Wednesday, April 26, 2006

Increasing inequality a good thing

If you want to be first with a provocative new viewpoint go to the Becker-Posner blog on why increasing inequality is a good thing in the US (and, following Andrew Leigh's valuable work, presumably Australian) economy because it correctly signals the increased value of human capital. Its a variant on the response that 'increasing gaps' are a good idea. It sets good incentives in place.

I will quietly anticipate the predictable social democratic response - that earnings are much more than a market signal - and then enter the action. Becker has a point but this thesis will drive some to distraction.


Christine said...

Since you seem to desire more comments, here's one for you, though I don't think it's quite the one you wanted.

Becker-Posner make it sound as though inequality changes have only been due to returns to education. But the evidence seems to be it's not. There's been an increase in variance of earnings conditioning on pretty much anything that can be conditioned on, including education - ie higher residual inequality. There's also, I think, been something of a decrease in the variance of education levels, so the net effect of education on inequality isn't so terribly clear. Plus it looks as though there's been a really big increase in inequality at the very top end of the distribution, which doesn't sound like it could have been driven by education. Some other talent/skill maybe, but not education.

So I'd say their posts don't really fit all of the evidence together very well.

(Also: does the big gaps are efficient argument make sense, really? If wage gaps were big enough that there were incentives for everyone to get a PhD (ha! some people are too sensible for that), so everyone did, and there was no educational inequality, wouldn't there be no gaps? Sorry, brain hurting. Must go.)

hc said...

Christine, What are the other factors that you beliewve drive inequality? Ny guess is that bringing in lots of cheap unskilled (and illegal) labour into the US would promote inequality. Also the enormous growth in productivity in the US economy over recent years relies very much on skilled labour.

One of the commentator's on Becker's post made the point that the key issue for social policy is to bring down the variance in incomes without reducing mean income. This sounds like a neat way of expressing the issue to me and suggests an econometric test that I assume someone has done - is higher growth among comparable sorts of economies associated with more inequality? I guess Becker-Posner would say it will be.

I note Posner accepts trhe need for antri-poverty measures (and does not see this as being inconsistent with a benign view of inequality).

Also Becker praises the work of Heckman (discussed on this blog) on the need to bring more disadvantaged kids - particularly the children of single parents - into good early-education environments.

Christine said...

The answer is 42.

Seriously, these are big big questions, and inequality is a pretty complicated thing. And I'm not going to set myself up as an expert.

From what I can tell, the consensus seems to be that the increase in inequality reflects rising returns to skill generally (not necessarily education only), possibly caused by skill-biased technical change (but what is that caused by?), with some role possibly played by increased trade with low wage countries.

On immigration: may have played a bit of a role, though most work seems to have a tough time finding big effects on native low skill wages. Also: illegal immigrants aren't going to be caught in any of the surveys, so they're not even in the stats we've got, most likely.

I was thinking about whether I'd be worried if it was all about returns to education earlier this morning, and decided it would depend on opportunities to attend uni. At least Becker mentioned Heckman's work, which does emphasise the importance of early education. I'm not sure I completely agree with Heckman's argument that there aren't important credit constraints affecting post-secondary ed decisions. [I really don't want to argue against Becker and Heckman, really I don't.] I've done some work looking at whether student loan programs affect enrollment decisions in Canada, and the results I got, which surprised me, suggest they have a bigger effect than could be explained only by their subsidised part, which in turn suggests there are credit constraints that matter. And if that's the case, then rising returns to education are going to benefit kids from high income families relative to kids from low income families, esp if as Becker suggests higher returns to ed cause tuition fees to go up. This may reduce mobility, which probably is more of a concern than a reduction in static inequality, esp if you're worried about the incentives.

On the mean-variance thing: there has been a lot of work done on this. Disentangling the two isn't easy though. Here, I will quote the abstract of a paper by Robert Barro (ha! some authority I can point to!): "Evidence from a broad panel of countries shows little overall relation between income inequality and rates of growth and investment. For growth, higher inequality tends to retard growth in poor countries and encourage growth in richer places. ... However, this relation does not explain the bulk of variations in inequality across countries or over time."

Christine said...

For some discussion of why inequality might matter, and a touch more on data, see:

Economist's View

hc said...

Christine, Thanks for that. I followed through the chain of references from the site. Inequality seemed to be traced to deunionisation, labour-intensive imports from poor countries, immigration and the 'superstar; phenomenon driving high CEO/Movie star salaries. Sounds right.

Illegal immirants will affect the distribution of incomes even if their incomes are unrecorded. In fact they might have very strong effects in competing low-skill job wages down.

CEO salaries in the US do seem to be completetely out of whack with reality - and unjustified on productivity grounds. One study claims that provide half of the highest US incomes.

The Barro conclusion that high inequality limits growth in poor countries but stimulates it in rich countries sounds plausible to me and I'll scout around for his study.

hc said...

One difficulty I think with the Becker reasoning is that it leaves open the question of what salaries should people with below average intelligence and below-average ability to acquire skills should earn. So your genes and - following Heckman et al - your upbringing drive your final income.

I would prefer a more egalitarian solution than this.

Also I wonder if highly unequal incomes in fact provide the incentives suggested. Will a CEO earning $6 million per year be that much more productive and effective than one earning $1 million per year?

With salaries of $1 million you can still have significant inequality to drive effort but at the same time compress the distribution of income.

lesleym said...

I've remarked before that IANAE, but it seems to me that you are using the word 'skill' in the same way that the general public now uses the word 'quality.'
IOW, 'skill' can not only be some combination of acquired information and the dexterity to use that information productively, but 'skill' can also be a measure of the value placed on it by the present consumers of that production. Perhaps an answer to Christine's question " what causes skill-biased technical change?" could be found in the pyschology of marketing rather than in accounting.

hc said...

LesleyM, I thought about your comment and I think you are saying that skill-intensive outputs have to involve high labour productivity directed at outputs that consumers want. I think that's true. But it is primarily an issue of skill - smart people are developing products they know people will want. I don't think it is marketing effort that makes us want to use smart software and fast computers. Maybe you are thinking of other products such as services.

Robert Merkel said...

Have you seen this post from Brad DeLong that suggests that in the United States most of the income gains of the past few years have gone to those at the very, very top of the income and wealth pile.

On a closely related topic, have you considered looking at inheritance taxes on your blog?

hc said...

Robert, Andrew Leigh makes similar points for Australia in the link above. I think Becker-Posner take these sorts of claims as the 'received wisdom'.

I'll think about the issue of inheritance taxes. Maybe a post.