Tuesday, May 13, 2014

Piketty: Inequality of Labor Income

After a look at the income of the top 10% and top 1% in France and the US, in Capital in the Twenty-First Century, Thomas Piketty now analyzes inequalities in labor income.  He wants to know "what caused the explosion of wage inequalities and the rise of the supermanager in the United States after 1980."

What is it that drives inequality?  First Piketty looks at the "widely accepted theory" of "a race between education and technology." It does not explain the rise of the supermanager, but it has its uses, resting on the two ideas that a worker's wage depends on his "marginal productivity" and the supply and demand for his "skill in a given society."

Naive as it is, this theory does point up the importance of two factors: "the state of the training [and/or education] system... and the state of technology".  New technology enables innovation, but if "the supply of skills does not increase at the same pace as the needs of technology, then groups whose training is not sufficiently advanced will earn less... and inequality... will increase."  It's up to the education system to remedy this deficit, "especially for the least well educated."

But what really happened in the last century?  In France, while the "average wage increased enormously" the inequalities remained because everyone moved up a notch, with the children of grade school graduates finishing high school etc.  That is not ideal, but if everyone had stayed where they were educationally, inequalities would have increased "substantially."  In the US, according to researchers, the wage gap between high school and college graduates "which decreased fairly regularly until the 1970s" suddenly began to increase after 1980.  This, in the view of the researchers, was "due to a failure to invest sufficiently in higher education."

So what's needed is to "invest in education" because output increased fivefold in the century in which skills were improved by universal education.  This would increase wages at the low end and cut the upper decile's income share.  However, "theoretical discussion of educational issues and meritocracy is often out of touch with reality."

The education-and-technology theory may explain the long term, but not the short term, for it fails to explain the rules and regulations that drive the labor market.  Wage compression in World War II was caused by government freezing wages for managers and thereafter by increases in the minimum wage (see chart).  For Piketty, the setting of a minimum wage and/or administratively establishing wage scales with union bargaining is the way to deal with inequalities at the low end of the income scale. Piketty does not discuss here the effect of welfare and labor market regulation on off-the-books economic activity.

The education-and-technology theory also cannot explain the explosion of upper centile labor income in the United States.  Increased productivity didn't do it, and doesn't explain why the "supermanager" income explosion is an Anglo-Saxon phenomenon and cannot be seen in Continental Europe and Japan (charts here and here).  Inequality has now reached, in the United States, the "record levels observed in 1910-1920".  But not in Europe and Japan, although inequality in the Belle Époque was higher in Europe than the US.

It was "concentration of capital" that caused the inequality a century ago in Europe, but why?  The answer lies in "low demographic growth".  That's how you get "greater accumulation and concentration of capital."

Piketty then looks at inequality in emerging economies.  The pattern is similar to the developed nations. Inequalities were high a century ago, declined in mid century, and have climbed since 1980.

But let's get back to the supermanagers in the United States!  Obviously their high compensation cannot be justified by "individual 'productivity'" and Piketty does some math to prove it.  So the high compensation must be the result of "hierarchical relationships" and the natural tendency of people "to treat themselves generously."  It's also a question of "social norms"; high compensation that is "shocking" in Europe and Japan is tolerated in Britain and the US, perhaps as a result of the "'conservative revolution' that gripped" the US and the UK in the Reagan/Thatcher era.  Or maybe it's a form of "meritocratic extremism" that wants to reward "winners".  Who knows where it might end?

Right at the end of the chapter, Piketty raises the question of marginal tax rates.  Maybe the "very large decrease in the top marginal income tax rate" in the US and UK may have encouraged top executives to shoot for higher pay.  You think?

Discussion

Thomas Piketty believes as an article of faith that it is the job of the ruling political class to ride herd on the ruling economic class and provide a guiding hand for the lesser mortals that work to create products and services.  Education must be provided; experts must tinker with minimum wages and wage schedules.  Corporate executives must be tamed and disciplined.  But what if the experts don't have a clue what they are doing?

Introduction

Part One: Income and Capital

Income and Output

Growth

Part Two: The Dynamics of the Capital/Income Ratio

Changes in Capital

New World Capital and Slavery

Capital/income Ratio in the Long Run

Capital's Share of Income

Part Three: The Structure of Inequality

Inequality and Its Concentration

Two Worlds: France and the US

Inequality of Labor Income

Inequality of Capital Ownership

Merit and Inheritance in the Long Run

Global Inequality of Wealth in the 21st Century

Part Four: Regulating Capital in the Twenty-First Century

A Social State for the 21st Century

Rethinking the Progressive Income Tax

A Global Tax on Capital

The Question of the Public Debt

Conclusion

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