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.