Income volatility for top earners, especially in finance

Justin Lahart has a new article about research in the works on top earners, here is one relevant snippet:

The economists have also been looking into what’s going on with the top 0.1%, while digging more deeply into incomes for specific occupations. In a preview of this work he presented at the American Economic Association’s annual meeting last month, Mr. Guvenen showed that over the past 30 years income cyclicality for this group has risen substantially relative to the population at large.

That is largely a result of a change in the composition. It used to be that doctors — a group with very little income cyclicality — represented about a quarter of top 0.1%. Now they account for less than a tenth. Filling the gap, a bigger share of people in finance-related occupations.

The underlying research you will find here.  For the pointer I thank Ray Lopez.


Top earners can handle earned income volatility because they have significant assets that generate passive income. The increasing number of finance people in that top slice will invest their proceeds from deals.

Fat Cats are living large off the 2.61% Treasury gravy train!

That's just the basic subsidy the wealthy get from the government. It's the basic risk-free return to wealth provided by the government. The non wealthy with just cash or basic checking/savings accounts have much lower returns.

Yes, but now the non-wealthy can enjoy the same risk-free return by investing in a myRA. Problem solved.

Pretty sure he's being sarcastic.

I'm not being sarcastic. It's a fact. There's a risk-free return to wealth provided by the government. The non wealthy with just cash or basic checking/savings accounts have much lower returns.

You don't have to be wealthy to invest in Treasuries.


Yes, I'm aware of such instruments. Their irrelevant to my point though, since the wealthy will have a greater percentage of their net assets subsidized by the risk free rate provided by the government. The non-wealthy, if they have any net assets at all, will have a greater percentage of their net assets in cash or checking/savings accounts with lower returns.

The riskless rate of return is not provided by the government. Absent outright manipulation by the government, the rate is set by the market according to the supply and demand for capital. The government pays the rate because it has no choice. So do other borrowers (they pay the riskless rate plus a premium or yield spread for credit risk).

So the idea that humans exhibit intertemporal choice preferences is wrong?

No, it's not. Please see my post just above yours.

Also, inflation is not a risk? Or default even?

Tax-free Munis. Until the Detroit effects ripple through the system.

Those effects aren't the problem....the ongoing and increasingly ugly Puerto Rico muni situation is much worse

You mean living large of that 80% return on the S&P in the last 5 years?

The point is not that they "can't handle income volatility". The point is that the top 0.1 percent is not a static group as the impression is often given in the public debate over "inequality" and taxation. Nor, for that matter is the composition of any other cohort static, particularly the lowest cohorts. The top .1 percent might earn $1.7 million. Depending on how that was earned (wages, bonus, stock options, etc), that might net $1 million in investible assets. A normal return on that amount is not, by itself, even going to make one "middle class" in the following year. The odds are quite good that at some point in the example given above that 0.1 percenter was considered to be "living in poverty" at some time in his or her earlier life.

This is probably true for 90 percent of pro athletes. Still, income inequality is nothing compared to wealth inequality.

Not quite sure how to interpret that comment. First, the reference to "this" is not clear. If by "this", you mean that most pro athletes begin their adult life "poor" and might be considered "rich" during a few years of their career as measured by income, I've no doubt that is true. But, it is also true for many non-athletes.

As for "income inequality (being) nothing compared to wealth inequality", you appear to be making a value judgement (wealth inequality is "better"?). Perhaps a less sarcastic interpretation would be that "differential in wealth" is a better measure of "inequality" than the "differential in income". Arguably so, but financial wealth is also not static, as many pro athletes (and others) will attest, particularly those who invest in sport celebrity restaurants, etc.

Wealth inequality whining is flat out entertaining.

Didn't some supposedly respectable paper publish an article about billionaires having more wealth than the poorest 50% of the world's population? Heck, any American with no credit card debt and a fully paid off car probably has more wealth than 20% of the world's population!

Thanks, Alexei, for letting us know what amuses you.

I fit your .1% profile almost dead on. Yes, you are right that I was "living in poverty" at some point (fresh out of Ivy league, working on a start up.)

Get real through: I, and most people like me, earned over $400k in the decade leading up to that .1% payoff year. Those wages, bonus, stock options, etc, didn't magically appear out of nowhere. Heck, I took a week on Little Palm Island back when I was making $200k/yr. Your typical $1.7M year follows a $1.5M year.

Claiming the top .1% won't get a return to make them middle class for life based on a one-year return is insulting both to the elite earners and the middle class.

I don't think that you're not disagreeing with Vivian in any material sense.

Vivian isn't trying to say that everyone in the .1% was a pauper the year prior, nor that they'll be paupers the following year.

And yes, it is a fact that your after tax on $1.7M will not provide a middle class income in any normal conservative investment vehicle. Put that $1M in Treasuries and you're pulling in what, $27k/year?

"I, and most people like me, earned over $400k in the decade leading up to that .1% payoff year."

Well, that's a profound revelation--you and everyone else like you who earned $400K leading up to a .1% payoff were "like you"?

So, what's the big lesson here? That we should not merely consider that .1% payoff year, but all years leading up to and subsequent to that year? By "getting real" do you mean we should look at all years and not just one? Why do you think an assumption regarding income in all those years is superior to the actual data?

Do you really think that considering you were counted as "living in poverty" fresh out of your Ivy league education should lend support to the idea that we live in an unequal world? And, I'm the one who needs to "get real"?

Good, what we really need are more finance people and fewer doctors.

Actually, even though you're being satirical many economists would agree with you. Medical spending on the margin is associated with zero, and possibly even negative, impact on health (see first link). On the other hand financial sector size and development has been strongly linked to economic growth, physical capital development and productivity (see second link). Economics tells us that America would be better with fewer doctors and more bankers.

Economics also tells us that reducing the number of doctors would tend to increase medical costs, unless the idea is that the existence of doctors tends to create artificial demand for health services that would disappear if we moved more of them over to financial services.

A well-functioning financial sector is important. A financial sector producing an outsized portion of the 0.1% suggests to me that something is off, and that rents are being collected. Maybe a better structured financial sector would have more bankers making $75k and fewer financiers making $10 million.

The real question in my mind is what are the barriers to entry that allow these outsized returns to labor?

Why are you assuming the returns to labor are outsized. Here's an exercise try to go out and beat the market in terms of risk-adjusted returns. Doing so is enormously difficult. The market's not perfectly efficient, but it's pretty damn close. Very few people are capable of consistently outperforming the market over any significant period of times. Those few that can with even a modicum of consistency represent some of the richest humans on the planet, e.g. Warren Buffett.

There's no barriers to entry, there's simply supply and demand. The demand for trading and investment skills is enormous, there's trillions of dollars of financial assets. The supply is extremely limited because so few people have natural talent along these lines. Hence the compensation that good traders command is incredible.

How many of those 0.1% Wall Street earners actually beat the market vs how many were the Gate Keeper for an IPO?

There are no barriers to entry in managing a multi-billion dollar portfolio?

>A financial sector producing an outsized portion of the 0.1% suggests to me that something is off, and that rents are being collected.

As 'risk free' returns fall (and they're currently extraordinarily low), more pressure is put on the financial system to make something happen. This is going to cause an increase in pay for financial sector workers. Nothing inherently wrong there.

Healthcare economists tell us that more medical consumption has zero to negative effect. Fewer doctors = higher price to see doctors = more rationing of healthcare (either by individuals being dissuaded by the price or insurance companies cutting back) = less medical consumption. The less doctors = less medical consumption is just basic microeconomics.

You're asserting that rents are being collected without any data to back it up. Decades of empirical results tell us that financial sectors produce economic growth. You're telling me that this time is different, and your only assertion is evidence is "those damn bankers are making too much money, it ain't right".

Furthermore here's a simple observation that strongly counters the rent collection hypothesis. What part of the finance industry makes the most money? Overwhelmingly hedge funds, now significantly more than banks. For example the CEO of Goldman Sachs last year made $23 million, the highest paid hedge fund managers made 100 times that amount. The point being is that banks are far more connected, essential, and rooted in the center of the financial system than hedge funds. Banks are in a far better position to capture rents than hedge funds. Yet we find the most outsized pay in the latter.

Less doctors = less doctor consumption is basic economics. Less doctors = less medical consumption is not, and your cite is to medical consumption having zero or negative effects on the margin, not doctor consumption. But I made my point badly regardless.

"You’re asserting that rents are being collected without any data to back it up. Decades of empirical results tell us that financial sectors produce economic growth."

As does a well developed legal sector and rule of law. Lots of rents collected there.

Why should there be a bunch of surplus value that can potentially be captured by financiers if the market is competitive and efficient? Shouldn't competition drive their profits down to a razor-thin level?

Thinking it through below, I'm now pretty sure I was right to begin with. The price elasticity of demand for doctor services is widely regarded to be inelastic. This means that a 1% decrease in quantity supplied (say if 1% of doctors quit tomorrow to get an MBA) would cause a greater than 1% increase in price. Thus, so long as the supply curve continues to cross the demand curve at a point where the price elasticity of demand is inelastic, inward movement of the supply curve through sudden doctor-to-MBA conversions would actually increase total expenditures on doctor services.

There will be a smaller amount of doctor services consumed, but the expenditure on this smaller amount consumed will be higher.

If the supply of doctors were reduced, prices would go up, but overall costs (price x quantity) would go down.

That depends on the price elasticity of demand and the extent of supply reduction, doesn't it? If the price elasticity of demand for doctor services is low - demand is inelastic, i.e. absolute value of price elasticity of demand < 1 - total spending will increase. If the AMA decreed that 5% of doctors should be executed, and demand would remain inelastic when the supply curve moves inward after this 5% cull, total doctor costs (price times quantity) would go up. This is because, by definition, if demand is inelastic, a 1% decrease in quantity supplied will result in a greater than 1% increase in price, meaning that the increased price over the whole of the quantity purchased more than offsets that lost quantity not purchased.

Seriously asking if this is right though, as it's late and I've had some whiskey.

'It used to be that doctors — a group with very little income cyclicality — represented about a quarter of top 0.1%'

That is truly stunning, at least from a German perspective - I know both a doctor and a dentist in this town of 6000 socially, and neither of them earns more than a middle manager at Mercedes, who I also know socially. And neither of those medical professionals considers themselves underpaid in any way, shape, or form.

And it goes a long way towards explaining just how screwed up the American health care system truly is, while also providing an explanation of why that is. (Admittedly, the German doctor I knew that worked for the NHS a decade ago did earn more than his fellow German stay at home compatriots - and the cost of commuting by Ryanair was trivial.)

This just in: some doctors in the United States also make roughly as much as a middle manager at Mercedes. Still confirming reports about whether they may or may not feel underpaid.

Physician income is a small part of our healthcare costs, as in less than 10%, but it seems to me that German physicians get paid relatively poorly by most international comparisons (according to the OECD data I've seen). One thing to keep in mind is that pay scales in the US are generally higher than they are in Germany. I think a better way to look at this is in terms of how physicians are paid relative to college grads; viewed this way the US seems to be broadly inline with the first world.

The days when doctors made up a quarter of the top 0.1% were a long time ago. Doctors' relative incomes peaked in the 1960s. I think that industrial-company executives had good incomes then too. Finance was a sleepy backwater, and a Harvard MBA who went to work on Wall Street was considered an odd duck who must not be interested in money.

This makes no sense. I thought health care costs were rising.

Healthcare costs are much more than just physician income (total nursing costs, broadly defined, significantly exceed physician income, not to mention the numerous other employees you find in a typical hospital or outpatient setting) and physician income has remained pretty flat in real terms for the past decade or so.

Not only is there extreme volatility at the high end of finance, but a good deal of that volatility is pure luck. A lot of it is simply being in a product or strategy that happens to be "hot" that year. In 2005-2007 CDO traders were taking home massive bonuses. Now you'd be lucky getting a job trading the handful of CDOs left. In 2008-2011 quant strategies and HFT was on fire and printing money. 2012 onward the strategy's have been struggling to cover their costs. Last year equity fund managers killed it, this year it isn't looking to hot.

The point is you can be really good in finance but luck plays an enormous role. Those guys getting huge bonuses that generate headlines don't get them every single year of their career. The giant bonuses for the top earners are in many senses compensation for the uncontrollable market risk that everyone in finance takes. The ex-ante expected compensation is much lower.

I sometimes wonder what the financial system would look like if it were totally unregulated, including having no deposit insurance, but still having the central bank be a lender of last resort (or I guess free banking if that's your thing. I just mean no liquidity problems).

Would it look like an old fashioned George Bailey type situation? Or would it be more volatile? It's hard to say.

One problem with the top tier's volatility in their earnings is just how dependent the retail sector of the U.S. is on this group. The top 10% of income earners in the U.S. account for somewhere around 45% of the retail spending. Now, aside from the fact that this can be debated as immoral and ridiculous, the problem with the current structure is when the capital markets suffer big corrections. Since so much of the spending is coming from a group of people that are so dependent on the financial markets, when the financial markets do poorly for any extended period of time it's basically a death sentence to X number of retailers and will mean hardship for many others. So if you think that the stock market doesn't matter to you, actually it matters to you and everyone you know.

Top 10%. Sounds like an elite few.

If you exclude part time workers, part-retirees, stay at homes, etc, that top 10% probably looks more like the top 30% or 40%.

Nothing to see here?

Why don't you include all the people who aren't earning an income at all instead and then all that spending is from the top 5%.

Why are retirees, students, and children relevant to his A-D's point?

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