Month: September 2010

*Winner-Take-All Politics*, the new book by Jacob Hacker and Paul Pierson

That's the new book by Jacob Hacker and Paul Pierson.  I have a different take on the main argument, but this is an important book for raising some of the key questions of our time.  I would recommend that people read it and give it serious thought.  The writing style is also clear and accessible.  Two of the key arguments are:

1. Skill-based technological change is overrated as a cause of growing income inequality among the top earners.

2. "The guilty party is American politics."

You'll find an article-length version of some of the Hacker-Pierson argument here, although the book covers much more.

I agree with #1, so let me explain why my take on #2 differs:

1. Median income starts stagnating in 1973 and income inequality starts exploding in 1984, according to the authors.  However, I consider this a "long" time gap for the question under consideration, namely whether there is a direct causal relation and whether people at the top are using politics to skim from people further below in the income distribution.  Furthermore income growth stagnates around 1973 for many countries, not just the United States, and most of those countries never experienced the subsequent "inequality boom" of the Anglosphere.  If they avoided the later inequality, why didn't they also avoid the stagnation?  The discussion of the causal issues here isn't convincing and the authors' hypothesis is not compared to alternatives or tested against possible disconfirming evidence.  

2. There is a lot of talk of unions, but I could concede various points and that's still just a ten to fifteen percent one-time wage premium, when workers are unionized.  It won't much explain persistent changes in growth rates over time, whether for the top one percent or the slow income growth at the median.  Furthermore the main U.S. sectors are harder to usefully unionize than, say, Canada's mineral and resource wealth or Europe's manufacturing.

3. The authors underestimate the role of finance in driving the growth in income inequality.  Their p.46 shows a graph suggesting that non-financial professionals are 40.8% of the top 0.1 percent.  Maybe so, but the key question is what percentage of income those professionals account for.  The Kaplan and Rauh paper, not cited in this book, suggests a central role for finance.  In 2007 the top 5 hedge fund earners pulled in more income than all the CEOs of the S&P 500 put together.  On top of that, some "non-financial" incomes are driven by financial market trading, such as in energy or commodity companies.  And a lot of top-earning lawyers are doing financial deals, etc.

Turn to Table 7 of the paper cited by the authors, p.56 here.  The "non-financial" category still looks bigger but it's incomes in the finance category which grow most rapidly and Bakija and Heim suggest that stock options and asset price movements account for a big share of the growth in "non-financial" incomes.  My view is that the increasing liquidity of financial markets drove much of the trend, which was distributed across both the "non-financial" and the "financial" sector.  If liquid financial markets allow a privately-owned warehouse company to buy a trucking company on the cheap, and profit greatly (plus the managers pull in a lot), I am calling that a financial markets development, even though it's in the "non-financial" sector.

4. Let's say the story at the top is mostly one of finance.  You could describe that as: "some change in financial markets led to rapid income growth for the top earners and politics did nothing about that."  Fair enough.  But it's still a big leap from that claim to portraying politics as the active force behind the change.  Politics was only the allowing force and I don't think there was much of a conspiracy, even if various wealthy figures did push for deregulation or more importantly an absence of new regulation.  I also don't think anybody was expecting incomes at the top to rise at the rates they did; it was a kind of pleasant surprise for the top earners to be so lucratively rewarded.  So the major change is left unexplained, for the most part, and the whole story is then shifted onto the passive actor, namely the public sector, which is elevated to a major causal role which it does not deserve.

5. pp.47-51 the authors talk about tax rates.  If we had kept earlier high marginal rates, the top earners would not have received nearly so much and also they would not have worked so hard.  Maybe so, yet this won't much explain the stagnating pre-tax incomes at the median and it doesn't fit very well into the overall story, unless you wish to make a complicated "lower tax revenue, lower quality public services, MP of the median earner goes down" sort of story. 

6. If the top earners are screwing over their wage earners in the big companies, by pulling in excess wages, options, and perks, we should observe non-stagnant median pay for people who avoid working in firms with fat cat CEOs.  Or we should observe talented lower-tier workers fleeing the big corporations, to keep their wages up.  Yet no evidence for these predictions is given, nor are the predictions considered.  It is likely that the predictions are false.

7. To the extent the high incomes at the top come through capital markets, it is either value created or a transfer/redistribution.  You can argue over the percentages, but to the extent it is the former it is not at the expense of the median.  To the extent it is the latter, the losers will be other investors, not the median earner or household, who does not hold much in the way of stock (lower pension fund returns don't count in the measure of median stagnation).

8. What follows p.72 is an engaging, readable progressive history of recent American politics, but the economic foundations of the underlying story have not been pinned down.

9. In my view, most likely we have two largely separate phenomena: a) median wage growth slows in 1973 because technology stagnates in some regards, and b) liquid financial markets, in various detailed ways, allow people with resources to earn a lot more than before.  Politics may well play a role in each development, but with respect to b) its role has been largely passively, rather than architectural and driving.

Anyway, I found it a very useful book for organizing my thoughts on these topics.

Addendum: Matt Yglesias comments.

Is the Fed doing more than U.S. commentators are suggesting?

The FT consistently paints the recent Fed as being somewhat dovish.  Here is one example:

The Federal Reserve broke a taboo yesterday when it said quite baldly that inflation in the US is now below the level “consistent with its mandate”. In other words, it is too low. This is a very big statement for any central banker to make, since the greatest feather in their collective cap is that they successfully combated inflation after the 1970s debacle…Since that period, most central bankers have been careful to avoid any language which even hints that a rise in inflation is acceptable to them. I can certainly find no previous record of the FOMC saying that inflation is too low, so it was a jolt to see this stated so starkly in the Fed statement yesterday.

…Bernanke Fed may be even more dovish than the Alan Greenspan Fed of 2003, and that is saying quite a lot. However sympathetic you are to the need for further monetary easing (and actually I am towards the sympathetic end of the spectrum), it is not difficult to see why the dollar has been falling, and gold rising, in the markets today.

The culture that is France

In the latest in a series of unusual efforts to make Paris green, the city is now offering residents free sparkling water to try to wean Parisians not from red wine, but from overconsumption of plastic bottles.

It comes from a water fountain and the idea already has been tested in Italy:

“We chill the water between 6 and 8 degrees Celsius,” said Philippe Burguière, the spokesman for Eau de Paris, “and then we inject carbon dioxide into regular tap water to make the bubbles thin and tasty.”

There is more here and for the pointer I thank Yana.

The high rate of employment for Mexicans in New York

In a time of widespread joblessness, Mexicans in New York have proved unusually adept at finding and keeping work. Of the city’s 10 largest immigrant groups, they have the highest rate of employment and are more likely to hold a job than New York’s native-born population, according to an analysis of the most recently available census data. They are even employed at a greater rate than Mexicans nationwide.

And as they have filled the city’s restaurant kitchens and building sites, they have acquired a reputation for an extraordinary work ethic.

There is more here.  There are interesting implications for whether current unemployment is all about demand and whether marginal productivities justify the expected costs of hiring (some groups of) non-Mexicans:

One reason Mexicans have found work in such numbers, experts say, is that many are illegal immigrants, and less likely to report workplace abuses to the authorities for fear of deportation.

“Illegal immigrants are very convenient,” said Demetrios Papademetriou, president of the Migration Policy Institute, a nonpartisan research group in Washington. “Employers are quite interested in employing people who are willing to work and to overlook some labor laws.”

…Across the country, immigrants in general are more likely to be employed than the American-born. They tend to be more willing to move in pursuit of jobs and to take any job they can find, especially if they lack access to unemployment benefits.

The evolution of premium pricing in Japan

This article is a little hard to excerpt, but it's not so long and well worth the read.  Here is one bit:

High prices in Japan are mostly a direct product of governmental policy. [TC: There is then talk of tariffs, cartels, and inefficient retail.]…So when foreign brands come into the Japanese market, the most obvious brand positioning has been to go “above” the domestic makers and be “premium.” This almost necessarily means pricing at a higher level than the standard Japanese price, which as we know, was already very high. When Brooks Brothers came to Japan in 1979, for example, they logically needed to set prices above the Japanese copies of their items like oxford cloth button-down shirts and ties. More recently, the standard $25 T-shirt at Supreme in New York was set at around $60 in Japan.

The rest of the article explains why U.S. brands now try the strategy of undercutting the Japanese prices.

For the pointer I thank Conrad Clark.

One simple point on Social Security reform

Social Security offers cash benefits, whereas Medicare is an in-kind benefit, in the form of health care (which in turn is distinct from health, itself another in-kind benefit).  Therefore always cut Medicare first.  (Addendum: a better phrasing here is "At current policy margins, or those we are likely to encounter, always cut Medicare first.")

That's all.

Addendum: Ezra Klein comments.

*Doing More With Less*

That's a new book out, edited by Joshua C. Hall, and it is a collection of essays with the subtitle Making Colleges Work Better.  My essay in the volume, co-authored with Sam Papenfuss, is a look at for-profit higher education.  It's not about the recent lending scandals, but rather the general question of why for-profits do quite well in vocational areas and in areas where the student is eventually certified by relatively objective tests.  Non-profits, in contrast, remain dominant in the liberal arts and in areas where quality is harder to measure.  What can we learn from this pattern of market segmentation about a) the true nature of education, and b) trust and agency problems in both non-profits and for-profits?  These cross-sectional questions have received surprisingly little attention and for-profit education in general has not attracted much research scrutiny, relative to its size and rate of growth.  Yet these questions date back to Plato, Socrates, and the Sophists.  Overall I believe that the not-for-profit model for higher education is robust.

Here is an interesting article on the recent growth in elite for-profit schools at the high school level and below.

Justin Wolfers on trade across the disciplines

What is interesting to think about are the terms of trade between economics and all these other disciplines. We are clearly a net exporter to political science and sociology. But at this point the trade with psychology is almost all one way. We are a near-complete importer. I wonder why we haven’t been bigger exporters to psychology. I think it has to do with the research method. Like political scientists and sociologists, economists are almost all about the analysis of observational data. And then there are second-order differences. Formal political scientists write down a model before they observe data; informal ones don’t. Ethnographers observe four people; survey researchers observe 4,000. But it’s all observational. But when I watch and speak with my friends in psychology, very little of their work is about analyzing observational data. It’s about experiments, real experiments, with very interesting interventions. So they have a different method of trying to isolate causation. I am certain that we have an enormous amount to learn from them. But I am curious why we have not been able to convince them of the importance of careful analysis of observational data.

Here is the much longer interview.  I would cite an additional factor.  We as economists can export models to political science and sociology and at least pretend that maybe those models work.  Even if they don't, someone can publish by knocking those models down.  When we try to export models to psychology, it's too obvious, too early on, that our models are limited in their ability to deal with context-dependent phenomena.

New data on income inequality and finance

They confirm the central role of finance and in a piece I am writing for another outlet, I summarized some of the results as follows:

…for 2004, nonfinancial executives of publicly traded companies account for less than six percent of the top 0.01% income bracket.  In that same year, the top twenty-five hedge fund managers combined appear to have earned more than all of the CEOs from the entire S&P 500.  The number of Wall Street investors earning over $100 million a year was nine times higher than the public company executives earning that amount.

That is based on material from the Kaplan and Rauh paper in The Review of Financial Studies, 2010 (the final version is gated for many of you).  I had blogged an earlier version of this paper (which was itself excellent), but the final revision has additional numbers of interest, plus a much richer discussion.

On-line "pre-publication" is wonderful, but let's not neglect the improvements in the subsequent drafts brought in part by…on-line pre-publication.

The value of a liberal arts education

Seth Roberts writes:

…is “liberal education” so hard to defend that no one can coherently defend it?

Bryan Caplan also seems skeptical, although I do not recall if he has tackled liberal arts education per se.

A liberal arts education helps us think with greater subtlety, even if it does not improve our performance on subsequent standardized tests.  I see an impact here even on the lesser students in state universities.  It also helps explain how the U.S. so suddenly leaps from having so-so high schools to outstanding graduate schools; how many other countries emphasize liberal arts education in between?

Liberal arts education forces us to decode systems of symbols.  We learn how complex systems of symbols can be and what is required to decode them and why that can be a pleasurable process.  That skill will come in handy for a large number of future career paths.  It will even help you enjoy TV shows more.

For related reasons, I believe that people who learn a second language as adults are especially good at understanding how other people might see things differently.

I am interested in food (among other topics), not only because of the food itself.  I also view it as an investment in understanding symbolic meaning, cultural codes of excellence, the transmission of ideas, and also how the details of an area fit together to form a coherent whole.  I believe this knowledge makes me smarter and wiser, although I am not sure which mass-produced formal test would pick up any effects.  I view this interest as continuing my liberal arts education, albeit through self-education.  

Up close, I see Yana getting four years of a liberal arts education and I believe that her school is a very good one.  I have not seriously flirted with the idea that she is learning nothing important.  

The Institutional Causes of China’s Great Famine, 1959-61

Written by Xin Meng, Nancy Qian, and Pirerre Yared, this paper is a very good applied study of Mises and Hayek:

This paper investigates the institutional causes of China’s Great Famine. It presents two empirical findings: 1) in 1959, when the famine began, food production was almost three times more than population subsistence needs; and 2) regions with higher per capita food production that year suffered higher famine mortality rates, a surprising reversal of a typically negative correlation. A simple model based on historical institutional details shows that these patterns are consistent with the policy outcomes in a centrally planned economy in which the government is unable to easily collect and respond to new information in the presence of an aggregate shock to production.

You can find ungated copies here.

How should economic instruction change?

I'll transplant the links in from Mark Thoma:

Here's my response, along with responses by Alberto Alesina, Laurence Kotlikoff, Michael Pettis, Gilles Saint-Paul, Paul Seabright, Richard Baldwin, Michael Bordo, Guillermo Calvo, Tyler Cowen, Harold James, David Laibson, and Eswar Prasad [All Responses].

I realized I forgot to talk about the need for more economic history, but that is discussed by several others so at least the point got made.