Stiglitz on Singapore

Joseph Stiglitz writes:

Singapore has had the distinction of having prioritized social and economic equity while achieving very high rates of growth over the past 30 years — an example par excellence that inequality is not just a matter of social justice but of economic performance.

Finally, an example of a country that can walk and chew gum at the same time!  Oh, wait...

I'm not really that familiar with Singapore (aside from knowing you can't chew gum there), so I won't comment on the particulars, but its worth noting that the comparison Stiglitz makes of Singapore's growth record to that of the US is a little unfair because Singapore was once - not that long ago - a much poorer country than the US.  Standard growth theory predicts that low-income countries should "converge" (i.e., catch up) to higher income ones.  That means that they'll have higher growth rates.

(Data: World Bank)

That said, many low income countries haven't managed to converge, so Singapore does stand out as a successful example which may provide some useful lessons.

Cowen on Finance and Inequality

In his American Interest essay, "The Inequality That Matters," Tyler Cowen offers a number of reasons not to be too troubled by the general rise in income inequality over the last 30 years (not surprising given his generally libertarian-ish outlook).  As he notes, much of the increase in inequality is really occuring within the top 1% of incomes, and much of that is driven by the financial sector.  That, according to Cowen, is where the real problem lies. Along the way he also offers one of the best nutshell explanations for why financial sector incomes exploded to such monsterous proportions:

The first factor driving high returns is sometimes called by practitioners “going short on volatility.” Sometimes it is called “negative skewness.” In plain English, this means that some investors opt for a strategy of betting against big, unexpected moves in market prices. Most of the time investors will do well by this strategy, since big, unexpected moves are outliers by definition. Traders will earn above-average returns in good times. In bad times they won’t suffer fully when catastrophic returns come in, as sooner or later is bound to happen, because the downside of these bets is partly socialized onto the Treasury, the Federal Reserve and, of course, the taxpayers and the unemployed. 

Furthermore,

To this mix we can add the fact that many money managers are investing other people’s money. If you plan to stay with an investment bank for ten years or less, most of the people playing this investing strategy will make out very well most of the time. Everyone’s time horizon is a bit limited and you will bring in some nice years of extra returns and reap nice bonuses. And let’s say the whole thing does blow up in your face? What’s the worst that can happen? Your bosses fire you, but you will still have millions in the bank and that MBA from Harvard or Wharton. For the people actually investing the money, there’s barely any downside risk other than having to quit the party early. Furthermore, if everyone else made more or less the same mistake (very surprising major events, such as a busted housing market, affect virtually everybody), you’re hardly disgraced. You might even get rehired at another investment bank, or maybe a hedge fund, within months or even weeks. 

Like Keynes said:

A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.

Back to Cowen:

In short, there is an unholy dynamic of short-term trading and investing, backed up by bailouts and risk reduction from the government and the Federal Reserve. This is not good. “Going short on volatility” is a dangerous strategy from a social point of view. For one thing, in so-called normal times, the finance sector attracts a big chunk of the smartest, most hard-working and most talented individuals. That represents a huge human capital opportunity cost to society and the economy at large. But more immediate and more important, it means that banks take far too many risks and go way out on a limb, often in correlated fashion. When their bets turn sour, as they did in 2007–09, everyone else pays the price.

Health Care Reform and Inequality

In the Times, David Leonhardt argues that the health care reform just passed by Congress (!!) can be understood as part of President Obama's effort to reverse - or at least lean against - the trend of widening income inequality in the US. He writes:

The bill that President Obama signed on Tuesday is the federal government’s biggest attack on economic inequality since inequality began rising more than three decades ago.

Over most of that period, government policy and market forces have been moving in the same direction, both increasing inequality. The pretax incomes of the wealthy have soared since the late 1970s, while their tax rates have fallen more than rates for the middle class and poor.

Nearly every major aspect of the health bill pushes in the other direction. This fact helps explain why Mr. Obama was willing to spend so much political capital on the issue, even though it did not appear to be his top priority as a presidential candidate. Beyond the health reform’s effect on the medical system, it is the centerpiece of his deliberate effort to end what historians have called the age of Reagan.

The Theory of the Blackberry Class

In the Times last week, Daniel Gross revisited The Theory of the Leisure Class, the most famous work of Carleton College's most famous alumnus, Thorstein Veblen. Though much of what Veblen wrote continues to be relevant today, Gross notes that conspicuous leisure no longer seems to be a preferred way for people to display their wealth. Indeed, quite the opposite:

In the contemporary money culture, to be at leisure, to be idle, is to be irrelevant. After Bank of America acquired Merrill Lynch, John Thain, the former chief executive of Merrill, was pushed out, in part because he insisted on going skiing at Vail over Christmas and wanted to attend the World Economic Forum in Davos amid the company’s continuing crisis. A great many people can afford not to work and could spend their time shuttling between multiple homes, eating fabulous meals and playing golf. Yet they continue to work around the clock. Of course, the private jet, the BlackBerry and the Internet allow people to do all of the above. But among Type-A, self-made members of the leisure class, there’s a sort of reverse prestige associated with leisure. At Davos, which is filled with conspicuous consumers, the only people who ski are the journalists.

Ezra Klein has an explanation: unlike in Veblen's era, when tycoons derived their income from capital, their contemporary equivalents - investment bankers, CEOs, professional athletes etc. - are the beneficiaries of increasing disparities in labor income. Klein writes:

Veblen, who died in 1929, saw a large overclass that earned most of its wealth through returns on capital. Essentially, their money made money for them. Which gave them time to hang about and conspicuously consume. In the period after his death, that overclass shrank substantially, first because the Great Depression battered them and then because the New Deal disadvantaged them. But by the start of the 21st century, they were back. At least in terms of wealth concentration. Their money, however, wasn't coming from capital returns. It was coming from wages and salaries. They were -- gasp! -- working.

Morning in America

Under the headline the Times' David Leonhardt writes:

The budget that President Obama proposed on Thursday is nothing less than an attempt to end a three-decade era of economic policy dominated by the ideas of Ronald Reagan and his supporters.

The Obama budget — a bold, even radical departure from recent history, wrapped in bureaucratic formality and statistical tables — would sharply raise taxes on the rich, beyond where Bill Clinton had raised them. It would reduce taxes for everyone else, to a lower point than they were under either Mr. Clinton or George W. Bush. And it would lay the groundwork for sweeping changes in health care and education, among other areas.

More than anything else, the proposals seek to reverse the rapid increase in economic inequality over the last 30 years. They do so first by rewriting the tax code and, over the longer term, by trying to solve some big causes of the middle-class income slowdown, like high medical costs and slowing educational gains.

Limits of Tax-Based Redistribution

Washington Post columnist Steven Pearlstein makes some good points about inequality, and Barack Obama's plans to chip away at it through the tax code, by lowering taxes for middle- and lower-income people while raising them at the top. Pearlstein writes:

Two things to note about the Obama tax plan:

First, there is little evidence that the proposed tax increases on high-income households would seriously harm the economy. The effective average tax rates at the top would be about the same as they were in the mid-'90s, which if memory serves were boom years for investment and entrepreneurship, boom years for the U.S. economy, and boom years for federal revenue.

Second, even with the Obama tax plan, the distribution of after-tax income would still be roughly where it was only four years ago.

The reality is that the market's tilt toward unequal outcomes is now so strong that you can't just rely on a progressive tax code to counteract its effects...

Consumption Inequality

is much lower than income inequality. The Dallas Fed's W. Michael Cox and Richard Alm explain in the New York Times, with the aid of a nifty chart. They write:

[I]f we compare the incomes of the top and bottom fifths, we see a ratio of 15 to 1. If we turn to consumption, the gap declines to around 4 to 1. A similar narrowing takes place throughout all levels of income distribution. The middle 20 percent of families had incomes more than four times the bottom fifth. Yet their edge in consumption fell to about 2 to 1.

Let’s take the adjustments one step further. Richer households are larger — an average of 3.1 people in the top fifth, compared with 2.5 people in the middle fifth and 1.7 in the bottom fifth. If we look at consumption per person, the difference between the richest and poorest households falls to just 2.1 to 1. The average person in the middle fifth consumes just 29 percent more than someone living in a bottom-fifth household.

Update: Paul Krugman is skeptical.

Update #2 (2/11): So are Mark Thoma, Dean Baker and Free Exchange.

Update #3 (2/12): And Barry Ritholtz.

New Inequality Data

The NY Times reported Friday:

The increase in incomes of the top 1 percent of Americans from 2003 to 2005 exceeded the total income of the poorest 20 percent of Americans, data in a new report by the Congressional Budget Office shows.

The poorest fifth of households had total income of $383.4 billion in 2005, while just the increase in income for the top 1 percent came to $524.8 billion, a figure 37 percent higher.

The total income of the top 1.1 million households was $1.8 trillion, or 18.1 percent of the total income of all Americans, up from 14.3 percent of all income in 2003. The total 2005 income of the three million individual Americans at the top was roughly equal to that of the bottom 166 million Americans, analysis of the report showed.

The data come from the latest update of the CBO's Historical Effective Tax Rates report, which combines the effects of all the federal taxes - income taxes, payroll (social security) taxes, corporate and excise taxes, to show how the tax burden is distributed across households of varying income levels. As part of figuring this, they put together data on income inequality. From the data in the supplemental tables, here is a picture of how the distribution of income has evolved since 1979 (when the data begins), by quintile (i.e. each slice is the share of income going to 20% of the population, with the poorest 20% on the bottom and highest-earning 20% on top):The share going to the top 20% has risen from 42.4% in 1979 to 51.6% in 2005, while all the others have decreased. I've used the after-tax data, so this is income after accounting for whatever redistribution occurs through taxes and transfers (in the pre-tax data, the distribution is even more unequal).

As the lede from the Times story suggests, much of the action is at the very top, as the highest earners are pulling away from what we might call the "upper middle class" (or UMC). In 1979, average income in the top 20% was 5 times that of the middle, and incomes in the top 1% were 10 times those in the middle. By 2005, these multiples increased to 9 and 27, respectively:

Presumably the greater volatility for the top 1% is because they receive a higher share of income from financial assets (the dip in 2001-02 coincides with a bear market; the Times story's focus on 2003-05 makes the change in distribution seem more sudden than it really is).

CBO Director Peter Orzag discussed the report (and methodology behind it) on his new blog. A further breakdown (and more charts) can be found in this brief analysis by the Center on Budget and Policy Priorities.

This issue came up in Greg Mankiw's interesting post on how economists of the "left" and "right" differ - his last point was:

There is one last issue that divides the right and the left—perhaps the most important one. That concerns the issue of income distribution. Is the market-based distribution of income fair or unfair, and if unfair, what should the government do about it?

Mark Thoma spoke for the "left" (or, probably really the "mainstream" since Democrats outnumber Republicans among economists by 2.9-to-1) in his response:

Fair or unfair depends upon how well markets are functioning. If you do not believe that markets are competitive, or that opportunity is equal, then the intervention and redistribution may be correcting the outcome toward what a perfectly competitive, equal opportunity system would produce rather than away from it. It's not that we don't believe that competitive markets are fair, though I can only speak for myself, it's that we don't believe markets that deviate from perfect competition in important ways, i.e. have important market failures, produce outcomes that have defensible equity properties.

There are good reasons for those on the right, who may have trouble seeing either injustice or market failure, to be concerned as well. This is because of two tensions -

1. The contradiction between Christian gospel teaching and extreme wealth, (see, e.g., Matthew 19:24). Growing inequality may lead the part of the "right" that is "Christian" to reconsider whether their politics is truly consistent with their religious views.
2. The tension between political equality and economic inequality. Extreme inequality could ultimately undermine political support for the "free market" economic system and generate more support for "populist" economic policies.

Throughout most of its history, the US has generally shown an exceptional ability to live with the contradiction between economic inequality and the political and moral equality of our political and (majority) religious creeds. As economic inequality continues to increase, thoughtful people of the right may want to consider whether this ability is limitless.

Income Inequality Update

The Wall Street Journal reports:

The richest Americans' share of national income has hit a postwar record, surpassing the highs reached in the 1990s bull market, and underlining the divergence of economic fortunes blamed for fueling anxiety among American workers.

The wealthiest 1% of Americans earned 21.2% of all income in 2005, according to new data from the Internal Revenue Service. That is up sharply from 19% in 2004, and surpasses the previous high of 20.8% set in 2000, at the peak of the previous bull market in stocks.

The bottom 50% earned 12.8% of all income, down from 13.4% in 2004 and a bit less than their 13% share in 2000.

Debunking David Brooks

In a column titled "A Reality Based Economy," the Times' David Brooks writes:

If you’ve paid attention to the presidential campaign, you’ve heard the neopopulist story line. C.E.O.’s are seeing their incomes skyrocket while the middle class gets squeezed. The tides of globalization work against average Americans while most of the benefits go to the top 1 percent.

This story is not entirely wrong, but it is incredibly simple-minded. To believe it, you have to suppress a whole string of complicating facts.

The first complicating fact is that after a lag, average wages are rising sharply. Real average wages rose by 2 percent in 2006, the second fastest rise in 30 years.

The second complicating fact is that according to the Congressional Budget Office, earnings for the poorest fifth of Americans are also on the increase. As Ron Haskins of the Brookings Institution noted recently in The Washington Post, between 1991 and 2005, “the bottom fifth increased its earnings by 80 percent, compared with around 50 percent for the highest-income group and around 20 percent for each of the other three groups.” ...

Sharp-eyed bloggers were all over this one: Economist's View has a roundup of the smackdown. The quote above provides two good examples of how easy it is to deceive with statistics:

1. Brooks uses average wages, rather than median wages - rising incomes of the top few will increase the average, without making people in the middle of the income distribution better off.
   
2. The overall rise in incomes of the poorest fifth from 1991 to 2005 is the end result of an increase between 1991 and 2000, followed by a decline since then.

Lies, damned lies and statistics, indeed.

Tycoons!

In a fascinating NY Times feature, Louis Uchitelle examines the "New Gilded Age." He writes:

These days, Mr. [Sanford I.] Weill and many of the nation’s very wealthy chief executives, entrepreneurs and financiers echo an earlier era — the Gilded Age before World War I — when powerful enterprises, dominated by men who grew immensely rich, ushered in the industrialization of the United States. The new titans often see themselves as pillars of a similarly prosperous and expansive age, one in which their successes and their philanthropy have made government less important than it once was.

Some of the new tycoons naturally try to justify their position at the top of an increasingly unequal distribution of income and wealth:

Other very wealthy men in the new Gilded Age talk of themselves as having a flair for business not unlike Derek Jeter’s “unique talent” for baseball, as Leo J. Hindery Jr. put it. “I think there are people, including myself at certain times in my career,” Mr. Hindery said, “who because of their uniqueness warrant whatever the market will bear.”

He counts himself as a talented entrepreneur, having assembled from scratch a cable television sports network, the YES Network. “Jeter makes an unbelievable amount of money,” said Mr. Hindery, who now manages a private equity fund, “but you look at him and you say, ‘Wow, I cannot find another ballplayer with that same set of skills.’ ”

Derek Jeter, of course, is vastly over-rated. As are, perhaps, the new super-rich:

“I don’t see a relationship between the extremes of income now and the performance of the economy,” Paul A. Volcker, a former Federal Reserve Board chairman, said in an interview, challenging the contentions of the very rich that they are, more than others, the driving force of a robust economy.

Of course:

The new tycoons oppose raising taxes on their fortunes.

Fairness is in the eye of the beholder, but the US economy actually grew faster when top marginal tax rates were higher. Here is the annual average growth in real GDP and the average annual top marginal tax rates for the US, by decade:

1951-60 - 3.42 - 91.2%
1961-70 - 4.11 - 78.4%
1971-80 - 3.14 - 70.0%
1981-90 - 3.21 - 44.5%
1991-2000 - 3.22 - 37.9%
2001-2006 - 2.51 - 36.2%

Accompanying the article is a nifty interactive graphic with the top 30 all-time richest Americans. Bill Gates is the one in the pink polo shirt (he really should consider a top hat). [Tax data are from the Urban-Brookings Tax Policy Center]