'Inequality and the American Dream'

A meritocracy only works if it seen to be fair. The US system increasingly fails that test, as this week's Economist cover story on inequality and the American dream explains. It was this quote from the leader, Inequality and the America Dream, which put it most succinctly:

Inequality is not inherently wrong - as long as three conditions are met: first, society as a whole gets richer; second, there is a safety net for the very poor; and third, everybody, regardless of class, race, creed or sex, has an opportunity to climb up through the system.

A dynamic, fast-growing economy may sometimes look ugly, but it offers far more hope than a stagnant one for everybody in the United States.

Quite. But as the feature story, The rich, the poor and the growing gap between them, makes clear, those three conditions are not always being met in the United States:

In their haste to applaud or lament this tale, both sides of the debate tend to overlook some nuances. First, America's rising inequality has not, in fact, been continuous. The gap between the bottom and the middle - whether in terms of skills, age, job experience or income - did widen sharply in the 1980s. High-school dropouts earned 12% less in an average week in 1990 than in 1980; those with only a high-school education earned 6% less. But during the 1990s, particularly towards the end of the decade, that gap stabilised and, by some measures, even narrowed. Real wages rose faster for the bottom quarter of workers than for those in the middle.

After 2000 most people lost ground, but, by many measures, those in the middle of the skills and education ladder have been hit relatively harder than those at the bottom. People who had some college experience, but no degree, fared worse than high-school dropouts. ...So, whereas the 1980s were hardest on the lowest skilled, the 1990s and this decade have squeezed people in the middle.

The one truly continuous trend over the past 25 years has been towards greater concentration of income at the very top. ...The figures are startling. According to Emmanuel Saez of the University of California, Berkeley, and Thomas Piketty of the Ecole Normale Supérieure in Paris, the share of aggregate income going to the highest-earning 1% of Americans has doubled from 8% in 1980 to over 16% in 2004. That going to the top tenth of 1% has tripled from 2% in 1980 to 7% today. And that going to the top one-hundredth of 1% - the 14,000 taxpayers at the very top of the income ladder - has quadrupled from 0.65% in 1980 to 2.87% in 2004.

Put these pieces together and you do not have a picture of ever-widening inequality but of what Lawrence Katz of Harvard University, David Autor of the Massachusetts Institute of Technology and Melissa Kearney of the Brookings Institution call a polarisation of the labour market. The bottom is no longer falling behind, the top is soaring ahead and the middle is under pressure.

Mark Thoma has also posted on this piece; worth checking. And at the bottom of the Economist piece, they have helpfully provided links to 10 recent papers on the topic. Here they are:

“The Polarisation of the U.S. Labour Market”, by David H. Autor, Lawrence F. Katz and Melissa S. Kearney. NBER Working Paper No 11986. January 2006

“Trends in U.S. Wage Inequality: Re-assessing the Revisionists”, by David Autor, Lawrence F. Katz and Melissa Kearney. NBER 11627. September 2005

“The Evolution of Top Incomes: A Historical and International Perspective”, Thomas Piketty and Emmanuel Saez. NBER Working Paper 11955. January 2006

“Top Wealth Shares in the United States, 1916-2000: Evidence from Estate Tax Returns”, by Wojciech Kopczuk and Emmanuel Saez. National Tax Journal. June 2004

“Trends in the Transitory Variance of Earnings in the United States”, by Robert A. Moffitt and Peter Gottschalk. Economic Journal. March 2002

“Understanding Mobility in America”, by Tom Hertz, American University. Centre for American Progress. April 2006

“American Exceptionalism in a New Light: A Comparison of Intergenerational Earnings Mobility in the Nordic Countries, the United Kingdom and the United States”, by Markus Jantti, Knut Roed, Robin Naylor, Anders Bjorklund, Bernt Bratsberg, Oddbjorn Raaum and Tor Eriksson. IZA Discussion Paper No 1938. January 2006

“Do Poor Children Become Poor Adults? Lessons from a Cross Country Comparison of Generational Earnings Mobility”, by Miles Corak. IZA Discussion Paper No 1993. March 2006

“Where Did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income”, by Ian Dew-Becker and Robert Gordon. NBER Working Paper 11842. December 2005

“How Computerised Work and Globalisation Shape Human Skill Demands”, by Frank Levy and Richard J. Murnane. May 2006

Comments

[Arthur Eckart]

If you want to be rich and successful, then the U.S. is the best place to be. However, if you're not interested, then the U.S. is the last place you want to be (on a relative basis, because of income inequality). That's why foreigners who want the best opportunities to actually succeed come to the U.S. The statistics speak for themselves. U.S. income in 2006 will be $11.5 trillion and over the next 10 years it'll be over $140 trillion. Much of the new wealth will be generated in emerging industries by entrepreneurs, who create "new money." "Old or safe money" earns relatively very low returns in the U.S. (adjusted for inflation, taxes, lost opportunity costs, etc.). Also, consumer surplus in the U.S. is the highest in the world. So, the U.S. leads the world both on the production and consumption sides. Obviously, the Economist magazine doesn't really know what a meritocracy is (or just made up a definition) from its statement below. In a meritocracy, only those who perform successfully receive the rewards regardless of anything else. American history has been a history of "rags-to-(almost unlimited)-riches," which is more so today. So, of course, wealth will be concentrated at the top and income inequality will be high.

"A meritocracy only works if it seen to be fair. The US system increasingly fails that test. Inequality is not inherently wrong - as long as three conditions are met: first, society as a whole gets richer; second, there is a safety net for the very poor; and third, everybody, regardless of class, race, creed or sex, has an opportunity to climb up through the system."

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[Arthur Eckart]

Yes, this is a blog with excellent content and style. I'd also like to see more comments.

There are trade-offs between economic stability and economic flexibility. Wage rigidies, labor immobilities, high taxes, large social programs, and other restrictions slow improvements in living standards. However, the quick and massive U.S. Creative-Destruction process that began in 2000 freed-up inputs for emerging industries and made surviving firms more efficient. Moreover, wages in new industries tend to be higher. Also, globalization (e.g. free trade, open markets, and unrestricted capital flows) increase competition (e.g. through cheaper imports) making U.S. firms even more efficient and increase consumer surplus. Consequently, it seems, U.S. production is understated and U.S. consumer surplus is high. U.S. corporations had 16 consecutive quarters of double digit earnings growth and U.S. productivity has been at high levels throughout the 2000s. It's difficult to measure improvements on the consumption side. Consequently, gains in U.S. living standards may be vastly understated using only production side data.

[Lord]

I wouldn't confuse how US companies are doing with how the US is doing. US companies are doing well abroad, not at home. The US has generally seen lower wage jobs proliferating driving demand for illegals and has largely been stagnate at higher wages. The rich have gotten richer, but the median has stagnated or worsened.

[Arthur Eckart]

Lord, the old saying was "What's good for General Motors is good for the America." However, today that saying fits better with Information Age and Biotech Revolution firms (along with other firms in many new industries). U.S. firms are doing well in the U.S., because cheap imports force U.S. firms to produce more with less and that's good for U.S. consumers, and U.S. producers. Also, Americans consume far more than they produce (through huge annual trade deficits). So, that's good for U.S. consumers too. China for example exports vast amounts of low-end and cheap products to the U.S. So, it seems, lower wage workers are benefiting. My argument is using only production side data will understate true U.S. living standards. So, wages by themselves don't explain the true gains in U.S. living standards and income. Also, the "medium" isn't stagnant in a dynamic economy. Many Americans are becoming rich and getting richer, which is (partially) reflected in GDP growth.

[Lord]

Good for consumers as consumers, bad for consumers as producers. Imports are cheap and this has kept inflation lower than what it would be, but does anyone seriously believe inflation is currently overstated? Is "medium" your term for average? If you excluded the top 5% or even the top 1%, I doubt you would see any change. That is a pretty poor indication of dynamic.

[Kirk]

I'm not sure about the first comment "If you want to be rich and successful, then the U.S. is the best place to be." Singapore has the highest population per capita of millionaires of any city in the world http://business.asiaone.com/Business/News/My+Money/Story/A1Story20070702-16949.html
. Moscow, Russia has the highest per capita population of billionaires. Of course in Russia the billionaires comes from the ownership of mainly previously communist natural resource firms, won at (through questionable means) at privatization auctions. Although it should be noted that a high percentage of the top 1% of the US's highest wealth class comes from stock options -- the percentage of CEO pay from stock options has typically ranged from approx. 70% to 30%: http://www.commondreams.org/headlines05/0412-10.htm
and from funds management with regards to the stock market. It is questionable if stock options are awarded according to merit -- there are now wide ranging scandals of back dating of options and also, many compensation boards have complained that they weren't aware of the total amount of compensation they were granting the CEO http://www.thecrossbordergroup.com/pages/1464/April+2007.stm?article_id=11723
The US compensation system is somewhat dysfunctional and non-merit based in that the CEO essentially chooses and fires his compensation committee. Also it is questionable whether or not most fund managers -- note that hedge fund managers are the highest compensated group in the US -- actually add value -- efficient market and academic studies, in addition to the founder of Vanguard Funds, John Bogle - say no to most funds adding value. In other words, it is questionable if a large percentage of the most wealthy Americans earned much of their wealth by adding significant value.

If the US is a meritocracy, then merit should be rewarded with commensurate pay. Does the average US based CEO add more than 300 times more value to the firm than the average US based worker?

Further, in the US -- according to the Economist article above -- has an implied agreement that people who work hard and add value should succeed -- that is, corruption is kept to a minimum and politics and favoritism is kept to a minimum and recognition of good work is maximized. The US's Corruption index is trending down (lower is worse) at 7.2 in 2006, from 7.6 in 2004, just above Chile at 7.0 in 2006 -- of course other countries are much worse -- China at 3.5 and Russia at 3.5, see: http://en.wikipedia.org/wiki/Corruption_Perceptions_Index
but many countries are ahead of the US, the Norway, Denmark, Australia, Canada, and more are all above 9.0. From this, it appears about 19 countries have a more transparent and less corrupt system than the US.

[Arthur Eckart]

It seems, the Economist magazine is considered mainstream media in Europe. However, most Americans know being "locked" in a welfare system doesn't provide incentives for individual improvement and upward mobility. Also, U.S. employers want workers who are ambitious, reliable, competent, etc. To discriminate based on race, sex, religion, etc, creates a competitive disadvantage to the firm. The U.S. is the most competitive country in the world. Moreover, I've provided data before showing U.S. union membership has fallen sharply from its peak. Union workers were grossly overpaid, while non-union workers were relatively grossly underpaid. That disparity is much more narrow today. The data also show U.S. real compension has risen sharply (e.g. 70% from recent decades). Reality tends to be much less biased than perception.

[kirk]

The Economist asserted in "Inequality and the American Dream" that social mobility may be a bit lower in the US than certain European countries:

"This is not to let the American system off the hook when it comes to social mobility. Although the United States is seen as a world of opportunity, the reality may be different. Some studies have shown that it is easier for poorer children to rise through society in many European countries than in America. There is a particular fear about the engine of American meritocracy, its education system. Only 3% of students at top colleges come from the poorest quarter of the population. Poor children are trapped in dismal schools, while richer parents spend ever more cash on tutoring their offspring."

[Arthur Eckart]

Kirk, perhaps you can explain how "it is easier for poorer children to rise through society in many European countries than in America" with a permanently higher unemployment rate, limited work hours, larger proportion of government jobs, greater union power, more obsolete jobs, labor immobility, wage rigidies, tax & welfare systems that discourage work, etc. In the U.S., there are many workers without a high school diploma earning over $30,000 a year with overtime, while the quantity and quality of education are higher in the U.S. than in Europe.

You may have received that information from the following article, which states: "At the top 146 colleges and universities, 74 percent of students come from the wealthiest quarter of society, compared with 3 percent from the poorest quarter." Perhaps one reason why poor students don't attend top schools is they're too expensive. However, another reason may be poor students, and their parents, place a low value on education (which may help explain why they're poor). The article has further information:

http://www.msnbc.msn.com/id/9043838

[Arthur Eckart]

It's been stated "CEO income was about 30 times the average worker's pay. Today, it's closer to 500 times."

Microsoft, for example, made 12,000 of its employees millionaires, while four employees became billionaires. The four billionaires may have earned 1,000 times more than the 12,000 millionaires. However, is that a reason to retard growth?

There's been substantial upward mobility in the U.S. Currently, 20% of U.S. households earn over $100,000 a year, while millions of Third World immigrants moved to the U.S.

Also, I may add, thank God women are in the workforce :) Hardly any children have to work nowadays. Yes, U.S. living standards are way up.

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