there's some evidence that that has indeed been going on. But the more that the increasing returns to skill theory is subjected to scrutiny, the less likely it seems that it is the whole story.

There are multiple instances where the theory falls short. It's a difficult theory to test, and one reason for this is that "technological change" is difficult to measure. Moreover, technological change and a relative shift in demand for skilled workers have been constant features of our economy from at least as far back as the beginning of the 20th century. Yet there's little evidence that the dramatic upsurge in inequality that began in the 70s was accompanied by an equally dramatic increase in demand for technology-based skills.

In addition, over the past several decades, other industrialized countries were faced with the same economic forces, such as technological change, globalization, and trade, that the U.S. did. Yet among OECD countries, only the U.S. and the U.K. saw large increases in wage inequality; the other countries saw only modest rises in inequality.

The "increasing returns to skill" argument also conveniently omits the fact that the most of the college wage premium is driven not so much by increasing wages for college grads but by declining wages among the non-college-educated. Indeed, the largest gains in income and wages have not gone to the top 20% of earners, or even the top 10%. Instead, says Paul Krugman, it's been concentrated at the very top:

Between 1972 and 2001 the wage and salary income of Americans at the 90th percentile of the income distribution rose only 34 percent, or about 1 percent per year. . . .But income at the 99th percentile rose 87 percent; income at the 99.9th percentile rose 181 percent; and income at the 99.99th percentile rose 497 percent.

It's pretty hard to swallow that the relative demand for skilled workers has skyrocketed to such a shocking extent. No, something else must be going on here.

Increasingly, economists are looking at other factors to explain the steep rise in economic inequality. Political and institutional factors are getting renewed scrutiny. Several studies show that deunionization has played a major role. That's not surprising, because unions not only increase the wages of their members, but often have a spillover effect that pulls up the wages of other workers as well. Let's not forget that Ronald Reagan ushered in presidency by breaking the PATCO union, setting the example for union busters everywhere. And over the past 30 years, Republicans have largely controlled appointments to the NLRB as well, which has led to many decisions that have made it harder for unions to organize.

I would also argue that deunionization has impacted inequality in a less direct way. Union power is exercised not just in collective bargaining agreements but in the political arena. In short, unions create Democrats, and Democrats tend to support policies that reduce economic inequality. If a voter is a union member, chances are he is a Democrat, even if he's a member of a demographic group (such as white males) that tends to go Republican. The more powerful unions are, the more likely it is that we'll have more Democrats in office, and more Democrats in office tends to mean less economic inequality. But deunionization means fewer Democrats, and thus more inequality.

In addition to unions, another institutional factor that has led to increasing inequality is the decline of the minimum wage, as several studies have shown. A declining minimum wage means lower earnings for low-income workers. Even those who don't earn the minimum wage are affected when the minimum wage declines in value, because, as with unions, the minimum wage has a spillover effect, and an increase in the minimum wage tends to increase the wages of other workers as well.

It's clear that the decline of certain wage-setting institutions has created more inequality. Indeed, industrial countries that have stronger institutional protections for workers have tended to experience only modest increases in inequality.

And there's yet another factor at work. Intriguingly, some economists such as Paul Krugman, Thomas Piketty and Emmanuel Saez, and Julio Rotemberg have suggested that changing social norms have led to more inequality. Krugman summarizes:

 Much more than economists and free-market advocates like to imagine, wages -- particularly at the top -- are determined by social norms. What happened during the 1930's and 1940's was that new norms of equality were established, largely through the political process. What happened in the 1980's and 1990's was that those norms unraveled, replaced by an ethos of ''anything goes.'' And a result was an explosion of income at the top of the scale.

In short, the engine driving the inequality train is conservative politics. It is conservatives who have who have done their best to destroy those institutions, like unions and the minimum wage, that have created more equality in America. It is conservatives who have tirelessly propagandized in favor of the sanctity of unregulated markets, and have pushed wage-setting norms away from fairness and toward greed.

It is outrageously disingenuous to pretend that the huge increases in inequality that we have witnessed are merely the result of impersonal forces over which we have little control -- or, in Kaus' terms, "problematic trends we all need to confront."

Dude -- you may have forgotten, but you and your friends at The New Republic spend the 1980s bashing unions and economic regulations, and relentlessly pimping for free trade, unregulated markets, less progressivity in our tax system, and the crippling of the welfare state. Just what did you think would happen? It was utterly predictable that those policies would usher in the era of grotesque inequality we're experiencing today. Inequality is a very much feature of those policies, not a bug. Shifting power away from poor and working folks and toward corporations and the rich -- that was the whole goddamn point!

The sex columnist Dan Savage has written about a certain genre of letter he frequently receives, which he calls HTHs, or "How'd That Happen?!" letters. They're written by people who painstakingly explain that somehow, due to circumstances beyond their control, they find themselves partaking of some bizarre sexual kink. Like carnal relations with the family pet, for example. Or the guy who signs his letter "Mr. 200% Straight" asking, in essence, "How did his cock end up in my mouth?"

The bad faith that many people like Mickey Kaus display, when confronted with the consequences of political policies they have long supported, never fail to amaze me. Their writings are amount to a political version of Savage's "How'd That Happen?!" letters. Like the "How'd That Happen?!" folks, they are deeply dishonest with themselves. What I'd say to the "How'd That Happen?!" people, and the Mickey Kauses of the world, is simple: act like an adult, and own your desire. What has occurred is exactly what you signed up for, and at some level you must know it, too.

Comments

[Siun]

Bravo Ms G! What a treat to see Dan Savage used so appropriately ... and more so to see your wit and smarts have a lovely blog home!

[Crevette]

Tres formidable. And to think that we must now rescue the rapacious lenders who earned billions in subprimes!

Great blog

[Hebisner]

Unfortunately, Kaus will apply the usual analysis, which will be it's not that his free market, anti-union policies were destructive to the middle and working classes of this country, it's that we didn't deregulate and union bust enough! Kaus is the ultimate "that dick in my mouth doesn't make me gay or bisexual" sort of pundit. His embrace of the right wing economic ideology doesn't make him one of them, just..ah..tolerant?

[crack]

Check out Dani Rodrik's latest post. It deals with this issue, though it wisely ignores Kaus.

http://rodrik.typepad.com/dani_rodriks_weblog/2008/03/american-politi.html

[Kenneth Almquist]

One point that Krugman makes, but that isn't reflected in the organization of your article, is that economic inequality is not a single phenomenon. There is what I might call broad-based economic inequality, such as the gap between individuals with a college degree and those without. And then there is the gap between the people at the very top of the income scale and everybody else.

The first of these gaps is affected by things like the minimum wage and the level of unionization. The latter is harder to explain. The idea, expressed by Krugman, that there has been a cultural shift, is the most plausible explanation that I have heard.

[Eric]

Conservatives make the world safe for plutocrats - and that explains the growing difference between the 99.9th percentile, the 90th percentile, and the rest of us. The guys that were born on third base get together and make sure that while the rest of us may get a hit or two, they score all the runs.

[swampcracker]

(A thank you to Lindsay for this hat tip; and my congrats on your new forum)

Succinctly stated by another of my favorite bloggers, Echidne:

"The middle class is the only thing that keeps America from turning into a banana republic" (rough paraphrase).

It is even more amazing to me that working class Americans who support conservative economic theories have been coopted into a mindset that goes against their own economic self-interests. It is like the executioner who gives the condemned prisoner the lever with which to dispatch oneself.

[Kathy G.]

Thank you all for your comments. crack, I hadn't looked at Dani Rodrik yet today, but that graph is amazing. I will definitely blog it.

[lemuel pitkin]

Another nice post.

You are certainly right, and Kaus wrong, on the big question: increased inequality has far more to do with political and institutional changes than with trade, let alone technology.

But, I don't think it's correct to say that increased inequality is limited to the US and UK. Unfortunately the linked article isn't available to non-academics, but the Luxembourg Income Study is. Here are some representative Gini Indexes (the standard measure of income inequality) for various countries in the mid-1980s and early 2000s. 0 would be perfect equality and 1 would be a single household with all the income.

Country ... ~1985 ... ~2000
Austria ... 0.227 ... 0.257
Belgium ... 0.227 ... 0.279
Canada .... 0.283 ... 0.315
Taiwan .... 0.269 ... 0.296
Denmark ... 0.254 ... 0.228
France .... 0.288 ... 0.278
Germany ... 0.260 ... 0.275
Italy ..... 0.306 ... 0.333
Netherlands 0.260 ... 0.231
Norway .... 0.233 ... 0.251
Spain ..... 0.318 ... 0.336
Sweden .... 0.218 ... 0.252
UK ........ 0.303 ... 0.343
USA ....... 0.335 ... 0.372

As you can see, the trend toward increasing inequality, while not universal, is far more widespread than just the US and UK. The US has always been the most unequal rich country, followed by the UK, and this continues to be true, but most of the world is heading in the smae direction.

Finally, I agree with you 100% about the importance of unions in this story. Unfortunately, union density is dropping almost everywhere, not just in the US.

[sherifffriuitfly]

Just a quibble: Amy Sullivan is the world's most annoying democratic concern troll, imo.

[Kathy G.]

Lemuel, thanks for the info. You're right of course that inequality isn't limited to the U.S. and the U.K., but I believe the largest increases in inequality have been in those two countries. I found some more info about inequality in OECD countries, especially in the post-94 period, and I'll be writing about it later today. As your comment suggests, the situation is more mixed than I made it sound in my original posts, so I want to be sure to correct the somewhat misleading impression I may have left.

[Sinbad]

Why shouldn't the 1993 tax law changes putting in place a $1 million deduction cap for businesses and thus shifting much more executive pay into what became (for most and in most instances) far more lucrative stock options be a significant part of why the inequality came to exist at the highest level?

[Pete Murphy]

Kathy, you're obviously well-versed in economic theory. I'd like to offer a completely new perspective on the loss of manufacturing jobs in the U.S.

Our enormous trade deficit is rightly of growing concern to Americans. Since leading the global drive toward trade liberalization by signing the Global Agreement on Tariffs and Trade in 1947, America has been transformed from the weathiest nation on earth - its preeminent industrial power - into a skid row bum, literally begging the rest of the world for cash to keep us afloat. It's a disgusting spectacle. Our cumulative trade deficit since 1976, financed by a sell-off of American assets, is now approaching $9 trillion. What will happen when those assets are depleted? Today's recession may be just a preview of what's to come.

Why? The American work force is the most productive on earth. Our product quality, though it may have fallen short at one time, is now on a par with the Japanese. Our workers have labored tirelessly to improve our competitiveness. Yet our deficit continues to grow. Our median wages and net worth have declined for decades. Debt has soared out of control.

Clearly, there is something amiss with "free trade." The concept of free trade is rooted in Ricardo's principle of comparative advantage. In 1815 Ricardo hypothesized that every nation benefits when it trades what it makes best for products made best by other nations. On the surface, it seems to make sense. But is it possible that this theory is flawed in some way? Is there something that Ricardo didn't consider?

At this point, I should introduce myself. I am a self-published author of a book titled "Five Short Blasts: A New Economic Theory Exposes The Fatal Flaw in Globalization and Its Consequences for America." To make a long story short, my theory is that, as population density rises beyond some optimum level, per capita consumption begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (which always rises), inevitably yields rising unemployment and poverty.

This theory has huge ramifications for U.S. policy toward population management (especially immigration policy) and trade. The implications for population policy may be obvious, but why trade? It's because these effects of an excessive population density - rising unemployment and poverty - are actually imported when a nation attempts to engage in free trade in manufactured goods with a nation that is much more densely populated. Their economies combine. The work of manufacturing is spread evenly across the combined labor force. But, while the more densely populated nation gets free access to a healthy market, all we get in return is access to a market emaciated by over-crowding and low per capita consumption. The result is an automatic, irreversible trade deficit and loss of jobs, tantamount to economic suicide.

One need look no further than the U.S.'s trade data for proof of this effect. Using 2006 data, an in-depth analysis reveals that, of our top twenty per capita trade deficits in manufactured goods (the trade deficit divided by the population of the country in question), eighteen are with nations much more densely populated than our own (and many of these are wealthy nations, debunking the myth about low cost labor driving our trade deficit). Even more revealing, if the nations of the world are divided equally around the median population density, the U.S. had a trade surplus in manufactured goods of $17 billion with the half of nations below the median population density. With the half above the median, we had a $480 billion deficit!

Our trade deficit with China is getting all of the attention these days. But, when expressed in per capita terms, our deficit with China in manufactured goods is rather unremarkable - nineteenth on the list. Our per capita deficit with other nations such as Japan, Germany, Mexico, Korea and others (all much more densely populated than the U.S.) is worse. In fact, our largest per capita trade deficit in manufactured goods is with Ireland, a nation twice as densely populated as the U.S. Our per capita deficit with Ireland is twenty-five times worse than China's. My point is not that our deficit with China isn't a problem, but rather that it's exactly what we should have expected when we suddenly applied a trade policy that was a proven failure around the world to a country with one sixth of the world's population.

Ricardo's principle of comparative advantage is overly simplistic and flawed because it does not take into consideration this population density effect and what happens when two nations grossly disparate in population density attempt to trade freely in manufactured goods. While free trade in natural resources and free trade in manufactured goods between nations of roughly equal population density is indeed beneficial, just as Ricardo predicts, it is a sure-fire loser when attempting to trade freely in manufactured goods with a nation with an excessive population density.

If you're willing to consider a new economic theory that has originated beyond the hallowed halls of academia, one that sheds new light on how trade actually functions in the real world, then I invite you to visit my web site at OpenWindowPublishingCo.com where you can read the preface for free, join in the blog discussion and, of course, buy the book if you like. (It's also available at Amazon.com where you'll be able to have it shipped outside the U.S.) However, it appears that your blog has a substantial following. If you'd be willing to read and review the book on your blog, I'd be happy to send you a free copy if you'll just send me a shipping address.

Please forgive me for the somewhat "spammish" nature of the previous paragraph, but I don't know how else to inject this new theory into the debate about trade without drawing attention to the book that explains the theory.

Pete Murphy
Author, Five Short Blasts