Thursday, December 18, 2008

Income Inequality, Part II.

Luckily for you (sarcasm), I engrossed myself in income inequality literature and blogs over the past couple of days and I excitedly found very good information! I really wanted to conduct my own regression having the Gini Coefficient as an independent variable, and dependent variables for measuring how quickly a country exports more technologically advanced goods, educational differences and control for primary commodity export dependence, inflation, etc.

But alas, until I get $500 for SAS or eViews, I am stuck hypothesizing. Here is my guess: that income inequality has risen where countries have adopted technologically advanced products-- and that although manufacturing has been shown to raise a country's overall GDP, the spread of wealth might be quite large. Consider Nazi Germany-- a cliched example, I admit, but in this case it might work. Mandatory wage-holding down policies created a decline in the share of wages to national income. Though total GDP increased, the quality of life deteriorated. This must have meant that income inequality rose-- and indeed, according to Tyler Cowen (the Marginal Revolution blog), the income share of the bottom half of the income distribution fell from 25 to 18% from 1928-1936, while the increases in profits were incredible.

There might be something to the Kuznet's inverse-U hypothesis (1955): that is, that income inequality will raise during an era of heavy industrialization as the skilled workforce becomes more valuable and more heavily demanded. After time, according to Kuznets, people will re-train themselves and their offspring to move in this new direction, returning to normal levels of inequality.

I do not think this is the whole story. In fact, it does not do much to explain why there has been a U-shaped (versus Kuznet's inverse U-shaped) income inequality curve over the last century in America. Douglas Massey, an economics sociologist from Princeton, suggests that there has been an increasing trend to model markets after the natural world- something I mentioned previously. In fact, markets are not states of nature, and do not react like living beings. They "respond" based on human interaction and human desire. Markets are created by governments. And because markets are not natural, the government's inclinations are particularly important in determining their structure. After the 1970s, income inequality took a sharp turn upward, and Massey suggests (as I mostly agree) that it was due to a change in the political atmosphere. Some well-known causes for income inequality include educational differences, immigration (with a minimal effect), a shift in skilled labor demand with technological progress, unionization, globalisation and a decline in the real value of the minimum wage.

I will begin with unionization. In 1947, the Taft-Hartley Act was passed and restricted the power of labor unions. Specifically, it allowed states to dictate their own labor standards. The southern states eagerly amended their union laws in order to further exclude blacks from being able to organize. They did so by outlawing "closed shop", punishing actions against companies, a mandatory "cooling-off" period in which workers were not allowed to strike, investigation and possible suing of unions if they are found to be destructive to businesses, etc. There was a temporary stabilization in unionization, but minority workers began to organize themselves again, which lead to another anti-union legislative move in 1959, decertifying certain unions. Finally, Johnson's Great Society programs began to deracialize the heavily racialized New Deal programs that Roosevent initiated, of which radically excluded blacks from receiving public assistance or participating in the workforce programs. The Civil Rights Act in the 1960s helped to allow minorities to unionize with greater ease and less barriers, leading to a lower inequality level. Unions have lost their power recently, and only a small percentage of private companies are unionized in America, at much lower levels than other industrialized nations. There is a clear trend between the ability to unionize and an income gap.

The 1920s was a period of low taxation and heavy income inequality. World War II took icnome away from businesses, which decreased the earnings of business owners, creating a more equal post-tax society. President Johnson moved to an extremely progressive tax system, which made the after-tax income gap much narrower. What followed this relative equality in incomes was a period of radical fiscally conservative ideology, beginning with President Nixon and continuing almost steadily (excluding a minor dip during the Clinton era) until the present-day Bush administration. President Reagan's notion of the "welfare queen" began a pattern of legislation to cut welfare eligibility and lower taxes for the wealthiest Americans.

A lot of the analysis of income inequality requires you to think of the whole as the a set of a few individuals. So think of the society as a small group of people. One person in the group has hit the proverbial jackpot. He has made an enormous amount of money doing a particular job. The only thing is, only he can do this job, because he has the skills to do so, and he excludes other people from this job. Let's say he's a hedge fund manager. Nobody else in the group knows how to get where he is at the time, so they do what they can and try to live like he does. Meanwhile, the wealth that he has accumulated has lost its value in each increasing amount-diminishing marginal returns to his satisfaction, if you will. So he will need more and more to make him as happy as the first unit of wealth had. If there is an outside check on this "need", he will be forced to stop (IE, the government, or cultural ethical standards). Otherwise, in order to feed this desire, he will perhaps appoint his friends to the board of executives who will allow his income to reach exorbinant amounts (I owe part of this analogy to Paul Krugman). The other people of the group will try to get where he is, by taking out massive credit card debt. Perhaps the rich guy will realize that he can loan these people money and then charge them extraodinary amounts of interest. There is more than a little validity to this statement. Indeed, the interest rates for credit cards versus the interest rates that banks pay has been widening substantially. Banks will make a profit, therefore, off of consumer debt, and consumer debt will further push lendees into poverty.

What of these cultural standards? Are they particularly important? Research at the University of Colorado has conducted experiments with morality and income distribution that seem to suggest that cultural morals are important in this discussion. Candidates from Russia, China, and the United States were asked to participate. The criteria was that one person of the group would receive a larger monetary gain than the others. The group could vote against or for this gain. A vote was conducted knowing which person will receive the gain, and a vote unknowing who the gain would go to. Post-soviet or post-Communist states tended to vote against the gain, even if they had a chance of receiving it; while people in America were more likely to vote for the gain, even if they knew who would receive it. It is sometimes reported in the news that in Russia, one person will sabotage another's house or belongings if that person has received a monetary gain above that which is deemed acceptable.

Income inequality, as I touched on earlier, is not a fluke. It did not happen due to a natural relationship. It occured out of human greed and a deliberate manipulation from a few influential and already wealthy people of the majority of the population. In Michael Parenti's book, "Culture Struggle", he notes the socio-cultural trend towards rugged individualism, the concept that we are each responsible for our own destiny. Hyper-individualism, which has been a wealthy hipster trend of practicing Yoga, Buddhism and meditation, is great for peace of mind of the individual, but allows the individual to blame each person's problems on their own state of mind. When a family is living in poverty, it may be difficult to convince yourself you and your children are not starving. Brad DeLong, in his August 10, 2008 blog, discussed inequality as a result partially by the government, but not completely. He reasonably stated that the government mostly controlled after-tax inequality, not pre-taxation inequality. A good point, I think. I do think there are other ways to lower wage incomes than taxation-- something that the government has much control over, such as exclusionary public services and barriers to unionization. Certainly, there exists no single answer for this problem, and several interconnected trends are reciprocally enforcing one another.

Any insight is welcome.

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