Saturday, June 25, 2011

The Great Divergence by Timothy Noah (in Slate)

I read a fascinating piece of journalism trying to explain what causes the widening income inequality in the US. In 2008, the richest 10% accounted for 48% of US income (including capital gains). The accumilation of weath in a few hands started going up markedly from 1980 onwards and is called the "Great Divergence" by Paul Krugman (in his book The Conscience of a Liberal). From 1980 to 2005, 80% of the total increase in American's income went to the top 1% of income earners.

Why is this important? If we can figure out and agree on what causes the Great Divergence, then policy makers, economists and politicians can work to fix it. 


Why isn't it a bigger problem with the American public? One reason is the enduring belief in social mobility. And probably the fact that as a whole, incomes were going up (perhaps, not true from 2000 onwards when income increases are barely keeping up with inflation)


What caused this Great Divergence (GD)?

  1. Gender and Race: The inequality between men and women has decreased over the 1980-2010 time period. And inequality between black and white people have stagnated during this time peroid (sad!). So, no, this did not cause the GD.
  2. Rise in single parenthood: Growth of single parent families started before 1980 and has grown at a significantly slower pace than the Great Divergence. Also, while singe parenthood increased inequality, the income gap was closed by mothers who entered into the workforce. Again, this did not cause the GD.
  3. Computerization: Previously, technology was designed to perform physical tasks. But, computers were designed to perform cognitive tasks. However, computers while eliminating jobs are also creating new jobs. The "job polarization" that computers created occurred at same rate in Europe and US, but only US sees the GD. The rate and time of computer growth does not match the GD spike. Also, skill-based technology change is not new (electricity and manufacturing in the early part of the 20th century) and does changes did not bring about a GD. So, no, computerization did not cause the GD.
  4. Immigration: Based on education levels, yes, immigration reduces income levels. But the income reduction rates are too small to attribute as the main cause for the Great Divergence. For unskilled workers with no high school diploma, immigration caused a 7.4% reduction in income and overall for all workers, a 3.4% reduction. But unskilled workers with no high school diploma is a small pool of the population that cannot cause the Great Divergence. To put this in perspective, the top fifth income earner's income increased at 70% higher than the middle fifths. We can attribute 5% of the GD to immigration.
  5. Fiscal Tax Policy: Reagen dropped the top tax bracket from 70% to 50% and eventually to 28%. Could the subsequent wealth gain at the highest level have caused the GD? Not really. The effective tax rate (when you add up tiered taxes, capital gains, pensions etc) moved from 43% for the top 0.01 percent of folks to 32% during Reagan's time. However, if you go beyond just taxes, and look at a broader set of policies instituted by Democrat and Republican administrations, you can see that when Republicans rule, inequality increases vs when Democrats rule. During democrats reign, all populations do better and especially the bottom 20th percentile. A non-partisan view of policy shows that the GD increased as corporations' lobbying power increased. Timothy Noah attributes 5% of the GD to the tax policies of the govt.
  6. Globalization and Trade: With the import of cheap Chinese goods, the manufacturing industry in the US was affected especially since the 1990s i.e. it became high enough to make a dent on the GD. Chinese goods are cheap because for e.g. in 2005 they paid their workers 3% of what US workers receive.TN says 10% of GD is caused by Trade.
  7. Lack of unions: The great compression during the 50s and 60s was also the same time that labor unions were the strongest. Folks in labor unions fare better wage-wise than those not in unions. While folks in unions are a small percentage of the working population, there is a general sense in which labor unions set the standard for wages. For those not in unions, that is the high bar to reach. Over the peroid of the GD, govt has consistently passed laws that make it harder to organize. Minimum wages in the US have stagnated by 2008 to a point where it's buying power had reached a 51 year low. Countries that have kept wages high like Germany and Sweden have not seen the GD like the US has. TN attributes 20% of the GD to the downfall of the union's collective bargaining power and the subsequent lower wages. 
  8. The Rich: The share of the national income going to the top 1% (earning above $368,000 pa) is 21%. During the period of the GD, the share of the national income going to the top 0.1% (stinking rich who earn more than $1 million pa) increased four fold. This sharp increase in the wealth of the rich caused 30% of the GD. How did the stinking rich's income grow so much? They are the beneficiaries of the "Winner Take All" phenomenon, in which locally successfully folks go world-wide, thanks to technology updates. For wall street stinking rich, they became rich by deregulation of the financial industry and for CEOs, a combination of tax policy, lack-of-internal promotions and a new Hollywood like celebrity status caused their incomes to sky rocket. 
  9. Education: So, while computerization did not cause the GD, the lack of educational advances to cater to the demand for highly skilled workers did. In short, lack of educational attainment caused 30% of the GD. During the 30's onwards, high school education became free thereby causing moderately skill workers to enter the workforce in the 50's and 60's leading to the Great Compression. A similar output of college graduates did not accompany the GD. Instead, there was a halt and subsequent slowdown of educational attainment that began around the GD and this was a uniquely american experience. The Vietnam education deferment and baby boom in the late 70s caused the monetary return on a college education to drop to its lowest level since WWII. Why did that trend continue? Poor high school education (i.e. not relevant to the changing ecomony's needs) and high cost of college education caused folks not to study more. 

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