The Ramble: Occupy Wall Street and the Hourglass Economy

Well, it looks like Occupy Wall Street (OWS) has pretty much been completely disbanded at this point, but the fact remains that a lot of people are concerned about rich people and the income distribution.  Here are some thoughts on the topic:

First off, what does the data say about income inequality?  Here's a chart from The World Top Incomes Database that shows the share of income held by the top 1% of earners in Australia, Canada, Germany, Japan, and the U.S. since 1915:

The two things you should really take away from this chart are (1) income inequality has been going up over the past 25 years in all of the developed world and (2) the U.S. has one of the most unequal distributions of developed countries.

Now, the first question you should ask yourself when you see data like this is: So what?  Do we really care if there is a more unequal distribution?  My capitalistic self says no, I couldn't care in the least!  (NB: I also have an equitable, behavioral self which does care, but I'm not listening to him right now!)  What I really care about is whether income is rising or falling absolutely, not relatively!  If the top income earners are making a bazillion more dollars, that's just fine with me as long as the middle- and low-income earners are earning more money as well.  And to me, that's the real problem.  Here's a chart of how income has changed over time for different percentiles of the income distribution (from Wikipedia).  Note that these numbers are adjusted for inflation:

As you can see, income has pretty much stagnated completely for those in the low end of the distribution, while it has taken off for those at the high end.  People at the 10th percentile of the income distribution are making no more today than they were 45 years ago!  Even those at the median haven't seen their incomes rise by much at all.

The question is, why is this happening?  Here are three possible theories:

1. Rich people are exploiting poor people by forcing them to take low wages, stealing money from companies by taking huge salaries, twisting the laws in their favor, and relying on government bailouts to back them up.
2. Individuals at the low end of the income distribution have made some major mistakes, and those mistakes are costing them.  Examples might include: buying houses that they can't really afford, failing to invest properly, etc.
3. The economic forces of technological change and globalization are causing the shift.

As with most theories, there is some truth to all of these, I think.  What we need to be careful of is when we become dogmatic about a single one, so that we're blind to the others.  In this case, I think that OWS has focused completely on #1, and has thus ignored the other two.  In my opinion, #3 is mainly to blame for the big changes in income inequality, while points 1 and 2 are only mere footnotes in comparison.  Let me try to de-bunk #1 and #2, and then I'll explain why #3 is the root of it.

Is Wall Street really the reason that the rich are getting richer?  The truth is that most rich people really don't work on Wall Street.  In fact, only about 14% of top income earners are in finance.  That's a significant portion, but not as high as many people probably think.  Executives (CEOs, CFOs, CIOs, etc.) make up close to a third of the 1%, and doctors make up nearly 16%.  Regardless, if you think that rich people are exploiting poor people, you would have to make several arguments:  First, you would have to tell me what changed in the early 1980s to make it possible for them to do this, since that's when we see inequality really start to rise.  Second, you would have to argue that this happened in many developed countries and not just in the U.S., because inequality is rising in a lot countries (as seen in the top graph).  Third, you would have to convince me that the market for top earners is not competitive.  That is, these CEOs and doctors and bankers are all making much more than they're actually worth, and companies for some reason are not able to hire them for less.  Do you think that Goldman Sachs would pay its hedge fund analysts $400k if it could get them for $200k?  Of course not!  Would shareholders and boards of directors pay their CEO 10x more than an equally good CEO?  Definitely not.  Fourth, you would have to show that rich people are somehow forcing poor people to accept low wages.  Why does Wal-Mart pay low wages?  Because people are willing to work for those wages!  If they weren't, Wal-Mart would pay more.  Wal-Mart is not holding a gun to these people's heads and making them work for peanuts.  Anyway, I think that making a strong case that includes all four of those arguments is going to be very tough to put together.  Are there cases in which rich people exploit poor people in some way?  Yes.  Are there enough of them to cause the kind of movements shown in the graphs above?  No.

So much for theory #1.  What about theory #2?  I actually think that this is a very important idea.  I believe that the poor get stuck in a trap whereby they keep making the same mistakes, making it difficult for them to climb the social ladder.  For example, if poor people always choose to play the lottery instead of saving a bit of money each month, at the end of their lives they'll likely find themselves substantially poorer than they otherwise would have been.  You can probably think of many more such examples.  Anyway, while I think this is a real and important issue, I don't know of anything that might have changed in the past 35 years to make the poor even more prone to these kinds of mistakes.  Do you?

What I really think is causing the changes is globalization and improvements in technology.  The basic idea is that technology and cheap foreign labor have made a lot of people who used to be middle-income earners uncompetitive, and so now they are low-income workers.  Let me explain this with a simple example.  Suppose John and Wayne are Pony Express riders in 1860.  They both earn, say, $1 for each message they transport 100 miles.  Let's suppose they can do 3 messages a week, so that they each earn about $150 per year.  The only difference between the two is that John went to school long enough to learn how to read, but Wayne did not.  What happens to the two when the first transcontinental telegraph line is erected in 1861?  Not many are willing to pay the Pony Express to deliver their messages anymore, since the telegraph is so much faster.  Wayne can only find enough work to deliver 2 messages a week, and wages drop to 50 cents per 100 miles.  His annual earnings fall to only $50 per year.  John, on the other hand, finds a job in a telegraph office, since he is one of the few around that can read.  He quickly learns Morse Code and is able to transmit messages.  Let's just suppose that the price of telegraph messages is the same as Pony Express--50 cents per 100 miles.  If the average message travels 200 miles, and if John can send just 2 messages a day, he earns $500 per year!

Do you see how the technological change also caused a shift in the income distribution?  It caused the income of well-educated John to rise dramatically, while uneducated Wayne's wages fell off a cliff.  I believe that this is essentially what has happened in our economy over the past 40-50 years or so.  We've seen incredible technological improvements.  Those who are replaced by the technology are much worse off because of it, but those who use the technology are much better off.  The difference is in how equipped we are to use the new technology that is developed.

Globalization has a very similar effect, except in this case there is a flood of cheap labor instead of new technology.  For example, if the only thing I'm good at is data entry, I'm in big trouble when my job gets outsourced to India.  But if I've been doing a lot of data entry as a part of my job as an accountant, I'm thrilled when I can send that work to India because I means I can focus on actually producing financial reports, which is what I really get paid for.

I'm a huge fan of technological progress and globalization.  I firmly believe that in the long run both of these things are good for everyone, and I really mean that.  But, we need to recognize that the transition periods can be very painful for those who are displaced.  Our problem in the U.S., and really across the developed world, is that we have not educated our workforce so that they can take advantage of globalization and technological progress.  The problem is not globalization or new inventions, it's education!  40 years ago, a high-school educated person could make a comfortable middle-class wage by working in a manufacturing factory.  Now, that person is competing against China, India, Singapore, Brazil, and robots, and that person is losing badly.  What we need are retraining programs, and changes to our educational system that allow us to keep apace with technology and globalization.

To sum up:  I can sympathize with OWS, but I think they're pretty misguided in their focus on the 1%.  Rich people are not to blame for the changes in income inequality!  The real problem is that we have not kept up with the world around us, and as a result many are getting left behind.  The key will be to fight the right battle.  Fighting the rich is not going to help.  You can't fight globalization or technological progress, because you'll lose, and you'll be shooting yourself in the foot in the process.  And don't even get me started about fighting big corporations.  No, the right battle to fight is the education battle.  That's where we have to focus our angst, effort, and hopes.

What do you think?  Is education really the problem?  If so, how can we fix it?  Let me know in the comments.