Is "aggregate demand" really what anyone cares about? I don't think so. We care about the quality of peoples' lives. And new research is starting to look at what sorts of fiscal policies matter for improving well-being whatever the macroeconomic aggregates say. Evan Soltas describes some of this work and interviews the authors:
Tax revenues fall automatically in recessions, and governments back that up with lower tax rates and/ or new credits and deductions. On the spending side, extra outlays on unemployment benefits and other transfers greatly exceed extra outlays on infrastructure and other purchases. This modern kind of fiscal stimulus is supposed to work by stabilizing disposable income. Stabilize that, the thinking goes, and you stabilize output and employment.
But is that right? In a new working paper, Ricardo Reis of Columbia University and Alisdair McKay of Boston University say no. They find that stabilizing aggregate disposable income plays a “negligible role” in stabilizing the economy as a whole. Transfer payments can indeed stabilize output, they find, but mainly through a different channel -- not by changing disposable income in the aggregate, but by changing its distribution. Fiscal policy, in other words, is all about inequality.
“It’s the redistribution that has a lot of kick,” Reis said in an interview. “The usual argument for transfers is basically Keynesian. We find that has very low impact in our model.”
More on the fiscal side here. What about the monetary side? Marc Chandler, a Wall Street manager writing in the Jacobin, describes the relationship between monetary policy and distribution.
Central bank independence was never what it was cracked up to be. During “normal” times, central banks protected the interests of the owners of capital. Paul Volcker is often cited as the epitome of the independent central banker, but surely his tight monetary policy, justified in terms of some technocratic money supply target created winners and losers. The owners of capital were among the winners, while those who did not own capital were losers (through such things as higher unemployment and downward pressure on real wages). ...
The setting of monetary policy was never simply a technocratic exercise as the [central bank independence theory] pretends. There were always those interests that benefited and those who did less well. Few cried of a loss of central bank independence, for example, when the Bundesbank would threaten tighter monetary policy in reaction to unions seeking a sharp increase in wages.
Much more here. Both the commentariat and academia have focused too long on the supposed technocratic features of policy: whether unemployment is at its "natural" rate, whether output is at "potential", whether central banks are "independent", whether inflation is "low and stable". None of these concepts exist in nature. None of them are even definable quantitatively, although they may be described quantitatively. Hence, they are not scientific concepts but terms of art with important distributional ramifications.
I have a paper forthcoming which looks at how banks respond to monetary arrangements. It turns out that monetary politics goes well beyond central bank independence. I'll post a link when it's available.
There are a lot of ways to think about what's happened to the flattening of median American income growth. One of the most interesting is Cowen's stagnation hypothesis, which attributes the lack of wage growth to not generating enough job-creating innovation. I like some parts of that hypothesis -- although I prefer to look at changes to political systems and developments in the global economy -- but there have been other things going on as well. One of them is this:
I want to focus on the period ending around 2000. If you go from the early-1970s trough to the late-1990s peak, the U.S. added about 9 percentage points of its labor to the workforce in about 30 years. At current population levels, that's about 30 million people. Even if you go from 1970 peak to the 2000s average, it's about 15 million people or so. Often these would be members of disadvantaged groups, such as women and minorities, whose wage potential would be lower than that of white males that were already in the workforce, so we're adding a bunch of relatively low salaries to our statistics over that stretch.
Looked at that way, it's almost impressive that median wages have been flat. If there had actually been stagnation, median wages would have gone down as more people got added to the labor force at low wages.
Or, instead of looking at median individual wages, we could look at median household wages:
As you can see, until the 2000s we had pretty strong growth that was actually accelerating over time. This doesn't consider everything -- more two-worker households means greater expenses for child care, etc. -- but we generally think employment is good for its own sake. It yields psychological benefits, allows greater flexibility for satisfying preferences and tastes, etc. In terms of social justice, excluding fewer women and minorities from pursuing the good life is also a good thing.
If we're thinking about trends in the U.S. economy over the past few decades we might consider it good news that we've been able to integrate more people into the workforce and that household incomes have increased. That's not stagnation. That's improvement.
This only gets us up to the 2000s, and it doesn't tell us anything about the future, but it's a component of the U.S.'s postwar economic history that doesn't get talked about enough.
Felix Salmon nails it in a post titled "All bank regulators are captured":
The fact of the matter, however, is that all regulators are captured by banks. Or, to be a little more precise, all legislatures are captured by banks, and all regulators do what the government tells them to do.
In countries like Canada and India, there’s a very small number of strong, well-capitalized banks with a vested interest in maximizing barriers to entry. So they’re happy with very tough standards. In Europe, national banking systems are also concentrated, so in theory they could go the same way. But European banks are more likely to have cross-border and global ambitions, and in any case as a matter of contingent fact they’re not very well capitalized. So they get the regulation they want — which allows them to grow fast without having to raise lots of expensive new equity capital.
And then there’s the US, which is pretty much unique among major economies in having thousands of pretty vibrant small banks. Those small banks have a lot of political clout in Congress, and they hated Basel II, because they’re not nearly sophisticated enough to take advantage of it. So they essentially bullied Congress into keeping the old Basel I standards, for fear that otherwise they would be at a massive competitive disadvantage with respect to the big US banks like JP Morgan Chase. Congress obliged, and used the FDIC as its chosen mechanism for blocking the adoption of Basel II in the US.
Does that make the FDIC particularly virtuous? No: it makes the FDIC just as beholden to the banks as any European regulator. Look at the banks’ contributions to the FDIC insurance fund, for instance: they fell to zero, for no good reason, just because the banks didn’t like making those payments.
Cross-national differences in regulations are not due to one country's regulators being somehow wiser than the rest. It has to do with different organizations of domestic interests within (and across) countries. These lead to different policy outcomes.
Paul Krugman does not in a post titled "Crats, Maybe, But Not Much Techno":
But it’s more than that: these alleged technocrats have in fact systematically ignored both textbook macroeconomics and the lessons of history in favor of fantasies. The European Central Bank has placed its faith in the confidence fairy, while imagining that it can run policy in a way that has never worked in several centuries of central bank experience. Meanwhile, the European policy elite has simply wished away the clear evidence that the euro zone needs to make an adjustment that is virtually impossible unless inflation targets are raised.
The point is that I know technocrats, and these people aren’t — they’re faith healers who are making stuff up to suit their prejudices.
I contend that Paul Krugman does not know technocrats. He knows people who have different priorities than those he dislikes in the government and punditocracy. He claims that his side are the true technocrats -- untainted by avarice or bias -- because that gives them a moral authority that they would not otherwise have. But Krugman's preferred "technocrats" are just those who prioritize labor over capital, to use a short-hand, while those he decries have the opposite preference. As Salmon notes, capital generally wins, but in varying ways that reflect their varying preferences in disparate places.
"Textbook macroeconomics" presupposes a political system that is dedicated to the pursuit of utilitarian aims, a "socially optimal" mix of outcomes. But there is no universally agreed upon social optimum. There are only different, competing interest groups with different, competing preferences. Rousseau was wrong about this. There is no General Will, only the Sum of Private Wills. Some interests are narrower than others, as OWS has figured out, but that's really the only difference.
If I am reading this right, then Suzanne Mettler believes that any tax rate lower than 100% is "indirect social policy":
Conversely, many of our mostly costly forms of social provision today camouflage government’s role as a provider of social benefits. They do this by channeling benefits through the tax code, as does the Home Mortgage Interest Deduction, for example, and/or through subsidies to private organizations, such as employer-provided health insurance benefits, for which recipients are not required to pay taxes. These latter, indirect policies are the ones I call the “submerged state.” It is easy for citizens to miss government’s role in these policies, and to assume that only the market at is at work.
Now as it happens I am against deductions and all other loopholes as a matter of course. But I do not define "things not taxed" as the government acting as "provider of social benefits". Mettler, it seems, does:
The difference between the direct and indirect social welfare policies, however, is illusory. From an accounting perspective, they are the same thing: both impose costs on federal spending and add to federal deficits.
This is only true if you start from the assumption that 100% of national income belongs to the government, which then distributes according to a mix of "indirect" tax breaks and "direct" spending programs. I.e., it's only true if you believe that there is an implicit 100% tax rate, from which the government deducts differing percentages based on a number of criteria. In that case a tax deduction and a spending program are the same thing.
But if you start from the assumption that 100% of national income does not belong to the government then this makes no sense at all. If I buy a house and the government does not tax a small portion of the amount I pay for it -- I still pay taxes on the purchase of the home... I just get to deduct the interest -- I am hardly "getting" anything from the government. I'm just not having something taken away.
And in that case the only thing that adds to federal deficits are spending increases. Think of a scenario: there is a tax rate of 0%, and no federal spending. The government decides to pass a child tax credit equal to 5% per child. Does this add to the federal deficit? No, because 5% of 0% is 0%. Under this scenario the child tax credit is meaningless. Now suppose the government was to keep taxes the same but spend 5% on the child. The deficit goes up.
More:
In most cases, tax breaks distribute resources by permitting people to pay less in taxes, rather than by paying out dollars or providing services. That aspect of their design makes it easy to construe them as tax cuts rather than as social provision. But this, too, is a false distinction. “Social tax expenditures” assist people with particular circumstances, granting them resources to which others are not entitled. This is in stark contrast to across-the-board tax cuts to all Americans.
That's true. People without children cannot claim child tax credits. And the child tax credit is a politically-motivated tax exclusion designed to encourage better care for children (or, perhaps, having more of them). But it is qualitatively not the same as a spending program that is also intended to benefit children. The latter redistributes income from some people to other people. The former does not. The latter increases the budget deficit. The latter former does not. See? It's a very important distinction.
Note also that according to Mettler's definition a progressive tax code is a government "social provision" because the tax does not apply equally to everyone.
You could make the same argument about some of the other programs Mettler discusses. The GI Bill could be considered part of the compensation contract that the military makes with service members. I know my siblings in the military (there are currently five of them) think of it that way. Many wouldn't join the military just for the salary; the fact that part or all of their college education is included in the package is what tips the scales.
If you look at the famous table that Mettler produced in her paper, the programs that people tend not think of as government programs are things in which there is no redistribution happening. All of them are tax credits (except for student loans, which are paid back usually with interest). The things that people do think are government programs are the things in which there is redistribution happening. Mettler recognizes this:
In short, the fact that citizens often fail to recognize these policies as government social provision is attributable not to some fault of citizens, but rather to the characteristics of the policies themselves.
Precisely. And the characteristic of the policy is what is important. A policy of not taxing 100% of income is not a government intervention. It is the absence of a government intervention. A policy of not taxing mortgage interest is similarly a lack of taxing mortgage interest. People have different attitudes about whether these are "social provisions" from the government because they have different definitions of what constitutes a social provision from the government. Remember the outcry when Obama started talking about "tax expenditures" a few months back? That's because people immediately recognized what he was talking about: he wanted to raise taxes and redistribute the proceeds to others. So the phenomenon Mettler is describing is at least partially about semantics, not just cognitive dissonance.
I do not write this to disparage Mettler's research program, which I find very interesting and valuable. And the phenomenon she describes certainly happens sometimes. But I see the tendency to use the accounting that Mettler uses, which presupposes that 100% of national income belongs to the government, from a lot of political scientists. I've never understood it. It goes against all of the common principles pertaining to the nature and role of liberal government in a democratic society.
I came across the Occupy Prishtina Tumblr the other day. While I find the rapid spread of the #OWS movement across the globe to be interesting, it also got me thinking. Kosovo is the poorest country in Europe. According to the CIA World Factbook, about 15% of its GDP GNP comes from remittances, and another 7.5% comes from aid and foreign donors. Kosovo has 40% unemployment and per capita income is under $3,000/year. And, of course, they are perpetually threatened by their stronger, richer, larger neighbor -- Serbia.
Almost anyone in Kosovo would gladly trade places with almost anyone camping out in Zuccotti Park. This is illustrative of the fact that the "We are the 99%" sentiment very much depends on which sample you are looking at. If you make $39,000/year you are below the US mean and median, and thus firmly within the domestic 99%. But an income of $39,000/year puts you in the top 1% of the global income distribution.* The American middle class may have stagnated in recent decades, but it is still a much better life than that of 99% of the world's population.
Not including my tuition remission, the stipend UNC gives me for teaching is about $15,000/year. I am occasionally able to supplement that by another grand or two through various sources. While that is above the poverty line, I obviously don't lead an extravagant life. And yet I am in the top 8% of the world's income earners, with expectations of doing far better within a year or two.
Of course the top 1% of Americans are even more elite. I'm not trying to diminish that fact, and I know that the "We are the 99%" is a slogan intended to amplify a broader political point. But I'd like to encourage folks to think globally. There are few people in the US whose lives are not within the world's top 10-15%.
*Yes that is PPP-adjusted.
UPDATE: Suzy Khimm and Scott Sumner make similar points. Khimm's numbers are slightly different than mine; I'm not sure why, but the takeaway is the same. I think this portrayal by Sumner drives it home:
Now let’s start down through Dante’s seven circles of Hell:
1. The US is much richer than Mexico. So much so that millions of Mexicans will risk the horrors of human trafficking into the US to get crummy jobs picking tomatoes all day in the hot sun.
2. China in 2011 is still considerably poorer than Mexico. The Chinese take much greater risks to get here.
3. China today is so much richer than China in 1997 that it’s like a different planet. The changes (even in rural areas) are massive.
4. The China of 1997 seemed like paradise compared to the China of the 1970s. Throughout Hessler’s book, people keep talking about how horrible things were during that decade and how prosperous they are now (1997 in Sichuan!)
5. The China of the 1970s was nowhere near as bad as during 1959-61, when 30 million starved to death.
It’s fine to worry about income inequality in the US. I also worry about this issue. But it’s important to keep in mind that there is much more to life than income inequality, and much more to the world than the US. In the grand scheme of things, tinkering with government programs to help the poor, pitiful, beleaguered American middle class isn’t likely to make much difference, at least from a utilitarian perspective. We need to broaden our outlook.
Noah Smith considers The Great Stagnation, and comes to similar conclusions as me [1, 2] but from a different starting point:
The basic idea of the theory is this: It is expensive to move products around. This means that if you have a factory, you want to locate it close to where your customers are, to avoid paying a bunch of shipping costs. Now consider two factories. The workers in the first factory will be the consumers for the second factory, and vice versa. So the two factories want to locate near each other ("agglomeration"). As for the workers/consumers, they want to go where the jobs are, so they move near the factories. Result: a city. The world becomes divided into an industrial "Core" and a much poorer agricultural "Periphery" that produces food, energy, and minerals for the Core.
Now when you have different countries, the situation gets more interesting. Capital can flow relatively easily across borders (i.e. you can put your factory anywhere you like), but labor cannot. If you start with a world where everyone's a farmer, agglomeration starts in one country, but that country gets maxed out when the costs of density (high land prices) start to cancel out the effect of agglomeration. As transport costs fall and the economy grows, the industrial Core spreads from country to country. Often this spread is quite abrupt, resulting in successive "growth miracles" that get faster and faster (as each new industrial region starts out with a bigger global customer base). The evidence strongly indicates that agglomeration is the driver behind developing-world growth.
But here's the thing: in the theory, the "old Core" doesn't keep getting richer. In fact, under some scenarios, it even gets slightly poorer while the "new Core" catches up. For a while, the negative effects of relocation trump the positive effects of progress.
So this could explain why we in the rich world are getting poorer. In the 50s, America was the only industrial "Core" that was not a pile of rubble. But since the 60s, we have seen successive "growth miracles": Japan and Europe in the 60s/70s, then Taiwan/Korea/Singapore in the 80s, then China since then, and now even India. In a New Economic Geography world, we would expect these successive relocations of manufacturing to hold down income growth in the U.S., even if technology was advancing as usual.
Smith calls this the "Great Location". I called it the "Great Redistribution". Smith emphasizes structural economic factors, while I tried to also incorporate political factors. But in general the two stories are congruous and probably complementary. (Arnold Kling has written a fair amount on this too.)
Cowen says in response to Smith that this doesn't tell us everything we want to know because "Median income begins to stagnate in 1973, before this trend is significantly underway". But I'm not sure about that. Is it just a coincidence that the Great Movement began right at the end of the Bretton Woods system? There was a series of perturbations in global markets related to the re-industrialization of Europe and Japan in the 1960s (as Smith notes). And even if the internationalist story can't explain everything, it can arguably explain more than a stagnation hypothesis, which can't account for the fact that average incomes have grown at roughly the same rates post-1973 as pre-1973. What has changed is the divergence between the mean and median of the distribution. This does not imply (to me, at least) a general economic stagnation, but rather a shift in how the economy is organized. Additionally, any account of changes to the US economy over the past 40 years that does not consider international factors is likely to be under-specified.
I had some of this "economic geography" logic in mind when I wrote my posts, but I honestly don't know that literature well enough to say much of anything about it other than the basic story that Smith laid out. That is, I'm sure people have empirically examined these questions in some depth; I just don't know where the consensus lies, if there is one. Clearly it's important enough, since a Nobel Prize was awarded for it. I'm just not sure what the state of that particular literature is.
Anyway, I'm happy to see international dynamics be brought into this discussion.
Daniel Davies and Alex Tabarrok objected to the graphs of GDP I included in this post on The Great Stagnation. Specifically, they didn't like the fact that the hypothetical lines I drew reflect constant linear growth rather than constant percentage growth. I.e., I didn't compound the growth when i drew those lines. They're right that the latter is a better measure of trend (it's what is used in almost all statistical analyses), so here's a new graph that takes that into consideration.
This graph shows the actual GDP per capita growth (circles) for the US, OECD, and entire world. The lines that begin in 1974 reflect what GDP per capita would look like if it had continued to grow at the 1960-1973 rate*. Note that a "Great Stagnation" hypothesis would expect significantly weaker growth post-1973, not the same amount and certainly not more. So the fact that the US was above the trend line until the early 2000s provides fairly strong evidence that if we're in a Great Stagnation it's more recent than Cowen argues, and doesn't correlate with stagnating median incomes all that well. In fact, the US does better than either the OECD or the globe, if "better" is defined as "closest to 1960-1973 trend", although the OECD trend line is quite a bit steeper**.
Anyway, just wanted to make sure I didn't leave the impression that my main point (about distribution) relies on faulty extrapolation.
*Specifically, I regressed a year counter on the log of GDP per capita (constant dollars, via WDI) from 1960-1973. The coefficient estimate represents the average growth in GDP per capita per year during that period. I then took that coefficient estimate and added it to 1973's GDP per capita to get 1974's predicted point, added the same constant to the predicted 1974 to get the predicted 1975, and so on.
**Of course the US is a big part of both OECD and world economies; if you removed the US from those groups the US would likely look still better in comparison. Although in the OECD's case, they added some countries during the series (e.g. Mexico, Slovakia) with lower per capita GDP than more established industrialized countries.
Tyler Cowen's The Great Stagnation has gotten a lot of attention for both its form and content. (I.e., there's more than a little irony in the fact that a book alleging that technological progress has markedly slowed was the first notable electronic-only book, although it has since been released in pulp-and-glue as well.) In the video above he presents his main thesis at TEDxEast. For those unaware, the argument runs basically like this: since 1973 or thereabouts, there has been a slowdown in median American income growth, and that trend has increased in the past decade. That slowdown is mostly attributable to a decline in technological innovation. We've reaped the gains of past innovations -- cars, planes, electricity, plumbing -- but haven't made many new ones. We tweak the old innovations to our advantage -- we've made cars safer and added GPS -- but those are marginal improvements, not fundamental advances. The exception is the internet and communications more generally, but while those improve quality of life they do little to improve typical incomes.
Cowen's argument has bothered me on a number of levels. First, I think he understates the real, and monetary, value of the internet and improved communications technology for standards of living. Second, I think he makes a mistake by looking almost entirely at the U.S., and almost entirely at median income. I want to focus on the second of these, placing it in the context of the first.
I'm really late to this party... Cowen's book has been covered by everyone in the blogosphere and almost everyone in the corporate press, so I'm sure someone has written more or less exactly what I'm about to write, but I've haven't seen it in quite this form before. So to see why I think Cowen's thesis is wrong, or at least incomplete, let's start with some global data.
This graph shows global real gdp per capita from 1960-2009 (blue line). I've highlighted 1973's income level -- $1,148 -- to show what the world looked like around the time that Cowen thinks the Great Stagnation started in the US. In the following 35 years, per-person income increased by nearly 800%. If the pre-1973 trend had continued (red line), that number would be more than halved. If growth post-1973 had stagnated, we'd be below the red line. But that didn't happen, as we can see from this series. First, global growth in the 1970s was faster than in the 1960s. And while that trend wasn't consistent through the 1980s and 1990s (dark green line), global GDP growth in the 2000s was the fastest during the period. In fact, by the end of the decade we'd caught back up to where we'd be if the 1970s trend had been consistent, before the financial crisis knocked us back a bit. But the story here is of pretty rapid growth on a global scale that actually accelerated in the most recent decade. No Great Stagnation, on a global level at least.
Cowen agrees that global growth has been strong as other countries adopt the innovations the U.S. has already exploited. This "catch-up" growth may be fine for developing countries, which have a lot of low-hanging fruit, but he wants to focus on those at the edge of the technology frontier, especially the US. So let's look at what's happened to US growth over the same period.
The green line represents approximately where US incomes would be if we had stayed at the pre-1973 rate of growth. Average incomes would be less than half what they are now. If the economy had stagnated, as Cowen claims, average incomes would be below the green line. Instead, the rate of US growth actually increased over that period, at a more rapid pace even than the increase in global growth depicted in the first graph. This doesn't look like stagnation at all, much less a Great Stagnation. So what is Cowen going on about?
Ah, the picture looks a bit different if you compare mean GDP/capita to median GDP/capita. Before 1973 the two tracked each other very closely. Post-1973, mean GDP/capita (the white circles) kept growing at roughly the pre-1973 trend rate, while median GDP/capita (black diamonds) stagnated. But the economy overall did not. Just median incomes. That indicates, to me, that Cowen's preferred causal mechanism -- a stagnation due to slowdown in innovation -- is missing what's actually happened. There's been enough growth, it just hasn't gone to the median earner. The result has been higher inequality.
Why has that happened? Theories abound. Some political scientists have recently made the case that rising inequality is a result of wealthy groups hijacking politics for their own economic benefit. In other words, the distribution of growth is zero-sum, and it's been redistributed towards the wealthy in the form of tax cuts, decline in union membership, erosion of the welfare state, and deregulation. I think there's something to that, but I think it's too focused on developments specific to the US. To get the whole picture, I think we need to situate the US in a global context.
It's difficult to find reliable estimates of global median income in a time series (in fact I couldn't... pointers welcome), but indications are that inequality is increasing within many countries, and across them as well. This is also not consistent with Cowen's argument, since the movement towards the technology frontier in the US was associated with rising median income, not rising inequality. If that's the process that rapidly-growing economies like China and India are in, then we should see less inequality, not more. And if the Great Stagnation is something that afflict the US specifically, we might expect the gap between the US and the rest of the world to narrow, not widen.
So I think a more nuanced theory is needed. Specifically, we need to be able to explain two things: stagnating median, but not mean, incomes; global, not just local, trends. So what do we know about the major ways in which the global economy has changed over the past 40 years? I think three things are most relevant:
1. The global economy has become more integrated. This is partially due to politics, as more countries opened their economies to trade and investment. Average tariff rates have fallen dramatically during the GATT/WTO tenure. Capital accounts have been opened by many countries. Additionally, technological improvements have lowered transaction costs. International trade and investment have increased dramatically as a result. The consequence of this movement is a larger (global) market with more middle- and high-income consumers, and increased competition in production. This leads to point #2.
2. The US's post-WWII advantage was conducive to broad-based growth. The US share of global manufacturing was nearly 50% immediately after the war. The other industrialized economies were mostly decimated by the war, and many countries had not yet industrialized. For an American worker during this period, a high marginal product (relative to a foreign worker) did not require large amounts of human capital. Relatively low-skilled workers could mix with (non-human) capital in fairly lucrative ways. In a sense, the median American worker was able to collect rents from the rest of the world from 1945-1973, because the de-industrialization in Europe and pre-industrialization in much of the rest of the world operated as barriers to competition. By the early 1970s those advantages had waned, and trade agreements made it difficult for the US to protect domestic workers. The increased competition from workers in Europe and the Asian NICs (which shifted to export-biased development in the 1960s-70s) led to the US's share of global manufacturing output to fall to 20-25% by 1973, where it has stayed more or less ever since. This hit high-wage/less-skilled workers in tradable industries the hardest, since those were the workers that would face international competition directly. It isn't surprising that incomes would stagnate as those "rents", born of circumstance, are competed away.
3. These same processes benefit high-skilled workers with lots of human capital, as did the technological improvements, particularly in information technology and communications. The rise of the rest has increased the market into which they can sell their labor (demand curve shifts right), but the high skills required to compete with them provide a continuing barrier to entry (supply curve sticks). Compensation for those high-skill workers (and innovators) goes up, but is stuck for everyone else. We get a weak version of "superstar economics", where the highly-skilled are able exploit lower transaction costs to sell into an ever-enlarging global market, while the lower-skilled face increased competition. It's a two-track economy.
Cowen dismisses globalization-rooted theories of the Great Stagnation (around minute 12 in the video above), but (to my knowledge) he hasn't dealt with the sort of mechanisms I'm discussing in any kind of detail. Somewhat bizarrely, Cowen also claims that modern innovations (the internet, satellite-based telephones) have not contributed to GDP very much. But then how to explain how GDP growth, and total worker productivity, have increased post-1973 at the same rate as pre-1973? Median incomes have stagnated because those innovations, unlike previous innovations in manufacturing, do not require the mobilization of huge numbers of workers to increase output. A few computer programmers or financiers can create generate output on their own.
There's another aspect to this that I think Cowen has missed. Increased inequality and a move to a superstarish economy should create more of an incentive for innovation, not less. And while Cowen complains that scientists are no longer heralded by society as they once were, innovators most definitely are. We make movies about them and their social networks, and then give awards to the movies. We make them the richest people in the world. And, contra Cowen, we have seen a lot of innovation in the past 35 years. Cowen focuses on innovations in two major areas that led to the pre-Stagnation growth: transportation and energy. He may be correct that innovation in transportation has declined, although the rise in high-speed rail (outside the US) might be one counterpoint), but part of that is because innovations in communication and information technology has made transportation less necessary. In terms of energy, there have been more breakthroughs in new energy sources from 1980-now than there was from 1945-1973.
There's more I could discuss, but this is long enough. So in short: I do not see a world economy that has stagnated overall. I don't even see a US economy (pre-2008) that has stagnated. I see a redistribution from a certain class of American workers to workers with similar skills in other countries, and to workers with very high skills in the US that can market those skills to a global economy. This doesn't have to be a bad thing, if the government can respond by encouraging innovation by high-skilled workers, and even encourage a lot of compensation for them, but provide for the rest with a fairly robust safety net. And, in fact, the major political cleavages of the present focus on precisely these issues. The political battles aren't about stagnation, but about distribution.
UPDATE: A few folks thought the graphs above are misleading, and they've got a point. So rather than just draw some lines in Powerpoint, I did a more reasonable comparison here. It doesn't change the substantive conclusion of this post, but it was worth doing.
I don't recall reading much discussion of "Performance Pay and Wage Inequality", a paper by Thomas Lemieux, W. Bentley MacLeod, and Daniel Parent, either when it was released as an NBER working paper in 2007 or when it was published in the Quarterly Journal of Economics in 2009 (ungated pdf here). That's too bad, because it is an important paper and does more than any other to answer the perennial question "What has caused the increase in income inequality in the U.S. since the 1970s?" Almost all of the shift in income distribution over that period has accrued to the top 10% of workers, but it hasn't been clear why. Some have argued that the increase in inequality was caused by increased trade openness, changing cultural norms rewarding greed, the decline of labor unions, skill-biased technological change, shifting tax policy that rewarded the rich, and/or increasing returns to economic "superstars" like entertainers and athletes.
The authors make a pretty strong case that it has been because employers have become better able to find and reward more-productive workers for their work, while less-productive workers are left behind. (This is largely consistent with the "skill-biased technological change" explanation, though more specific in theory and causal mechanism.) The abstract:
An increasing fraction of jobs in the U.S. labor market explicitly pay workers for their performance using bonus pay, commissions, or piece-rate contracts. Using data from the Panel Study of Income Dynamics, we show that compensation in performance-pay jobs is more closely tied to both observed and unobserved productive characteristics of workers than compensation in non-performance-pay jobs. We also find that the return to these productive characteristics increased faster over time in performance-pay than in non-performance-pay jobs. We show that this finding is consistent with the view that underlying changes in returns to skill due, for instance, to technological change induce more firms to offer performance-pay contracts and result in more wage inequality among workers who are paid for performance. Thus, performance pay provides a channel through which underlying changes in returns to skill get translated into higher wage inequality. We conclude that this channel accounts for 21% of the growth in the variance of male wages between the late 1970s and the early 1990s and for most of the increase in wage inequality above the eightieth percentile over the same period.
In other words, workers that have earned more have largely deserved to earn more, by objective criteria. Employers have become better at discovering top performers and compensating them accordingly. Top employees have become better at finding ways to demonstrate to employers what their true value is. Over time, more jobs have included performance pay as some or all of their compensation, so inequality has increased. The striking thing is that this explains almost all of the inequality increase in the 80th percentile and above, which is where almost all of the increase in inequality has occurred. It's a powerful paper.
This isn't as sexy or sinister as other narratives of increasing inequality, but it makes sense. Technology has made it easier to demonstrate and assess productivity, especially in information-intensive professions. The information technology sector has increased relative to traditional salaried sectors like manufacturing. Hence, inequality has increased.
I'm amazed that this wasn't covered more in blogosphere. Is it because it contradicts some sacred cows?
Anyway the news that the American political economy is not unjustly controlled by the rich using their power to extract rents should be welcomed by everyone. In other words, we should be very pleased that we do not live in a "NewGildedAge", at least if that's defined by robber-barons seizing wealth that they were not entitled to. This paper is evidence that the wages are distributed more fairly than most of us had thought.
The increase in income inequality has led some to fret about the shrinking middle class in America. See, e.g., this piece by Krugman from a few years back. And the data actually do show that the middle class is shrinking, at least if measured by static income groups. But not because of rising income inequality:
The middle classes fell too, though by less. The sum total across the $35K to $75K categories fell by 5.4 percentage points. In other words: the net movement of households was an 11.5 percentage point gain in households above $75K and a net reduction of 11.5 percentage points in houses below $75K. So the percentage above $75K rose from 18.9% to 30.4%. That is, it increased by over 50%.
Let me repeat that: over 30% of US households in 2006 earned above $75K compared to under 20% in 1980. Over the same period, the percentage of US households earning under $35K fell from 42.8% to 36.7%. Fewer households are poor, fewer are middle class, and a hunk more are above $75K. (And in case you were wondering, those general trends hold for black and hispanic households too - with the percentage of black households under $35K falling by 10.9 percentage points and the number above $75K increasing by 8.9 percentage points, for example.)
Yes, those numbers are adjusted for inflation (2006 dollars) but they are not adjusted for the decline in household size or the real improvement of much of what we buy (i.e. a $1,000 computer in 1995 is much worse than a $1,000 computer in 2009 even though they show up as the same thing in the data). These would both understate the improvements in life quality, perhaps by quite a lot.
This gets at the eternal "absolute vs. relative gains" debate: in absolute terms, America has done very well in the past 30 years. We have more wealthy people and fewer poor and middle-income people. On the whole, the rising tide has lifted all boats. But it has lifted some boats much faster than others. Normative political economy is largely determined by which of the two is deemed more important.
"The bottom fifth [of Americans} earned just $9,974 [in 2006], but spent nearly twice that — an average of $18,153 a year." How is that possible? " So begins a fascinating Op-Ed in today's New York Times written by two Federal Reserve Bank of Dallas economists. The editorial's broader purpose is to offer an alternative measure of economic inequality in contemporary America.
The punch line is simple: measuring household income yields a 15:1 ratio between the highest and lowest fifths of the income distribution. This gap income lies at the base of most hand-wringing over globalization. Yet, if one measures household consumption expenditures instead of income, the ratio between the richest and poorest fifths falls to 4 to 1. Measured at the individual (rather than the household) level, the ratio falls further to only 2.1 to 1 (wealthier households have more people than poorer households). Thus, the extent of inequality we observe is sensitive to how we measure it.
I don't know if they are right when they assert that consumption expenditures provide a better measure of inequality than income. What I do know, however, is that different measures of the same concept can generate very different conclusions. As we often base policy on what we believe is happening, it might prove useful to examine multiple measures before deciding on a change in policy.
Update: Krugman posts on this article. He thinks it's inaccurate: "So my basic reaction to the piece was, there they go again. There’s some truth in what they say, but no news."
In case you missed it, Paul Krugman's Friday column focused on the distributional consequences of international trade. He argues that as imports from developing countries have risen during the last fifteen years, trade flows have begun to follow the expectations of standard comparative advantage. Consequently, trade has a more pronounced impact on wage inequality in the US today than it did fifteen years ago.
I am predisposed to the general argument, but am puzzled by the magnitude he claims. He asserts that "it’s hard to avoid the conclusion that growing U.S. trade with third world countries reduces the real wages of many and perhaps most workers in this country...The highly educated workers who clearly benefit from growing trade with third-world economies are a minority, greatly outnumbered by those who probably lose."
He draws on textbook Stolper-Samuelson logic to make the argument: "workers with less formal education either see their jobs shipped overseas or find their wages driven down by the ripple effect as other workers with similar qualifications crowd into their industries and look for employment to replace the jobs they lost to foreign competition. And lower prices at Wal-Mart aren’t sufficient compensation.
Yet, exactly how many workers have lost jobs to "foreign competition?" The competition Krugman emphasizes comes from imports of manufactured goods. The Bureau of Labor Statistics reports that manufacturing employment fell from roughly 17 million in 1997 to 14 million in 2006. That's a reduction of 3 million manufacturing jobs over ten years--300,000 per year on average--in a total labor force of 136 million people. To assert that this displacement imposed a substantial wage reduction on others seems a bold claim to make without providing any evidence to support it.
I look forward to seeing Krugman's research on this question develop. He has posted a few short pieces about the paper he is writing on his blog, here, here, and here. If you want to read what appears to be the state of the art on trade and income distribution, see Robert Lawrence's paper here.
Paul Krugman makes much of the "Great Compression" , which is his term of choice for the dramatic reduction of income inequality that occurred in the United States between 1935 and 1945. He attributes this equalization of income to FDR and the New Deal. "So what happened to the rich? Basically the New Deal taxed away much, perhaps most, of their income" (Krugman COAL, page 48)
One of the scholars whose research Krugman cites produced a similar series on income inequality for France. The graph for French income inequality (click for larger image) between 1920 and 1945 looks strikingly similar to the graph for American income in the same period.
Surprisingly, Piketty does not attribute France's Great Compression to the New Deal. Instead, he concludes: "the decline in income inequality that took place during the first half of the 20th century was mostly accidental. In France and probably in a number of other developed countries as well ... the secular decline in income inequality is for the most part a capital income phenomenon: holders of very large fortunes were severely hit by major shocks during the 1914-1945 period, and they were never able to fully recover from these shocks, probably because of the dynamic effects of progressive taxation on capital accumulation and pre-tax income inequality" (page 29).
In short, financial crisis, depression, and global war reduced inequality by greatly reducing wealth and the return on wealth; postwar tax rates kept it from re-emerging (for a while). If this pattern is common across the industrialized world, just how important was FDR?
Dani Rodrik points out that trade economists often stress the gains from trade and de-emphasize its domestic distributional consequences. I have always found it puzzling that while political scientists have made the Stolper-Samuelson theorem the workhorse of their models of trade politics, trade economists have tended to downplay the domestic distributional consequences of trade. Rodrik points to recent papers by Josh Biven and Robert Lawrence that simulate the impact of trade between the US and developing countries on the relative wages of low and high skill workers in the US.
The Biven paper in a nutshell: "This paper revisits the insights of Stolper-Samuelson and estimates the impact on American wages of trade flows between the rich U.S. economy and a poorer global economy...Despite a rather conservative methodology, this paper finds that: • Trade with poorer nations had by 1995 led to a rise in relative earnings of skills vis-à-vis labor of just under 5%, relative to baseline of no trade with poor nations. This is an amount roughly equal to 12.5% of the dramatic increase in earnings inequality that happened between 1980 and 1995. • By 2006, trade flows between the U.S. and its poorer trading partners increased relative earnings inequality by just under 7% relative to a no - trade baseline."
The Lawrence paper reaches different conclusions: "while increased trade with developing countries may have played some part in causing greater wage inequality in the 1980s, surprisingly, over the past decade the impact has been too small to show up in aggregate wage data."
