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Inequality in America

by Brad Setser
April 20, 2008

Unions in the American manufacturing sector used to have the bargaining power to secure a middle class wage for their members. Not any more. And no one else – apart from corporate CEOs, hedge fund managers and star athletes – seems to have all that much bargaining power either.

The chart that accompanies Justin Lahart and Kelly Evan’s report on voter angst in Pennsylvania is worth the price of the Saturday Wall Street Journal. It isn’t (yet?) available online; for some reason it isn’t part of the graphics package that accompanies the online story. It shows the enormous gulf between the income of the top 0.1% of the income distribution and the rest of the population. It also shows that family income, adjusted for inflation, has fallen by 4% for the bottom 90% of the population while rising 22.2% among the top .01% (all parts of the top one percent saw income gains greater than 5%, but the gains were biggest at the top. The graphic I liked is based on the Piketty/ Saez data, and the income calculations exclude capital gains.

UPDATE: the key graph can be found here; hat tip to an anonymous contributor.

I am not sure than Makiw’s explanation – a fall-off in educational achievement and slower growth in the supply of highly-skilled workers – is a sufficient. The top 5% of the American families are all reasonably well-educated. But even among the 5%, almost all the income gains have been concentrated at the top. A fall-off in educational achievement can perhaps explain why the real income of the top 10% of American families is rising (a bit) while the income of the bottom 90% isn’t. But it cannot explain increasingly inequality among those at the top.

It isn’t that hard to see why so many Americans think the US is on the wrong track. Most Americans didn’t benefit from the expansion of the past few years. And now the economy isn’t expanding.

It also isn’t hard to see why public support for “trade” has eroded dramatically, despite the Bush Administration’s ongoing rhetorical critique of “economic isolationism.”

The Doha round has stalled. Trade hasn’t. China’s exports increased from under $250 billion in 2000 to $1220 billion in 2008. It isn’t clear that increased trade with low-wage countries has contributed to lower wages for less-skilled workers in the US. Krugman didn’t find a strong link. But increased access to cheap goods clearly didn’t keep family income – adjusted for inflation and excluding capital gains — from falling for 90% of American families. The impact of globalization on prices isn’t all that clear: competition for oil has pushed its price up. Cheap oil was a big part of the post-war American lifestyle. Cheap financing from the rest of the world did make it easier for Americans to make up for falling wages by borrowing against their homes. That strategy was never sustainable, and it has clearly run its course.

If the gains from trade — for reasons that are hard to pin down — are not broadly shared, then building support for trade requires much bigger policy changes than many, including many in those income strata that have benefited the most from the recent expansion, are prepared to contemplate. Kenneth Scheve and Matthew Slaughter have this right.

Update: Christian Broda has sent me his most recent paper (with John Romalis) arguing that real income for the poor has gone up by more than it seems because the price of the goods that rich households consume (organic milk, German luxury cars) has gone up by more than the price of the goods that poor households consume. And since Chinese made goods account for a larger share of the goods (low-quality non-durable goods) that poor households consume, imports from China are a big reason for the increase in the living standards of poorer households.

It is an interesting argument, but I am not completely persuaded.

1/ Low-income Americans consume more goods that are made in China (i.e. shop at Walmart), but they also are employed more in sectors that produce goods that compete with goods made in China (there is a paper on this that I need to dig up), or in sectors where the equilibrium wage has been held down by the contraction in the US manufacturing sector (which is at least partially related to the rise in the goods trade deficit). While China initially produced goods that didn’t overlap with much production in the US, that is changing. Auto parts and household furniture are two examples. Even computer assembly — some companies still do final assembly in the US. This is partially captured in the study (which compares Chinese production over time) but it presumably is having a bigger impact more recently, as the volume of Chinese production and the technical sophisticated/ capital-intensity of Chinese exports have increased. My sense is that the “deepening” of Chinese production intensified in 2006 and 2007 (until 2004, Chinese imports and exports grew together, as China imported to export; after 2004 not so much).

2/ China also pushes up the price of the goods that it imports. Think oil. And increasingly think food. China doesn’t have to buy from the US to increase global prices. Much of the increase in the price of these goods has come after 2005 — the last data point in the survey. The rise in the price of food presumably has a bigger impact on low-income Americans.

3/ China imports a lot more debt from the US than it imports goods. The biggest winners from China’s imports of debt (US exports of bonds) are likely to be wealthier US households. Falling interest rates pushed up the price of homes. Home prices are now falling, but they aren’t back to where they were in say 2001, just before China became a big buyer of US debt. That delivered a windfall to existing home owners (while creating problems for those who took on too much debt to buy homes at the peak of the boom). Chinese demand for Treasuries also made it possible to cut taxes and run up the US government’s debt without driving up interest rates (and driving down asset prices). With a reasonably progressive tax structure, that helps those at the top more than those at the bottom. Looking only at trade in goods understates China’s impact on the US, because it ignores the now very large (and one-sided) trade in financial assets.

I am not sure that China has had a huge impact on the US income distribution, one way or the other. It may be that China had a bigger impact on prices for the basket of goods that lower-income households consume than it had on wages — directly, and indirectly, through reductions in workers bargaining power in manufacturing sectors exposed to Chinese competition — for those households. The overall effects are complex, because they offset. I am fairly confident that China isn’t going to just produce low-quality durables for much longer.

34 Comments

  • Posted by Duric Aljosa

    Then:

    Hitler’s fervent wish and vision – a Europe united.

    Through one encroachment after another, the independence of the Reichsbank was repudiated.It was made subject to the instructions of the state.

    Now:

    Gordon Brown: "For the first time in human history we have the opportunity to come together around a global covenant to reframe the international architecture and build the truly global society."

    7-year plan aligns U.S. with Europe’s economy

    Where is the difference?

    The most important thing: "Central Bank Independence".

    Inequality – So, Where is the Resistance?

    Or better:

    Why there is no organized resistance?

    USA vs John Lennon

    Are You Smarter Than A Chimp?

    20th-century history college students are missing

    You Tube Are Americans Stupid

    Best regards.

  • Posted by Stormy

    Do you have the link to any studies Krugman has done on this subject?

  • Posted by Guest
  • Posted by Twofish

    What is politically relevant is that American incomes started stagnanting in the late-1990′s, but personal wealth continued to increase because the housing bubble allowed people to continue to pull wealth from their houses. That stopped last year, and what happens next is going to be very, very interesting…..

    One thing that probably won’t work are calls to increase trade tariffs. One think about people at the top 10% is that everyone’s jobs depends on the global economy in a pretty obvious way, so even if you have a software developer whose income is stagnant, I don’t think that you can convince him that cutting trade is going to help him any. It’s interesting that while there isn’t any major call for new trade deals, there aren’t also calls for protectionist measures, and in any case increased tariffs and RMB revaluation aren’t going to stop the internet and technology.

    One story…..

    I went over to a co-workers workstation the other day, and we were trying to fix a problem. The mouse on his workstation seemed a little slow, and I asked him if he had some program running in the background. Turns out that the reason that the computer seemed a little slow is that the mouse and the keyboard were actually connected to a computer in Asia.

    Freaky…. Someone in the United States can work on a spreadsheet in Asia and vice versa…..

  • Posted by Twofish

    I do think that education plays a huge factor, along with the fact that the elite tend to send their kids to the same schools. It’s not what you learn at Harvard that is as important as who you meet. One that that happened in the 1950′s and 1960′s was a massive expansion in public education, which seems to have stalled.

  • Posted by Twofish

    One other question is whether these statistics take into account the "escalator effect". How are people who enter the workforce either as students or as immigrants counted? The other question is how are retirees counted? Also how much of this is cyclical?

  • Posted by bsetser

    Stormy — see this week’s economist, or follow this link:

    http://www.princeton.edu/~pkrugman/pk-bpea-draft.pdf

    Guest — huge thanks.,

    2fish — I suspect that the piketty/saez data is a cross section at any given point at time, so it doesn’t look at mobility between different parts of the income distribution. that said, the data on mobility for the us doesn’t tell all that encouraging a story from what I remember. mobility in the us is now lower than in a lot of european societies, which, i suspect is a big change from say the nineteenth century.

  • Posted by algernon

    While not altogether countering the thrust of the argument, I bet that 2001-2007 would look noticeably different than 2000-2006. 2000 was after all the peak of an extreme bubble. And market forces are even now countering the top heavy distribution as transportation costs & import prices increase make local labor more attractive.

    Having said that, I have to like George Will’s suggestion that management of any companies getting gov’t or Fed bailouts should have a pay ceiling equal to top civil service pay of ~$175,000 by law.

  • Posted by bsetser

    algeron — i suspect that 01 -07 (note that the 07 data isn’t available) would show a bitter % increase in the share of the income going to the top 1%/ top 0.1% — b/c, as you note, 00 was influenced by the .com era. 01 -08 might be different … I am not sure that the forces that you identified pushing for more equality are strong enough to have made much of a dent. the employment situation is getting worse for cyclical reasons, offsetting any "buy local" effect from higher transport costs.

  • Posted by Guest

    I recommend everyone watch this documentary.

    Brad you should see it.

    I.O.U.S.A.(2008)

    http://www.imdb.com/title/tt0963807/

  • Posted by Judy Yeo

    This is just pure guesswork but could widening inequality amongst the top 5% be an indication that just as the middle class is being squeezed out /into the upper class and lower class respectively, the top is readjusting to form tiers , the lower ones becoming collectively replacements for the middle class. Wasn’t class mobility a subject which was the focus of a Time magazine study some years ago? The results are pretty much the same

  • Posted by NICOLAS

    In fact the transferal of wealth from west to east is historic. Transferring the industrial base to expand capitalism and maybe some democracy. Keeping rates low

    so the consumer rather than save, spent every penny and subsequent bubbles bursting.

  • Posted by Twofish

    algenon: Having said that, I have to like George Will’s suggestion that management of any companies getting gov’t or Fed bailouts should have a pay ceiling equal to top civil service pay of ~$175,000 by law.

    They tried something like that with the Bear-Stearns bailout and it worked badly. The extremely low share price of $2/share was mandated by the Fed to punish upper management. The trouble is that with such a low offer price, other investment banks started very easily picking off the staff of Bear-Stearns, and so they had to raise the offer price to $10/share in order so that they didn’t end up with an empty building.

    Also, the big money in financial services is in bonuses. By the time the bailout happens, the bonuses have already been paid. Also, it can be argued that the salaries of government bureaucrats is too low. If I’m not mistaken the SEC and the Federal Reserve aren’t subject to civil service caps, and it’s a very good thing that they aren’t since you don’t want regulators making much less money than the people they regulate.

    One other thing that is striking is that poll that said that while 80% of the people said that the US was going in the wrong direction, 70% of those polled said that their financial situation was good or very good.

  • Posted by Guest

    Freaky…. Someone in the United States can work on a spreadsheet in Asia and vice versa…..

    it’s not freaky, it’s probably telnet/SSH (which has been around for years/decades) usually implemented by citrix if it’s in a corporate enviro (altho it’d been cooler if was thru 9P/styx — mostly a research protocol)

  • Posted by DC

    As Warren Buffet previously stated, if the entire US Economy was growing at a 4% GDP, it is not possible for the S&P 500 index to grow at a much higher rate over the long term. Granted that foreign economies are growing faster, but 70-80% of revenue and earnings of the S&P 500 corporations remains US domestic. Furthermore, foreign markets in strategic economic sectors are protected by respective governments. For instance, state-owned Petrobras of Brazil controls 95% of Brazilian energy production. Mexico’s energy assets are completely off-limits. AT&T was denied a telecom phone license for Shanghai by China’s Ministry of Information Industry. Guess what, the Chinese government majority owns China Mobile telecommunications, China Telecom, and China Unicom. The Washington Consensus would love to have foreign government privatize their strategic assets to US Corporations, but even in Iraq controlled by the US military, it isn’t going to happen anytime soon due to intense resistance from the population. But the one thing America can learn from China is to build up the domestic industrial economy, and stop interfering in foreign affairs of other civilizations which the US ultimately doesn’t have any control over anyway.

  • Posted by Guest

    um, like you could do that thru your iPhone/Eee/N810, i.e. anywhere…

  • Posted by Guest

    It is kind of amazing that nowadays USA actually is very hierarchical class society with little social mobility upwards.

    Working class guy with little money and living in EU has today better chances of getting rich than in the US. That is mainly because of better access to good quality and cheap job education.

  • Posted by Guest

    China is exchanging its depreciating reserves of US dollars for things of value, notably rice, with frightening consequences for dependent countries, and deadly consequences for American foreign policy.

    The chart below shows the price of 100 pounds of rice against the euro’s parity against the US dollar during the past 12 months. The regression fit is 90%. There is an even tighter relationship between the price of rice and the price of oil, another store of value against dollar depreciation.

    Reduced to essentials, America’s foreign policy sought two unattainable objectives: to stabilize the Middle East and destabilize China. Washington hoped to put China in its place over the Tibetan affair. The George W Bush administration might as well have used the State Department as a set for the Jackass reality show. American arrogance has eroded the ground under many of the governments on which its foreign policy depends.

    http://www.atimes.com/atimes/Global_Economy/JD22Dj01.html

  • Posted by Guest

    China, India, Russia and the Middle East for the first time will consume more crude oil than the U.S., burning 20.67 million barrels a day this year, an increase of 4.4 percent, according to the International Energy Agency in Paris. U.S. demand will contract 2 percent to 20.38 million barrels daily, the IEA says.

    Economic growth of more than 8 percent in China and India, coupled with increasing car ownership among the countries’ combined populations of 2.45 billion people, will more than compensate for falling U.S. demand. Oil use worldwide will increase 2 percent this year because of growth in emerging markets, the Paris-based IEA says.

    “Does the U.S. matter anymore?” said Mike Wittner, head of oil research at Societe Generale SA in London. “Has the U.S. mattered for the last few years? It is debatable. As far as the oil market is concerned, demand growth is going to be continued to be driven by China and the Middle East

    http://www.bloomberg.com/apps/news?pid=20601109&sid=a_YCEx7do3LQ&refer=home

  • Posted by Anonymous

    I was wondering if you think the fact that the graph’s data starts in 2000, a time of extremely low unemployment which has since gotten worse, has any effect on the bottom 90%. And whether the shape of the graph would be much different if it start in the mid 90s?

  • Posted by Twofish

    Guest: it’s not freaky, it’s probably telnet/SSH (which has been around for years/decades)

    Actually it was Microsoft Remote Desktop, but it could have been tightvnc. telnet/SSH has been around for years/decades, but it takes a while for things to go from the lab to the market and then some time for things in the market to have sociological impact.

    Guest: um, like you could do that thru your iPhone/Eee/N810, i.e. anywhere…

    Precisely, and the fact anyone can access a computer half way around the world from a cell phone means that it really doesn’t matter what Congress does with trade rules when it comes to globalization.

  • Posted by mheck82

    guest,

    The asia times article is badly researched. As Paul Krugman puts it in his column today, there is no sign that rice or oil are bought as store of value. Inventory would have to go up then, and this is not happening. People are buying rice and oil because they want to eat, heat and drive cars.

  • Posted by Guest

    so why is it freaky? what freaks you out about it?

  • Posted by Guest

    it’s not like the "sociological impact" isn’t already well-documented…

    "Communications tools don’t get socially interesting until they get technologically boring" http://arstechnica.com/articles/culture/book-review-2008-04-1.ars/

  • Posted by bsetser

    anonymous –

    table 1 of piketty and saez (link above) answers your question well:

    http://elsa.berkeley.edu/%7Esaez/saez-UStopincomes-2006prel.pdf

    for the bottom 99% (i.e. most of us), the clinton expansion produced larger income gains than the bush expansion. that data strips out the 01-02 recession. much as I prefer clinton’s economic policies to bush’s economic policies, i am not sure policies explain everything. something changed.

    incidentally, the increase in the income going to the top 1% started in clinton and continued under bush; the main difference is that there was better income growth for all in the clinton years/

  • Posted by Guest

    Alan Greenspan, the Ayn Rand loving currency assassin, once bragged during the go-go 1980′s that the American economy, as measured by the weight of cargo going out of the country was becoming ‘lighter.’ Who needs manufacturing, right? This weightlessness he reasoned was proof of the ‘New Economy.’ There was growth without inflation because of a new economic paradigm shifting America to a new permanent state of electronic Goldilocks. Greenspan wrongly thought that ‘financial services’ could permanently replace manufacturing in America. Imagine a nation of 100 million stock brokers trying to sell stocks and bonds to each other.

    Americans think their financial collapse is going to take the whole world down with them. No way. Aside from the world benefiting from a bankrupt America that can no longer bomb people for sport and oil, the other major benefit of an evaporated U.S. is the removal of the globe’s no. 1 waste producer. The U.S. has only 4.5% of the world’s population yet generates 25% of its garbage. And Americans themselves might benefit too. As the price of food skyrockets America’s obesity problems should dissipate. Greenspan will write a new book; "From Turbulence to Starvation: Lose Weight and Money at the Same Time." The rest of world (the parts of it the U.S. isn’t bombing-for-dollars) doesn’t see any risk in a collapsed U.S. America as the brand that is America just isn’t cool any more.

    http://www.huffingtonpost.com/max-keiser/us-dollar-euthanasia-whil_b_97371.html

  • Posted by Guest

    To protect the lower-skilled inhabitants of rich countries, and prevent intolerable social strains through Latin American-style income differentials within society, it is thus necessary to restrict immigration. The barber in Boston makes ten times the wage of the barber providing an identical service in Lagos; it is appropriate that he should. Fantasizing that the low-skill worker should get an education making him superior to his immigrant competitor is Neo-liberal elitist nonsense; if he’d been able to get into Harvard he would have gone there, while further years of drudgery at a community college are not going to provide him with any significant extra competitive ability.

    At the high skill level, the much lamented shortage of US engineers and surplus of lawyers is almost entirely due to the H1B visa system, which allows in competitors to graduate engineers, driving down their wages, while preventing easy qualification by foreign graduate lawyers, giving domestic lawyers a protected position.

    http://www.prudentbear.com/index.php/BearsLairHome

  • Posted by Guest

    OPEC President de facto admits to pegging Oil price to the Euro so when the US Dollar devalues, the Oil price increases. How simple is that?

    http://news.yahoo.com/s/afp/20080420/bs_afp/worldenergyoiloutputopec_080420203355;_ylt=AmY0LBS22uWAmC6wx8sVKTGmOrgF

    OPEC President Khelil, for his part, said the falling value of the US dollar was responsible for the surge in prices.

    "When the dollar loses one percent, the price of a barrel of oil rises by four dollars," he said.

  • Posted by Stormy

    "How can we quantify the actual effect of rising trade on wages? The answer, given the current state of the data, is that we can’t. As I’ve said, it’s likely that the rapid growth of trade since the early 1990s has had significant distributional effects. To put numbers to these effects, however, we need a much better understanding of the increasingly fine-grained nature of international specialization and trade."–Krugman

    The conclusion of the Krugman study. While he looks at wages, he does not look at jobs–or how the job market has been redistributed. Looking at the remaining manufacturing jobs may not answer the question.

  • Posted by Guest

    "My big gripe with economic predictions over the past five years, is that forecasters use the old closed economy simplifications that worked when the US was a unique capitalist economy, and international trade flows did not affect the total picture much… Today, I don’t try to analyze the US economy as a whole. I look at its sectors and try to analyze them in a global context… It is much richer to look at the sectors of the US economy, and look at them separately. They have varying exposure to the US and Global economies…" http://alephblog.com/?p=652

  • Posted by Farrar

    "But the one thing America can learn from China is to build up the domestic industrial economy, and stop interfering in foreign affairs of other civilizations which the US ultimately doesn’t have any control over anyway."

    Right on, Dave! I wouldn’t be surprised if you had a near majority of Americans with you on that one.

  • Posted by Guest

    Actually it was Microsoft Remote Desktop

    that’s why it was so slow

  • Posted by Guest

    The time is fast approaching when "conservative" will be a term of abuse, not praise. And when "socialist" ideas of income redistribution will be revived. I look forward to steep increases in taxes on the "rich" and more redistribution programs for the poor. The age of conservatism will to an end in the near future, in my view.

  • Posted by Guest

    Right on Dave, and continue to debase the dollar, driving up the cost of commodities and transportation costs, when coupled with taxes, greater investment in technical and vocational education, and government supports/subsidies for strategic industries would enable the US to top an overly mercantilist China. Why not simply put import taxes on every import that did not go toward developing the US’s productive capacity. Right on….For once we agree.