Effort: The Unrecognized Contributor to US Income Inequality

That is a new paper by J. Rodrigo Fuentes and Edward E. Leamer:

This paper provides theory and evidence that worker effort has played an important role in the increase in income inequality in the United States between 1980 and 2016. The theory suggests that a worker needs to exert effort enough to pay the rental value of the physical and human capital, thus high effort and high pay for jobs operating expensive capital. With that as a foundation, we use data from the ACS surveys in 1980 and 2016 to estimate Mincer equations for six different education levels that explain wage incomes as a function of weekly hours worked and other worker features. One finding is a decline in annual income for high school graduates for all hours worked per week. We argue that the sharp decline in manufacturing jobs forces down wages of those with high school degrees who have precious few high-effort opportunities outside of manufacturing. Another finding is that incomes rose only for those with advanced degrees and with weekly hours in excess of 40. We attribute this to the natural talent needed to make a computer deliver exceptional value and to the relative ease with which long hours can be chosen when working over the Internet.

I like that last sentence in particular.

Comments

Income inequality is good (within limits), so I am on board with Cowen on this one: labor should be paid based on what labor produces and markets value. The thing is that income inequality is the foundation for wealth inequality (because the extra income funds purchases of assets), and wealth inequality is the recipe for financial and economic crisis. Cowen would never accept this, but history proves it.

History proves no such thing counselor, but the opposite of what you say, see Piketty: the more peaceful a stretch of history, the more inequality due to accumulation of capital (r > g); equality only comes about during war, and who likes that? Capital, the basis for capitalism, is the bedrock for progress, something only Marx would deny (he famously, in "Capital", denied that capital in and of itself has value, i.e. PV < FV).
Put another way: it's not about "income" it's about "assets" (capital). In the USA you need over $400k a year to be in the top 1% in income, but you need over $10M net worth to be in the top 1% in assets. Which do people strive to be in? The latter, like me. The former only means you look impressive to friends ('down and out on $400k a year, as a meme put it); the latter means, like me, you can retire early with "FU" money.

In Europe equality came in war (WWI and WWII) because of the physical destruction of assets. In America, equality came when the value of assets were destroyed (following the 1929 financial crisis). Piketty states in his book that central banks will always intervene in a financial crisis and prevent the destruction in the value of assets. I actually hope he is right, although our Austrian friends prefer to let asset prices collapse. Trump has unleashed a populist uprising, an uprising that might prevent our Fed from intervening to stop the destruction in the value of assets in the event of a financial crisis. Ray, be careful what you ask for.

I think that the income inequality between 1980 and 2016 is due to the massive increase in legal and illegal immigration and to work visas. It should all be ended and reversed.

It seems to me that you might be groping toward cogency.

"Trump has unleashed a populist uprising . . . " Interesting. You explain the Fed's - "blind-sided again" - next failure. How do you explain the consistent record of Fed failures since 1913?

Apparently, in December 2016, the fed decided it needed the (traditional?) 500 basis points in rate cuts to fight the next recession. After eight (2009 to 2016) years of near-zero (target 0 - 0.25%) rates, they awoke (a month after the November 2016 election) and decided to raise rates eight times. Then, Trump began raising Hell and the markets equities crashed in late December 2018. That led to three rate cuts in 2019.

It's not true, in a lot of developed countries inequality was decreasing at the end of the 19th century and in a lot of them, it didn't really change through the 20th century.

A lot of historical inequality data is bad (Piketty's is very bad for the UK and the US) and we have only slightly more than 200 years of the modern economy for a lot of countries to make some universal laws about it.

" I am on board with Cowen on this one: labor should be paid based on what labor produces and markets value. "

So, as a business person, you want half your customers to buy very little from your business because they are worth very little to you as customers?

Or are you a Trump acolyte in lock step with the conservatives and GOP demanding government put more money in your customers' pockets, eg, tax cuts, tax rebates, EITC, easy money to promote lending money to your customers that will never be repaid.

Economies, when I grew up under Keynesian theory, were zero sum.

I learned this reading Milton Friedman in his Newsweek columns.

He railed against high business tax rates because, as he put it, the IRzS paid over 50% of the added labor costs of pay hikes, added benefits, and new hires, causing businesses to put too much money in consumer pockets in excess labor costs, especially building too much capital, like factories, utility capacity and redundancy, etc.

This then led to too much consumer demand as high school drop outs bought single family detached homes, then bought two or more cars, bought boats, then bought cabins on lakes, which of course drop so much demand prices rose causing business managers to hire more workers to build more capital and hire more workers to operate it producing more to meet the increased demand driven by higher labor costs, which were more than 50% paid for by the IRS, with added subsidies from States with high business profit tax rates.

He wrote extensively about the zero sum of utility regulation. Power utilities argued before regulators for authority to build lots more capital to supply lots more power more reliably, knowing the only way to increase returns to shareholders was to increase the capital base that helped set electric rates. Too many redundant power lines were built by paying too many workers, who got paid by 50% subsidies from the IRS, who then consumed too much in rural single family homes with utility service paid for by city dwellers, creating envy among other workers who joined unions to get the high wages union utility workers got, thus adding to excess consumer spending, driving increased demand, which caused businesses to use the IRS 50% labor cost subsidy to increase labor costs, thus increasing consumer spending demand.

Utilities liked nuclear power plants because they were very costly in labor costs, thus added a lot to the IC in ROIC, but had 40-60 year useful life unlike the decade useful life of coal power capital, so 20 years in a $200 million nuclear power plant would still be booked at $100 million generating $8 million in shareholder returns guaranteed with no significant capital costs, while the second generation coal plant costing $40 million had a book value of a few million generating mere thousands in returns to shareholders. Which meant millions of dollars in excess money extracted from consumer pockets for returns to shareholders, not to mention the high labor costs extracted for the nuclear engineers and technicians operating the nuclear power plant. Any cretin could poke at coal and clunkers stuck in the augers of a coal plant. The low wages of cretins means lower consumer demand, less demand for education, lower taxes, lower lower living costs, lower GDP.

Eliminating to business profit tax was to make hiring workers much costlier to drive cutting labor costs, thus cutting consumer demand, thus cutting wages and prices, cutting GDP growth, and especially cutting the amount of capital built. Less capital, whether factories, roads, water&sewer, schools, homes, etc, means capital scarcity AND production scarcity meaning the opportunity for high profits.

But Friedman knew that llow labor costs plus high profits did not work, unless government put money in consumer pockets. Thus his advocacy of the IRS subsidising consumer spending for low value labor: the negative income tax, which ensured a minimum level of consumer spending to drive high business profits.

Zero sum economics, Keynes v Friedman, explained by Friedman in Newsweek economics lessons.

Effort mattered even pre-internet, which wasn’t much of a thing the 80s.

I remember logging in via dial up to a time shared system (DEC 780 VMS) circa 1989, one morning about 2 am, and seeing one of the developers working for me logged in and working.

He enjoyed a successful career.

"He enjoyed a successful career."

I hope you did too, since you were also logged in at 2am!

But that was an industry created by Keynesian economic policies.

Not even 50% labor cost subsidies from the IRS were enough, so hiring was goosed by IRS subsidies for building capital via immediate or accelerated depreciation schedules. Both inside DEC and in sales, Congress central planners promoting building more capital meant more hiring to produce more computer hardware to replace the several year old hardware we, and our customers, were using. These IRS giveaways had deadlines, creating the "fire sale" shopping frenzy, buy now, buy anything now, before the IRS stops handing out free cash.

Of course, cutting tax rates to 35%, and now 21%, from 50% plus, means the IRS giveaways to create fire sale shopping frenzy requires the IRS simply give cash away, not simply not collect taxes. To fund these IRS giveaways, the Fed needs to print so much money interest rates on Tressury bonds go toward zero percent, into negative real returns.

Only government can put money in consumer pockets if businesses are not required to put as much money in consumer pockets as businesses want its workers to spend buying stuff from businesses, limited by wages and benefits.

So, given that investments in human capital lead to less inequality, shouldn't we we making it easier for a person to apply effort to the educational task by reducing the costs of education by subsidy (because there is an externality).

What good is exerting effort if you cannot afford to go to college where you could show through your effort your talent?

If you are going to have effort, you must also take away barriers for persons who want to exert effort to increase their human capital.

@Bill - the first part of your sentence "So, given..." is wrong, as in incorrect. The paper in fact says the opposite: "This paper provides theory and evidence that worker effort has played an important role in the increase in income inequality". That is, investments in human capital lead to MORE inequality not less.

I think you misunderstood me. Effort is obviously required, and that's what I said. But, you can't exercise or show effort unless you can afford college. So, the prerequisite to the opportunity to exert effort is reducing the impediments to getting to the platform where they can demonstrate and exert effort.

If A and B are necessary to produce C, and A is not available or blocks B, then even if B could have been produced, the absence of A leads to no C.

If it costs money to get into college, and the kid cannot afford it, but could have exerted the academic effort to succeed in college, the result of going to college is not achieved. Income inequality.

Is that clearer for you?

> "But, you can't exercise or show effort unless you can afford college"

Citation needed

Of course, how careless of me. Everyone knows that anyone can attend college regardless of their income level.

Chris, you are such a man of the world that you would spot this egregious error.

Take the silver spoon out of your mouth, and read this report: "Report: Low-Income Students Cannot Afford 95 Percent of Colleges" https://www.nasfaa.org/news-item/11623/Report_Low-Income_Students_Cannot_Afford_95_Percent_of_Colleges

"Overall, most colleges were unaffordable for eight of the 10 theoretical students, and “most dramatically unaffordable” for the lowest-income students. Of the 2,000 colleges examined, nearly half (48 percent) were affordable to wealthy students from families with annual incomes above $160,000, the analysis found. More than one-third of the colleges were only affordable to students with a family income over $100,000. Students from lower income backgrounds, the analysis found, could only afford 1 to 5 percent of the colleges.

“The college affordability problem is fundamentally one of inequity,” the report said. “This inequity enables a wealthy student to attend essentially any college while effectively shutting out many of her peers.”

Thank you Chris for informing me of your lack of understanding so that fill this gap in your education.

It looks like the measure of affordability they're using assumes that the student won't take out any loans and just completely disregards need-based aid from the colleges altogether. This is nuts: many colleges distribute a ton of money, even to middle-class students, as a form of price discrimination.

+1. Nor is there much evidence that we need more college graduates when businesses have little productive use for many of the ones that we already have. Few people want to discuss intersectionality with their Starbucks barista.

Apparently you didn't read the article, which discusses loans as well, but since you mentioned loans, you have to consider decisions people make under conditions of uncertainty, particularly when their parents are poor and uneducated..

First of all, your commentis utterly nonresponsive to the comment you are replying to. Fully 2/3 of adults in this country do not have a college education. None of them are able to exercise or show effort?

Second of all, are they looking at advertised prices? Most colleges have a lot of need-based aid available.

"even after taking into account federal student loans, at least 70 percent of the colleges were unaffordable for lower-income students"

So they ignored loans. But what about grants? Many colleges simply reduce prices for low-income students.

Anonymous, Wrong. I did respond to was Chris's statement of the need for a citation for evidence that people cannot afford college. Perhaps you should read more carefully.

The readers from their own experience or what they know of others can make their own decisions as to whether paying for college is an impediment to getting on the platform where they can show their effort.

But, as the paper says, if you don't get to college, good luck because your wages will be declining.

Level 1 trolling by Bill, who can do better. Bill is replying to his own narrative, not what the paper says. The paper says that more effort (as evidenced by a variety of factors, including going to college arguably, though I didn't read the paper and some say education is signaling) leads to more inequality. The short story by Kurt Vonnegut comes to mind.

Ray, I can see you didn't read the paper. "One finding is a decline in annual income for high school graduates for all hours worked per week. We argue that the sharp decline in manufacturing jobs forces down wages of those with high school degrees who have precious few high-effort opportunities outside of manufacturing. "

I guess you missed that.

'Precious few high-effort opportunities'... Hmm, I guess the writers of the paper conveniently disregard all those people working in professional trades - carpenters, plumbers, electricians, HVAC technicians/etcetcetc… none of which even require a high school diploma but DO require a significant level of personal inspiration... Pulling the Velcro off your butt is a pretty good place to start when considering any kind of career... people would do well to recognize just what kind of society we would have w/out the significant contributions of those in professional trades - there's no reason that a professional contractor cannot retire wealthy rather than as a broken down factory worker...…….

Agreed, but the subject is wealth disparities. So work your butt off, and you will still come up short relative to the others. But, you will still be better off than if you hadn't.

For some reason, my earlier response wasn't recorded. So, agreed, that if you work your butt off in professional trades you will be better off than if you did not. But, as the post said, there are few such opportunities.

Another example, from the paper again: ". The theory suggests that a worker needs to exert effort enough to pay the rental value of the physical and human capital, thus high effort and high pay for jobs operating expensive capital. With that as a foundation, we use data from the ACS ..."

Now, it may be that you are unfamiliar with the term "human capital" but it generally means education. So, when it says "the worker needs to pay for...the rental value of human capital...." it is saying: paying for the rental value of (or cost) of education. I know you are smart enough to put two and two together, and see the point: you need to pay for education to get to a platform where your effort is rewarded differentially from the person who has less or no education.

Effort matters, but to make it pay, you need education. Or else, read that quote again: " We argue that the sharp decline in manufacturing jobs forces down wages of those with high school degrees who have precious few high-effort opportunities outside of manufacturing. "

If you do not get this, after my repeated efforts to explain and quote to you the pieces of the report, with outside references to sources....you failed to understand the post.

Given the attrition rate of higher American higher education these days is near 50%, I would suggest that we're probably sending too many kids to college these days as it is, rather than not enough, and the returns to additional subsidies for higher education will be very low, possibly negative.

You are wasting your time with Bill.

be the change you want to see

Bill - The more people you educate the lower your return on cost. At some point, as you start accepting, say, people below the 40th percentile, you're probably starting to spend more than you get.

If you go to any academic blog, you'll find profs busily worrying about teaching, and developing decreasingly rigorous and increasingly time consuming ways to impart less information. On one blog I read recently, one prof even bemoaned her inability to build her "lecture narratives" to a gripping climax that would hold students' attention!

This probably reflects the declining ability, preparedness and motivation of incoming students.

The entire premise is racist. Just kidding.

Literally, the harder I worked the luckier I became.

Anyhow, here is a modest proposal. Either abolish the collection of statistics (which too often are politicized and employed by troublemakers to fabricate new theories, laws and regulations) or hang any statistician that equates correlation with causation.

Statisticians usually don't interpret their results... they just provide estimates and confidence intervals. Social scientists do the interpretation. To hang the statisticians is to kill the messengers.

It definitely took a ton of effort for easterbrook to preach company policy out of one side of his mouth while using the other on his employee, and I think his 6 months severance package with stock options totaling $40m and 2000x his median non-policy-violating employee's salary, is a totally appropriate compensation for his high level of effort.

It makes some sense to me that as we get richer some people will say enough is enough and put in less effort, even while the crazies will push for more and more money.

It’s no surprise as the total marginal tax rate nears 50% that more and more people will say no to any added effort. Of course compared to the few that really want to work this will just expand ‘inequality’

So, you are working for $30,000 a year to put hundreds of thousands more in your pocket in tax savings?

Warren Buffett was famously rich in 1970 before cutting tax rates to create jobs and make workers millionaires became a thing.

Instead, Milton Friedman argued that the high tax rates drove Buffett to build too much capital to dodge the 50% and up tax rates, thus becoming too rich by not spending the profits from his excess capital assets because that would require paying taxes.

On the other hand, the IRS subsidized building more capital by paying 50% of labor costs to build capital with tax dodges like writing off capital expenses or depreciating ten year and longer assets in just 3 years, thus turning profits taxed at 50% into capital which. Increased share value and price, which if held for 5+ years would be valued for tax purposes as increasing in price only by 20%, thus lowering a 70% tax rate to the lower bracket 50% times 20%.

In the 60s, Buffett could not afford to hold a $100 billion in cash from profits because it would be taxed at 50% business profits, unless $100 billion was paid for capital costs that were mostly in labor, ie, it's stupid to pay a business $100 billion which pays only $50 billion to workers building capital, eg a factory or providing services, with $50 billion wasted paying taxes and other people's shareholders. Paying $100 billion to workers and getting only $80 billion in value because workers are paid too much is better by $30 billion in added wealth than paying $100 billion to reward others for inflating the price of assets they built by 100% to get assets, wealth, costing only $50 billion.

Lesson in economics from Milton Friedman Newsweek lessons.

The last sentence describes the vast majority of college professors.

I have a hard time believing that telecommuting has a big impact on income inequality. Only five percent of Americans work from home and they're less likely to make over $100k than non-telecommuters. I doubt there are enough 10x programmers in their PJs to make up the difference here.

That's a bit of a weird framing. We've got, per this paper, a society where the vast majority of people can't get ahead.

"One finding is a decline in annual income for high school graduates for all hours worked per week."

and

"Another finding is that incomes rose only for those with advanced degrees and with weekly hours in excess of 40."

It's like "good news everyone, a *few* people still get ahead!" Or "it's a long shot, but since effort is involved, it's *fair*."

Someone needs to reread their JD Vance or Angus Deaton.

The percentages of high school graduates has plummeted. If you just look at the worst X% subset of high school graduates from the past, I'm sure incomes have risen.

By itself yes, and we knew that, but this takes it further.

"Another finding is that incomes rose only for those with advanced degrees and with weekly hours in excess of 40."

College and 40 hours don't cut it.

Basically I think Tyler is channelling too much Mugatu.

Can someone please explain why they are choosing to use CPI as a deflator, which is known to overestimate inflation and therefore could very well be driving their finding that "incomes rose only for those with advanced degrees and with weekly hours in excess of 40. "

Never trust anything that uses CPI deflation over more than a couple of years.

I suspect the boom in advanced degrees will limit the predictive applicability of this study.

The Bell Curve surveyed the literature at the time, as well as the NLSY, admittedly 25 years ago, and concluded that IQ was the prime determinant of income inequality, over education and personality factors, of which effort would be one. In the interim what has the verdict been on IQ? It would seem to me that in the US right now secondary and higher education would be an even less accurate indicator of quality human capital than a quarter century ago.

Surprising that IQ would have been independent of "effort". Today I think the notion is different - that intelligence, rather than fixed, can increase or decrease with experience.

Many, if not most programming tasks are difficult to subdivide between two people. A programming task assigned to people who work long hours gets an automatic productivity bonus simply because there is less interpersonal communication required.

It's a thoroughly studied subject in the much maligned (here on MR) field of psychology (more precisely, less what matters, more what individuals and cultures believe matters and how that relates to what they Do and how that in turn relates to measurable Outcomes).
Indeed, Effort matters. So does Ability. So does Luck. So does Competition and inherent Difficulty of the task ahead.

perhaps i am revealing myself, but does anyone else here think that more nominal hours worked does not mean more *effort* per se?

depends on what you mean by "worked". In an hourly job, "worked" hours are those on the clock. You can "work" without doing anything, as long as your on the clock. Salary jobs typically have "working" hours (aka 7a-4p), during which time most people would say they were "working". But staying after hours at a salary job, or working from home, usually means you're literally "working". So mostly no, I don't agree. If one is working, there is effort. If not, there isn't effort.

There are salaried people who will put in extra face time without being particularly productive in the extra hours. I've seen plenty of that sort of thing.

"...weekly hours in excess of 40."

My employment contract is for 42.5 hours a week. Sometimes I work more due to exceptional circumstances such as bad internal planning (deliver work before month's end to invoice) or bad client (slow and clumsy feedback for preliminary work). The immediate consequences are reduction in family time, less physical activity and fatigue. It's not fun to feel like hungover on a Saturday, even if you drank zero alcohol during the week, just because you made a 50 hour week.

45+ hours weeks are possible in order to go the extra mile. But, it's not sustainable to live like this. Eventually health or relationships break apart, burnout arises...people becomes miserable.

Exceptions to this rule are unique individuals that have a team that do the chores for them comprising planning assistants, drivers, health coach, someone how cooks and cleans the house, child care, shopping, etc. High level management and successful artists can afford that.

The issue here is that the way to earn more is to kill yourself in the process. If that's the price for higher income, it is not desirable after all.

PS. I look down at fat professionals: 1.5x my income, but.....come on, stare at a mirror every once in a while =)

"45+ hours weeks are possible in order to go the extra mile. But, it's not sustainable to live like this. "
I've found 60 hours to be sustainable if you wake up early, don't fall into timesucks (for me, it's avoiding screens), and can get by on 5-6 hours of sleep. Before I met my wife, I routinely worked 80-90 hour weeks, so maybe it's easier for me to justify 60-hour weeks as sustainable than if I were coming at it from a 40-hour week while holding a collection of timesucks I treated as necessary, or at least worthwhile.

Axa, a lot of professionals work 50 hours, especially if you can work from home, which frees up 10 hrs (for me) of travel a week. Lunch also is 30 min instead of an hour for another 2.5 hrs.

Yep, when i had the ability to work from home I would often put in hours of Saturday afternoon.
However productivity studies suggest that for most people their productivity axes out around forty hours and the extra time isn't good for much.

"Maxes out after forty hours"

I hardly see 9 hour work days as crushing. In at 8:00 half hour lunch out at 5:30. 10 is also easily doable in at 7:30 half hour lunch out at 6:00.

Wealth inequality doesn’t necessarily come from a lack of a college education.

It comes from a lack of basic investment knowledge, role models and self-sacrifice/delayed gratification.

True story. Daughter in her college psych class. Teacher asked how many have IRAs. She and one other raised hands. (We funded it, obviously.) The teacher who is in her 40s! said she was going to start saving next year.

Who should have more wealth at the end?

It also comes from different standards.

We are human. Some don’t want to work as hard, some have simple lives and pleasures. If they’re retired and they can work a few months (for cash or barter) to supplement and play the rest of the year, they will.

If they can keep their income under a certain level and qualify for reduced or free stuff they’ll do that, too.

If you want to free up more taxpayer cash to fund things, change the rules to not qualifying stuff like “free phones” by income, but assets. Or alternate minimum. They want to see income, but if you meet certain requirements, assets instead.

Or change the rules that even part timers default into an IRA with a government assist.

But it all means nothing if you tap into it for “hardship” reasons and don’t pay it back. There’s always a way to game the system.

Just because someone make $400k/yr, doesn’t mean that person is saving anything. There’s always a “need.”

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