Economic policy advice for the NDP, Part I: Inequality

One of the themes being played up in the NDP's convention is its attempt to 're-brand' (up to, but not quite, including dropping the 'New' from its name), and part of this is apparently an attempt to develop a credible economic platform. The NDP has historically been pretty consistent in its refusal to take advice from professional economists, so on the off chance that the NDP is serious about this endeavour, I'm starting a series of posts on the economic analysis behind some of its core themes. Below the fold, I'll do a brief survey of what is probably the most important economic issue for the NDP: inequality.

The first point to make is that the problem of growing economic inequality is real, well-documented, and more severe than what you might think. I prepared these graphs for my post on Emmanuel Saez' and Mike Veall's paper on high-end incomes in Canada:

The increase in the income share at the top end of the top end of the distribution is sometimes expressed in terms of the gains in the top quintile (top 20%) or the top decile (top 10%). But it's clear that the real winners since 1985 are those above the 99th percentile. And even within this group, the gains are concentrated at the upper end:

Here is a graph of the income gains by percentile since 1985:

Again, the data are taken from the Saez-Veall article (when oh when will Mike Veall find the time to update the data set?!?).

The fact that the income gains are concentrated at the very top means that the NDP has to be very careful in saying just *who* is in this privileged group. In 2000, the 99th percentile income was $145,774/yr. If we extrapolate the 3.5%/yr growth rate of that percentile over 1995-2000 and correct for inflation, we get something like $240k/yr; the corresponding number for the 99.5th percentile is $380k. These are back-of-the envelope guesstimates, but it gives us an idea of where the line is.

It's important to make this distinction. As a matter of statistics, it's perfectly true that people who are in (say) the top 10% have received the lion's share of gains to national income. But people who are at the 90th or even the 95th percentile could fairly object to such a broad brush, because they - like the people at the median - haven't seen much in the way of increases in income either. So when you talk about 'the rich', it's important to restrict attention to those making (say) $400-500k/yr or more.

Okay, so the problem is real. What can be done about it? The answer to this question greatly depends on the explanation for why income gains have been so tightly concentrated at the top end of the income distribution. Unfortunately, we don't yet have one. There are at least two explanations that sound reasonable, but which are not consistent with the data:

1) Skill-biased technical change. The idea here is that with the advent of the Knowledge Economy^TM, the big winners are those with the skills required to take advantage of new technologies. This would be a convincing argument if the gains were spread out more broadly across those who are highly-skilled, but as we have seen, that's not the case.

2) Stories based on profits. The idea here is that the share of income has shifted towards the owners of capital, and this shows up as an increase in the incomes of the very rich. This may have been a good story in 1946 (when the data start), but it's not a story of what has happened recently. The gains in income are almost entirely due to gains in earned income. In 1946, capital holdings accounted for 53% of the income of those in the top 0.01%, and 27% was wage income; the other 20% was entrepreneurial income from self-employment. In 2000, the very rich generated only 25% of their income from capital, and 74% was in the form of wage income; entrepreneurs who work for themselves have almost completely disappeared from the ranks of the very rich. (See also this table.) The increase in inequality has been driven by wages, not by capital income.

The problem remains unsolved. This is why I get very nervous when people like Ed Broadbent call for an 'all-out attack' on inequality. The sentiment is laudable, but there's little reason to think that a bold, comprehensive policy based on a partial understanding of the problem will lead anywhere but disaster.

So what can be done? One thing would be simply to focus attention on the problem: the gains in national income have been concentrated among a very, very small fraction of the population. Not enough people know this.

Given our still-fragmentary understanding of the problem, the only concrete proposal that I can think of that is unlikely to be completely stupid is to add another income tax bracket at the very high end of the income distribution, say those making more than $500,000/year. Make it clear that this measure will be felt by only one person in 200, and that this group has seen their incomes grow at a rate ten times faster than the rest of the population.

There are other things that can be done, of course, and I'll get to them in future posts.

This is part of a series:

• Economic policy advice for the NDP, Part II: Defending big government
• Economic policy advice for the NDP, Part III: The GST
• Economic policy advice for the NDP, part IV: Corporate income taxes
  
• Economic policy advice for the NDP, Part V: Give money to low-income households
• Economic policy advice for the NDP, Part VI: Climate change

Comments

[Jon]

Its a profession disparate inflationary effect.

Posit: the rate of inflation is actually quite high, but in certain sectors the price of goods is being held-down by a secondary process. e.g., certain prices are being suppressed by cheap production overseas, others are not.

Its principally those labor activities for which foreign labor substitution is possible where we see the stagnant growth. Whereas activities that are highly localized exhibit the full inflationary effect.

[Phil]

" ... this group has seen their incomes grow at a rate ten times faster than the rest of the population."

But no individual has necessarily seen his/her income grow at that rate. The high-income group consists of largely different individuals now than before.

BTW, what kind of jobs pay wages of three-quarters of $380K a year? That kind of information would help solve the unsolved problem of where the high-income growth is coming from.

[Stephen Gordon]

True, there is a certain amount of mobility in and out of these groups. I haven't yet worked out how to deal with the dynamics, but I expect that they're important.

I think the standard story is of corporate brass getting boards to vote them high salaries, and people in entertainment/sports: Céline Dion, Sidney Crosby, etc. But again, I don't really know as much as I'd like.

[epimetheus]

When we talk about inequality, is it the spread between gross incomes or net incomes that causes all the trouble? It would be nice if all we need to do is tax the exceedingly rich, but that almost sounds too easy to be true.

@Jon: Wouldn't that mean that only the top 1-5% of labour is highly-localized? I don't have the knowledge to say that's wrong, but it certainly feels implausible that 95% of people are hurting from Chinese sweatshops and Indian call centres.

[Jon]

Epimetheus:

No. That's not the only option. In particular, lower strata could be comprised of localized and non-localized wage groups. So overall growth is stagnant, but the upper strata could be highly localized, and thus the full-effect is apparent.

[Jim Rootham]

You missed a story. Don't economists read Galbraith? He spotted the mechanism that drives this in the fifties (which is when, if you look at individual rather than family incomes this distortion started).

Corporate senior management has captured a lot of the profits of corporations. So it is rising profits (effectively) but the owners aren't getting them.

I'm sure the increased scaling effects of entertainment is a factor as well. It would be good to have real numbers on all of this.

[Stephen Gordon]

That's a story with which I'm familiar (see my comment above), but then we have to figure out what happened around 1985. Why would they have been so magnaminous before then?

eta: I should add that I think it's an important part of the puzzle. But we don't know enough about how this mechanism works to make much in the way of policy.

[Don the libertarian Democrat]

I'm having a really rough time understanding this problem. You suggest taxing the highest incomes, but here's Lane Kenworthy:

"As the following chart shows, inequality reduction is achieved not through taxation but with government transfers (and services)"

He does like these taxes for the US:

"Two other progressive tax reforms are worth pursuing, though they would affect some in the bottom 95%. One is to reduce or end the homeownership subsidy. More than 80% of the $160 billion in foregone revenues from the deduction for mortgage interest and property tax payments goes to households in the top income quintile. The other is to introduce a modest tax on financial transactions."

Here's his final point, where he does talk about taxes again:

"Moderate or high levels of tax revenue can’t come solely from higher rates or new taxes on the rich; the math simply doesn’t work. To significantly increase spending on transfers and/or services, President Obama and/or his successors will need to increase taxes on the middle class. One way to do this would be via a federal consumption tax, such as a value-added tax (VAT). We have state and local consumption (sales) taxes, but we raise less money from consumption taxes than any other rich country. Consumption taxes are regressive, and for that reason they’re often dismissed by the American left. But they can be tweaked to limit the degree of regressivity. And if the money is put to progressive use, the benefits may outweigh this drawback."

But then how do we explain this, from Donald Marron:

"In a series of posts (most recent here), I’ve documented that Americans are getting an increasing portion of their income from the government.

BEA released new data on incomes a couple weeks ago, including revisions back to 1995. These data reinforce the story I’ve described in my previous posts:

* Transfers accounted for 17.3% of personal income in June. That’s the second highest in history, topped only by the 18.2% recorded in May, when transfers were boosted by one-time payments from this year’s stimulus act:"

In other words, since 1960, govt transfers as a portion of personal income has gone up from 6% to 18%. And yet we have rising inequality!?

Now, I've asked Krugman and De Long about this, and gotten no answer. Here's a possibility from David Hilfiker:

"And that leads to the second major straightforward cause of inequality in the country: the relatively low levels of government wealth transfer from the rich to the poor. By “wealth transfer” I mean both the effects of government taxation and the effects of government programs. There are obvious transfers of wealth like food stamps or welfare payments, but there are other more important sources of this wealth transfer. For instance, universal health care benefits everyone about equally, so, in essence, government-funded health care transfers wealth from the rich to the poor. Public education, social security, Medicaid, and Medicare are other examples.

Examining the statistics, one finds that it is this differential in wealth transfer that actually accounts for most of the difference in inequality between the United States and European countries. If you use the same international method to calculate poverty rates for the United States, Canada and Western Europe and if you calculate those rates before any government transfer of wealth, it turns out that the US poverty rate is among the lowest. But if you calculate that poverty rate after government transfers, the US poverty rate is by far the highest at 18% (the United Kingdom is 13% but all other European countries are 8% or under). So, the primary reason that other developed societies are more equal than American society is that, in essence, they take money from the rich and give it to the poor.

In other words, while some of the causes of American inequality are complex and would be fairly complicated to do anything about, two of the most important causes—taxes and government programs—are not complex at all and would theoretically be easy to correct."

And here's what's funny: I'm a Milton Friedman Democrat, and he loves Naomi Klein's book, which, as you can guess, I don't. But I agree with him! I agree with him about Inequality in general. He also likes the EITC. I prefer a Guaranteed Income. As Milton Friedman said, it has the benefit of focusing money on the poorest in our society. The only thing that I disagree with him about, and, here I disagree with you as well, is the effectiveness of tax increases on the top earners for Lane Kenworthy's reasons:

I wonder where you come down on this issue?

[Nick Rowe]

I'm just trying to imagine an election slogan: "Let's tax the ill-gotten and undeserved gains of evil greedy people like Celine Dion and Sidney Crosby!"

It is possible to make a moral and intellectual case for higher taxes, on the economic rents that such people earn especially. But politically, I don't see it flying on the populist left, which wants both to demonise the faceless people and 'corporations' taxed, and draw a veil of mystery and suspicion over how they earned their income ("they don't actually produce anything, they just steal from producers, through a shell-game with money and finance").

Sometimes I wonder if the "multinational corporation" conspiracy theory hasn't just replaced the "cosmopolitan jews" conspiracy theory in populist demonology.

I think that some on the left (the economically literate ones) are genuinely concerned about personal income inequality per se. But for others I think it's not genuine. It's more a concern about functional distribution based on some sort of proto-Marxian or pre-Marxian concept of exploitation.

Back to Celine and Sidney: I'm trying to think of reasons why the "economics of superstars" (which could apply to top managers as much as top sports and entertainers) would suddenly take off in 1985. But can't think of any.

[Robert McClelland]

The NDP has historically been pretty consistent in its refusal to take advice from professional economists...

...and the chickens have historically been pretty consistent in their refusal to take advice from the fox.

Seriously, why do you think the NDP should take advice from the guardians of the status quo?

[Stephen Gordon]

You might do well to read Joseph Heath's Filthy Lucre: Economics for People who Hate Capitalism.

[Robert McClelland]

Why, I don't hate capitalism. Besides that, having recently encountered a number of examples of Heath's work I can't say I'm impressed with his vaunted intellectual prowess. His shtick seems to be, "I once was stupid but now I see the light. Hallelujah! Hallelujah! Hal--le--lu--jah."

You avoided my question. Why should the NDP take advice from people who continue to promote ideas that have brought us no discernible benefits and have contributed to the very problem they're trying to address?

[Stephen Gordon]

Heh. A have-you-stopped-beating-your-wife question. Slick!

[reason]

Phil -
can you justify this

" ... this group has seen their incomes grow at a rate ten times faster than the rest of the population."

But no individual has necessarily seen his/her income grow at that rate. The high-income group consists of largely different individuals now than before."
mathematically.

Surely if people are moving up from lower income groups then their income is growing EVEN more rapidly.

[Robert McClelland]

Actually it's not. It's a when will you realize you're beating your wife question. Anyway, I don't mean to distract you with this tangential line of questioning.

[Phil]

reason:

It's possible (for instance) that nobody spends more than one year in the top group, but the amount earned by those people keeps growing.

Consider lottery jackpots that grow rapidly. Every year the income of jackpot winners increases by 10%, but next year they're back down to where they were before.

[Leo Petr]

@Robert: If the advice of a professional economist is to add another tax bracket for the very rich and tax it a higher rate, as would be your inclination anyways, why is your reaction to object?

[Too Much Fed]

Using Nick's apples example, can more bank loans based on currency shift the demand curve for apples to the right while productivity growth also shifts the supply curve to the right so that price inflation of apples is about 2%?

If so, can you see how that can lead to wealth/income inequality?

[Mike Moffatt]

Big question: How much added revenue would significantly increasing taxes on these folks bring in?

I think it'd be difficult to collect more than 1B a year, based on any kind of 'back of the envelope' type calculation. That's not chump change, but it's not going to go very far in reducing poverty - and may have all kinds of nasty unintended consequences.

Shouldn't the government (or NDP) focus on ways of bringing the low end up, rather than bringing the high end down?

[Too Much Fed]

I hope this applies here and from:

http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/08/banks-money-and-debt.html

""Can more bank loans based on currency shift the demand curve for apples to the right while productivity growth also shifts the supply curve to the right so that price inflation of apples is about 2%? "

Delete the bit about bank loans in that sentence, and that is exactly what the Bank of Canada tries to achieve: make the demand for apples grow just slightly faster than the supply of apples, so inflation is 2%.

The functional distribution of income (between labour, capital, land etc.) will affect debt insofar as it affects the personal distribution of income (between people) in such a way that it affects differences across the population in savings/spending decisions."

I think we are getting CLOSER TO THE TRUTH. Sorry, but I do NOT want to delete the part about bank loans because households are doing the borrowing.

How about can more bank loans based on currency (BECAUSE the central bank has allowed more bank reserves or some other means to lower interest rates) shift the demand curve for apples to the right (BECAUSE households have taken on bank loans based on currency and the ability to pay with current/future wage income) while productivity growth also shifts the supply curve to the right so that price inflation of apples is about 2%?

Can you see the difference between printing currency (current demand) and "printing" bank reserves to attempt to increase household bank loans based on currency (future demand brought to the present)?

About the functional distribution of (I assume NATIONAL) income (between labour, capital, land etc.), can you see if labor experiences negative real earnings growth and borrows to maintain their standard of living in the present how that can create positive real "earnings growth" for capital thru excess corporate profits?

[Stephen Gordon]

Mike: you're right on both counts. I really wasn't thinking of this as a way of a comprehensive solution or in getting much in the way of tax revenues, more like some sort of speed bump to slow an unfortunate trend. And yes, the focus should be on providing support for the low end.

[Too Much Fed]

Don said: "So, the primary reason that other developed societies are more equal than American society is that, in essence, they take money from the rich and give it to the poor."

It seems to me what they are doing is trying to undo what the rich have done by exploiting an oversupplied labor market.

[Kosta]

Lovely graphs Stephen, but I am curious about what group has increased their wages so disproportionately to the rest of the Canadian work forces. Understanding why this particular group has done so well might give some insights on how to act. Rather than taxing the group, maybe the size of the group can be expanded by training more workers to enter into the same or similar sectors.

[Patrick]

I think Galbraith Sr. basically has it right; it's 'innocent' fraud that is driving inequality, but I would add that it's made possible by a very, very broken system of finance and corporate governance. So long as hi fi and executive management compensation schemes provide incentives (and make it easy) to make huge sums of money by playing games with the short term psychology and volatility of the market, rather than through long term productive deployment of capital, then I think inequality will continue to increase as those in a position to tunnel wealth out of the system and allocate it to themselves do so, and leave the rest of us with ever decreasing amounts of productively deployed capital. As money accumulates in the hands of those best positioned to allocate it to themselves, the rest of us will be left doing their laundry and serving them lattés.

I would note that the rise in inequality basically corresponds with hi fi figuring out how to use available computing horsepower to do things like implement hyper-complex trading strategies and front run the markets on the microsecond scale (e.g. the recent GS software revelations). It's basically the transformation of finance from mostly figuring out where to profitably deploy capital for the long term to mostly searching for ways to use computers to find and exploit micro scale market inefficiencies.

My suggestions to fix it? I would be inclined to impose performance based taxes on income for management/executives. The basic idea would be if the company makes money and the execs makes money, that's fine. If the company loses money but the execs make money beyond normal salary, that is not OK and it gets taxed heavily. I would also like to see a tax on executive salaries that increases proportional to the difference of the execs salary and the median workers salary. On the other hand, I would give execs who use their own cash money to buy *common* shares on the open market a big tax break on dividends payed by those shares. It might also be a good idea to cut taxes on dividends. I think there is too much of a focus on capital appreciation and not enough on actual, real, cash in hand profits.

[Matthew]

"I'm sure the increased scaling effects of entertainment is a factor as well. It would be good to have real numbers on all of this."

These are Canadian data right? I think we would be hard pressed to come up with a significant number of Canadian entertainers (hockey players maybe) making a lot of money.

[Neil]

We don't know what's causing increasing inequality?

I thought this was pretty obvious. It's a social problem of executives getting paid well beyond the value that they provide. Particularly, the problem of how executive compensation is arrived at - high-paid consultants, selected by the executives for whom they're recommending wages - make a recommendation to the board, which is mostly a group of people who in turn benefit from approving large increases because then, when they go to their own boards at the companies they manage, they can say that so-and-so is making more money, and so should they.

Either way, the solution is pretty straight forward - an additional tax bracket for the very rich ($500k and above), which would reduce the tax burden on the broad middle class.

[Don the libertarian Democrat]

Here are my references for my post above:

http://lanekenworthy.net/2009/04/17/reducing-inequality-how-to-pay-for-it/

http://lanekenworthy.net/2009/04/20/how-to-pay-for-inequality-reduction-follow-up/

http://lanekenworthy.net/2009/04/17/reducing-inequality-how-to-pay-for-it/

http://dmarron.com/2009/08/13/latest-data-on-transfers-and-income/

http://www.davidhilfiker.com/docs/Justice/American%20Inequality.htm

[Stan]

Why is it anybody's business?

[Patrick]

There is a cogent argument that Sydney Crosby or Celine Dion (putting aside taste; as mine runs more along the lines of James Hetfield than Celine) really do offer something unique and in some sense their compensation isn't totally crazy. In any case, how many superstar entertainers and hockey stars are there? A few hundred at most. Hardly seems like they could skewing the numbers.

I think what Neil is describing is a symptom. Isn't the question *why* are executives and the hi-fi boyz being paid so much when, especially in the case of finance, they have failed.

A finance system that wasted trillions of dollars on the most unproductive asset imaginable (ok, maybe tulips would have been worse than suburban residential housing, but not much) while driving-up transaction costs and extracting huge fees is performing adequately performing the vital function of converting savings into investment.

Following Joe Stiglitz line of reasoning, one would have expected a functional finance sector to drive down transaction costs and allocate capital more effectively. Clearly, it failed on the first count. And just look at what it costs for a 'retail' investor to execute a simple stock transaction. Anywhere from $10 to $30 dollars PER TRADE. This despite the whole system being automated. It should cost fractions of pennies. Meanwhile, GS front runs the market on the microsecond scale to the tune of millions of transactions a day. How is that efficient?

Similarly, what is motivating corporate executives and management to pump & dump, or death spiral finance (e.g. short, issue convertible debt, cover with converted stock, lather rinse repeat)? And why is it that someone like Jeff Immelt can get away with being paid what he gets paid? One could forgive them if the stock holders were making money hand over fist, but in most case they really aren't.

I tend to think the market probably can work if the right incentives are in place. In the case of finance, there needs to be disincentives to pure gambling, arbitrage, exploitation of inefficiences and greater incentives to go out and make money the old fashioned way: earn it. If you look at the history of Wall St. investment banks, they actually did very, very well over more than a century through depressions, recessions and world wars. What changed? They started playing with other peoples money and using computers. It went from being business to being high stakes video poker.

In the case of super sized executive compensation, I think it's really just a matter of re-aligning compenstation with shareholder interests. Over time the game has been rigged so that it's a tails I win, heads you lose scenario. If we encourage execs to be stockholders with capital at risk who profit when shareholders profit, and discourage/taxed at confiscatory level profits had from volatility (e.g stock options or gifted shares), that would be a good start in my view.

As an aside: I always get a kick out of Jeremy Siegel. He correctly points out out active trading transaction costs means that you have to beat the market by an improbably large margin to realize real net returns that beat simple passive indexing, and thus the best strategy is by and hold. And the data says he's right. But it rare to here anyone, especially finance types, ever points out just what a distortion those transaction costs really are!

OK, I'll get off my soap box and stop boring you.

[Nick Rowe]

Patrick and Neil:

But why did it all start in 1985? What changed? Computers? And the financial sector was always playing with other people's money.

Sure Celine Dion and Sidney Crosby are very productive. Probaly W=VMP for both of them (or close too). But does that mean they *deserve* their high incomes? OK, it took a lot of practice, but they were also lucky, in being born with set of skills/qualities which people just happened to value. Suppose Sidney Crosby's identical twin had been born in...England (or some country that's not quite so keen on hockey).

Here's another thought that crosses my mind: suppose the best candidate for the top job in a large organisation is only very slightly better than the second-best candidate, and can only increase revenues (or cut costs) by 0.1%. You would be prepared to pay up to that 0.1% premium to bid that best candidate away from another organisation. 0.1% of revenues or costs of a large organisation is a very large number for a salary differential of the best over the second best.

(But then, did organisations suddenly start getting larger in 1985?)

Personally, I think Kosta's approach is worth exploring.

[anon]

“The answer to this question greatly depends on the explanation for why income gains have been so tightly concentrated at the top end of the income distribution. Unfortunately, we don't yet have one.”

Maybe it’s just me, but I’ve always thought the answer to this was obvious.

Its equity based compensation, whether entrepreneurial or corporate. (This is different than income on investment, of course.) I don’t know about the entrepreneurial side, but the corporate effect has been huge. It started in Canada in the early 90’s. Note that many in the entertainment field also receive compensation driven on the basis of corporate revenue and profits, probably more intensively than the case twenty years ago.

The trend in equity participation over this period has been more exponential than linear. That’s the reason for the concentration in income gains.

BTW, you’ll see the same relative pattern in high end real estate, also a reflection of exponential equity participation as the source of finance.

[anon]

P.S.

There was very little equity based compensation in the corporate world before 1985 or 1990.

The starting point was very low. That makes for big percentage gains over the full time period.

[Nick Rowe]

If anon is right (and I have no reason to think he isn't), the effect would be multiplied by rising stock prices since the early 1980's.

Pity the data doesn't go past 2000, then we could test by seeing if the share of the top 0.1% dropped in the tech crash. I can't quite tell if the spike in the late 1980's corresponds with the 87 crash.

[Adam]

"Okay, so the problem is real"

What problem? There's no problem whatsoever. Why is it a problem for me that someone else's standard of living is rising faster than mine? And how is it a problem for someone else that my standard of living is rising faster than theirs?

Jealously is not exactly a solid moral or intellectual foundation for public policy.

[Stephen Gordon]

It's a problem if those ginormous salaries at the top end consist of rents. It's hard to imagine how they could correspond to their marginal products.

[anon]

"the effect would be multiplied by rising stock prices since the early 1980's"

Yes.

But in addition to trend, volatility is friendly to equity based compensation.

First, via options.

Second, because equity based compensation includes a form of dollar cost averaging - i.e. more shares are awarded in the form of "restricted stock" after the stock market has gone down.

I.e., equity compensation is structurally biased in the sense that programs will be devised to mitigate the effect of cyclical stock market declines.

[Patrick]

Something I don't understand about marginal product as it applies to someone like a CEO, I'll illustrate: Say a CEO has a brain wave: "I'll hire a couple of Ph.D economist to advise us". So he hires Nick and Stephen, who give great strategic advice and the company makes huge sums of money as a result. Who lays claim to the marginal product? One of the economists suggests "let's split it equally 3 ways". The other economist says "Consider the market for apples ... ". The CEO says "Markets are efficient, therefore I've been paying you your marginal product, otherwise you wouldn't have agreed to work for me in the first place. So you just earned your salary. No bonus for you. Now, consider the market for unemployed economists..."

So, in a hierarchy of smart, skilled people working together (e.g. a tech company or an investment bank), how does one 'allocate' marginal product?

anon: agreed. I think that more or less counts as magneto trouble.

BTW, I actually got a variation of the CEO's response once when I thought I'd done a particularly profitable and clever thing and asked for a little extra in return. Power matters.

[Nick Rowe]

Patrick:

What you have just described is the classical example of imputation under fixed proportions of inputs, where MP is undefined.

Suppose the production function is Q=min{L,K} One worker plus one fork produce one bushel of wheat. A worker without a fork produces nothing; a fork without a worker produces nothing. You can define the MP of a worker plus fork, but cannot define the MP of a worker or a fork (You cannot take the partial derivative of a discontinuous production function).

Neoclassical solution: the MP alone does NOT determine input prices. MP determines the demand curve, but you need both demand and supply curves to co-determine MP and input prices. In this case the MP of a worker+fork is 1 bushel of wheat, so the demand curve for worker+fork combos is horizontal. But if you have 10 forks, the MP (demand) curve for labour is horizontal at 1 until you get to 10 workers, then it drops vertically to 0, and stays at 0 thereafter. The supply curves of forks and workers determine the division of the bushel of wheat into the wage and rental rate on forks.

[Off topic: there is an interesting parallel to the Marxian labour theory of value's difficulty in the case of joint production. Sheep are wool and mutton. If one worker produces 1 sheep, then you can determine the labour value of one sheep. But how do you divide that value into the values of wool and mutton?

Neoclassical solution: pure cost of production theories of value don't work. (Marginal) cost of production (which is the inverse of marginal product of labour, or forks) determine the supply curve, but you need demand (marginal utility) as well to determine value. The division of the value of the sheep into the value of wool and the value of mutton is demand-determined).]

[Patrick]

Thanks Nick.

[Patrick]

I found this instructive. It's seems to me to be a good explanation of why the labour theory of value is wrong:

http://www.j-bradford-delong.net/movable_type/2005-3_archives/000639.html

[Patrick]

This is depressing:

http://www.ritholtz.com/blog/2009/08/the-great-american-bank-robbery/

I wonder how much of the rise in inequality is simple criminality?

[reason]

Adam
"What problem? There's no problem whatsoever. Why is it a problem for me that someone else's standard of living is rising faster than mine? And how is it a problem for someone else that my standard of living is rising faster than theirs?"

That is actually a fairly naive view - regardless of the cause of the discrepancy. Firstly, there is the issue of positional goods (there is evidence that utility is not independent of other people's consumption in economic terms). Secondly, some resources are scarce (think land) and if access is becoming more concentrated, then some people may see falls in their "standard of living" that are not being captured in our statistics, because of relative price changes. Thirdly, the market mechanism is only way of our decision making processes, the rules and their enforcement are actually decided by democratic and legal processes which may be distorted by excessive concentration of economic power. Yes, and then what Stephen Gordon said.

[reason]

Oops
... Thirdly, the market mechanism is not the only way we make decisions, the rules ...

[westslope]

I suppose a Winner takes all approach doesn't apply to explaining real growth in top executive compensation.

Maybe the so-called democratization of the stock market offers a clue? That would suggest an increase in demand for those who can make capital owners wealthier. Economies of scale, facilitated by the digital age, suggest that higher executive compensation costs are spread over many, many owners.

In the meantime, as several of you have already hinted, the NDP and other conservative lefties need to drop their debilitating focus on envy.

[Nick Rowe]

One of DonThe LibertarianDemocrat's comments has been caught by the spam filter (too many links, Don ;) )

I can't retrieve it, because it's on Stephen's post.

[reason]

westslope

winner?

So you and I can freely enter the contest that gives every contestant an equal chance of winning (but maybe it is still just a lottery) against equivalent competitors?

[reason]

Nick Rowe
"Here's another thought that crosses my mind: suppose the best candidate for the top job in a large organisation is only very slightly better than the second-best candidate, and can only increase revenues (or cut costs) by 0.1%. You would be prepared to pay up to that 0.1% premium to bid that best candidate away from another organisation. 0.1% of revenues or costs of a large organisation is a very large number for a salary differential of the best over the second best."

But how could you possibly know?

[reason]

"In the meantime, as several of you have already hinted, the NDP and other conservative lefties need to drop their debilitating focus on envy."

Lets assume that they really are motivated by envy and not by concerns Henry Georgian type concerns about rents and unfairness. Now given that they are a party representing the interests of a certain part of electorate, if that part of the electorate is motivated by envy, shouldn't that envy have representation. You seem to think that a democracy should be better(? - whatever better means) than its constituants.

[Patrick]

reason: I'm still thinking through Nicks explanation, but I'm wondering if overpaid CEO's (and others) are essentially laying claim to marginal product that that doesn't belong to them. But I don't really have enough econ background to work out something coherent.

I'm wondering if part of the problem is informational. At any given time, how can anyone know if the execs are really tanking the company or are they just 'victims of circumstance'? The truth is only revealed over the long run, but wages and bonuses and paid at points in time.

[westslope]

reason, The 'winner' approach is used to try to explain extremely high professional sport salaries or the divergence between the salaries of ordinary musicians and superstars.

[reason]

OK - so not CEO's.

But I still question the long term merits of "winner-take-all" markets. If we think normal people are risk averse, then winner take all markets, not only create inequality, they will reduce the supply of what they want to reward (and reduce the competition). Isn't that why sports keep wanting to introduce salary caps.

[reason]

Patrick,
essentially the CEO is saying he is unique (and so can claim quasi-rents) and you aren't and so get paid the marginal productivity of your class of workers, not your personal actual productivity. We need a few CEO robots. Should be a winning AI application.

[reason]

I just realised of course, with regard to "winner-take-all" markets, the best example of PRECISELY the problem I mentioned is Microsoft.

[reason]

westslope
BTW you are bieng disingeniuos in your last comment - i quote you:
"I suppose a Winner takes all approach doesn't apply to explaining real growth in top executive compensation."

[Christian Gross]

I would argue this percentile scenario is actually missing a very important aspect that is rearing its ugly head in this economic downturn.

Let's say we have two people. One person makes 100 Dollars, and the other makes 120 Dollars. The person with 100 Dollars month after month just gets by, and in fact adds on debt. The person with 120 dollars saves 20 dollars a year, getting 10% return.

After year 1 person has debt and has to service this debt, costing them say 50 cents. Person 2 has no debt, but makes 2 dollars.

Let's fast forward this say 10 years and what you get are the rich getting richer and poor getting poorer.

To prove my point:

http://www.nytimes.com/2009/08/29/business/economy/29consumer.html?_r=1

Thus the gap between the rich and poor will drop dramatically. Hence the real problem is not to address the gap via restrictions, but to address the gap by giving poorer people a chance to improve their income.