We’ve often referred to a phenomenon called the ‘income shift’ where share of income goes more and more disproportionately to the very few at the very top of the income pyramid. Today this ‘income shift’ has reached a lopsidedness not seen since the 1920s.
It’s hard to avoid not noticing that the 1920s income shift preceded the Great Depression while the current income shift preceded the Great Recession. Our take has been to recommend progressive tax tables where the tax rates counter at least some of this inevitable shift of more and more income to fewer and fewer people at the top of the pyramid. Also these types of rates tend to better pay government bills and thus reduce deficits.
As for their impact on economic growth, progressive rates don’t seem to have any negative effect on economic growth. In fact they correlate extremely well to strong economic growth. But we’ve shied away from trying to explain this phenomenon. There are various explanations out there, but certainly no consensus. Our fall back position is that, lacking any agreed upon reason(s) why progressive rates correlate so well with robust economies, we’re going with the idea the rates themselves are not of primary importance for growth. Other dynamics may well be far more important. That said, they still pay the bills better and seem to counter the ‘income shift’ effect, so we like them.
Now a New York Times article by editorial writer Eduardo Porter sheds a little light on all of the above, and quite a bit more. The article is entitled ‘How Superstars’ Pay Stifle Everyone Else.’
“IN 1990, the Kansas City Royals had the heftiest payroll in Major League Baseball: almost $24 million. A typical player for the New York Yankees, which had some of the most expensive players in the game at the time, earned less than $450,000.
Last season, the Yankees spent $206 million on players, more than five times the payroll of the Royals 20 years ago, even after accounting for inflation. The Yankees’ median salary was $5.5 million, seven times the 1990 figure, inflation-adjusted.
What is most striking is how the Yankees have outstripped the rest of the league. Two decades ago. the Royals’ payroll was about three times as big as that of the Chicago White Sox, the cheapest major-league team at the time. Last season, the Yankees spent about six times as much as the Pittsburgh Pirates, who had the most inexpensive roster.
Baseball aficionados might conclude that all of this points to some pernicious new trend in the market for top players. But this is not specific to baseball, or even to sport. Consider the market for pop music. In 1982, the top 1 percent of pop stars, in terms of pay, raked in 26 percent of concert ticket revenue. In 2003, that top percentage of stars — names like Justin Timberlake, Christina Aguilera or 50 Cent — was taking 56 percent of the concert pie….
But broader forces are also at play. Nearly 30 years ago, Sherwin Rosen, an economist from the University of Chicago, proposed an elegant theory to explain the general pattern. In an article entitled “The Economics of Superstars,” he argued that technological changes would allow the best performers in a given field to serve a bigger market and thus reap a greater share of its revenue. But this would also reduce the spoils available to the less gifted in the business.
The reasoning fits smoothly into the income dynamics of the music industry, which has been shaken by many technological disruptions since the 1980s. First, MTV put music on television. Then Napster took it to the Internet. Apple allowed fans to buy single songs and take them with them. Each of these breakthroughs allowed the very top acts to reach a larger fan base, and thus command a larger audience and a bigger share of concert revenue.”
Beezer here. Mathematician Nassim Taleb, in his book ‘The Black Swan,’ explains this phenomenon as ‘scalability.’ Taleb says modern life is different in it’s scalabilty. Not just in entertainment, but in almost any endeavor. Whether it’s bank bonuses or book authors, a smaller and smaller share of ‘winners’ grab a larger and larger share of available income. As a mathematician whose specialty is measuring risk, Taleb warns one important negative side effect of this scalability is the increase in risk. And not just the increase of risk itself, but a dramatic increase in the effects of risk.
In our modern, scalable world, Taleb warns negative surprises will result in damages far worse than expected from past experience. Just as positive surprises result in far greater rewards for ‘winners’ compared to past experience, negative surprises result in far more severe consequences for everyone. Porter says capitalism depends on some inequality, it’s why we work so hard to ‘win.’ But too much inequality, he maintains, may have the opposite effect.
“Yet the increasingly outsize rewards accruing to the nation’s elite clutch of superstars threaten to gum up this incentive mechanism. If only a very lucky few can aspire to a big reward, most workers are likely to conclude that it is not worth the effort to try. The odds aren’t on their side.
Inequality has been found to turn people off. A recent experiment conducted with workers at the University of California found that those who earned less than the typical wage for their pay unit and occupation became measurably less satisfied with their jobs, and more likely to look for another one if they found out the pay of their peers. Other experiments have found that winner-take-all games tend to elicit much less player effort — and more cheating — than those in which rewards are distributed more smoothly according to performance.
Ultimately, the question is this: How much inequality is necessary? It is true that the nation grew quite fast as inequality soared over the last three decades. Since 1980, the country’s gross domestic product per person has increased about 69 percent, even as the share of income accruing to the richest 1 percent of the population jumped to 36 percent from 22 percent. But the economy grew even faster — 83 percent per capita — from 1951 to 1980, when inequality declined when measured as the share of national income going to the very top of the population.
One study concluded that each percentage-point increase in the share of national income channeled to the top 10 percent of Americans since 1960 led to an increase of 0.12 percentage points in the annual rate of economic growth — hardly an enormous boost. The cost for this tonic seems to be a drastic decline in Americans’ economic mobility. Since 1980, the weekly wage of the average worker on the factory floor has increased little more than 3 percent, after inflation.
The United States is the rich country with the most skewed income distribution. According to the Organization for Economic Cooperation and Development, the average earnings of the richest 10 percent of Americans are 16 times those for the 10 percent at the bottom of the pile. That compares with a multiple of 8 in Britain and 5 in Sweden.
Not coincidentally, Americans are less economically mobile than people in other developed countries. There is a 42 percent chance that the son of an American man in the bottom fifth of the income distribution will be stuck in the same economic slot. The equivalent odds for a British man are 30 percent, and 25 percent for a Swede.”
And of course there’s our friends in banking. Particularly investment banking.
“Remember the ’80s? Gordon Gekko first sashayed across the silver screen. Ivan Boesky was jailed for insider trading. Michael Milken peddled junk bonds. In 1987, financial firms amassed a little less than a fifth of the profits of all American corporations. Wall Street bonuses totaled $2.6 billion — about $15,600 for each man and woman working there.
Yet by current standards, this era of legendary greed appears like a moment of uncommon restraint. In 2007, as the financial bubble built upon the American housing market reached its peak, financial companies accounted for a full third of the profits of the nation’s private sector. Wall Street bonuses hit a record $32.9 billion, or $177,000 a worker…..
This ebb and flow of compensation mimics the waxing and waning of restrictions governing finance. A century ago, there were virtually no regulations to restrain banks’ creativity and speculative urges. They could invest where they wanted, deploy depositors’ money as they saw fit. But after the Great Depression, President Franklin D. Roosevelt set up a plethora of restrictions to avoid a repeat of the financial bubble that burst in 1929.
Interstate banking had been limited since 1927. In 1933, the Glass-Steagall Act forbade commercial banks and investment banks from getting into each other’s business — separating deposit taking and lending from playing the markets. Interest-rate ceilings were also imposed that year. The move to regulate bankers continued in 1959 under President Dwight D. Eisenhower, who forbade mixing banks with insurance companies.
Barred from applying the full extent of their wits toward maximizing their incomes, many of the nation’s best and brightest who had flocked to make money in banking left for other industries.
Then, in the 1980s, the Reagan administration unleashed a surge of deregulation. By 1999, the Glass-Steagall Act lay repealed. Banks could commingle with insurance companies at will. Ceilings on interest rates vanished. Banks could open branches anywhere. Unsurprisingly, the most highly educated returned to banking and finance. By 2005, the share of workers in the finance industry with a college education exceeded that of other industries by nearly 20 percentage points. By 2006, pay in the financial sector was again 70 percent higher than wages elsewhere in the private sector. A third of the 2009 Princeton graduates who got jobs after graduation went into finance; 6.3 percent took jobs in government.
Then the financial industry blew up, taking out a good chunk of the world economy.”
Maybe it’s just a general rule about balance. If anything gets out of balance for long, especially in this modern scalable world where the imbalance may be very great compared to previous experiences, then danger and pain lie ahead. We avoided a Great Depression this time (at least we have so far) but if we don’t start restoring more balance–whether it’s in budgets, trade, incomes or energy and transportation–then we’re just whistling in the dark.