Types of Inequality

HBR has an interesting article about inequality.

Ask CEOs about income inequality and stagnant wages, and you’ll inevitably hear about skills. The argument goes like this: Workers today face global competition and even the threat of automation. Those who can work with technology and possess sought-after skills in fields like computer programming are thriving in the labor market. Those without a college degree or specialized skills are struggling.

There’s considerable evidence to support this narrative of mismatched supply and demand. But recently the story has come under fire from a number of prominent economists, and some of them would like to discard it altogether. Instead, the critics want to talk about institutions, rules, and political power.

Criticism of the idea that wages are determined by supply and demand isn’t new, of course, but recent political focus on inequality has raised its volume. The result has been more discussion of executive compensation, corporate governance, and unionization.

Economists who pit these ideas against one another are missing the point.  There are two distinct types of inequality, or wage pressures.

The first is skills/globalization/automation.  This is not going away.  Jobs that can be done somewhere else for less money will often go there.  This has been ongoing for manufacturing for 35 years, and everyone knows the frustration of the Indian call center. Skilled jobs, like design detailing and coding, have varying degrees of outsourcing success, but it’s more than zero.  This phenomenon also does not require moving jobs away from the US.  In Erie, PA, the GE locomotive plant is in the process of laying off about half its union workforce.  This is due to work being moved to both a non union plant in Texas, and offshore to “partner” factories, which in this case are built with a cooperating foreign government (India).  The effect is to lower wages, and reduce the number of jobs available at those lower wages.  Automation is pretty easy to see.  It’s been applied in manufacturing for a long time, and it is now working its way into service industries.  As automation increases, the number of workers needed to produce the same amount of stuff goes down.  American manufacturing is not declining.  American manufacturing employment is.  Here’s how it looks:


I would anticipate that with the next recession, another 3 to 4 million people will lose manufacturing jobs that will simply never return.  There is no way to stop this kind of progress.  Unionization, minimum wage laws, and other artificial means of increasing labor costs will only accelerate the adoption of automation into new industries, ultimately having the opposite of the intended effect.

The other kind of inequality is what is referenced in the Stiglitz report that the HBR article references.  He shows how government policies have caused the ultra rich to come into being, and discusses his ideas for how to reverse this trend.  Here are the opening sentences:

Inequality is not inevitable: it is a choice we make with the rules we create to structure our economy. Over the last 35 years, America’s policy choices have been grounded in false assumptions, and the result is a weakened economy in which most Americans struggle to achieve or maintain a middle-class lifestyle while a small percentage enjoy an increasingly large share of the nation’s wealth.
I think he is 100% correct that the Big Inequality, that is, the .001% vs. everyone else, is caused by the rules.  And more indirectly, some of the other inequality is, as well.  However, I think he is wrong that “America’s policy choices have been grounded in false assumptions.”  I think that the top tier have made the rules on purpose to benefit only themselves.  The assumptions they used have worked out perfectly for them.  If they fooled a bunch of academics and politicians in the process, well, shame on them.  His assumption that there have been bad assumptions is, I think, an error in the analysis.  Additionally, he is proposing a whole lot more government intervention based on a bunch of new assumptions, of which some are obviously not true, my notes in italics:
we have a tax system that raises insufficient revenue (insufficient for what?) and encourages the pursuit of short-term gains over long-term investment (really?  short term cap gains taxes are higher than long term); weak and unenforced regulation of corporations (how will new laws cause enforcement?); a de facto public safety net for too-big-to-fail financial institutions (true, and not just in the obvious way); a dwindling support system for workers and families (this is not true in real $ terms, at least for unemployment and food stamps); and a reorientation of monetary and fiscal policy to promote wealth rather than full employment (true, but why should government be involved in either of these?).
His very detailed and prescriptive set of recommendations might or might not have the intended impacts, but it will cause government to be bigger and more involved in the economy.  Last night on 60 Minutes, Apple CEO Tim Cook decried the US Tax Code as outdated.  While this was a total sidestep of the question being asked (Are you minimizing your tax bill?  Well, of course we are, don’t you?,) that doesn’t mean Mr. Cook is wrong.  Imagine all these detailed laws going into effect just as our economy undergoes another massive change.   Which it is.  And will do again.  And the rate of these changes is accelerating.  I’m not sure we can regulate all this activity.  What we can do, that has not been happening, particularly in the financial sector, is allow these businesses to fail.  Remember the auto bailouts?  It was presented, at the time, as, “do this, or the industry will disappear.”  Really?  Wouldn’t it have just gone through an orderly reorganization like any other failing business?  We still buy cars, after all.
The idea of government promoting full employment is especially grating, but the specifics are less so, focusing on infrastructure, which is an area where almost everyone can agree that government should be doing more.  What about, for instance, the issues with the financial sector’s unregulated shadow banks?  I would include in that all of the unregulated financial products, such as certain types of options and swaps, that caused so many problems during the great recession.  You can’t just go in and regulate these innovations, and be done with it.  People will come up with new financial products that are not covered by the regulations, and then those will have the same results.  So do we give up and just assume that we will have periodic melt downs, to be refunded by public bailout?  Of course not, but whatever rules are put in place will have to account for ongoing innovation.  Additionally, if laws are not going to be enforced (what bank CEOs are in jail??), then none of the rules really matter anyway, do they?
Stiglitz is correct that “equality and economic performance are complements, not substitutes.”  But he needs to consider how the new rules he proposes will impact each of those, and also how these rules will work going forward as the economy changes.  He also says:
The focus here on the rules of the economy and the power to set them isn’t a call for the government to get out of the way. There is rarely an “out of the way” for the government. Rules and institutions are the backdrop of the economy, and the ways we set these rules, and keep them up to date and enforce them, have consequences for everyone.
This is so true.  Stiglitz suggests better transparency as one remedy, which should help.  But rules requiring that CEOs be compensated in specific ways, or with specific limits, seem like a lot of meddling.   It also seems like a lot more for the government to enforce, and more reporting for all the smaller corporations who aren’t doing this stuff anyway.  More regulations and reporting requirements act as a barrier to entry and a fixed cost, and are an advantage for the bigger companies.  Dodd-Frank elicits howls from the financial industry, but the truth is that it has actually caused the industry to further consolidate.  The big guys gobble up the small and mid size banks that cannot afford the new compliance.  This is also true for changes to laws that are labeled as “deregulation.”  Stiglitz recognizes this, ““Deregulation” is, in fact, “reregulation”—that is, a new set of rules for governing the economy that favor a specific set of actors.”
This is why checking the assumptions is so important.  You can’t look at what any of these actors say, not the politicians or the top .001% outside of politics.  You have to watch what they do, and assess the real effects.
There’s a lot more to the Stiglitz report.  He spells out the real problems with market power and political power, and it would be interesting to see which of his ideas would work.  Certainly allowing discharge of student loans in bankruptcy would be effective, although it would probably have the side effect of essentially ending private loans to students.  This is simply a reversion to how it was before the bankruptcy laws were changed in the first place.  He talks about the Fed (they shouldn’t have a dual mandate; it should only be employment).    He has a very divisive bit on taxes, arguing that taxes should be punitively progressive, both for income and capital gains, on the grounds that there is no evidence that allowing the high earners to keep some of their money is good for everyone else (huh?).   He argues for more unionization and a higher minimum wage, ignoring both the effects of reality as shown in the FRED graph above, and inflation (but seemingly arguing that keeping inflation low only helps the rich in his Fed policy section).  He also complains about labor law violations, while suggesting more labor laws.  His analysis of race and sex discrimination is excellent, although he somehow fails to even mention the war on drugs as a source of institutional racism.  This is another area where less laws, or less restriction on economic activity, might lead to better outcomes.

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