Tuesday, February 10, 2009

Fair Inequality.

In the midst of the current macro-economic crisis, I have come across many angry people. Yes, modern finance is flawed, but what are the alternatives? [a question that Obama and his team will have to address] I also feel that much of people's anger is misdirected [towards Alan Greenspan, who at least had the courage to man up and apologize.]

Firstly, not everyone who makes a shit ton of money is corrupt/doesn't deserve it. Income inequality is sad, but is it unfair?

In "The Conscience of a Liberal," Paul Krugman argues that poor institutions are to blame and that "movement conservatism" has been contributing to income inequality. He gives the "Great Compression" as an example of how great institutions can make this world a happier, more equal place. Now, Paul Krugman is a Nobel Laureate, and I'm a half-person who only started taking Econ classes 2 years ago, so don't eat up everything I say here, Jess. Haha. But here's my response to Paul Krugman's view:

Although the “Great Compression” of World War II is largely attributed to such institutional changes as the creation of the NWLB, NIRA, a redistributive tax code, and the introduction of health care benefits, one can not argue that the inverse is also necessarily true.
The equality that is characteristic of the "Great Compression" can also be explained by simple supply and demand for unskilled vs. skilled workers.
During World War II, the composition of labor markets changed drastically as the relative demand for unskilled labor increased and the supply decreased. The egalitarian structure of society was retained even after the institutions of World War II were dissolved b/c although the relative demand for skilled labor increased after the war, the relative supply increased at a faster rate [Piketty, Thomas, and Emmanuel Saez. "Income Inequality in the United States, 1913-1998." Quarterly Journal of Economics CXVIII (2003): 1-37.]

Currently, DEMAND for skilled labor outpaces supply. The wages of American educated workers are some of the highest in the world as a result of increasing demand and increasing scarcity value. The richest 1 percent of wage earners received 80% of all income gains from 1980 to 2005 [Piketty-Saez]. The gap between the median earnings of men with B.A. degrees and that of all full-time male workers has also increased from 14% in 1967 to 120% in 2005 [Levy, Frank, and Peter Temin. "Inequality and Institutions in 20th Century America." National Bureau of Economic Research: 1-42.]

Globalization has also increased the elasticity of demand for low-skilled workers as firms gain access to foreign labor markets, thus decreasing the comparative viability of the domestic low-skilled labor force. And since labor is not subject to arbitrage to the extent that tradable goods are, institutions that skew the price mechanism [minimum wage laws] further exacerbate the loss of income accruing to low-skilled labor. Although minimum wage is meant to protect the lower income brackets, it actually creates excess supply of low-skilled workers in the domestic market and pushes firms to take advantage of cheaper low-skilled labor abroad. In 1974, a 25% increase in the minimum wage, from $1.60 to $2.00 was correlated with an increase in the unemployment rate in the U.S. from roughly 5.0% to 7.2% ["Why the Minimum Wage Law Causes Unemployment." NCPA. National Center for Policy Analysis. 18 Sept. 2008 ]
Edit: Larry Summers also finds that wages above market rate increase rigidity in the labor market/may increase long term unemployment.

Also, rent-seeking behavior is railed upon when observed in developing countries with corrupt gov'ts, etc. But how is the auto industry in the U.S. any different?
Subsidies and bailouts which also work contrary to market mechanisms, increase the opportunity cost of propping up U.S. industries that have become increasingly non-competitive at the global level. For example, in 1979, Chrysler faced financial difficulty as oil prices rose making its fuel inefficient vehicles unappealing to consumers. Congress and the Carter administration granted Chrysler an unprecedented subsidized loan which saved Chrysler; it has since been described as a case of moral hazard in which risky behavior can be defined as the absence of innovation. Furthermore, such subsidies and bailouts provide temporary solutions to the sectoral shifts that the economy must eventually address. As global markets lower the value of non-competitive U.S. sectors such as manufacturing, income inequality can only increase as wages in those sectors decrease. Innovation is the only way by which such “dying” sectors, which witness decreased productivity in the U.S., can achieve sustainability. [see Schumpeter for further inspiration] Since real wages reflect productivity, by addressing sectoral shifts in the economy we are pursuing policies that would mitigate income inequality.

Increased re-education and training programs for displaced workers as well as improvements in the education system for the future labor force will allow workers to take advantage of the sectoral shift as opposed to resorting to protectionist policies. During this transition, measures to decrease income inequality include less xenophobic views on imported skills and more means tested policies, such as the EITC that do not skew price mechanisms. Policies that take advantage of changing markets will allow the U.S. to continue to be viable in a global economy.
[Read "The Age of Turbulence" by Alan Greenspan for more on skill biased technological change. He's a great writer. It's a great book. He's so cute. When he first started working in D.C. he would go back to NYC on weekends to water his plants AND visit his mom. WHO does that?! ALAN GREENSPAN.]

So I think "Buy American" sucks and just keeps us from eating yummy Roquefort cheese, and I think rent-seeking industries should just get their shit together and step up.

I'm not saying I support inequality, and that I want some people to be way poorer than others. The purpose of this post was to get you to think about why inequality upsets you. Maybe the reasons will be a little different than what you thought before you read this post.

Special thanks to Chanda for contributing to research/creation of this blogpost. So, if you were bored, you can blame her. Haha. Just kidding.


  1. Very well thought out and researched post! Kudos to you (and chanda)! To comment tangentially on inequality, this recession could perhaps lead to less inequality. You're right that there is a high demand for skilled labor and a relatively low supply, which is why skilled Americans get paid so well. With this recession, I think you can safely say the demand for skilled labor has decreased relative to before the recession (just look at how much harder it is for us to get jobs!). If unskilled workers take the time to get education/training now while we are in recession, the opportunity cost of them giving up labor hours to go to school would be much lower, so they lose less money now. Additionally, when they come out of training, they would be skilled workers and thus get compensated more than before. The combination of decreased demand for skilled workers and a increased supply of skilled workers (if the unskilled get trained now) would theoretically lead to more equality, right? This probably sounds really stupid, so feel free to let me know if I'm wrong.

  2. Evs, you never sound stupid, even if Lucas might want to laugh at you from time to time. Haha.
    But can I just say that the NYTimes (or something) actually had an article about how there is actually a decline in those choosing to attend graduate schools. you'd think ppl would be rushing back to school.
    Higher discount rates?? Changed preferences/expectations?? I don't know man.