Incomplete and Partial Thoughts on Greg Mankiw's Updated "Lazear vs Krugman"

Greg Mankiw quotes my claim that the Piketty-Saez data are hard to interpret as the result of a general rise in the economy's skill and education premium driven by skill-favoring technological change:

Greg Mankiw's Blog: Lazear vs Krugman: Update 2: Brad DeLong tries to explain what Paul might have been thinking:

DeLong: The big rise in inequality in the U.S. since 1980 has been overwhelmingly concentrated among the top 1% of income earners.... It's hard to attribute this pattern to a rise in the premium salary earned by the well-educated by virtue of the skills their formal education taught them. Such a rise in the education premium would produce a much smoother rise in relative incomes among the whole top tenth of the income distribution...

And he comments:

I am not convinced that the conclusion follows from the facts presented. I would guess that the top 1 percent of income earners (those [household tax units] earning more than $276,945) are disproportionately very well educated--doctors, lawyers, MBAs, etc. So the rise in the income of the top 1 percent could well represent in large part a higher education premium.

What might well be true is that the returns to education have become increasingly non-linear: The most educated are now getting a bigger return from a marginal year of education than those with moderate amounts of education. In other word, two years getting an MBA from Harvard Business School may increase a person's income more in percentage terms than does two years getting an Associate Degree from Mass Bay Community College. My understanding from my labor economist friends is that some evidence favors this hypothesis of increasing nonlinearity...

I don't think this works particularly well. Yes, if you confront a computer with a strongly nonlinear increase in inequality and ask it to explain it by increases in skills and the values of skills of those at the top, it will spit back that there is evidence of nonlinearity. But so much? The top 0.1% in the United States has gone from 2.3% of income in 1980--23 times average--to 7.6% today--76 times average. The next 0.9% has gone from 6.3 times average to 9.2 times average. And the next 4% has gone from 3.2 to 3.7 times average. Just what have been the changes in technology over the past twenty-five years that have made the skills of the 130,000 households in the top 0.1% so much more highly-valued vis-a-vis the skills of Mr. and Ms. 95th percentile? We are awarding 550,000 advanced degrees a year in this country. The overwhelming majority of them must be gaining little or nothing in relative-income terms vis-a-vis their predecessors of 1980--and those 15,000 a year or so who will someday join the top 1% have seen their relative incomes triple. Continuity: just what is it that the top 13,000 have learned that the other 537,000 have not that is so valuable?

Mankiw also comments, I think more promisingly:

To some extent, the returns to human capital are random (as is true of physical capital). Getting an MBA gives you a shot at being CEO, but it is not a guarantee. This may be part of the Lemieux finding that higher levels of education are associated with higher residual variance. And perhaps it can reconcile the differing perspectives of Krugman and Lazear...

The implicit model, I think, is that when you get an advanced degree--or perhaps when you get an advanced degree from a good school--you not only get skills, but you also get a lottery ticket. Either because of dumb luck or because of the interaction of talent with formal education and technology or because of the interaction of the willingness to work like a dog beyond all reasonable measure with formal education and technology, the lucky or talented or workaholic today can, thanks to revolutions in computer and communications technology, leverage their symbolic-analyst skills over a much larger base of routine manufacturing, marketing, and distribution workers than they could have a generation ago. In this model, we have become much more of a "winner take all" economy than we used to be. Much more income is distributed in the form of winner-take-all tournaments than used to be the case.

My first reaction is that this is possible, but unproven. My second reaction depends on whether victory in the winner-take-all tournaments is due to luck, talent, or industriousness. If it is luck or talent, the 60% of me that is a social democrat thinks that this is grossly unfair, and that we should think very seriously about powerful public policies that will level the distribution of income.

Then the 20% of me that is a libertarian breaks its chains, comes running out of the cave, hits the social democrat on the head with a brick, grabs the microphone and rants: "Do you really trust the American government to manage a major downward redistribution of wealth without doing immense harm? And who would you rather have deciding how Bill Gates's $100 billion and Warren Buffett's $40 billion will be spent--Karl Rove or Bill Gates and the staff of the Bill and Melinda Gates Foundation?"

Now let's return the libertarian to its cave. There, there, everything will be all right. See? Just inside? Catalaxy. Zero government. Private order. A free society of associated autonomous producers...

Where was I?

Oh yes, in the event that it is neither luck nor talent, but instead industriousness, things become harder to evaluate. Organizations adopt winner-take-all compensation policies because they see a benefit, and the benefit is that they get a lot more people than there are big prizes to work very hard. These non-tournament winners are probably irrational--overestimate their chances of winning the tournament--and are thus exploited by the rest of society: putting in MorganChase hours and doing MorganChase-quality work without getting MorganChase pay scales. Jim Mirrlees has argued that such a society--in which those with a high marginal product were forced to work like dogs and had a relatively low utilitarian happiness--could well be optimal on utilitarian grounds.

We should think, and think hard, about all these issues. But I don't think that it's useful to characterize this mechanism for increasing inequality as "a rise in the premium paid to the skills acquired through education." I'm not sure what to call it, but it is something very different.

---

UPDATE: And Paul Krugman emails:

First, the question of which dates to look at depends on the question you're trying to answer. If you're asking why the public doesn't feel good about the economic growth since 2003 - which was, after all, what my "Left Behind" column was about - pointing out that inequality fell between 2000 and 2003 is irrelevant; everyone felt lousy about the economy during those years. The point is to explain why most people don't feel better about performance since 2003 - and rising inequality since then is the explanation.

Second, the data aren't encouraging about the long-term trend. The slump in top income shares after 2000 gave us reason to hope that the extreme income concentration at the end of the 90s was an artifact of the bubble, and would not return. But 2004 data already show a return almost to 2000 levels of inequality, and other indicators suggest that the trend has continued since then. Gilded Age II, here we come.

Third, both Greg and Eddie Lazear have asserted not just that rising inequality is partly due to an increased skill premium, which is true, but that it's mainly due to skill, which is false. I don't see why this distinction is so hard to understand. The median income of college grads is up since 1980, but only modestly, around 1 percent per year; the big gains are for people at the 99th percentile and beyond.

Comments

[Movie Guy]

BD - "If it is luck or talent, the 60% of me that is a social democrat thinks that this is grossly unfair, and that we should think very seriously about powerful public policies that will level the distribution of income."

Brad, as you know, there are also other sources of income that come into play which impact income inequality. And other types of income earners beyond hired guns who skew the income inequality we are observing. Educational attainment is not the only consideration among the success of the top 10%, top 1%, and top 0.03% of income recipients. That's an absurd claim. All business owners aren't sitting on piles of advanced degrees.

Most troubling, on the front end of the arguments against Paul's position, is the lack of distinction between those elements of discussion focusing on wages and salaries as compared to remarks directed at total income. Sometimes the subject jump is made in the same paragraph by the authors. That offers the first element of confusion or misdirection.

Further, the lack of acknowledgement that U.S. tax policy changes and trends have direct bearing on portions of income inequality is a remarkable oversight if not an overt attempt at slight of hand misdirection.

The frequent glossing over of capital income growth and spread is also a significant error of omission.

The income inequality argument is not well organized thus far.

But Paul Krugman is correct in his observations.

And Greg ManCow (that's the humorous nickname I granted him) is missing parts of the income inequality picture altogether. He's just drawing a big blank.

[Bruce Wilder]

Movie Guy has sliced and diced quite credibly. The whole tenor of the argument, and especially, the contribution of Prof. ManCow, has an air of unreality.

Someone, whose inner liberatarian has ridden the elevator of a government-mandated upward redistribution of income for 25 years, should not get squemish, at the merely theoretical possibility of riding down.

"what have been the changes in technology over the past twenty-five years that have made the skills of the 130,000 households in the top 0.1% so much more highly-valued vis-a-vis the skills of Mr. and Ms. 95th percentile?"

Economics will have to have a theory of production, to have a firm foundation for a comprehensive analysis. Wicksteed's "production function" is not going to suffice; "marginal product" is not even a good first approximation for the determinants of income distribution. Risk and “insurance” being huge factors, they ought to figure in the construction of an explanation. Notice might be taken of such epochal developments as the decline of unionization.

And, before anyone gets too carried away with tournaments and the like, let's put aside any naive notions that a tournament with hundreds of millions at stake is going to bring out only "industriousness" and “skill”. The thieves and brigands rising to the top in Corporate America thank you for your kind regard, I'm sure, but let’s get real, people.

Tournaments can become a bloody business. One reason kingdoms become hereditary is that competition to see who will be king can get out of hand, threatening the continuance of the kingdom for everyone. A good indication of the limits to administrative and leadership “skill” would be the compensation of top executives at shareholder-controlled companies, where founders retain the kind of power, which pension funds and mutual funds are not allowed to exercise. What’s the top salary at Microsoft? Compare and contrast, say, Tyco or Disney or Exxon.

[dsquared]

[To some extent, the returns to human capital are random (as is true of physical capital). Getting an MBA gives you a shot at being CEO, but it is not a guarantee.]

In what sense is this "human capital"? This is clique membership. There is a perfectly good economic theory of cliques, insiders and signals. Referring to this lottery ticket as "human capital" just shows the intellectual damage that has been done by lazy neoclassical assumptions.

"I saw the finest minds of my generation wrecked by the Solow model, starving hysterical naked and calling a residual a theory".

[James Wimberley]

How much of the premium to Harvard MBAs is simply a networking and selection effect rather than the added value of the learning? A lot. An interesting datum is the CV of the Russian steel tycoon Alexei Mordashov, (http://www.severstal-speaks.com/files/AMordashov_biography_en.pdf), who holds a British MBA from Northumbria University: an ex-polytechnic ranking low in the academic packing order. Think Alabama State. In today's Russia, the status and networking effects of Western business education don't count for anything. But he must have learnt what he needed.

[Foobarista]

How many of the top 1% get their income from working for others versus owning their own businesses, being self-employed, being real-estate investors, etc? If there's lots of the latter, shiny educational bling like a Harvard MBA is probably not so important, although the connections would matter in many areas even in self-employment.

My own intuition is that many if not most households at the $277K level would get less of their income from salaries versus business income, passive (rental) income, or capital gains/dividends. Given the massive difference in taxes of salary income versus other types of income at these levels, you'd be an idiot if you didn't.

[Cary Rader]

I am not an economist, but it seems to me everybody is ignoring the most obvious factor in this growing income inequality: globalization. Tax cuts for the wealthy largely go into investment and, with capital able to cross international borders so easily, much of that money goes into creating jobs in India and China. This brings high returns to large corporations and people who have the money to invest. Supply side tax cuts worked during the Kennedy administration because the American economy was largely self contained. But now they help finance outsourcing jobs and only increase downward pressure on average wages. On the other hand, a middle class ("demand side") tax cut would be spent first in this country to create jobs here, before trickling up to the wealthy.

The very lax policy on illegal immigration over the past few years works in a similar way. It creates a cheap, docile domestic workforce, so profits soar while wages stagnate. With reference to the Senate Bill, we working Americans should support a swift route to legalization and citizenship for these undocumented workers, so they can organize to demand their political and legal rights. A serious effort to deport eleven million people would easily cost something like $100 billion in police and court costs. But eleven million more workers with democratic rights could swell the ranks of labor unions. On the other hand, we must vehemently oppose the guest worker program, because it would create a whole new class of indentured servants to undermine labor protections.

[TW]

Any theories as to why, in the data that Piketty & Saez use, half the increase in income share for the top 1% that has occurred over the past two decades, happened in just two years (from 1986 to 1988)? I don't know enough about their data set, but would the tax reform of 1986 account for a large portion of that? Literally, by taxing the very highest salaries at lower and lower rates, has the tax code created the increasing inequality observed in the data?

Which isn't to say the increase isn't real & doesn't have fundamental causes, but to some extent is this just business owners & managers taking advantage of a lower top tax rate (and an even lower capital gains rate) to shift compensation out of tax sheltered forms and into regular wages, bonuses & stock options? Which suggests maybe the apparent lull in income share going to the top 1% was illusory all along ...

[liberty]

Reposting, since it got erased:

The problem that I see with your analysis is that you assume a static
state. The income of the top 1% is not the absolute income of those
persons and their educational status for life, just as the
income and education of those earning within the bottom quintile are
not their income and educational status' (stati?) for life.

In fact, most people in America start out in the bottom quintile and
end up in the top quintile - or stay there briefly and slide back down
during retirement. Most 40-50 year olds are in the fourth or top
quintile. Most people don't make it into the top 1%, but the fact
that the incomes of the top 1% are much higher and growing much faster
than the incomes of the bottom 20% means something different when you
recognize that it is a highly dynamic system: productivity growth
of the most productive during their most productive periods is growing
faster than productivity of the least productive during their least
productive periods.

[Ari]

The comment was erased because it is either trollish or thoughtless. DeLong and Krugman know what income mobility is and isn't and know there is a growing problem of income inequality and lack of mobility.

[liberty]

I certainly hope you are wrong and that it was an accident, Ari. Real dollar mobility is not lower today than in the past and even if it were, the static state assumption would still have skewed the analysis of nonlinearity. Regardless, erasing detractors just makes a blog homogenous and boring. It makes much more interesting debate to combat the arguments presented.

In any case, I am sure that it was a TypePad accident - there appear to be many.

[Ari]

Then, I may have been too blunt but there has been a long-running set of posts on increasing income inequality and thoughtful economists do not disregard life-cycle changes in income and wealth status. I wish there were such an easy answer to what is a real problem.

[anne]

http://www.nytimes.com/2005/06/06/opinion/06herbert.html?ex=1275710400&en=c03b1056decb6b77&ei=5090&partner=rssuserland&emc=rss

June 6, 2005

The Mobility Myth
By BOB HERBERT

The gap between the rich and everybody else in this country is fast becoming an unbridgeable chasm. David Cay Johnston, in the latest installment of the New York Times series "Class Matters," wrote, "It's no secret that the gap between the rich and the poor has been growing, but the extent to which the richest are leaving everybody else behind is not widely known."

Consider, for example, two separate eras in the lifetime of the baby-boom generation. For every additional dollar earned by the bottom 90 percent of the population between 1950 and 1970, those in the top 0.01 percent earned an additional $162. That gap has since skyrocketed. For every additional dollar earned by the bottom 90 percent between 1990 and 2002, Mr. Johnston wrote, each taxpayer in that top bracket brought in an extra $18,000.

It's like chasing a speedboat with a rowboat.

Put the myth of the American Dream aside. The bottom line is that it's becoming increasingly difficult for working Americans to move up in class. The rich are freezing nearly everybody else in place, and sprinting off with the nation's bounty.

Economic mobility in the United States - the extent to which individuals and families move from one social class to another - is no higher than in Britain or France, and lower than in some Scandinavian countries. Maybe we should be studying the Scandinavian dream.

As far as the Bush administration is concerned, the gap between the rich and the rest of us is not growing fast enough. An analysis by The Times showed the following:

"Under the Bush tax cuts, the 400 taxpayers with the highest incomes - a minimum of $87 million in 2000, the last year for which the government will release such data - now pay income, Medicare and Social Security taxes amounting to virtually the same percentage of their incomes as people making $50,000 to $75,000. Those earning more than $10 million a year now pay a lesser share of their income in these taxes than those making $100,000 to $200,000."

The social dislocations resulting from this war that nobody mentions have been under way for some time. But the Bush economic policies have accelerated the consequences and intensified the pain.

A big problem, of course, is that American workers have been hurting badly for years. Revolutionary improvements in technology, increasingly globalized trade, the competition of low-wage workers overseas and increased immigration here at home, the decline of manufacturing, the weakening of the labor movement, outsourcing and numerous other factors have left American workers with very little leverage to use against employers....

[anne]

http://www.thenation.com/doc.mhtml?i=20040105&s=krugman

January 5, 2004

The Death of Horatio Alger
By PAUL KRUGMAN

Let's talk first about the facts on income distribution. Thirty years ago we were a relatively middle-class nation. It had not always been thus: Gilded Age America was a highly unequal society, and it stayed that way through the 1920s. During the 1930s and '40s, however, America experienced what the economic historians Claudia Goldin and Robert Margo have dubbed the Great Compression: a drastic narrowing of income gaps, probably as a result of New Deal policies. And the new economic order persisted for more than a generation: Strong unions; taxes on inherited wealth, corporate profits and high incomes; close public scrutiny of corporate management--all helped to keep income gaps relatively small. The economy was hardly egalitarian, but a generation ago the gross inequalities of the 1920s seemed very distant.

Now they're back. According to estimates by the economists Thomas Piketty and Emmanuel Saez--confirmed by data from the Congressional Budget Office--between 1973 and 2000 the average real income of the bottom 90 percent of American taxpayers actually fell by 7 percent. Meanwhile, the income of the top 1 percent rose by 148 percent, the income of the top 0.1 percent rose by 343 percent and the income of the top 0.01 percent rose 599 percent. (Those numbers exclude capital gains, so they're not an artifact of the stock-market bubble.) The distribution of income in the United States has gone right back to Gilded Age levels of inequality.

Never mind, say the apologists, who churn out papers with titles like that of a 2001 Heritage Foundation piece, "Income Mobility and the Fallacy of Class-Warfare Arguments." America, they say, isn't a caste society--people with high incomes this year may have low incomes next year and vice versa, and the route to wealth is open to all. That's where those commies at Business Week come in: As they point out (and as economists and sociologists have been pointing out for some time), America actually is more of a caste society than we like to think. And the caste lines have lately become a lot more rigid.

The myth of income mobility has always exceeded the reality: As a general rule, once they've reached their 30s, people don't move up and down the income ladder very much. Conservatives often cite studies like a 1992 report by Glenn Hubbard, a Treasury official under the elder Bush who later became chief economic adviser to the younger Bush, that purport to show large numbers of Americans moving from low-wage to high-wage jobs during their working lives. But what these studies measure, as the economist Kevin Murphy put it, is mainly "the guy who works in the college bookstore and has a real job by his early 30s." Serious studies that exclude this sort of pseudo-mobility show that inequality in average incomes over long periods isn't much smaller than inequality in annual incomes.

It is true, however, that America was once a place of substantial intergenerational mobility: Sons often did much better than their fathers. A classic 1978 survey found that among adult men whose fathers were in the bottom 25 percent of the population as ranked by social and economic status, 23 percent had made it into the top 25 percent. In other words, during the first thirty years or so after World War II, the American dream of upward mobility was a real experience for many people.

Now for the shocker....

[anne]

http://www.nytimes.com/2005/06/05/national/class/HYPER-FINAL.html?ex=1275624000&en=f1af44c9cec8c79e&ei=5090&partner=rssuserland&emc=rss

June 5, 2005

Richest Are Leaving Even the Rich Far Behind
By DAVID CAY JOHNSTON

Draw a line under the top 0.1 percent of income earners - the top one-thousandth. Above that line are about 145,000 taxpayers, each with at least $1.6 million in income and often much more.

The average income for the top 0.1 percent was $3 million in 2002, the latest year for which averages are available. That number is two and a half times the $1.2 million, adjusted for inflation, that group reported in 1980. No other income group rose nearly as fast.

The share of the nation's income earned by those in this uppermost category has more than doubled since 1980, to 7.4 percent in 2002. The share of income earned by the rest of the top 10 percent rose far less, and the share earned by the bottom 90 percent fell.

Next, examine the net worth of American households. The group with homes, investments and other assets worth more than $10 million comprised 338,400 households in 2001, the last year for which data are available. The number has grown more than 400 percent since 1980, after adjusting for inflation, while the total number of households has grown only 27 percent.

The Bush administration tax cuts stand to widen the gap between the hyper-rich and the rest of America. The merely rich, making hundreds of thousands of dollars a year, will shoulder a disproportionate share of the tax burden.

President Bush said during the third election debate last October that most of the tax cuts went to low- and middle-income Americans. In fact, most - 53 percent - will go to people with incomes in the top 10 percent over the first 15 years of the cuts, which began in 2001 and would have to be reauthorized in 2010. And more than 15 percent will go just to the top 0.1 percent, those 145,000 taxpayers.

The Times set out to create a financial portrait of the very richest Americans, how their incomes have changed over the decades and how the tax cuts will affect them. It is no secret that the gap between the rich and the poor has grown, but the extent to which the richest are leaving everyone else behind is not widely known.

The Treasury Department uses a computer model to examine the effects of tax cuts on various income groups but does not look in detail fine enough to differentiate among those within the top 1 percent. To determine those differences, The Times relied on a computer model based on the Treasury's. Experts at organizations representing a range of views, including the Heritage Foundation, the Cato Institute and Citizens for Tax Justice, reviewed the projections and said they were reasonable, and the Treasury Department said through a spokesman that the model was reliable.

The analysis also found the following:

¶Under the Bush tax cuts, the 400 taxpayers with the highest incomes - a minimum of $87 million in 2000, the last year for which the government will release such data - now pay income, Medicare and Social Security taxes amounting to virtually the same percentage of their incomes as people making $50,000 to $75,000.

¶Those earning more than $10 million a year now pay a lesser share of their income in these taxes than those making $100,000 to $200,000.

¶The alternative minimum tax, created 36 years ago to make sure the very richest paid taxes, takes back a growing share of the tax cuts over time from the majority of families earning $75,000 to $1 million - thousands and even tens of thousands of dollars annually. Far fewer of the very wealthiest will be affected by this tax.

The analysis examined only income reported on tax returns. The Treasury Department says that the very wealthiest find ways, legal and illegal, to shelter a lot of income from taxes. So the gap between the very richest and everyone else is almost certainly much larger.

The hyper-rich have emerged in the last three decades as the biggest winners in a remarkable transformation of the American economy characterized by, among other things, the creation of a more global marketplace, new technology and investment spurred partly by tax cuts. The stock market soared; so did pay in the highest ranks of business.

One way to understand the growing gap is to compare earnings increases over time by the vast majority of taxpayers - say, everyone in the lower 90 percent - with those at the top, say, in the uppermost 0.01 percent (now about 14,000 households, each with $5.5 million or more in income last year).

From 1950 to 1970, for example, for every additional dollar earned by the bottom 90 percent, those in the top 0.01 percent earned an additional $162, according to the Times analysis. From 1990 to 2002, for every extra dollar earned by those in the bottom 90 percent, each taxpayer at the top brought in an extra $18,000....

[liberty]

Thanks anne,

I have responded to this topic in depth at my site, the article is here:
http://economicliberty.net/mobility_stats.htm