Arnold Kling  

Skewness in Earnings

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Brad DeLong asks,


What skills and assets do the top 1% of America's pretax income distribution have today that lead the market to grant them 14% of total income, when their counterparts back in 1980 were granted only 8% of total income?

He cites this paper by Thomas Piketty and Emmanuel Saez.
I suspect that two things are going on.

One is that we have added a lot more low-income households, because of immigration and family break-ups. This pushes some high-income households into the top of the income distribution who previously were closer to the middle. The second development is increased entrepreneurship, which takes some people out of the middle of the income distribution and moves them either toward the bottom or the top.

For example, suppose that we have one hundred families, and the top family gets $1.8 million, the next family gets $1.7 million, the next family gets $1.6 million, and so on, until the tenth family gets $0.9 million. Families 11 through 100 each earn $50,000. [typo in earlier version had this at $40,000] Total income is $18 million, and the share of income earned by the top one percent (the top earner) is 10.0 percent.

Next, add 100 new families, consisting of immigrants, single-parent households, and so on, earning $30,000 per year. The total income in the economy is now $12 million, so the share of the top earner has declined a bit. However, with 200 families in the population, the top one percent now includes the top two earners, whose combined income of $3.5 million is now 16.67 percent of the total.

The other factor is entrepreneurship. For me, becoming an entrepreneur meant that for several years, my income went down. It increased when the business became successful, and it spiked when the business was sold. Since then, it has been below what I would have earned as a salary, but the one-time spike makes up for that.

As Paul Graham put it,


Economically, you can think of a startup as a way to compress your whole working life into a few years.

The rise of the personal computer has increased the potential for entrepreneurship. More entrepreneurship means that more people are compressing their working lives and generally increasing the variation in incomes.


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CATEGORIES: Income Distribution



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The author at Newmark's Door in a related article titled More excellent work by Arnold Kling writes:
    Arnold Kling is just so consistently excellent. He proposes a benign explanation for the increase in income inequality that is alarming certain folks. And, in an older article, he torches the happiness research that is often advanced to further a [Tracked on February 9, 2006 5:40 AM]
COMMENTS (32 to date)
george writes:

In the first part of the example families 11 through 100 must earn $50,000 for your other numbers to work.

In the second part of the example:

"The total income in the economy is now $12 million, so the share of the top earner has declined a bit."

Again the income of the 11-100th households should be $50,000 and the total income should be $21 million not $12 million.

Bill Stepp writes:

The market doesn't grant anyone an income to the extent that it's earned, although the government can, thanks to the patent raj and other intellectual monopoly restrictions such as copyright.
Check out the new book by Michele Boldrin and David K. Levine, Against Intellectual Monopoly, which can be read at their homepages.
Uncle Sam really is an intellectual monopoly man.

liberty writes:

I would also point out that it isn't skills and assets, it is productivity that determines income. And one doesn't earn a percent of total income, they simply earn the dollar worth of their productivity to society. If there are a few people that are incredibly productive to society - so that their contribtion changes so many lives, more lives than people ever had been able to change before - such as Bill Gates for example, then those people will create a top one percent who earn a whole lot. Then if the rest of society each contribute much less to overall productivity, then the top one percent will have earned a large chunk of the income.

Tim Lundeen writes:

As Russell Roberts points out at Cafe Hayek in Please Do Your Job, and you note indirectly here, it is really misleading to think of any income perctile as consisting of the same people year after year, and then using these percentile-band-income numbers to conclude that "income inequality" is growing. I've personally been in both the bottom and the top 1% -- so what does comparing my income in bad years to good years have to do with showing income inequality?

To show income inequality, it seems as if you'd have to look at people who stay in the bottom and top percentiles for some period of time. I actually would expect this to show growing income inequality, just because I think productivity at the high end is growing faster than at the low end. But I'm sure that if this is the case, the answer is not to restrict productivity growth anywhere, or to significantly disincent people at the high end from working hard.

Tim Lundeen writes:

And the next blog on my list was Steve Antler's, where he has an excellent section showing actual income growth for people in different quintiles in Illinois: We just happen to have these numbers....

The numbers show dramatic income growth over a 7-year period for all starting quintiles except the top :-)

Vorn writes:

liberty:

You obviously don't understand Bill Gates. He did not earn all the money he had as much as he gained it through position. He was first with an operating system and IBM foolishly became dependent on his product. Having moved into an advantageous position, Gates quite shrewdly leveraged that position for all it was worth.

The problem with your analysis is you talk about "productivity" and "earning" but not about position. Bill Gates is incredibly rich because he moved himself into an advantageous position. He also worked hard and was productive; those were necessary but not sufficient conditions for his wealth. His position is enhanced by intellectual property protection granted by government.

Mr. Lundeen:

You analysis suffers from much the same flaw as that provided by liberty. You are right when you say we don't want to disincentivize productivity by any population group. (Ensuring, of course, that you have a proper definition of productivity. It is not always more productive to take actions that maximize income. For example, people who work so much that they neglect physical fitness are not truly maximizing productivity.)

Your analysis fails to take into account the importance of position. For example, CEOs and other top officers of corporations, much more than other professionals, have much more influence over the setting of their pay. This more than "productivity" determines their compensation. This does not mean that there is no market forces which constrain CEO pay at all; only that those market forces are much weaker than those which determine, say, for example, the pay of ordinary accountants. The market forces are weaker because individual firm decision-making by boards of directors are not entirely market based. In a world of perfect competition, of course firms who make inefficient compensation decisions would not survive. The world of perfect competition is not our world; inefficient compensation decision do happen. Top management has undue influence over their own compensation. Position explains, to some degree, income inequality.

In a discussion about income inequality, one should not talk only about "productivity" without also discussing "position." If you fail that, then you do not see a big part of the picture. Which is not to say that productivity is not important, only that it is not the whole story.

Vorn writes:

Kling:

One problem with your analysis is that it assumes the difference between people in the top 1% and 2% (call them the next 1% for convenience) and the newcomers is greater than the difference between the top 1% and everyone else (excluding the newcomers). This might be true; but it is much less likely than in your hypothetical example where the top 1% and the next 1% constitute precisely one family each who have virtually identical incomes. I suspect that the difference between the top 1% and the next 1% is much greater in the real world, where 1% of the U.S. population consists of approximately 3 million people.

So, unlike you, I suspect this is not a big factor. I suspect that rather than being virtually identically, that there is a large difference between the top 1% and the next 1%, unlike your hypothetical.

Empirical data may prove me wrong; but I think your suspicion is most likely incorrect. In any case, even if your suspicion were partially right, I think the effect would likely be small; much too small to explain much of the increase in income inequality.

liberty writes:

>You obviously don't understand Bill Gates.

Actually I know quite a bit about Microsoft and how it go its "position."

>He did not earn all the money he had as much as he gained it through position. He was first with an operating system and IBM foolishly became dependent on his product.

Actually he was neither first nor best with an operating system and it wasn't foolish for IBM to make the contract with him - IBM did quite well with the deal. What Microsoft did was to offer a very user friendly operating system that would continue to make things easier both for the user and for the seller. And it worked. He also revolutionized business and the productivity of the individual by doing this - his product made it possible for millions of non-computer-friendly workers to begin to make use of the personal and business computer within a very short time frame, propelling the country into the information age as no other operating system (maker) or software maker could.

> Having moved into an advantageous position, Gates quite shrewdly leveraged that position for all it was worth.

True.

>The problem with your analysis is you talk about "productivity" and "earning" but not about position. Bill Gates is incredibly rich because he moved himself into an advantageous position.

No. You misunderstand the economic analysis. He was not only productive but he produced and helped others to produce. It is true that if he had bad business sense, he would not have produced so much because a competitor might have taken that place, but that can still be effectively measured through productivity. If he had not made the deal with IBM and had lost out to Macintosh, then Steve Jobs might be several million richer and Bill Gates much poorer - if Steve Jobs was unable to make Macintosh as successful as Microsoft and sold fewer computers, if the country was less productive as a result, then Jobs may never have become as rich as Gates. In addition there may have been room for more competitors and productivity may have been just as high but spread out over several suppliers; the price of the computer may have been more or less depending on the drive forward in technology as well as the ability for the supplies to compete - it gets a bit speculative. Probably it would not change the numbers regarding the top 1%.


> He also worked hard and was productive; those were necessary but not sufficient conditions for his wealth. His position is enhanced by intellectual property protection granted by government.

Actually, there have been so many anti-trust suits against Microsoft that I would argue that government has done much more to attempt to destroy his wealth than to help him achieve it through the patents/copyright and intellectual property rights.

Vorn writes:

liberty:

First of all, to address your last point. Microsoft would not exist without intellectual property protection. So, obviously, your argument that IP protection is less beneficial than antitrust suits harmful is obviously incorrect.

Second, please explain to me when there was ever robust competition in operating systems on early IBM personal computing sytems? Never? Could it be that by being first, Gates and Microsoft had an advantage? Could it be that it was Microsofts initial contract with IBM that had something to do with that advantage? Could it also be that IBM later came to regret the leverage it gave Microsoft? The answer to all these questions is yes.

Guess what, if Bill Gates was never born, today we would still have personal computers and user friendly operating systems. I AGREE that Gates has been quite productive; but lets be realistic. If Bill Gates had not been there first, someone else would have. You thus cannot give him credit for all productivity acomplished through the use of personal computers.

I don't deny that Gates has been productive. It is also undeniable that he has been predatory and destructive with respect to competition in some instances. For example, trying to make Java Microsoft specific so that it couldn't be used to make OS independent software. For example, trying to control standards so that others cannot compete on a level playing field. Trying to thwart open standards that would allow competition to thrive. Efforts to control proprietary standards are ALL about positioning. If I control the standards, I control when they change and how they change. I have superior access to information on how they will change. I have the ability to make my competitors life more difficult by making disruptive changes. That is about position.

Here is another example.

Microsoft spent hundreds of millions of dollars developing Internet Explorer and gave it away for free. In other words, it used its position to attack a competitor who could not afford to compete with a free product. Microsoft would not have been able to spend hundreds of millions of dollars on a free product either, but for its position. It had revenue from other sources that enabled it to do that.

I am not saying that productivity is not PART of the story of Microsoft and Bill Gates. I am only saying it is not the WHOLE story. The other part of the story is how a kid dropped out of Harvard and positioned himself at the right place at the right time. I am not saying that positioning itself is a totally random event; however, I am suggesting that it involves something more than mere effort and productivity.

David Thomson writes:

“What skills and assets do the top 1% of America's pretax income distribution have today that lead the market to grant them 14% of total income, when their counterparts back in 1980 were granted only 8% of total income?”

Why should we even care? What interests Brad DeLong is simply of little interest to me. I take it for granted that so-called unequal wealth will increase as the economic pie gets bigger for everyone. The bottom line is this: today’s poor are far better off than their counterparts in 1980.

I recently read a piece by DeLong praising John Kenneth Galbraith. We obviously see the world quite differently. I consider the well meaning Galbraith to have unintentionally caused enormous damage throughout much of his long life. DeLong regrettably fails to sufficiently appreciate the value of economic creative destruction. Oh wonder, he gets so hung up the silliness of inequality.

Vorn writes:

David:

You ask why should we care about income inequality. I ask, why shouldn't we care?

I think we should care because sometimes income inequality leads to bad living conditions for our fellow human beings. To the extent that income inequality is necessary to avoid making EVERYONE worse off, then it is not a bad thing. On the other hand, to the extent that income inequality makes some better off at the EXPENSE of others and is not necessary for overall economic well-being (i.e. it is unearned and merely the result of position), we should be concerned. When economic inequality is not based on moral dessert, it is usually not necessary for overall economic well-being.

Here is an example of income inequality that is bad. In Saudi Arabia, there are many families that are very rich with oil wealth that is entirely the result of position rather than innovation or any sort of moral dessert. These people tend to import housekeepers from foreign countries, for example, Sri Lanka. At the same time, these privileged Saudi families often discriminate and look down upon their domestic help.

Sri Lankan women working as domestic help often end up leaving their children in Sri Lanka while they work for these (often ungrateful) Saudi families. This is an example of bad income inequality leading to bad results. Merely to help clean up after a Saudi family too lazy to clean up after itself, economic exchange induces these women to abandon the raising of their own children. Which activity is truly more valuable, raising children or cleaning up after lazy slobs who should clean up after themselves?

Sometimes, economic inequality leads human energies being focused on satisfying wants and desires that are less important. In this case, there is no reason that these Saudi families deserve to be rich. They just happen to have been born into the right families, unlike the vast majority of Saudi Arabian families facing much tougher circumstances.

I think you could tell this same story, the story of human energy being directed towards less noble ends due to income inequality, in many different ways with many different examples.

So, here is the question. What sorts of economic equalities should we not interfere with because to do so would only make us worse off as a whole and which are unjustified and merely result in bad allocations of human energy? Not alawys an easy question (though sometimes there are easy cases), but I think a worthwhile one.

I think you have part of the story down: "I take it for granted that so-called unequal wealth will increase as the economic pie gets bigger for everyone. The bottom line is this: today’s poor are far better off than their counterparts in 1980."

It certainly is right that sometimes the side effect of innovation or progress that benefits everyone is greater economic inequality. To interfere with that would merely harm those who are already worst off. But this is not the WHOLE story. Sometimes economic inequality is not justified by innovation or progress and then merely results in skewed distributions of human energy for no good reason. Sometimes economic inequality is a story of productivity and hard work, other times, it is a story of merely exploiting an unearned position of advantage.

David Thomson writes:

“I think we should care because sometimes income inequality leads to bad living conditions for our fellow human beings.”

Oh my God, I strongly recommend that you pick up all your books authored by the well intentioned John Rawls and John Kenneth Galbraith, and throw them into the garbage. Do you really wish to help the poor and disadvantaged? If so, you should never consciously strive for an equal universe. We need to instead push policies favorable to rapidly increasing the pace of economic creation and destruction. Explicitly pushing for a “fair” world almost certainly results in bringing about a hell on earth. Help make the pie bigger for everyone---and then get the hell out of way.

David Thomson writes:

“To interfere with that would merely harm those who are already worst off.”

The dogmatic gods of creative destruction are not always kind. Some people do indeed lose their jobs and never truly get back onto their feet. I’m sure that many early twentieth century American saddle makers went ot their graves unable to ever find another viable way of earning a living. Sadly, some Third World workers will be undeniable distressed by the introduction of more productive labor techniques and equipment. What will they do? You are right to be concerned. However, you must be very cautious. Their jobs, at the end of the day, must be destroyed. That is nonnegotiable. Did somebody promise you an utopian universe? Well, it wasn’t me.

Paul N writes:

To me this is an easy one. Let's get back on track:

1) 1980 was the pits of a recession, which means less earnings for capital holders, i.e. most of the top 1%. On the other hand, 2005 is boom times.

2) The tax structure in 1980 was seriously messed up, which depressed growth. Tax reform has improved the quality of life for all income deciles, and not surprisingly it's improved the income of the very top/investment class most of all. Would Brad prefer the alternative, that everyone's worse off, even if the poor/rich disparity were less?

Vorn writes:

David:

By the strength of your reaction, I quote: "Oh my God," I feel you may be assuming my views are different from what they are. Just relax and think about what I am actually saying.

First of all, I am for, not against innovation that leads to greater productivity while eliminating obsolete jobs. I don't like obsolete jobs; I would rather have people devote their energies to doing things that are actually beneficial, not merely collecting payments for things that can be done more efficiently in some other manner.

If you really want to disagree with me, you have to justify Saudi Arabian oil wealth, which has nothing to do with creative destruction.

All I am saying is that there are two kinds of income inequality, justified and unjustified. If you disagree then you should address the specific examples I mentioned.

Who said anything about a utopia? I don't believe in utopias. I, like you, believe in progress. That things can be made better. Are you aiming for a utopia when you advocate creative destruction? No. Well, I am not advocating a utopia when I advocate a careful examination of income inequalities. Like you, I think things can be made better.

We should be cautious, of course. Creative destruction may destroy more than it creates. Free trade may have unintended consequences. Challenging certain forms of income inequality also presents risks. But like any entrepreneur, you should realize that without risk, there is no reward. One should take on a rational level of risk in order to improve things. That is not the same as being blinded by impossible visions of utopia.

aaron writes:

Perhaps we have passed a threshold where productivity is so high that a smaller and smaller percentage of the population is needed to support the entire population. This makes it so that those who have wealth, or access to high income jobs, are in a much better position to invest. The pool of workers continues to grow, but the pool of jobs grows more slowly. Investment income becomes a greater and greater part of total income, and as salaries flatten out and benefits become a larger part of compensation, it becomes more difficult to invest a significant part of income.

Mcwop writes:

Why, oh why, oh why, can't people that discuss the top 1% insert the damn starting income level in their discussion.

I suspect it is because the income level will not be perceived as that big, since it starts at around $230,000 for the top 1%. And there are about 650,000 people with that income or higher. Or the top .5%, which starts around $315,000 and there are about 524,000 earners. Or the top .1% which starts around $790,000, and has around 118,000 earners. And the top .01%, which starts at $3.6 million, and has 13,100 earners.

Source

Lastly, can someone explain how this harms me (I am not in the top 1%, but my wife and me are in the top 10% if you combine our incomes)?

Anecdotal: My dad is a Lawyer that made the top 1% for about 5 years our of a 35 year law career - he has never made it through the top 1% in any other year. So how much do people fluctuate through these income levels?

spencer writes:

The story behind the sharp increase in income for the top few actually goes to the story of
CEO compensation. The story behind this is that in the late 1970s -early 1980s a belief emerged among professional investors that the reason for poor stock market performance was that CEO's interest were not tied to the interest of stockowners. So they lobied to get the system changed and alter the compensation package of top management to be more dependent on stock market returns. So over the 1980s the pay packages of top managements shifted to include a large element of stocks and options. This happened just in time for the great stock market bubble of the 1990s and management income soared largely because they were leveraged to the stock market. Notice, the trend ended about the time Bush took office and actually fell modestly since then. But this reflects the stock market -- the S&P 500 is still below where it was when Bush took office.

The interesting thing is that the theory that poor stock market returns was due to poor management has essentially no basis in fact.

The part of stock market returns that management influences has not changed despite the surge in top managment pay. There is essentially no evidence that trend S&P EPS growth has changed from the 7% long term trend since WW II. Stock returns were low because of the impact of inflation and higher rates on the PE side of the equation -- something management has essentially no impact on. Moreover, stock returns soared in the 1980s and 90s because inflation and rates eased and the PE side of the equation soared - not because of any change in EPS growth.

So what we really have is an "agent" problem
in that stock owners are being taken for a ride by top management.

The discussion above about Gates misses the point. Gates was a true entrepreneur and risked
everything to create a new company in a new industry. In a capitalist society that is exactly what we want to reward and he should be
a great billioner -- we are all better off because of it. But the typical CEO is not an entrepreneur and the system does not need to provide them the outsized rewards. While jack Welch was a great manager and did great things for GE, his bets were always one way. If GE did well so did he. But if GE did poorly, or his ideas had failed he would still do fine.

So Arnold, I do not think your analysis of what caused this or the idea that changing demographics or the IT revolution was the driving force is very accurate. Now if you were comparing the returns the middle and next to the top higher quintile of income relative to the income of the bottom two quintiles the demographic changes and the impact of the IT revolution on the returns to education probably do play a major role -- but not for the top 1% or 2%..

liberty writes:

>Could it be that by being first, Gates and Microsoft had an advantage?

1. He wasn't first, as I pointed out. There were other OS at the time.

2. He didn't have to do anything at all - he might have chosen to do something else, he might have worked on the OS quietly in his house and not made a business, he might have written a BASIC type language but not worried about a user-friendly OS, etc.

>Guess what, if Bill Gates was never born, today we would still have personal computers and user friendly operating systems.

Are you one of those people who believes that people don't affect history much, that things would likely have turned out the same regardless of the primary characters in history?

Do you make excuses about communism saying that neither Reagan nor Gorbachev matered - it was going to happen the same year anyway? Maybe Gorbachev mattered, but his time was coming, and Reagan did nothing at all?

What Gates did was to make computers very accessable. DOS before Gates was really sucky. Its like when you boot into MS-DOS mode to fix your Windows, except even worse. The other OS at the time was a very primitive UNIX that was also for the super-brainy. Gates made an OS that the averge non-specialist could learn and use in a day. That was a major innovation.

If you think that it was going to happen with or without him that year anyway then you know nothing about what the other software writers at the time were doing and it sounds just like the excuses about the fall of the Soviet Union with or without the major characters of the time - it doesn't fit history.

You give Gates credit for choosing to be "anti-competitive" but no credit for choosing to be innovative and making a computer that was user-friendly. One was inevitable, the other his choice...

The fact is that he could have done neither and we might be 10 years behind where we are now. He might have made the computer but not bothered to fight for his company and we might be 5 years behind - his fight probably propelled us forward, not dragged us behind.

liberty writes:

>If GE did well so did he. But if GE did poorly, or his ideas had failed he would still do fine.

This is a good point. CEOs must have their job on the line or they won't be taking personal risk and will perform poorly.

Randy writes:

Vorn,

Your thought about the unfairness of the distribution of Saudi oil wealth is an interesting one.

I have been thinking lately of a division between free market activities and socio-political activities. Free market activities create wealth through value for value transactions. Socio-political activities utilize wealth to its "best" purposes via redistributive transactions. The government does both. In some cases government is a free market actor in that it participates in value for value transactions. In other cases government is a socio-political actor in that it participates in redistributive transactions. The purpose of this division is to draw the line between the activities that create wealth (free market) and those that redistribute wealth (socio-political), and to show the dependancy of those who redistribute on those who create.

Now, it is often said that wealth is not a zero sum game. But in one case, that of natural resources, wealth truly is a zero sum game. At some point in history, the natural resources were distributed by the socio-political systems in place at that time. E.g, land was distributed to fuedal barons in reward for their service to the king, the oil in Saudi Arabia was distributed to the house of Saud by the British, some of the best land in the American west was distributed to the owners of railroads, and of course, the entire continent was taken by force from its native inhabitants, also a case of redistribution by socio-political systems.

So, it seems logical to me that if a socio-political system has created an unfair condition, that it should seek to remedy that condition. But, the socio-political system should accept the blame for creating the condition, and not try to pass the blame on to free market activities. And, the current socio-political system should recognize that the free market activities offer the best chance of a successful remedy, as they are the only activities capable of creating the wealth that will be needed to achieve it. While the policy that created the unfair condition may have been an unfair distribution or a violation of property rights, the best remedy may not be another unfair distribution or another violation of property rights.

aaron writes:

How do things look when you adjust for age?

Vorn writes:

liberty:

First of all, I never said anything about determinism. I didn't say that NOBODY matters. I said that Bill Gates doesn't matter with respect to progress; that the operating system he developed just was not that innovative. I make this judgment as someone who is in a position to judge innovation in this area; my undergraduate major was computer science.

Second, I did give Gates credit. I said the story is one of productivity and hard work. Then I said that wasn't the whole story. The story was also one of position. When I say first, I mean the first to sign a big contract with IBM and make IBM dependent on his OS. There may have been others, but once this contract existed, there were major barriers to entry by competitors.

spencer:

You write that we are all better off because of Bill Gates. But I think you need to break up your assessment rather than making general and sweeping assertions. What I mean by that, is we may or may not be better off as a general matter, but with respect to more specific acts, some we can say more unambigiously were beneficial and some we can say rather certainly that they were harmful. You said my discussion "misses the point," but then you simply bring forth your general assessment of Gates. But I was not engaged in a general assessment, simply asserting that the picture has two sides. What I said is consistent BOTH with the thesis that we are all better off due to Gates and his actions and the thesis that we are worse off. It all depends on how you aggregate his productive actions versus his anti-competitive ones.

spencer writes:

Actually, the real contribution Gates made was not the creation of an operating system. The real contribution of Gates and Microsoft was the establishment of universal standards. This is what gave Microsoft its market position and the real wealth it created.

Yes, he has exploited his market power, but that is a secondary story to the real contribution.

Vorn writes:

Randy:

I think your on to something. The distinction between socio-political and economic may indeed help distinguish between "good" sources of income inequality, and "bad" sources.

Of course, the division between socio-political and economic is to some degree an artificial one. Why do I say that? Take intellectual property, specifically copyright and the music industry as an example. The government defines exactly what is protected. It also determined the scope of protection. It determines what the penalties are for infringement. In individual cases of infringement, the government decides whether or not to bring criminal charges. It decides how long a copyright lasts. It determines what formalities are required to maintain a copyright. Now clearly, the government is not the only actor that determines market price; different products will have different value depending on their perceived desirability. But government has an unmistakable footprint in this area that largely determines value and has a major impact on what the market looks like. For example, the distribution of income for musicians in the music industry tends to be a skew log distribution. This is actually a predictable result having to do with the structure of the industry, which is itself determined by background legal rules. If you studied copyright and the music industry and the transactions that occur, you would be amazed at the tight relationship between legal rules and the structure of the industry and resulting transactions.

So, in this example, it is very difficult to seperate the socio-political and the economic. Which is not to say that your initial distinction between the two is unsound, only that in some number of cases, there will be some mixing between the two. Your distinction works quite well at correctly classifying the Saudi Arabian example.

Overall, I totally agree with the principle behind your distinction. That is, trying to find a way to articulate and distinguish between "good" sources of income inequality and "bad" sources of income inequality. I also think that your initial distinction may work in a good number of cases.

Roger M writes:

What skills and assets do the top 1% of America's pretax income distribution have today that lead the market to grant them 14% of total income, when their counterparts back in 1980 were granted only 8% of total income?

Baby Boomers explain part of it, for as people age, their incomes increase and old BBers make up the largest chunk of the population. Also, today we have more households with two incomes than we did back in 1980, especially among the wealthy. Poor households tend to be headed by a single mother.

Vorn writes:

Spencer:

I don't want to beat the Microsoft horse dead, but I did want to respond to the point you made about universal standards.

First, standards can be used as an anti-competitive weapon; there is a reason that Microsoft has resisted open standards and often refused to cooperate with other major firms in the development of neutral standards. Proprietary standards are one major creator of market power in the software business. For example, people will resist moving to another OS when the programs they are used to running by third party vendors will not run. In other words, these third party vendors have chosen the Microsoft standard because that is what everyone else is doing. It is not really about competition on the merits as much as the difficulties consumers will face moving away from the status quo. Consumers have invested time and money into third-party products; they are very unlikely to move to a different OS if those investments are lost. This would be so, even if that different OS were better on the merits. In essence, their investments in the third-party products hold them captive to a particular OS.

A better system, from a consumer perspective would be a neutral standard so that different operating systems and other software could interoperate. With an open standard, multiple vendors could make operating systems that conform to that neutral standard and all could run the same third-party software. A world with competition in operating systems would be a better world; Microsoft hasn't exactly been as good as it should in the areas of reliability, stability, and security. Competition in this area, both respect to features and with respect to price would be good for consumers.

Anyway, I don't want to go too much more into this, except to note that the idea that we should be "grateful" to Microsoft for developing "universal standards" might be the exact opposite of the truth. I agree that "universal standards," in some contexts, can have advantages. However, the issue it not one of universal standards versus multiple standards as much as it is one of proprietary standards versus open standards. Proprietary standards restrict competition. In contrast, open standards maximize the possibility of competition.

spencer writes:

Vorn -- good points, you are right I am over generalizing. We all seem to do that here.

aaron writes:

Roger M.,

The points you made are reasons that the top 1% should probably be earning less. The large population of babyboomers eat up a good chunck of income that would otherwise go to the top 1%.

aaron writes:

Now, a second baby boom entering the workforce (and without wealth) + the fact that baby boomers have yet to retire, would mean that the income that the top 1% doesn't lay claim too is spread out over a larger population. And, babyboomers eating up payrolls makes it more difficult for new entrant to save. It is difficult for new entrants to gain wealth, which is used to stake claim on investment income, while those in the top 1% maintain and increase their wealth, ever increasing their share of income.

aaron writes:

Roger M, My previous comment only addressed you babyboomer point. The others are valid. Your point about dual income makes a lot of sense, again this increases the size of the population of the 99%ers. Those at top still have the most wealth and investment income.

John Thacker writes:

Even without entrepeneurs-- more people go to college and grad school. Say someone has three options:

1) Get a job out of high school making $50,000, get small raises each year
2) Go to college and perhaps work part time or not at all, get a job once you get out making $70,000, get small raises each year
3) Go to grad school and work for $20,000 for five years as a grad student, then get a job once you get out making $90,000, small raises each year.

The more people who choose #3 the higher income inequality will be compared to more people choosing #1. Since not everyone is at the same stage of their life at one time, when lots of people choose #3 we have a lot of poor students and a lot of wealthier people with advanced degrees, which is more inequality than if there were fewer students, fewer people in advanced degree jobs, and more people in blue-collar work.

Consider also immigration, as Professor Kling touched on. Say someone is tremendously poor in a poor country and comes to the United States. They can be much wealthier than they were in their old country, yet still make the USA have more income inequality. Can you really say that it's all that bad, though, since the immigrants are better off? (And indeed, if you exclude immigrants, the data clearly shows that poor people who were already in the US are getting better off, on the whole. It's just that immigrants have brought in a new class of poor people who are yet better off than in their old countries.)

There are so many trends, such as women (especially wealthy women, as poor women always worked) working, more education, immigration, divorce among the poor, working towards greater income inequality. Many of them are positive things, however, showing that boiling things down to one number is misleading.

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