The Rich and the Rest

A recent issue of the Economist carried a 14-page special report on inequality. The Atlantic Monthly had a cover story titled The Rise of the New Global Elite. The issue at hand is the sharply rising inequality of the past few decades, particularly in the United States. According to numbers from the Congressional Budget Office the picture is pretty bleak. The share of the bottom 80% of the population has shrunk from 55% in 1979 to 45% in 2006. In the same period, the share of the top 10% of earners increased from 31% to 42% while the top 1% earners more than doubled their share from 9% to 19%. To be fair the financial meltdown saw a huge decline in the incomes of the top earners but that is an old story now. Corporate profits have rebounded smartly and so have bonuses. With wages still down and unemployment hovering at 10% (if one includes people who have given up looking for a job its a staggering 17%) its a fair bet that the share of the wealthiest percentile has crossed the 20% mark.

The previous peak of the share of the richest 1% was at the end of the last Gilded age in 1929 when it 17.2%. From that peak it declined to 12.3% in 1941 and 9.6% in 1946. It hovered in the neighbourhood until 1982 and from there on has followed the stock market booms and busts. The mid 1980s commodities boom pushed it up to 14% in 1986 followed by a sharp drop to 11% the next year as that bubble burst. Then it climbed through the 90s as the tech mania gathered pace to finally cross the previous peak and hit 17.8% in the year 2000. After a sharp decline during the post tech bubble recession, it roared back to the aforementioned 19% at the peak of the business cycle before the banks blew themselves up. 

 [Update: Actually, the CBO numbers don’t include capital gains. As the very kosher numbers from the Top Income Database show, the 1928 peak of the income share of the top 1% was 24%, fell all the way to 8.9% in 1976, and was back up at 24% in 2007. Its 2011 now, and with the robust growth in GDP after the recession ended in June 2009, the share of the highest earning percentile is more or less a quarter of all income: 25%]

Note that all this time the economy has been growing at a robust pace. As these CBO numbers show, while the average income of the poorest fifth has barely increased from $16,200 in 1979 to $17,200 in 2006, real incomes at the top 1% have more than trebled from $534,800 to $1,743,700. Similar numbers hold for the bottom 80%. For instance, the 4th quintile saw a rise of a measly 25% in 28 years. In effect, almost all the gains from increased productivity in the past three decades have been captured by those at the top.

Here is a chart for real family income growth by quintile during 1947-73:

And here is the Great Divergence: Real family income growth by quintile during 1973-2000.

Now these numbers are 11 years out of date and do not capture the most energetic gains made by the rich in the past decade. In particular, they do not capture the increasing inequality among the rich. According to the Federal Reserve Board Survey of Consumer Finance, between 1995 and 2004 the number of Americans with a net worth exceeding one million jumped from 3.77 million to more than 9 million. Most of these households are salaried managers and professionals with most of their wealth tied to their primary residence. Growth in the number of high-networth individuals (HNI), those with wealth excluding the value of primary residence exceeding one million, has been sharper. The number of deca-millionaires increased from 66,000 in 1983 to 345,000 in 2004. There were just 13 billionaires in the United States when Forbes started compiling their list in 1982. By now having a billion dollars doesn’t even get you into the Forbes 400 list of the richest Americans. Top CEOs and bankers making tens of millions a year used to be a big story. Nowadays, top hedge-fund managers rake in billions.

What we are witnessing is in fact the greatest wealth boom in the history of the United States.

Another major theme is the rise of the cognitive elite. Ever since the publication of the Bell Curve in 1994, it has been well understood that the returns to cognitive ability have been rising throughout the modern period. Despite a lot of brouhaha from liberals at first, the central thesis of this seminal work is now accepted across the board: above and beyond the rising returns to education, the returns to innate mental ability have been rising. IQ differentials are increasingly positively correlated with differentials in income and wealth. The Economist worries about “Assortative Mating”, highly educated men are much more likely to marry highly educated women than they were a generation ago, with potential political implications.

So we need to answer related but distinct questions. Why has there been an increased concentration of wealth and income at the top? Why are we observing increasing income differentials, and what explains the fact that inequality is increasing fastest at the top of the food chain?


A lot of authors have tackled the first and most obvious question. A particularly insightful one was Kevin Phillips, whose book Wealth and Democracy explores this in a broader historical account of Gilded ages of earlier eras. Another was Robert B. Reich and his terribly named Supercapitalism.

Reich’s essential argument is that the computer, telecommunications and transportation revolutions altered the underlying economic fundamentals of the post-war economy. The consequent decline in the bargaining power of labor coupled with increasing financialization of almost all the dynamic sectors of the US economy tipped the scales towards executives and financiers. In essence, the political economy equilibrium shifted as a result of technological change.

Many commentators have argued that the business friendly policies pursued by Washington: deregulation, lower taxes, and corporate welfare generally played a major part. This is a popular position among coastal liberal elites like Paul Krugman. Noam Chomsky and other serious Marxist thinkers argue that there was a concerted attack on labor by Business, and that is what caused the decline of the unions and subsequent stagnation in working class incomes.

Kevin Phillips sees this as nothing new: every major technological revolution heralds a new Gilded age. He sees the constellation of finance, technology and large corporations as the key drivers of concentrated wealth and increased inequality. In the United States, this was manifest in two earlier periods of great wealth creation and rising inequality: 1890-1906 and the 1920s. Both saw new technologies, stock market booms and the emergence of corporate giants. More ominously, Phillips sees parallels with former empires of Spain, Holland and Britain who went through similar periods of commercial/industrial expansions, financialization and decline.

One serious omission in my reading list is Edward N. Wolff, an economist at NYU who specializes in economic inequality. Unfortunately, his book Top Heavy is only available in a dead tree format.

The most interesting reading turned out to be a leaked internal report by analysts at Citigroup. (Click on this link, its a very short and extremely interesting report). Barely able to suppress their glee, they also explain the rise of the plutonomies to be driven by a combination of technology and pro-wealth policies.

I explored much of this phenomenon is a previous post so let me just summarize here. The increasing concentration of wealth and income has been driven largely by the technological revolution and the increasing bargaining power of capital at the expense of labor. All major industries are now characterized by global supply chains. Capital has become increasingly mobile and investors chase returns globally. This has strengthened the bargaining power of bankers, private equity moguls and money managers whilst increasing the rewards to the most brutal CEOs and top corporate executives, and depressing working class wages. I think it makes more sense to see business friendly policies in Washington as a response to the increasing bargaining power of Capital–not a cause, but an effect of the changed economic fundamentals.


Coming to the second question: why are we seeing rising income differentials and not just a two-tier stratification which the Reich thesis would imply?

To answer this question we need to distinguish between those who earn their income from salaried work and those who make most of their money from ownership of capital. For the latter, note that business equity is highly concentrated: the richest 1% of Americans control 62% of it. As the returns to capital have increased at the expense of labor, this section has taken off. And as you go up the income and wealth ladder, the proportion and concentration of business ownership increases sharply. The extremely rich also have more investment options than the merely rich. Only people with investible assets in excess of $10 million are permitted to invest in hedge funds and private equity. JP Morgan requires a minimum of $25 million for private banking and at Citigroup only clients with $100 million or more get into its Private Capital Partners Group. The extremely wealthy have access to lucrative opportunities like buying a share in Facebook from Goldman Sachs before its IPO. The billionaires have holdings of an entire portfolio of companies. Much of this has been driven by financialization, deregulation and the creation of the highly profitable and unregulated alternative asset management industry.

What about the salaried? Here we must distinguish between the CEOs and the rest. From the political economy of CEO compensation to tournament models, the compensation of CEOs has been the subject of much analysis. All of them provide some insight but the larger driving force of this phenomenon is clearly the aforementioned process of financialization and globalization.

Increasing differentiation on the second rung is being driven by a different process. The best explanation of this comes from the theory of asymmetric information and signaling games. As the costs of obtaining information have declined and schools have become more meritocratic and competitive the separating equilibria have become more ‘separate’. For example, admission to Harvard has become much more meritocratic than before so that a potential employer’s estimate of a graduate’s ability has increased. This phenomenon is not just restricted to school hirings. Beginning at GE, corporations have increasingly come to rely on objective metrics to evaluate their employees. This has led to a finer and wider gradation in compensation practices. Also, as the focus on the bottom line has sharpened and decision making has deepened in the technostructure the bargaining power of high-impact, highly skilled workers has increased. This is what is driving the effects captured in the Bell curve.

So, what can be done about all this?

According to the Economist and the Atlantic, there is not much to be done at all. Both appeal to the global elite to be more generous and make the system more equitable. They think that the way to curb inequality is to lift the bottom, not pull down the top. Matt Taibbi calls this ‘worshipping at the Altar of the Economic Producer’. Of course, I didn’t expect anything else from the Economist but in my naivete I expected more from the Atlantic Monthly.

There is plenty that can be done about all this. One obvious policy recommendation is to increase the number of tax brackets: why should the dentist earning $200,000 and the banker making $68 million face the same marginal tax rate? That is just ridiculous. Another prescription is to close the carried interest and hedge fund fees tax loophole. John Paulson pays 15% on his $4 billion income while his secretary pays 30%. This is absurd. Another obvious one is to curtail the political power of capital – its absurd to allow corporations to spend unlimited amount of money in political campaigns. A more serious proposal would be to negotiate an international tax agreement on capital. Without international coordination, any country imposing higher taxation on capital fears immediate capital flight.

The same kind of international cooperation is required on the labor front. Labor market flexibility, so beloved of the economists, has been tried and found wanting. The German model has clearly proven to be superior. There needs to be an international effort to impose collective bargaining agreements across the board. Strengthening unions and collective bargaining would strengthen democracy in the United States. Even though German GDP contracted by 4%, the unemployment rate did not rise, as opposed to the United States and Britain where it stayed over 10% for years. This was the result of collective bargaining agreements between industrial unions and business owners that enabled businesses to cut hours and total payroll spending in lean times, instead of slashing the workforce and laying off workers.

Even more significant would be to reduce corporate welfare. Just killing the farm subsidies ($100 billion), giveaways to the healthcare industry ($80 billion) and cutting the supermassive gravy train of the Pentagon ($700 billion) would be enough to fund progressive initiatives in healthcare, schools, college tuition support, unemployment insurance, worker retraining, green technology and infrastructure, and cutting the federal deficit. It might be impossible to control rising inequality but it can be made more palatable by eliminating corporate welfare and creating a more level playing field.

So there are plenty of options and policy levers. But don’t hold your breath. All of the above is not just not going to happen, its going to get worse. Anyone who predicts otherwise is completely tuned out of Washington politics and the current phase of late capitalism. American democracy is broken and its population isolated. Let me end by quoting Matt Taibbi again:

“[There is] an extremely unfortunate loophole in the system of Western democratic capitalism, which never foresaw that in a society governed passively by free markets and free elections, organized greed always defeats disorganized democracy.”


17 thoughts on “The Rich and the Rest

  1. Perhaps it would be nice to write a post exploring why increasing inequality is a bad thing. I am convinced that it is increasing, but why I should care or be upset? hmmm

    I would also be somewhat interested (not taking it seriously as these indexes are somewhat dubious in the first place) in seeing the correlation between say the Gini index and one of these Economic Freedom indexes (like say the heritage index). I guess I could do that now that I stole a copy of excel, but I am lazy and you seem ambitious with this new blog.

    I do agree though that those subsidies are ridiculous though.

    “[There is] an extremely unfortunate loophole in the system of Western democratic capitalism, which never foresaw that in a society governed passively by free markets and free elections, organized greed always defeats disorganized democracy.”

    That is a very important observation and it is exactly why I dislike large government involvement, namely that it is intrinsically highly corruptible.

    1. So GDP per employed person has increased (in constant 2005 dollars) from $56,155 to $80,222 between 1973 and 2000 according to the Labor dept:

      As is clear from the second graph, almost all of these gains in productivity have been captured by those at the top. So clearly this is not just about inequality. While workers are becoming more productive they are not seeing any increase in their real incomes. Even libertarians would appreciate the disconnect here. Presumably you would say a distribution is more or less fair if everyone earns their marginal contribution to at least a first approximation. We are very far from that libertarian ideal and even further from the liberal ideal of an even more equitable distribution.

      1. How do you define/justify ‘marginal contribution’ it sounds like a dressed up way of saying ‘labor theory of value.’

        I don’t presuppose a platonic ‘just distribution.’ I also shy away from arguments that there is one. Macroeconomics is hardly a science, I trust very little to their ‘theories.’ But perhaps you can change my mind?

        The only theory of value that has ever made sense to me is: ‘a thing is worth what you can get for it’

  2. Also of interest was the state of the union address. Listen to the tone that Obama takes when talking about being ‘pro-business.’ It is very us vs. them.

    This is really an insane way to look at things, rich trade partners enrich you. Maybe Nintendo screwed over a couple hundred programmers in the 90’s, but it enriched the lives of many many more.

    It makes sense though if you are in bed with big business, then a strong competitor bringing a cheaper better product is indeed a threat, as you are not concerned with the benefits it will bring to the american consumer, but to the profits it will bring to you donors.

    He described it as bi-partisan, which I guess is a buzz word for good governance, but a cynic might find some dark humour in interpreting it to mean – team red, team blue… it doesn’t matter either side is on the payroll.

    1. Totally, as Chomsky likes to say, we effectively have a one party system. There are no credible alternatives to the pro-business party line. To be sure, different sectors back different parties – Oil bankrolls Republicans and Finance usually backs the Dems.

      As an interesting aside, in his book Richistan, Robert Frank shows how lower Richistanis (those with net-worth between one and ten million dollars) overwhelmingly support Republicans, while Middle and Upper Richistanis ($10+ and $100+ million) back the Dems. There is something interesting going on there.

      1. that’s an interesting distinction, but my first thought/question is whether this correlation would disappear once you controlled for concentrations of Dems in large cities.

        Supporting team read or team blue often says more about your social set.

        Another excel project: see how the correlation between the individual’s “foot ball team” and the their family/social circle’s “foot ball team” compares to their political ‘view.’

  3. Clearly you don’t know basic economic theory. First of all this is a microeconomic question having nothing to do with macroeconomic issues of inflation, unemployment etc. The conception of ‘marginal contribution’ is just as rigorous and basic as marginal cost and marginal revenue. In fact, there is no way of defining efficiency without it.

    According to the Fundamental Theorem of Welfare Economics, a competitive equilibrium is Pareto efficient – in the sense that all factors earn exactly their marginal contribution to the value created. To put it simply, its what someone would earn if all markets were perfectly competitive and free.

    This is central to the theory of free markets. How can you not know this?

    1. Notice how what I said was clear and made sense while this is filled with technical jargon and dubiously connected buzz words?

      This thread also fufills what I am going to name ‘The Fundamental Theorem of political/economic discussions with Anusar’:

      As the number of exchanges tend to infinity, the probability that Anusar launches into an angry ad hominem tirade goes to 1.

      1. ha ha ha

        I am going to ignore the personal attack and concentrate on the matter at hand.

        Firms hire workers because it increases their production/revenue/profits. The ‘marginal contribution’ of the new hire is simply = post-hiring revenue minus pre-hiring revenue. And since we have uncertainty, define

        expected marginal contribution = expected post-hiring revenue minus pre-hiring revenue

        In an economy with free, competitive markets this is what each worker would earn. For free market fundamentalists like yourself – this generates the fair income distribution that I claim is embedded in Libertarian theology. It is fair in the sense that – once you have killed monopolies and govt subsidies and intrusion, it will be realized in your utopia.

  4. Thanks for clarifying that point.

    Let me try to be more clear about mine and why I said it sounded like a variant of the ‘labour theory of value’ and why I don’t like it.

    Both of them try to argue that a commodity or a laborer’s effort can be given an ‘intrinsic’ or ‘true’ value. And that anything shying away from this is a distortion by the corrupt world of the ‘correct platonic world.’

    I am partial to this way of thinking in physics 🙂 but not in economics.

    I believe that value is decided on an individual basis. For example what is the ‘value’ of your favorite math tome. To you or me, it can be worth in the neighbourhood of a hundred dollars. George Bush probably would not pay more than the price of kindling.

    I anticipate one objection: the book does have a value, namely its price on amazon etc.

    In some sense this is true, all commodities can be thought of as very illiquid currencies… and in fact their is a lot to think about there, but in the end the price on amazon is rooted in the fact that the book is of value to an individual.

    Another good/more extreme and clarifying example of the difficulty of any theory for ‘intrinsic/true’ value would be in the valuation of fine art. If you realize that value is a very personal thing, then the market for fine art is not confusing or a strange anomalie. I don’t believe that the labour theory of value has any explanation for this other than perhaps dismissing it as bourgeois nonsense.

    1. I don’t see why you think there has to be a theory of value for marginal contributions to exist. You agree that we ought to have competitive markets right? Well, I am just pointing out that if we did have competitive markets, whatever the theory of value underpinning the market price of $10 per widget, the marginal contribution of Bob joining Acme (the widget maker), can be computed. And if the labor market was open and competitive as well, that is what Bob will be paid because of market pressure.

      Free market enterprise has embedded in it an optimal distribution of spoils. Per the ideology, you eat what you kill. This can means billions for Paulson and Zukerberg and below minimum wage rewards for a lazy ass, unskilled bum. But this optimal exists by construction of the doctrine itself.

      The point I am trying to make is rather that the empirical distribution of income, wealth and power is far more concentrated that what we would expect in a free enterprise system. That in particular implies you, as a true Libertarian ideologue, should care about it as well. Because this level concentration creates and sustains a highly concentrated entrenched elite that can effectively defend its interests at the expense of both democracy and markets.

      Do you not agree that this has come to pass?

  5. Also this article is rather tangentially related to what we have been talking about, but I think it is an interesting read:

    SHAFFER: In 2004, liberals were distraught over the working class’s going Republican, and they asked, “What’s the matter with Kansas?” Then, in 2008, financiers and the wealthy generally went overwhelmingly for Obama. As somebody ensconced among both the financial and tech elite, can you tell me, what’s the matter with Greenwich?

    THIEL: There’s a degree to which it is just a status and political-correctness issue. The debates are for the most part not about the policies or about the ideas, but what is cool, what is trendy. Take something like the climate-change debate. I think it’s an important question, and I think it’s actually quite hard to figure out what the science is. It might be something for us to worry about. But I think there’s actually no debate at all — there’s no attempt to understand the science. It’s mostly moral posturing of one form or another….”

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