April 18, 2010
Trends in American Income Inequality Prior to the Recession
Trends in American Income Inequality Prior to the Recession-Becker
While median family income in the United States fell for over a decade prior to the beginning of the recession that started in late 2007, per capita incomes continued to grow during that time period. From 2000 to the beginning of 2008, American per capita GDP, after adjustment for inflation, grew at a decent pace at about 1 ½ percent per year. Per capita real consumption of both durables and non-durables, an important measure of the real incomes of individuals, also grew at a good rate until the recession. These measures suggest sizable improvements in the welfare of the average person during most of this decade, yet the median household income cited by Posner suggests the opposite. How can these conflicting conclusions be reconciled?
The data I cite are arithmetical averages, while, as Posner indicates, his data on household incomes are medians, or midpoints, of the distribution of household incomes. Trends in arithmetical average incomes and median household incomes have differed in the US for a variety of reasons. One obvious factor is changes in the degree of inequality in the distribution of earnings. Earnings inequality of full time workers did rise rapidly in the United States during the 1980s, and more slowly but significantly during the 1990s. However, inequality among different education and skill groups increased much more modestly during the first seven years of this decade than in the prior two decades.
As Posner indicates, incomes at the very high end, especially in the financial sector, did grow rapidly during the years leading up to the recession. That contributed in a modest way to the difference between the trends of average and median incomes. Other factors that helped raise inequality in median household incomes during the past 30 years include the growth in the number of households headed by a single parent to about 9% of all households. Also important has been the decline in the labor force participation of males at the lower end of the skill distribution, especially of African-American males, and the growth in earnings from the underground economy, due to illegal immigration, taxes, and regulations. Earnings from the underground economy are not included in most statistics on earnings. These and other factors explain why the number of Americans with incomes below the official poverty line seemed to increased by 15% between 2000-2006, and why by the end of 2008 over 30 million workers appeared to earn less than $10 per hour.
The best longer-term solution to the inequality problem is to reduce the fraction of Americans who dropout of high school, a theme I have continued to emphasize in various postings on our blog. This drop out fraction has been stagnant for the past several decades at about 30% for males, and a somewhat lower but still high percent for females. This is almost surely the highest fraction of high school dropouts among rich countries, and is heavily concentrated among children from African-Americans and Hispanic families. In large cities, often less than half of all the children enrolled in public schools end up graduating.
In the first half of the 20th century, dropping out of high school reduced economic prospects, but not by so much since many good jobs were available to persons with limited education. Prospects for high school drop outs began to fade after World War II, and really fell during the past 30 years because of technological changes toward greater demand for skilled workers, shifts of the economy toward health, education, and other services that use more skilled workers, and globalization that reduced jobs in America for low skilled workers. High school drop outs now face a dismal future not only in the form of low earnings, but also poor health, less likelihood of both marrying and staying married, and worse outcomes on practically all other aspects of life in the modern world.
Probably the most fundamental cause of the continuing high drop out rates has been the large deterioration in family stability during the past 50 years. This has led, among other things, to the growth of low-income single parent families that contain about ¼ of all young children, and to the absence of the influence of fathers on the discipline and motivation of children in these households. Family stability is difficult to improve, particularly in the shorter run (although see my blog post of April 4).
However, schools can be improved relatively quickly by holding teachers and administrators up to higher standards. President Bush took important steps in this direction, and President Obama has been adding to and improving these changes by requiring even better school performance. I addition, studies have shown that charter schools, vouchers, and other ways to raise competition among schools that cater to children from poorer families contribute in important ways to better achievement scores of these children. That is why the caps placed by many states and localities on the number of charter schools-mainly under pressure from teachers unions- should be removed, as some cities are doing.
In trying to use public policies to reduce inequality, the goal should be to achieve this without reducing the efficiency of the economy. When efficiency declines, incomes of poor as well as better off households tend to fall. The great attraction of reducing the high school drop out rate, and other improvements in the school performance of children from lower income and lower educated families, is that they are likely to increase the economy's efficiency while at the same time raising incomes at the lower end of the earnings distribution.
American Wage Stagnation—Posner
Between 1997 and 2008, median U.S. household income fell by 4 percent after adjustment for inflation. It presumably did not rise in 2009, and may not in 2010 either. A median is not an average; average income rose because the incomes of high earners rose, and so the effect was to increase the inequality of the income distribution.
Three factors appear to have contributed significantly to this trend. One is the continuing increase in the returns to IQ and education as the United States shifts to a highly automated economy; another was and is the historically unprecedented revenue of the finance industry during this period, much of it received by financial executives in the form of very high incomes; and third is the steep increase in premiums for employer-provided health insurance: the increase was almost 80 percent between 2000 and 2009. Much of this is nominally paid by the employer, but because it is a cost of labor it substitutes for wage increases and so holds wages down.
There is no reason to think these trends will not continue; and until unemployment falls to a normal level, it is hard to see what might work to overcome the trends if they do continue.
In considering the effect of wage stagnation and growing income inequality, it is important to distinguish between money income and standard of living. As long as the quality of goods and services increases (largely because of technological innovation in a broad sense that includes new business methods as well as scientific and engineering progress) faster than their cost, the standard of living will rise even if incomes do not. The quality of health care continues increasing rapidly, and part at least of the rapid rise in health insurance premiums is payment for that increased quality. The quality-adjusted cost of consumer electronics has plummeted in the same period.
But even if the standard of living has increased for most people whose incomes have not risen, or have even fallen, this would not alleviate the growing political problems that wage stagnation and the resulting increase in economic quality are likely to create, if they haven't done so already. People take for granted most improvements in goods and services, and do not consider the improvements to be full compensation for a flat or declining income. Then too liquidity constraints may exclude people from access to many of the improvements; this is a problem for many people who cannot afford health insurance.
Economic anxiety arising from wage stagnation was masked until the fall of 2008 by the Federal Reserve's low interest rate policies; people could borrow cheaply to maintain and even increase their consumption. Now they realize they are overindebted and cannot continue to support consumption by borrowing.
Economic anxiety can produce dire economic consequences by increasing the demand for trade protection, for restrictions on immigration, for union protections, for other anticompetitive measures, and for government subsidies; it can also create class resentment, and thus lead to inefficient regulatory policies, as we may be seeing with proposals to "rein in" the "greedy" banks. One reason I continue to believe that what we have gone through in the last two years is a depression and not a mere recession is that it has raised economic anxiety to a politically dangerous peak. I regard the "tea party" movement as rooted in a widespread sense (not limited to those who identify with the movement) that something is seriously wrong with the country.
My analysis suggests that measures to reduce income inequality, especially measures that raise the median household income (as distinct from reducing inequality by leveling down the incomes of the well off, which would have serious disincentive effects), could increase economic efficiency by reducing political pressures for inefficient policies. That was the rationale for "socialist measures," beginning with Bismarck, designed to secure capitalism against communism and other radical political ideologies. And the measures worked!
The problem is that the social safety net has become too expensive to be expanded further without jeopardizing the nation's solvency, given our huge and growing public debt. The only measures that would address wage stagnation without increasing our public indebtedness further would be subsidies that could be realistically defended as profitable investments in human capital (such as public subvention of college tuition), and essentially costless regulatory changes such as eliminating the tax subsidy for employer-provided health benefits, eliminating or at least reducing many other tax subsidies, instituting means testing for Medicare and Social Security benefits, relaxing certain safety and environmental laws to reduce costs to businesses, weakening teachers' unions and other public employee unions and reducing the number of public employees, further privatization of public services, reducing tariff barriers, and allowing greater immigration of highly skilled workers.