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Economics and Inequality

This article is part of Occupy the Future, a forum on lessons to be drawn from the Occupy movement.

The specific problems of the current U.S. economy—the drastic increase in unemployment and sluggish increase in output—overlay a tendency of much longer duration, a drastic and rapid increase in the inequality of income. Every economy of complexity produces an unequal distribution of the good things in life. But the period immediately following World War II showed a considerably increased equality of income compared with either the Great Depression or the previous period of relative prosperity.

Since the middle 1980s, this tendency has been reversed. In the United States, median family income (adjusted for size) has remained virtually constant since 1995, while per capita income has risen at about 2 percent per annum. The difference in income between college graduates and those with only high school degrees increased at a rapid rate, even during the period before 1990 when per capita income grew very slowly. Further, the proportion of the college-age population enrolled in college, which had been rising rapidly, stopped increasing and has remained the same for thirty years.

Clearly, the bulk of the gains from increased productivity went to a small group of upper-income recipients. Indeed, closer study has shown that the bulk of the increase went to the top 1 percent of income recipients and much of that to those in the top .1 percent.

The causes of this growing inequality are varied. There has been a steady attack on the use of the tax system as a means of equalizing income. Income and estate taxes were once the most directly effective factors in redistribution. The top rate in the federal income tax was over 90 percent in the 1950s and is about 35 percent today. The exemption level for estate taxes has risen steadily, ensuring that less and less can be taxed. On the other hand, the earned-income tax credit has actually permitted negative income taxes (payments by the government to the tax filer) at the lowest end.

Shifts in the composition of goods and services have reduced income opportunities for many. Skilled industrial jobs have disappeared, while growing information services require a different set of skills. This shift has undoubtedly been augmented by globalization, which has resulted in considerable imports of manufactured goods. The weakening of unions is in good measure attributable to the relative decline in manufacturing, where unionization is easier.

Contemporaneous with the decline of manufacturing has been the increase of two service industries, finance and health. Profits from the finance sector, which historically have been about 10 percent of all profits, have risen to an extraordinary 40 percent. The sector’s labor needs are, of course, directed in considerable measure to the best-educated.

A proper sense of responsibility has to be enforced by legislation.

The notion of a well-running market is applicable to manufactured goods; different items are produced to be alike and can be evaluated by consumers. But the products of the finance and health industries are individualized and complex. The consumer cannot seriously evaluate them—a situation that economists call “asymmetric information.”

This casts light on the claim that the problem is one of personal ethics, of greed. After all, the search for improvement in technology, and consequently in the general standards of living, is motivated by greed. When the market system works properly, greed is tempered by competition. Hence, most of the gains from innovation and good service cannot be retained by the providers.

But in situations of asymmetric information, the forces of competition are weakened. The individual patient or financial client does not have access to all the relevant information. Indeed, when the information is sufficiently complex, it may be impossible to provide adequate information.

In these circumstances, greed becomes more relevant. There arises an obligation to present the relevant information as fully as possible, an obligation that has been violated in the financial industry. In the medical field, this challenge has to a considerable extent been met historically by standards of proper practice. These may involve revelation of all information, or at least the requirement that differences in information not be exploited.

It is clear that the financial industry is well behind the medical in this respect. A proper sense of responsibility has to be enforced by legislation, as it was in the 1930s. There has been some erosion in the law, for example under the Clinton administration, and in enforcement. The Dodd-Frank law is a step in the right direction, but the influence of the financial industry watered it down and created unnecessary complications.

It is not superfluous to argue that steepening the income tax progression, removing a number of blatant loopholes, such as the special treatment of capital gains, and reducing the exemption level for estates would add considerably to post-tax equality.




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Comments

1 |
"But the period immediately following World War II showed a considerably increased equality of income compared with either the Great Depression or the previous period of relative prosperity."
Isn'it "decreased inequality". How inéquality of income evolved since the 50' till the 70'?
— posted 12/01/2011 at 08:17 by Serge d'Agostino
2 |
Economist
The most important issues in this debate are missing from this article. 1. Does inequality even matter from an economic standpoint? The empirical evidence shows that for the most part, it does not - if the inerquality comes about as a result of market forces. If inequality comes about due to political favors, government intervention, and protectionism, inequality is very damaging. A progressive tax system could take us from a system of beneficial inequality to damaging. 2. What about income mobility? While there are various studies showing the slowdown in labor mobility in the US, the fact remains that it is still higher than any other European country. Broad studies like this that look at "inequality" in the aggregate miss individual-level effects, in that the top 1% today (especially) is not the same as even one year ago. So to say thing are accruing to that 1% is to make it sound like there's this oligarchy of rich - when in reality, people are moving up and down the ladder. There should be incentives to make that top 1%. Unfortunately, not everyone remains there. These two issues are crucial to understanding "inequality."
— posted 12/01/2011 at 12:11 by christopher Hartwell
3 |
@ christopher Hartwell
"Does inequality even matter from an economic standpoint? The empirical evidence shows that for the most part, it does not"
Emirical evidence of a normative statement?
Oh my, you´re funny.
— posted 12/01/2011 at 12:37 by nemi
4 |
On regulation
"A proper sense of responsibility has to be enforced by legislation, as it was in the 1930s".
A similar process happened with the selling of manufactured goods, starting in the 19th century. Laws were passed that outlawed the use of poisons in foodstuffs (arsenic was used as a colorant in sweets), weights and measures laws prevented shopkeepers from cheating people by selling goods with inaccurate weighing scales and regulations were passed that prevent manufacturers from selling goods that might electrocute us. These are all cases of asymmetric information - we can't know what the baker puts in his bread and by the time we find out we may be dead.
Free market purists may argue that the market will always find such practices out in the end, but it can take a long time and a lot of damage can be caused in the meantime.
— posted 12/01/2011 at 13:51 by Steve Green
5 |
Raising inequality lowers economic growth
@ christopher Hartwell
"Does inequality even matter from an economic standpoint? The empirical evidence shows that for the most part, it does not"
What empirical evidence? Social mobility in USA and UK has been deteriorating just as their GINI coefficient has grown. The consumption of the bottom is flat out limited, not for a year or two but for a life time, ergo GDP growth is limited. The consumption of the top is also limited because they hoard their spare income and wealth, limiting their investments to achieve status protection. It's a new global feudal system, where by what used to be regional land has now extended to general rent producing mix of global assets.
— posted 12/01/2011 at 14:13 by Senjap
6 |
Actually, the empirical evidence shows that inequality does matter—a lot: http://www.amazon.com/Spirit-Level-Equality-Societies-Stronger/dp/1608193411/
— posted 12/01/2011 at 15:02 by Henry
7 |
In answer to Hartwell's comment on beneficial inequality, there are so many objective empirical studies that suggest much differently too many to name here. If there is one answer to all of the inequality in the US is the TBTF banking system since 1980 makes clear that the fraud and corruption bolstered by their ownership of Congress gave them the best influence money can buy.
— posted 12/01/2011 at 21:11 by Brian
8 |
Hartwell:

"So to say thing are accruing to that 1% is to make it sound like there's this oligarchy of rich - when in reality, people are moving up and down the ladder. There should be incentives to make that top 1%. Unfortunately, not everyone remains there. These two issues are crucial to understanding "inequality.""

In addition to the other problems, this has been covered by Krugman, and others. The USA is very, very low in OECD countries on social mobility. IIRC, the US is in a position know as 'thank God for the UK'.
— posted 12/02/2011 at 20:32 by Barry
9 |
Adjusted for size
The median family income was adjusted for size and the size has come down. That partly explains the stagnation of the median family income.
— posted 12/03/2011 at 14:11 by Matti Linnanvuori
10 |
Interesting perspective of "asymmetric information" and inequality but also narrow and misleading. The government should regulate public goods in accordance of the society basic values- even right wing agree of some type of health care and social benefits. The problem that America is clinging on an expired constitutions, a delusion that 300 years old right to bear arms is superior to the right to be healthy, educated or for dignity. If the free market can not make sure the efficiency of the health system (from the citizen perspective) the government should secure it. It is a superior right to many others - rewrite the bill of rights -- that's the solution.
— posted 12/05/2011 at 17:47 by Roy
11 |
US mobility is poor
Christopher Hartwell concedes that increasing US income inequality has not been offset by increasing income mobility. A careful review of the data (http://lanekenworthy.net/2011/03/08/inequality-and-mobility-at-the-top/) shows that income mobility has not increased; a recent analysis shows a slight decline (http://jaredbernsteinblog.com/income-mobility-a-warning/). And a lot of supposed mobility is the statistical anomaly that families close to an income boundary can cross it with very little change in income (http://krugman.blogs.nytimes.com/2011/11/03/millionaire-for-a-day/, http://jaredbernsteinblog.com/rep-ryan-reality-check/).

But Christopher Hartwell asserts that US mobility is greater than in any other European country. Since European countries experience less inequality, and less growth in inequality, than the US on various measures (click on Graphics at http://g-mond.parisschoolofeconomics.eu/topincomes/), this is improbable. One example: the correlation between a person's economic status and their parent's educational level is stronger in the US than in the 7 European countries in a sample (http://www.economicmobility.org/assets/pdfs/CRITA_FINAL.pdf).
— posted 12/05/2011 at 23:06 by Scott Weikart
12 |
Free markets are an illusion, a fetish perpetrated by the Republican party. The aura of this big lie displaces intelligent discussion of "what is a market, what makes is less or more free, free for whom, and to what purpose?" to the left side of the internet; the mainstream media treats "free markets" with the reverence of religious dogma. Witness free markets in health care, finance, fossil fuels. Health care has a market that would make the Politburo proud (yes, this is democracy... just ask Sarah Palin--- think death panels). It is dominated by insurance companies with no interest in competition, by high end, specialist physicians ("do no harm to my income") who are fixatws with selling the most expensive treatment at the highest volume, and by device manufacturers (think knee replacements and stents that give no improvement in quality of life) in collusion with the insurance companies (why provide a product that doesn't maximize profits?) Collusion? Think cherry picking patients and the fact that most $$$ are raked in from elderly patients in the last 6 months of life. Oligopoly or clepto-capitalism, take yer pick!
— posted 12/26/2011 at 01:48 by Don
13 |
Facts leading to pessimism
A Normal Relationship?
Poverty, Growth, and Inequality
J. Humberto Lopez and Luis Servén*
The World Bank

This paper, based on a sample of 100+ countries over 40+ years, i.e. on FACTS , shows that growth (in per capita income)is achieved at the cost of greater inequality Gini coeff., and the more so, the poorer is the populatin segment considered. Very sad , yet thir statistics is impeccable.Carlo Castelli
— posted 04/07/2012 at 15:26 by Carlo Castelli
14 |
To pretenders
I have to say, to the people "calling out" KA in a comments section on a web page. My money is on Professor Arrow. Just sayin.
— posted 05/31/2012 at 11:28 by Ethan
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About the Author

Kenneth Arrow is Professor of Economics and of Management Science and Engineering Emeritus at Stanford University.

Occupy the Future, a forum on lessons to be drawn from the Occupy movement.


   



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