Category Archives: income distribution-wealth-poverty

Good Sentences

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From Ashok Rao.

Is the mind-blowing wealth of 30,000 Americans absurd? Sure. But it would be difficult to say, as the video suggests, these elite are beneficiaries of any inequality other than owning the right capital at the right time. (Indeed it is capital gains in the stock market that drive the income of this group).

Pointer from Tyler Cowen.

I strongly recommend Rao’s entire post. Later, he writes.

Sure the bottom 95% are doing a little worse and the top 5% a little better today, but the changes are nothing near the drastic increase in income inequality in the same time period. This suggests policy has changed favoring high income over low income in a much clearer fashion than high wealth over low wealth. This isn’t surprising given that much of the richest 0.01% are executives and bankers, not heirs to mounds of wealth. After all, it is the group of affluent-but-not-rich people for whom we subsidize housing (indeed more than we do food for the poor!) It is for the doctors we protect the medical market. It is for the middling executives and partners at law firms nobody has heard of we decrease taxes on those earning more than $200k. It is for the top 15(- top 2)% of Americans who couldn’t afford frequent flights to Florida without Spirit or Southwest we refuse to tax carbon emissions from airplanes the way they should be!

Robert Solow on Piketty

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Solow writes,

if the economy is growing at g percent per year, and if it saves s percent of its national income each year, the self-reproducing capital-income ratio is s / g (10 / 2 in the example). Piketty suggests that global growth of output will slow in the coming century from 3 percent to 1.5 percent annually. (This is the sum of the growth rates of population and productivity, both of which he expects to diminish.) He puts the world saving / investment rate at about 10 percent. So he expects the capital-income ratio to climb eventually to something near 7 (or 10 / 1.5). This is a big deal, as will emerge. He is quite aware that the underlying assumptions could turn out to be wrong; no one can see a century ahead. But it could plausibly go this way.

…The labor share of national income is arithmetically the same thing as the real wage divided by the productivity of labor. Would you rather live in a society in which the real wage was rising rapidly but the labor share was falling (because productivity was increasing even faster), or one in which the real wage was stagnating, along with productivity, so the labor share was unchanging? The first is surely better on narrowly economic grounds: you eat your wage, not your share of national income. But there could be political and social advantages to the second option. If a small class of owners of wealth—and it is small—comes to collect a growing share of the national income, it is likely to dominate the society in other ways as well. This dichotomy need not arise, but it is good to be clear.

Both Tyler Cowen and Solow make the same point about wages, but they do so subtly. Let me be blunt: Piketty’s nightmare scenario, in which capital accumulates and has a high return, is a terrific scenario for wages in absolute terms. If workers care about what they can consume, as opposed to the ratio of their net worth to that of the capital owners, they would hate to see any policy that might interfere with the high rates of investment that Piketty is envisioning. Note, however, that I personally would not concede that the distinction between workers and capital-owners is as clear-cut as it is in the Solow growth model.

The tone of Solow’s review is generally laudatory. It also is by far the clearest explanation of Piketty’s argument that I have read. It reflects Solow’s command of the logic of economic growth as well as his abilities as a teacher.

I think that Solow arrives at a higher evaluation of the book than I would for two reasons. First, Solow gives Piketty the benefit of the doubt on nearly every uncertain issue. For example, on the crucial assumption that Piketty makes that the rate of return on capital remains steady even as the capital-income ratio creeps ever higher, Solow writes,

Maybe a little skepticism is in order. For instance, the historically fairly stable long-run rate of return has been the balanced outcome of a tension between diminishing returns and technological progress; perhaps a slower rate of growth in the future will pull the rate of return down drastically. Perhaps. But suppose that Piketty is on the whole right.

On another issue, the fact that inequality is high between different workers, not just between workers and capitalists, Solow offers a hand-waving defense of Piketty. Solow writes,

Another possibility, tempting but still rather vague, is that top management compensation, at least some of it, does not really belong in the category of labor income, but represents instead a sort of adjunct to capital, and should be treated in part as a way of sharing in income from capital…

it is pretty clear that the class of supermanagers belongs socially and politically with the rentiers, not with the larger body of salaried and independent professionals and middle managers

To this, I would say: why draw the line at supermanagers? Why not say that the salaries of college professors that are paid out of university endowments are “a way of sharing income from capital”? The way I look at it, the amount of income that does not represent “a sort of adjunct to capital” (including human capital) is miniscule, perhaps less than 1 percent of GDP.

My second disagreement with Solow is that he, like Piketty, omits any discussion of risk as a component of “r.” In that regard, Tyler Cowen’s skeptical review better accords with my own thinking.

The way I see it, Piketty and Solow work with models that incorporate homogeneous workers (with no differences in human capital) and homogeneous capital (with no differences in ex ante risk or ex post returns). The real world is so far removed from those models that I simply cannot buy into the undertaking.

Greg Mankiw Quotes a Professor of Social Work

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Greg cites a piece in the NYT by Mark R. Rank. Before I get to that, let me read to you from Rank’s bio page at Washington University.

Mark R. Rank is widely recognized as one of the foremost experts and speakers in the country on issues of poverty, inequality, and social justice. . .

His next book, “One Nation, Underprivileged: Why American Poverty Affects Us All,” provided a new understanding of poverty in America. His life-course research has demonstrated for the first time that a majority of Americans will experience poverty and will use a social safety net program at some point during their lives.

He is currently completing a book with his long-time collaborator, Thomas Hirschl of Cornell University, entitled, “Chasing the American Dream: Understanding the Dynamics that Shape Our Fortunes.” It explores through a multi-methodological approach the nature of the American Dream and the economic viability of achieving the Dream. The book is designed to shed light on the tenuous nature of the American Dream in today’s society, and how to restore its relevance and vitality.

The NYT piece is based on the latter book. In it, Rank writes,

It turns out that 12 percent of the population will find themselves in the top 1 percent of the income distribution for at least one year. What’s more, 39 percent of Americans will spend a year in the top 5 percent of the income distribution, 56 percent will find themselves in the top 10 percent, and a whopping 73 percent will spend a year in the top 20 percent of the income distribution.

…Likewise, data analyzed by the I.R.S. showed similar findings with respect to the top 400 taxpayers between 1992 and 2009. While 73 percent of people who made the list did so once during this period, only 2 percent of them were on the list for 10 or more years. These analyses further demonstrate the sizable amount of turnover and movement within the top levels of the income distribution.

Some comments:

1. Many people experience having an income below the poverty line for a short period of time. However, I am not sure that one can conclude from this that they “experience poverty.” Think of graduate students, or people who experience a spell of unemployment but otherwise are able to hold a job.

My first year after graduate school, when I got married and started working at the Fed, my salary made us eligible for Montgomery County’s low-income housing assistance (we did not make use of that eligibility). Our household income probably did not exceed the median household income until my 8th or 9th year out of grad school.

2. Similarly, many people experience windfalls. We broke into the top 20 percent for exactly one year, the annus mirabilis 1999 when my Internet business got sold.

3. You would think that the perspective of a social work professor on income dynamics would be less valuable than the perspective of, say, Thomas Piketty. Yet it is possible that Rank’s new book might have something to add, because he is working with longitudinal analysis that follows the same people over time, rather than working with a time series of cross-sections and writing down a model that treats households (really, just abstract social classes) as persistently occupying the same place in the income distribution.

4. I have started reading Chasing the American Dream, and I may write a review. It is much closer to what you would expect from a professor of social work than what you would expect from, say, Greg Mankiw. The book treats economic position as being determined by race and social class.

Greg on Greg

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Meaning Cochran on Clark.

If moxie is genetic, most economists must be wrong about human capital formation. Having fewer kids and spending more money on their education has only a modest effect: this must be the case, given slow long-run social mobility. It seems that social status is transmitted within families largely independently of the resources available to parents.

Pointer from Jason Collins.

Brad DeLong on Piketty

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Brad writes,

We have a world in which some eminent economists (Larry Summers) say r1 is too low, and other eminent economists (Thomas Piketty) say r2 is too high…

The difference between r1 and r2 is the risk premium. In a well-functioning market economy with well-functioning financial markets, there are powerful reasons to believe that this risk premium should be small: less than 1%-point per year. The fact the risk premium appears to me to be 7%-points per year today is a powerful evidence of the profound dysfunctionality of our financial markets, and of their failure to do their proper catallactic job. But that is a separate and largely independent discussion: that is a dysfunction of our modern market economy which is different from either the dysfunction feared by Summers or the dysfunction freaked by Piketty. For the moment, simply note that it is perfectly possible for all three of these major dysfunctions to occur together.

Pointer from Mark Thoma. Read the whole thing. The risk-premium solution was also suggested here in a comment by Matt Rognlie.

So far, the left-wing journalistic verdict on Piketty is rapture. Economists, even those inclined to agree with Piketty’s conclusions, seem somewhat unsatisfied with with his treatment of capital and interest.

Wealth, Income, and Stock Prices

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As I start to read Piketty, the following train of thought occurred to me.

How would I explain fluctuations in the ratio of wealth to income? In particular, why did that ratio fall in the 1930s and why has it risen in recent decades?

My first thought is to look at stock prices, and at the P/E ratio. As the P/E ratio goes up, the ratio of stock market wealth to earnings goes up.

What drives the P/E ratio? The standard explanation would use some version of the discounted earnings model. That is, the P/E ratio will be high when the discount rate is low and/or expected future earnings are high. Over the past century, stock prices have trended upward because of one or both of these factors. That is, investors have been willing to discount earnings at lower rates or they have raised their expectations for earnings.

Call the discount rate r and the expected growth rate of earnings g. In short, the discounted earnings model says that the P/E ratio will be high when r is low and/or g is high.

Yet Piketty sees the rise in the ratio of wealth to income as caused by the opposite configuration. That is, he thinks it has taken place because r is high and g is low.

Of course, his r is “return to capital,” not the discount rate. And his g is the growth rate of total income, not corporate earnings. But I wonder how one sorts this all out, and how one goes about choosing between the finance-theoretic explanation of changes in the ratio of wealth to income and the Piketty-Marxist explanation.

UPDATE: James Galbraith writes,

when asset values collapsed during the Great Depression, it mainly wasn’t physical capital that disintegrated, only its market value. During the Second World War, destruction played a larger role. The problem is that while physical and price changes are obviously different, Piketty treats them as if there were aspects of the same thing.

Krugman Reviews Piketty

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He sticks to economics, which makes the review quite readable. He drops this sentence into the end of a minor paragraph:

the fact is that the most conspicuous example of soaring inequality in today’s world—the rise of the very rich one percent in the Anglo-Saxon world, especially the United States—doesn’t have all that much to do with capital accumulation, at least so far. It has more to do with remarkably high compensation and incomes.

In fact, that is one of the more damning criticisms of Piketty that one is likely to read. Krugman stops short of calling the book an intellectual swindle, but it appears to be one (I have yet to read it).

Suppose we know two things: First, wealth at the high end of the wealth distribution has increased a lot. Second, the share of wages and salaries in GDP has decreased. Do these two things tell us that capital is gaining at the expense of labor?

The swindle here is to treat “capital” and “labor” as homogeneous, separate categories. You are either a worker or a coupon-clipper. In fact, most people are labor-capitalists. They invest in human capital. They decide how much to save and how much risk to take with their savings. And there is a lot of heterogeneity among these labor-capitalists.

Bill Gates, Jeff Bezos, and Mark Zuckerberg are not coupon-clippers. Their wealth comes from a combination of skill and risk-taking.

Looking at the 21st-century economy through the filter of the Marxist categories of “capital” and “labor” is not particularly insightful. This is not a good era for either a plain coupon-clipper or an ordinary worker to accumulate great wealth. For that purpose, it is better to be a successful entrepreneur or a high-skilled worker.

I think that Krugman correctly views Piketty’s scenario dominated by inherited wealth as offering a speculative analysis of the future. It does not well describe the present.

For example, suppose you look at the Forbes 500 or somesuch, meaning a list of the wealthiest Americans. Compare the list in 2010 to the list in the supposedly egalitarian era of 1950-1970. I will wager that the 2010 list has a smaller fraction of inherited fortunes as opposed to fortunes that were amassed by the wealthy themselves.

Moreover, looking at the low interest rate on risk-free assets today, I would say that the near-term future is one in which the inheritors shall be meek. The next generation of great entrepreneurs should easily surpass the heirs of current fortunes.

UPDATE: Steve Sailer has links to some papers on the Forbes 400. In particular, one paper by Kaplan and Rauh, says

We find that the Forbes 400 in recent years did not grow up as advantaged as in decades past. Those in the Forbes 400 today are less likely to have inherited their wealth or to have grown up wealthy.

Folk Pickettyism

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Harold Meyerson writes,

Indeed, Piketty’s book provides a valuable explanatory context for America’s economic woes. Wages constitute the lowest share of U.S. GDP, and profits the highest, since the end of World War II. And with heightened accumulations of wealth come heightened accumulations of political power — a shift toward plutocracy to which Wednesday’s Supreme Court decision, permitting the wealthy to contribute to as many electoral campaigns as they wish, adds a helpful push.

…Piketty gives us the most important work of economics since John Maynard Keynes’s “General Theory.”

1, It is interesting that Meyerson deems himself qualified to make this last statement.?

2. Suppose that the book becomes nothing but popular folk economics for “Workers are getting screwed. Tax the rich.” Will Picketty consider that a success or a failure?

3. “Wages and salaries” is mostly a return on capital, albeit human capital. Labor in its purest form (unskilled) earns a much lower share of GDP than Meyerson, Pickety, or anyone else has calculated.

4. How does the growth in equality of payments to individuals compare to the growth in inequality in payments for land? Has the ratio of rent for a square foot of office space in Manhattan to that for of a square foot of lowest-value land in the rural United States gone up as much as the ratio of CEO pay to the wages of unskilled workers? In both cases, where are looking at the ratio of improved to unimproved factors of production. Should we be appalled by the growth in land inequality?

Gary Burtless on the Redistribution Recession

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He writes,

CBO’s newest estimates confirm the long-term trend toward greater inequality, driven mainly by turbo-charged gains in market income at the very top of the distribution. The market incomes of the top 1% are extraordinarily cyclical, however. They soar in economic expansions and plunge in recessions. Income changes since 2007 fit this pattern. What many observers miss, however, is the success of the nation’s tax and transfer systems in protecting low- and middle-income Americans against the full effects of a depressed economy. As a result of these programs, the spendable incomes of poor and middle class families have been better insulated against recession-driven losses than the incomes of Americans in the top 1%. As the CBO statistics demonstrate, incomes in the middle and at the bottom of the distribution have fared better since 2000 than incomes at the very top.

Pointer from Greg Mankiw. Burtless says that the recession caused redistribution toward the bottom. Casey Mulligan says that redistribution toward the bottom did a lot to deepen the recession.

Brad DeLong’s Hierarchy of Work

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He writes,

We (1) move things with large muscles; (2) manipulate things with small muscles; (3) use our hands, mouths, brains, eyes, and ears to make sure that ongoing processes and procedures stay on track; (4) via social reciprocity and negotiation try to keep us all pulling in the same direction; and (5) think up new things for us to do. The coming of the Industrial Revolution –the steam engine to power and the metalworking to build machinery — greatly reduced the need for human muscles and fingers for (1) and (2). But it enormously increased (3), for all those machines needed to be minded and all of that paper needed to be shuffled. Each improvement in machines made each human cybernetic control element more valuable as well.

Think of (1) as working without tools. (2) is working with tools, but without machinery. (3a) is working with machinery in large organizations. (3b) is working in middle management in large organizations. (4) is managing large organizations, but without creativity and innovation (I think of accountants, m. (5) is creativity and innovation.

Brad’s point is that over historical time, you can watch machines move up the food chain. Today, the computer revolution is in the process of taking away jobs at level (3). The question is whether it is possible to find matches at level (4) and level (5) for most workers, or whether they are instead doomed to a lower-level existence.

Along similar lines, see Kevin Maney’s column, which I arrived at via Irving Wladawsky-Berger (who writes that “larger numbers of people will have to invent their own jobs”) by following a pointer from James Pethokoukis.