You Ask, I Answer

September 30th, 2011 at 4:45 pm

Q: What is the mechanism by which higher incomes from increases in productivity get back to workers?

A: Well, the problem is: it doesn’t.  I mean, sometimes it does, and it should, but in recent decades, productivity growth has diverged from the compensation and incomes of middle- and lower-income families.  This is really another way of saying inequality has grown.

For years, economists didn’t think much about this.  They observed that average compensation grew at around the same rate as productivity growth and figured that all was well (in fact, a commonly used model, the Cobb-Douglas production function, embeds this assumption that average comp grows at the rate of productivity).

But of course one of the characteristics of growing inequality is that the average is less descriptive of outcomes throughout the income scale.  For years, through the 1950s and 60s, real MEDIAN family income kept pace with productivity growth—both about doubled in those years.  But since then, median family income has grown about one-third as fast as productivity growth.

What changed?  A lot—fewer unions, the shift from manufacturing to service jobs (hastened by the increase in trade with lower wage nations), outsized returns to folks in certain sectors, like finance, and the growth of the educational advantage, to name some of the more important factors.

But no small part of this disconnect comes under the heading of “bargaining clout.”  The benefits of productivity growth don’t naturally flow to those responsible for said growth.  Some people have to fight for it.  And I’m not just talking unions here. 

I think one of the most important answers to your question is “full employment.”  Labor markets were much tighter during the period noted above when median incomes grew with productivity, and when they got that tight for a moment in the latter 1990s, low- and middle-earnings again begin to rise with productivity.

In those years, employers had to bid compensation up to get and keep the workers they needed.  In that way, low unemployment was the “mechanism” you seek.  And yes, it’s been very much missing ever since.

Q: You seem very positive on switching to chained CPI. But it feels like it’s being proposed mostly as a cost cutting measure. Shouldn’t that decision be based on some data that shows that chained CPI is the more appropriate measure?

A: OK, I’ve been threatening to post on this for a while and promise I’ll do so any minute now.  For the record, I don’t think I’m “very positive” about the change—how big a nerd do you think I am that I get all excited about switching deflators (that’s a rhetorical question)?

But I think it measures price growth, i.e., inflation, more accurately.  More to come.

Q: All of this discussion around the “fairness or unfairness” of average tax rates and who pays what % of “income taxes” or “total taxes” obscures the cumulative effects of these rates on the even larger issue of wealth concentration and its effects on marginal propensities to consume. Isn’t the reduction in GNP from the increased savings on the part of the wealthy really a tax on everyone? How much bigger might the economy be if a considerable portion of these savings were redistributed to those with a high propensity to consume or spent by the government instead of being invested overseas?

A: First of all, you’re right the wealth is even more concentrated than income at the top of scale—see figure.

But while I kind of follow your logic, I’m not sure I’d go there.  First of all, in normal times, savings gets used for investment that helps to boost growth.  There are many complications, of course, like with lots of investment flowing abroad or into opaque and non-productive financial instruments (or into the bubbles such financial engineering helps to inflate).  But savings is a good thing.

You make a good point re propensity to consume, especially in a downturn like now.  And in fact, the President is onto this point, promoting a jobs plan that targets tax cuts, infrastructure, public sector jobs, unemployment insurance extension, and subsidized jobs for low-income workers, paid for by in large part by increasing taxes on high-income families.

Q: Any thoughts on this piece?

A: I found this to be an interesting and well-presented argument—that the Federal Reserve should target nominal GDP growth instead of emphasizing inflation so much.  But I’ve got two prominent concerns that would lead me to be wary of getting behind this idea.

First, the big problem as I see it, and, bless his soul, as Fed governor Charles Evans sees it, is high unemployment, which is already half of the Fed’s mandate, so we shouldn’t outta have to undergo a big argument about what they should target, as a switch to nominal GDP would engender.

Second, though it’s not the case right now, I can easily imagine a recovery with nominal GDP growing quickly, say coming out of a recessionary trough, yet with inflation quiescent and unemployment high.  And I wouldn’t want the Fed to tighten in that scenario.

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13 comments in reply to "You Ask, I Answer"

  1. Dan Furlano says:

    I’m looking forward to your comments on MMT.

  2. Dan Furlano says:

    Slowly… oh so slowly… the message is getting through.

  3. perplexed says:

    Thanks Jared; and another great chart!

    I may be misinterpreting this, but I’m thinking that what Keynes was saying is, that while it seems to be intuitive that there is a “savings” benefit to allowing high wealth concentration, this is another paradox. He believed that incentives were needed, but that the extremes worked against us. What I’m understanding him to be saying is that the negative effects of allowing such a high proportion of income (and subsequently wealth) to be “siphoned” off to the savings of accounts of the wealthy produces more of “drag” on the economy than any “savings” benefit (because of the differences in marginal propensities to consume). He also finds (if I understand him correctly) that the additional savings needed for increased investment will be provided as interest rates alter the marginal propensities to consume for everyone. Almost all will become “savers” at some interest rate. If not, the government can intervene, but there is no reason to think that we need a “wealthy class” to perform this function. If this relationship holds, then wealth concentration could be a much bigger factor in our output gap than anyone is giving it credit for. Has this relationship ever been empirically discredited? The last time wealth concentration was anywhere near this high was 1929. Just a coincidence? Could it be that the “tax & spend” label that the republicans are continuously trying to paint the democrats with is the optimal solution for the economy as a whole?

    Here, in Keynes’s words, is where I’m getting this (what am I missing?):

    The General Theory of Employment, Interest and MoneyChapter 24. Concluding Notes on the Social Philosophy towards which the General Theory might Lead
    THE outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes. The bearing of the foregoing theory on the first of these is obvious. But there are also two important respects in which it is relevant to the second.
    Since the end of the nineteenth century significant progress towards the removal of very great disparities of wealth and income has been achieved through the instrument of direct taxation — income tax and surtax and death duties — especially in Great Britain. Many people would wish to see this process carried much further, but they are deterred by two considerations; partly by the fear of making skilful evasions too much worth while and also of diminishing unduly the motive towards risk-taking, but mainly, I think, by the belief that the growth of capital depends upon the strength of the motive towards individual saving and that for a large proportion of this growth we are dependent on the savings of the rich out of their superfluity. Our argument does not affect the first of these considerations. But it may considerably modify our attitude towards the second. For we have seen that, up to the point where full employment prevails, the growth of capital depends not at all on a low propensity to consume but is, on the contrary, held back by it; and only in conditions of full employment is a low propensity to consume conducive to the growth of capital. Moreover, experience suggests that in existing conditions saving by institutions and through sinking funds is more than adequate, and that measures for the redistribution of incomes in a way likely to raise the propensity to consume may prove positively favourable to the growth of capital.
    The existing confusion of the public mind on the matter is well illustrated by the very common belief that the death duties are responsible for a reduction in the capital wealth of the country. Assuming that the State applies the proceeds of these duties to its ordinary outgoings so that taxes on incomes and consumption are correspondingly reduced or avoided, it is, of course, true that a fiscal policy of heavy death duties has the effect of increasing the community’s propensity to consume. But inasmuch as an increase in the habitual propensity to consume will in general (i.e. except in conditions of full employment) serve to increase at the same time the inducement to invest, the inference commonly drawn is the exact opposite of the truth.
    Thus our argument leads towards the conclusion that in contemporary conditions the growth of wealth, so far from being dependent on the abstinence of the rich, as is commonly supposed, is more likely to be impeded by it. One of the chief social justifications of great inequality of wealth is, therefore, removed. I am not saying that there are no other reasons, unaffected by our theory, capable of justifying some measure of inequality in some circumstances. But it does dispose of the most important of the reasons why hitherto we have thought it prudent to move carefully. This particularly affects our attitude towards death duties: for there are certain justifications for inequality of incomes which do not apply equally to inequality of inheritances.
    For my own part, I believe that there is social and psychological justification for significant inequalities of incomes and wealth, but not for such large disparities as exist today. There are valuable human activities which require the motive of money-making and the environment of private wealth-ownership for their full fruition…. But it is not necessary for the stimulation of these activities and the satisfaction of these proclivities that the game should be played for such high stakes as at present. Much lower stakes will serve the purpose equally well, as soon as the players are accustomed to them. The task of transmuting human nature must not be confused with the task of managing it. Though in the ideal commonwealth men may have been taught or inspired or bred to take no interest in the stakes, it may still be wise and prudent statesmanship to allow the game to be played, subject to rules and limitations, so long as the average man, or even a significant section of the community, is in fact strongly addicted to the money-making passion.

    • Jared Bernstein says:

      No, I think your interpretation is correct. And it’s a fine justification for progressive taxation (and for the jobs plan as I stressed). Keynes’ insight that savings doesn’t automatically equal investment in a liquidity trap is incredibly important right now, and weirdly ignored or misunderstood by many economists.

      My only point was that in normal times, private savings does help finance investment, and so some degree of wealth accumulation is good…but it’s way too skewed today, with middle and low income families facing sharply diminished net worth.

      Great excerpt–btw–I was just re-reading chapter 19 (the one on wages)!

      • perplexed says:

        Thanks for your reply Jared; its always a bit of challenge with Keynes’ incredible insights. I want to be sure I’m not misinterpreting him as the implications of what he was saying, both economically and politically, are so critical to our current situation. It seems that many economists have dismissed his ideas without empirical evidence to support why they know better than he did. Its good to see the new focus on Keynes that Sylvia Nassar’s new book is generating Nasar on Keynes (, and I thought Mark Thoma’s comments were spot on Thoma on Keynes and Marshall (

        I must admit that Krugman’s recent post on “History Roolz” History Roolz ( was a bit of an “Aha” moment for me; I hadn’t realized that you could actually get a PhD. in economics without a solid background in economic history. It explains a lot. How would you ever know if some variation of your “new” ideas had already been tried repeatedly in the past with disastrous results without a solid background in history? I’m still trying to figure out what, if any, real difference there is between a libertarian, a tea partier, an Ayan Rand apostle, and an anarchist is. It seems to me that, fundamentally, the only real difference is the chronological years of their respective marketing campaigns. What really is the difference between laissez-faire fair economics and the economics of anarchy? Are these people completely unaware that their “new” ideas are just old ideas in new, transparent costumes? Or are they just aware that manipulation of the ignorance of others works to the benefit of achieving their objectives? Keynes was an optimist with regard to these questions, Hacker & Pierson would likely argue he’d be pretty naive saying the same was true today. As Keynes himself saw it:

        “Is the fulfilment of these ideas a visionary hope? Have they insufficient roots in the motives which govern the evolution of political society? Are the interests which they will thwart stronger and more obvious than those which they will serve?
        I do not attempt an answer in this place. It would need a volume of a different character from this one to indicate even in outline the practical measures in which they might be gradually clothed. But if the ideas are correct — an hypothesis on which the author himself must necessarily base what he writes — it would be a mistake, I predict, to dispute their potency over a period of time. At the present moment people are unusually expectant of a more fundamental diagnosis; more particularly ready to receive it; eager to try it out, if it should be even plausible. But apart from this contemporary mood, the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil.” Paul Krugman’s VSP’s are not a new phenomenon by any means; Keynes warned of their resurgence, we chose to ignore him.

        I wholeheartedly agree that private savings and wealth are indeed important to funding investment. I’m interpreting that what Keynes is saying though, is that this has nothing to do with that wealth being concentrated, is in fact impeded by the wealth and income concentration, and that this reality is the “exact opposite” of what the generally accepted view is (and this drag on the economy is a factor right up to the point of full employment). “But inasmuch as an increase in the habitual propensity to consume will in general (i.e. except in conditions of full employment) serve to increase at the same time the inducement to invest, the inference commonly drawn is the exact opposite of the truth.” -Keynes. I believe he’s saying here that savings and wealth distributed widely are just as beneficial as savings and wealth concentrated among a select few, without the downside. He’s also saying that this widely distributed savings will occur naturally as the incentives to save change in response to the need for greater investment that the increased demand results in. He says specifically that “But it does dispose of the most important of the reasons why hitherto we have thought it prudent to move carefully” (with regard to redistribution). The only real concern is that incentives are important, so some degree of income inequality is necessary to provide incentive. But ultimately he thought that it was the role of the government to manage these outcomes and that, un-managed, capitalism would result in “arbitrary and inequitable distribution of wealth and incomes.” He states this rather emphatically in another quote:

        “Whilst, therefore, the enlargement of the functions of government, involved in the task of adjusting to one another the propensity to consume and the inducement to invest, would seem to a nineteenth-century publicist or to a contemporary American financier to be a terrific encroachment on individualism. I defend it, on the contrary, both as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative.

        For if effective demand is deficient, not only is the public scandal of wasted resources intolerable, but the individual enterpriser who seeks to bring these resources into action is operating with the odds loaded against him. The game of hazard which he plays is furnished with many zeros, so that the players as a whole will lose if they have the energy and hope to deal all the cards. Hitherto the increment of the world’s wealth has fallen short of the aggregate of positive individual savings; and the difference has been made up by the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual good fortune. But if effective demand is adequate, average skill and average good fortune will be enough.

        The authoritarian state systems of today seem to solve the problem of unemployment at the expense of efficiency and of freedom. It is certain that the world will not much longer tolerate the unemployment which, apart from brief intervals of excitement, is associated and in my opinion, inevitably associated with present-day capitalistic individualism. But it may be possible by a right analysis of the problem to cure the disease whilst preserving efficiency and freedom.” -Keynes. Back to the future right? Is this “disease” he refers to anything other than wealth & income concentration, and the improper management of redistribution that causes them? Are these not the arbitrary outcomes of the capitalist system that need to be managed? But what happens if instead of “right analysis of the problem” you instead have a wrong analysis of the problem?

        Nassar mentions Karl Marx and his pessimism about the viability of capitalism. I’m not sure of the specifics of exactly how Marx thought that capitalism would self destruct, but I know that he thought it would. Was this self destruction process the same process Keynes referred to above as what he thought could be avoided by proper management i.e.: “…government, involved in the task of adjusting to one another the propensity to consume and the inducement to invest…”? Is the deadly cycle of un-managed income concentration leading to increased wealth concentration leading to greater political power leading to greater income concentration the force that would lead to the “destruction of existing economic forms in their entirety.”? Is this why he defends government intervention as “the only practicable means…” of avoiding this destruction and as “the condition of the successful functioning of individual initiative”? I don’t know Marx’s specifics but it seems to me that this is what Keynes was warning about. If he was right, its already very late in the game with a .84 wealth Gini and out of control income concentration. Can we really afford to have 20% of our national income going to a group whose consumption would change very little with a quarter of that income? 20% of the income of the richest country in the world is an awful lot of money to be sending to group with a very low marginal propensity to consume. What really is the effect of this and how different would our current situation be if a significant portion of this income, and wealth, were being redistributed to those with a high propensity to consume as Keynes suggests? Where’s the model of this scenario? Teddy Roosevelt, and later FDR, were able to muster the political strength to break this vicious cycle, but that was before TV & financial control of the electoral process by the wealthy benefactors of the cycle. I suspect this makes the political challenges today considerably more insurmountable than those they faced, which were considerable. The wealthy & corporate interests have never been as well organized and powerful as they are today. They control political access, they are in control the ideological battles; do they even control the military? Scary thoughts, but who would have thought five years ago that we’d be in a depression today? Those that know history know that things can happen quite quickly once the “table is set.”

        It seems incontrovertible to me that Keynes thought that government intervention to manage both income and wealth concentration was a necessary part of the success of capitalism. It also seems that tying wealth taxes, estate taxes, and marginal income tax rates to measures of wealth and income concentration like Gini, are a very practical way of accomplishing this. If what Keynes is saying is correct, then there is likely to be some “optimal” level (or range on an inverted U) of wealth and income concentrations that generates the bests results for the country as a whole. Is there any research on what this level might be or have all of our efforts been on tweaking monetary policy to the optimal trade off between inflation and unemployment? Based on what Keynes is saying, it would appear to me that the real “job creators” are those with a high marginal propensity to consume; getting money to them will actually create jobs. Whether that money comes from wealth taxes, income taxes (on only those with low marginal propensity to consume), estate taxes, or deficit spending is probably irrelevant in terms of creating jobs. The already high deficits generated by failed tax policies of the past would make wealth and income taxes (on those with a low MPC) the better option. Whatever impedes this process will likely perpetuate our current crisis. Which is just about everything we are now doing.

        Keynes’ observations on the role of government are also extremely important for another reason. If the better managers of capitalism are likely to be the higher achievers in a global race, then it may come down to who is better at playing the government’s role of being the most effective at redistribution that will likely determine the winners. Weakening your government is antithetical to winning this contest. We will not shrink to greatness as the current crop of anarchists suggest. While we’re consumed with all of this infighting, the playing field on the world front is rapidly changing. Michael Moore is right, there is nothing American, or even democratic, about capitalism. Its not in our constitution; we don’t own it or even get license fees from it. Anyone that chooses to can use it, and many non-democratic forms of government are. If they turn out to be better “managers” of capitalism than we are, their economies will benefit at a much greater rate than ours. The Romans were superior at managing transportation infrastructure, the Prussians were superior at managing their armies, we were superior at managing our industrial revolution. It remains to be seen who is really better at managing capitalism; but democratic governments have some serious deficiencies to overcome. A totalitarian government has few of the obstacle that we have to planning and managing their economies. We talk at length about currency pegs and “beggar thy neighbor” strategies to grow through exports, but, if what Keynes is saying is correct, they will have much more speed and flexibility in controlling their “income distribution” decisions than any democracy. So while we battle over “who should pay what % of income taxes, the wealthy or the other 95%” to the detriment of all, the more critical battle could be about freedom. Keynes observation that “The authoritarian state systems of today seem to solve the problem of unemployment at the expense of efficiency and of freedom.” may indeed be an observation about a time that no longer exists. If totalitarian governments solve the “inefficiency” side of that puzzle with better management of capitalism, then their solutions would only be at the expense of freedom wouldn’t they? A strong, effective government may be the key competitive advantage in a race to better manage capitalism in a competitive world where everyone uses the most effective system developed to date. Using a gun when your opponents are using water pistols is one thing, but when they all have guns you’d better be pretty skillful, and focused. Maybe we’ve just been on this island way too long; its impeded our ability to learn in a truly competitive environment.

        The ideological battle is critical but so is campaign finance reform. We need to win both battles and economists play a hugely outsized role in both. Even a Teddy Roosevelt or FDR would be seriously outgunned by the current realities of the campaign finance situation. Its unlikely they’d be able to raise enough money to even run for office; and certainly not enough to win. Our political choices have been restricted to those that have the approval of the wealthy minority; not will be restricted, have already been restricted. That’s how effective this combination of financial control of politics and organized propaganda has been. The Teddy’s & FDR’s of our day have been neutered by the moneyed interests they would oppose; not by the power of the intellectual superiority of their arguments, by their money. We need to manage this so that the reverse is true. Who knows, maybe Keynes was right to be optimistic about human nature. Maybe we need to recall all economics PhD’s until the candidates can demonstrate that they have enough knowledge of history to be responsible participants in this ideological struggle. There’s way to much riding on the outcome to allow otherwise.

        • Peter says:

          damn perplexed, you nailed this so spot on. the observation on the real job creators is one that should be picked up by all progressive politicians (they all have to some extent but an overt campaign to correct the causal direction of this political meme is sorely needed). the larger point about all political actions being social engineering and the need for effective engineering to obtain to serve the collective welfare is a massively important one and must not be shied away from.

  4. ReaderOfTeaLeaves says:

    Thanks for another great chart.

    Qu 1: Is it possible to overlay the data in the post with that amazing chart from CPPB that shows the mushrooming emergence of the two unpaid- for wars and begins around 2001?

    Qu 2: All the datasets used in the graphs at OTE appear to come from public sources. Is it possible to ever post a list of those so that any of us who like data diving can go schlump through some of it on our own time?

    Qu3: Would it be possible to have a separate Charts Page, perhaps linked from a central nav link (ie, in addition to About, Pubs, Contact, add an add’l nav link for Charts)? I ask in part because I have wasted time trying to locate a couple of your earlier charts to use as references; going through the old posts is just not all that efficient. I would *love* to be able to click from the main nav bar to a list of chart titles, then click on the titles that are relevant to my topic.

    In other words, 4 clicks rather than 22 would be really nice. Plus, easier on your server.
    (Then the data souces are always listed with the charts, so double-handy for locating datasets.)

    Thanks for considering the request.

  5. Scott Sumner says:

    Jared, Thanks for commenting on my NGDP targeting piece. Let me just say that I share your concern that faster than normal NGDP growth might be required when coming out of a recession. I’ve discussed the idea of targeting a trajectory with 5% annual growth, which allows for faster than normal NGDP growth to “catch-up” for any shortfalls during a recession (and vice versa.) I’ve also favorably contrasted the Volcker Fed to the current Fed. In the first 6 quarters of the 1983-84 recovery NGDP grew at an 11% annual rate, and only 3.3% of that was inflation (the other 7.7% was real growth.) Then NGDP growth slowed (appropriately) when we got closer to full employment.


    • perplexed says:

      Jared is way too kind! I can hardly wait until Krugman gets a chance to reveal the obfuscated arguments that this piece is really about; I hope he considers it worth his time. Now that you VSP’s have been so wrong about the inflation arguments you vested so much “capital” in, you need a way to back off them or risk reversal of the austerity measures that are causing so much damage don’t you?

      So the solution is to come up with a smoke and mirrors way to support increased inflation that will never come about anyway in a thinly disguised argument to protect the austerity that benefits the rentiers at a cost to everyone else.

      How transparent & disingenuous! Don’t you people ever get embarrassed?

  6. Dan Furlano says:

    In the current economy I really do not understand what the FED can do to effect NGDP.

    IMHO it is only fiscal policy that can effect NGDP.