The Top 1% and the College Earnings Premium: Don’t Confuse Them (as Mankiw Does)

June 25th, 2013 at 10:21 pm

Larry Mishel has a useful blog up responding to Greg Mankiw’s piece defending the top 1% (for much more discussion of Greg’s essay, start here and click through the many links).

I’ll get to Larry’s point in a moment, but one thing re Greg’s paper.  Much of the criticism, which I’ve (predictably) found resonant, is directed at a) his failure to comprehend that the opportunity set facing families and their kids on the have-not side of the inequality divide is diminished, and b) the role that inequality itself has played in that outcome (I’ll have a second post up soon on point b—it’s one I’ve consistently stressed in these parts).

For me, that undermined his essay, which sounded too much like the weatherman telling you that according to his model it’s a sunny day while you’re stuck in a storm.  But aside from that, he raises an important challenge: how do we distinguish rents from just rewards?

For a traditional economist, it’s incredibly simple to defend the top 1% (or the bottom 1%, for that matter).  You just apply the assumption that their rewards are commensurate to the value they’re creating.  How do you know they’re being paid their value added, and not some extra amount based on their systemic advantages (privilege, power, collusion with pay setters, inside info—called “rents” in economics)?   There are theoretical arguments about efficiency constraints—pay the CEO more than she’s worth and the firm will fail—but that’s just more assumption, and the argument has certainly not been settled by evidence.

What does Greg have to offer?  He slips into the old skills-based defense, and in doing so, as Mishel reveals, loses the argument (or almost loses, see below), because he conflates the college premium with the top 1%.  That is, he believes the inequality story is a story of more highly educated workers getting evermore “just rewards” because their skills are increasingly more valuable to employers than those of less educated workers.

In Greg’s view, “the story of rising inequality, therefore, is not primarily about politics and rent-seeking but rather about supply and demand.”

All Mishel then has to do is plot two lines:

…the growth of top one percent incomes has not followed the same pattern as the wage premium of ‘skilled’ workers (meaning the wage premium earned by college graduates). …the figure below…shows the…wage premium of college graduates…relative to non-college educated workers and the ratio of top one percent incomes…to the incomes of the bottom ninety percent…The first thing to stand out is that the top one percent income advantage moves like the stock market, much like the pay of executives and financial professionals, rising rapidly in the late 1990s, crashing after the tech bubble burst and again in 2008 and recovering as the stock market does so.


Source: Mishel, EPI

Mishel also points out that starting in the mid-1990s, these two lines don’t even follow the same trend.  The college premium—the factor Mankiw says is driving inequality—flattens and the top 1% accelerates like crazy, before crashing and rising again as the next bubble recovery gets underway.  The cyclicality alone should prevent anyone from wholly conflating an inequality story with a skills story (skills were highly and increasingly valued…then they weren’t for a few years…then they were again!).

Now, re that “almost” above.  Greg and others who don’t think rents are in play here could easily look at Larry’s chart and say: We’re not wrong—we were just focused on the wrong group.  The real productivity wizards are the top 1% or 0.1%, are whomever’s making a killing!

That’s a tautology, of course, and what’s required here is a systematic way to separate rents from value-added.  Clear distinctions are not likely to be forthcoming, but work like this (oil executives get pay bumps for favorable price movements on world markets—clearly not their doing) and this (an important lecture where Richard Freeman explores the rent/value-added distinction) are helpful.  Dean Baker has developed a literature on rent-seeking through non-market mechanisms like patents and copyrights.  Then there’s the financial markets guys and gals that tanked the economy and got bailed out (Greg himself wonders if flash traders are really adding value).  If there’s a value-added story in there, it’s awfully hard to read.

Still, even with the clearest evidence of rent-seeking, at the end of the day, there will always be people who will defend the top 1%, as Greg does here, as earning what they make fair-and-square.  That’s why I think the more egregious stumble in his essay is the denial of the case that US levels of income and wealth concentration are zapping opportunity and mobility.  I’ll turn to that later in the week.

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7 comments in reply to "The Top 1% and the College Earnings Premium: Don’t Confuse Them (as Mankiw Does)"

  1. Kevin Rica says:

    Mankiw says this doesn’t happen:

    companies just making more money because they can set prices.

    If the 1% was earning more by providing more, it would be a mutually beneficial relationship and BOTH parties would gain. In that case, they would not be the only ones with more income while every one else’s income stagnates (aside from those sneaking across the border: which Mankiw approves of).

  2. smith says:

    In opposition to Mankiw, written by Corak, as linked to by Krugman, talking about the top 20%:

    “For them the “American Dream” lives on, and as a result they are likely not predisposed, with their considerable political and cultural influence, to support the recasting of American public policy to meet its most pressing need, the upward mobility of those at the bottom.”

    Corak actually presents a weaker argument than is warranted by reality. The top 20% don’t just protect the top 1% because of aspirational motivation, instead they actually benefit from the current system. See my June 6 comment:“hem/

    The 4th group are the power elite of moderate liberal, socialist, and centrist governments. They represent the top 20 and 10% for whom lower growth, low taxes, low inflation, low wage growth, high corporate profits are quite beneficial. They want clean water, equal rights, free health care, and other liberal policies associated with moderate costs. We get Romneycare, most of the Bush tax cuts, 7.5% unemployment, record foreclosures (3 times historical avg still).”

  3. Fred Donaldson says:

    It would be fascinating to watch Greg (or many other elites) perform the simple task of calculating, measuring and cutting 100 or more roof joists, hip and valley rafters, collar beams and ridge members, and then install them into a second or third floor in 100 degree heat. Folks actually do that, and even more challenging jobs without a fabulous liberal (able to do what?) degree. So, which person deserves more in society – the producer who creates, or the non-producer with a piece of paper?

  4. Alan says:

    JB writes: “For a traditional economist, it’s incredibly simple to defend the top 1% (or the bottom 1%, for that matter). You just apply the assumption that their rewards are commensurate to the value they’re creating.”

    To me, a noneconomist,this seems like a classic rhetorical trick of defining a word with a common meaning – “value” – in a technical way, and then applying the results as if the word still retained its standard moral implications. The impropriety of this device was pointed out by one of the early British marginalists:

    “Economics, it is said, have nothing to do with ethics, since they deal, not with the legitimacy of human desires, but with the means of satisfying them by human effort. In answer to this I would say that if and in so far as economics have nothing to do with ethics, economists must refrain from using ethical words; for such epithets as ‘useful’ and ‘advantageous’ will, in spite of all definitions, continue to carry with them associations which make it both dangerous and misleading to apply them to things which are of no real use or advantage.” Philip Wicksteed, The Alphabet of Economic Science (London Macmillan & Co. 1888) page 8.

  5. Tom in MN says:

    If it was your skill as a CEO that was getting you the big bucks, then poor outcomes should lead to less pay (the usual risk in any profession), but there are repeated examples of CEO’s making a complete mess of a company and then going on to another company as CEO. These top spots seem much more like a club, that once you are in, you are considered for other CEO jobs independent of your previous accomplishments — that is — once a CEO you collect CEO rent (pay) for just being there all out of proportion for the value you add. The idea that you are a risk taker as CEO does not relate at all to how they are paid. And without the risk component you are collecting rent not pay for work.

    I think you could make a case that the decrease in the college premium is due to the rents extracted by the top 1% leaving less for those that do the real producing. When a CEO leaves with a Billion dollars (United Health, GE, etc) in total compensation, that clearly leaves less for the rest of the workers.

  6. JRHulls says:

    I think the real question is whether the financial sector is worth what we pay it. If their task is the efficient distribution of capital, why is the rise of financial sector assets not matched by the rise in GDP which should result from the more efficient distribution of capital, or have they merely rigged the game to keep the money for themselves?

    See: for further discussion as to the consequences.

  7. Main Street Muse says:

    If inequality in America is increasing because the top 1% are getting better and better at their jobs – “the very wealthy get that way by making substantial economic contributions” – then why is the economy in such poor shape?

    A consumer-driven economy in which 99% of the employed see several decades of stagnant wages is a troubled economy.

    With regard to Mankiw’s paper, that the chairman of the Harvard economics department can make such a poor argument in defense of current income inequality is a terrible reflection on the thought coming out of Harvard. Then again, this is the school that gave us the first MBA president…