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.

Income Inequality in America

First, I enjoy Paul Krugman's theories on income inequality in the United States. He cites one of the proximate causes for this trend as an increasingly individualistic-centered political sphere. To be clear, the notion of more limited government and the rugged individualism ideals which promoted private gain and social indifference exceeded a mindset of the government aiding its citizens and equalizing living conditions. Political and social environments thus metamorphasized from a post-depression era compression of income inequalities into an incredible disparity between the lowest and highest incomes in the United States.

The "skilled-biased technological change" argument has some validity, though I find it more or less a cop-out argument, which doesn't relate to the central problem of widening incomes. For instance, it's as if you are reasoning that the reason why someone would punch another person in the face is because they are angry. Yes, but why are they angry? Weird analogy, but it's workable. Skilled-biased technological change, for less nerdy economic gurus than myself, is the idea that as a country's exports and production move towards an industry with a higher skill level, the demand for this industry will shift outward and will require more workers with higher wages. This will in turn release workers from the lower skilled sectors, and push the demand for labor in these sectors down, along with their wages. With the relatively rapid advancement of technology over the past few decades and a shift towards a higher demand for information technology, it seems like this is more or less completely the case. It is also the reason why many Americans say that Mexican immigrants are depressing their wages. True as it may be, nobody seems to ask what is causing these movements, and why some people get left behind and others get magnificently rewarded. Could they just be lucky? Perhaps, suggests Krugman, it is a financial sector that has been able to loosen moral standards over the past couple of decades in order to gain higher incomes for themselves, which they argue they deserve--such as hedge fund managers, financial analysts, etc.

Again, what is causing this? Why is it that some people have the right skills at the right time and others do not? The American notion that individual prosperity rests on the individual leaves many behind that cannot afford to be left behind. The only problem with this is, that as more and more people get left on the bottom to eat the richs' leftovers and die on the richs' streets, the greater portion of the population will be engulfed by this percentage. It is not sustainable. It never has been, and I find it difficult to believe that it will continue. What needs to change is the political atmosphere of corporate elitism, not the skills that the population possesses. It is a cause of this problem, and not an effect. As power and the density economic wealth concentrates, to the degree that it concentrates, this pattern perpetuates, and creates trends which will continue the concentration of power. It is in their best interest to do so, if they are given the chance to further nurse their greed and need for control. Nothing is checking these people-- and though I hope that their mindset is a unique one, and not of the majority of the world's population, their actions are incredibly pervasive, as well as destructive.

I will be posting more on income inequality and notable economists' opinions on the concentration of prosperity soon-- if you have anything to say, please do so.

Human Economics in Bhutan

Listening to NPR yesterday, I heard a very interesting short segment on happiness derived from wealth; something I take personal opinion to as being relatively unrelated. (Read: http://www.npr.org/templates/story/story.php?storyId=95650430) As most commodities, wealth seems to have diminishing marginal returns. That is, as wealth increases, the satisfaction derived from each additional unit tends to decrease. It becomes harder to become marginally happier as we get richer. Make sense? Of course it does. Unfortunately, most standard measurements of implicit happiness in countries is GDP-- a country's income. It is assumed that as standards of living increase, and people become marginally more well-off financially, their happiness will increase continually as well. This is not true, logically as well as scientifically.

Perhaps if someone has very little wealth, an increase in income will decrease the burden of taking care of a family, paying bills, paying rent or a mortgage, whatever. This will be very noticeable when this person's income is increasing from very little to begin with. After a certain point, though, it will have little or no effect on happiness. Human beings are social creatures, and need human interaction to lead content and satisfied lives. Money has a little to do with happiness, but is vastly overestimated. The country Bhutan started a Gross International Happiness Program, based on Buddhist principles, in which GDP is not a fair measure of well-being of a country's citizens. Bhutan has attempted to isolate itself from the effects of globalization and international trade. Over recent years, this has proved to be somewhat impossible and perhaps as a result, the Gross Happiness Index has fallen.

Interesting concept, don't you think?

"Increases in income are matched by increases in aspirations for income. And the net effect is no change in happiness."-Prof. Richard Easterlin; happiness economist.

Why Bono is doing more harm than good for Africa

For somewhat ridiculous reasons, I got to thinking a lot about international aid-- in particular the celebrity endorsement of completely ineffective policies in an effort to "help" Africa. For the purposes of my own argument (and because his music is awful) I single out Bono. This is fair, in my opinion, to counter the absurd amounts of praise this man receives for promoting the mass consumption of consumer goods like iPods, increasing the sale of his records by painting himself as a hero, and most importantly, diverting very scarce amounts of money, knowledge, and willing hands away from significant problems in order to focus on what is most popular.

The very notion that the West is the only way Africa may be saved is underhandedly racist and insulting. Though we may like to believe we have come a long way from believing colonization was simply "saving" uncivilized Africans, we have truly only shifted our haughtiness to a new line of rhetoric- Africa is in ruin and we must sweep in and save the continent as only we can. There is no stastical link between throwing money at nations and economic growth or disease control. In fact, the policies that have been used have worked so horribly, they have arguably contributed to a negative growth rate, perpetuation of corrupt institutions, and growth of disease. Funny, then, that the IMF, the World Bank, and the alphabet soup of aid organizations continues in this direction. You may say we don't know-- and you would be correct. There are little efforts to ask those affected by these policies if the problem to be addressed is getting better. There is zero accountability.

The far-reaching, utopian ideas spout out by Jeffrey Sachs and Bono are quite attractive. Unfortunately, without accountability and feedback (paraphrasing from Easterly's book) we have no way to see what needs to be done and what is most effective. It is interesting that people have tended to gravitate towards speaking out against worldwide calamities only when they become severe and difficult to address. The outbreak of AIDS, for instance, was well predicted by the international community as early as the 1980s. Where were prevention programs, why wasn't Bono inspiring others to support sex education in Africa? Instead, it was ignored, implying that, although the problem was known and preventable, we decided to let it happen anyways. Perhaps there is more implied racism in the Western aid's actions than its self-proclaimed purpose. Revealed preference theory in economics aligns perfectly with this idea. Here is a concise definition of this very simplistic idea from economist.com:"This is the notion that what you want is revealed by what you do, not by what you say. Actions speak louder than words."

Anyways, the most important non-contribution to relief efforts has been diverting resources away from what is most important. If you truly care about who you are trying to help, despite their nationality, cries from celebrities, and your own past failures-- you will place what you have in what will help the most amount of people in the quickest amount of time. When we prolong the life of an AIDS victim one more year, we divert at least $1500 away from other problems. Vaccines to prevent much wider-spread diseases (malaria, diarrhea, etc.) sometimes cost pennies and can save thousands of lives at the cost of prolonging someone's life an additional year. These diseases kill 2.5 times more people than AIDS, but cost much less to prevent and to treat. It seems cruel to say that we are effectually killing people by giving money instead to people already infected with AIDS, but from a simple tradeoff approach, it is true.

Africa's poor does not need our pity, does not need our aid dollars spent on what "we" think is best for them. My dislike for Bono is simply due to his extremely loud presence and the focus of his message to be increasing the amount of aid poured into countries, rather than its effectiveness. It is easy to say that you are concerned with the world's poor and suffering. Most people stop at that, and are not concerned with whether or not our interference is helping those we are supposedly intending to help. As long as we are doing something, right? Anything? The West is, again, effectually hurting Africa much more than it is helping; while it can sleep at night thinking it is the hero, the savior, of those it is convinced cannot help themselves. History repeats itself in interesting ways, and it is even more fascinating why it is never realized.

If you're as interested as I in this topic, I highly recommend William Easterly's The Elusive Quest for Growth and The White Man's Burden: Why the West's Efforts to Aid the Rest Have Done So Much Ill and So Little Good; as well as Paul Collier's Bottom Billion.

Paul Krugman wins Nobel Prize!

In case you're interested (as I certainly am), Paul Krugman-- professor at Princeton University, op-ed writer for the New York Times, and a well-respected member of the economics community, won the Nobel Prize in economics. Quite deservably, if you ask me!
From the NY Times, today:

Honoring Paul Krugman
By Edward L. Glaeser
Edward L. Glaeser is an economist at Harvard.

Rarely, if ever, has an economics Nobel laureate been as widely known before receiving the prize than Paul Krugman. His New York Times columns have been read by millions; he has argued economic policy eloquently in a large number of popular books. Yet these pursuits had little to do with the decision of the Nobel committee. They gave this prize to honor a truly seminal figure in economic trade and geography. Mr. Krugman’s fame as a public intellectual should not lead anyone to think that they understand his contributions to economic research just because they regularly read his columns.
The Nobel Prize citation highlights two distinct but connected contributions: Mr. Krugman’s development of the “new trade theory” and his work on the “new economic geography.” International trade has a long history in economics, and for the bulk of the field’s history, patterns of trade have been explained by factor endowments and comparative advantage. Why does England export wool and Portugal export wine? The cold winters of Yorkshire produce really fluffy sheep and the banks of the Douro produce splendid grapes. Yet comparative advantage does little to explain much of modern international trade, especially not trade within industries.
Mr. Krugman published two seminal papers in 1979 and 1980 that made sense of the fact that Toyota sells cars in Germany and Mercedes-Benz sells cars in Japan. Mr. Krugman started with a variant of Edward Chamberlain’s model of monopolistic competition. In this model, every firm sells a slightly different good — an Infiniti is not exactly the same thing as a BMW. There are fixed costs of production, which means that producers get more efficient as they sell more. Finally, consumers like variety, so that even if they live in the Land of the Rising Sun, with its abundant well-made cars, they still occasionally want something a little more Teutonic.
These ingredients came together and provided a framework than can match the world’s trade patterns better than the 19th-century framework of David Ricardo, or the mid-20th-century models of Eli Heckscher, Bertil Ohlin and Paul Samuelson. The fact that two out of three of those 20th-century giants are themselves Swedes should remind us of how seriously the Swedes take their trade theory, and what a big deal it is for them to admit Mr. Krugman to the pantheon.
Mr. Krugman’s trade models became the standard in the economics profession both because they fit the world a bit better and because they were masterpieces of mathematical modeling. His models’ combination of realism, elegance and tractability meant that they could provide the underpinnings for thousands of subsequent papers on trade, economic growth, political economy and especially economic geography.
Mr. Krugman’s 1991 Journal of Political Economy paper, “Increasing Returns and Economic Geography,” is the first article that provides a clear, internally consistent mathematically rigorous framework for thinking simultaneously about trade and the location of people and firms across space. It is one of only two models that I insist that Harvard’s Ph.D. students in urban economics be able to regurgitate, equation by equation.
The model begins with the same basic elements as the new trade theory: monopolistic competition, scale economics, love of variety. To these elements Mr. Krugman adds free migration of workers across space and industries. Because workers are able to move, real wages equalize across space. People in New York City may be paid more, but they give some of that back in the form of higher housing prices. The paper provides economists with a clear framework that can make sense of where we all live. Firms and workers are pulled toward the same location to reduce transportation costs of shipping goods. For example, the garment industry located in New York City, in part because of the vast trade in textiles that was already moving through the city and because of the large number of customers already living in America’s largest city.
Of course, we don’t all live in the same city. A good model of geography needs both a centripetal and a centrifugal force. In Mr. Krugman’s model, populations are pulled apart by the desire to be close to natural inputs, like land or coal mines. Cyrus McCormick moved his reaper business from Virginia to Chicago to be closer to his rural customers in the Midwest. Later models incorporated traffic congestion and other forces that limit the growth of a single large urban area. Mr. Krugman’s model proved to quite adaptable; it has received thousands of citations.
In his public role, Paul Krugman is often a polarizing figure, loved by millions but also intensely disliked by his political opponents. I still chuckle over an old New Yorker cartoon with one plutocrat saying to another that he gets some satisfaction from the fact that his vote will cancel out the vote of Paul Krugman. Within the less divided world of the academy, Mr. Krugman’s economic research has generated plenty of light, but far less heat. His papers are universally acknowledged to be immense contributions that helped to create two distinct fields. His Nobel Prize is extremely well deserved and not unexpected. I, for one, had bet on him in Harvard’s Nobel Prize winner pool.

Hoover versus McCain

Thank you, Paul Krugman, for pointing out an interesting coincidence.

Herbert Hoover, Oct. 25, 1929: "The fundamental of business is sound."

John McCain, September 16, 2008: "The fundamentals of our economy are strong."

Time to pay for deregulation. We'll just blame Alan Greenspan for this one, just like all the other flaws of an economy. After all, being Fed chairman gives you sole power of the immediate and long-run health of the economy. Right? Excuse my sarcasm, but I hate scapegoating. Particularly if it is Alan Greenspan, a man I give much respect to.

President Bush announced with Treasury Secretary Henry Paulson, a proposal to buy up highly leveraged investment banks, hoping to add liquidity to the markets. Unfortunately, this seems to me like putting a bandaid on the problem and offering incentives for banks to increase risk in the future. Not to mention the bad money that is being created to buy these banks, probably at a cost that is above what they are worth, placing the burden on taxpayers. we'll see what happens, but I have a bad feeling about the prospects of government taking over bad assets with taxpayer money.

Abusurdity in the World of Aid

Though my faith in international aid organizations was weak at best to begin with, I think it has reached a new low. The International Monetary Fund and what would become the World Bank never intended to be lasting institutions. They were created for the sole purpose of establishing order in the international financial world that had been in chaos because of the war. Power was vested in the victors of the war, mainly the United States and to a smaller extent England. Countries who lost the war were given much lesser power, and those without any financial clout were ignored entirely. These were temporary organizations. And temporary organizations, particularly when created for the sake of security, allow those in control to act above what is normally acceptable. In times of war and fear of war, this is also very prevalent.

My concern isn't entirely with the foundations of these organizations. My concern is the way that they are handled today. As the gap between the world's poor and rich thickens, it becomes easier to distance oneself from the deprivation of the third world, living in a relatively excessively rich country as the United States. And it is easy to say that we are doing all we can--that it is up to the governments to respond-- perhaps, according to a quasi-racist remark in a university classroom-- it is simply their culture, assuming that they are happily starving and dying of disease because they hold onto a particular ancestry. I find that difficult to believe. It reminds me of a dehumanization process that people allow themselves to undergo when they are at war, or they want to justify the murder or oppression of large groups of people. It is also difficult for me to believe that, for example, Africans' culture has made their poverty, and not the blundering, raping, and divisiveness of European colonization.

In any case, as an economics student, I have been conditioned to believe that people are selfish. And I do agree with this. I believe that any benevolent act-- regardless of its positive effect or perceived kindness, has a selfish intention. Even if this is to make a person feel better about their own soul, whatever it may be, people have little to offer others besides their self-interest. And this can be managed! That's the best part. Adam Smith, though preceded by similar thinkers, was the loudest voice of the utilization of self-interest to the betterment of society. And this is possible, (why not?) on a global scale the same as it applies to closed economies. In fact, I believe it would be even more effective. The important point to keep in mind is that a global organization must align people's incentives with goals of world development and growth, particularly for third and second world countries. The IMF and the World Bank have the power to do this. But instead, they arbitrarily give loans to countries who cannot pay them back. And these organizations indirectly make sure that they will never pay back these loans by allowing recipient country's governments to have a constant and perpetual cushion of aid.

William Easterly's point in The Elusive Quest for Growth--which I highly recommend-- is that the appearance of helping developing countries is far more important than the actual benefit given to these countries. This could explain why there is little emphasis put on asking the poor what they need. The not-so-underlying assumption is that we know better than they do, while our half-hearted efforts to help have unquestionably failed. Before I get too carried away, I want to say that a large part of this failure is also failed economic theories of growth. The World Bank and the IMF still cling to the theory that investment will automatically trigger growth--that there is a so-called financing gap between the savings potential of a country and the investment potential of a country. This is an attractive theory. It must have been, for those in international aid organizations to cling with such undying fervor. That's a beautiful thing, when the theory hasn't been proven wrong over and over throughout the past century.

The key to growth, according to Robert Solow (read Growth Theory: An Exposition) is technology. Investment is only about a third of the causation behind growth. The problem is, that aid organizations dump funds, theoretically, for investment-- though most or all of it goes to immediate consumption-- and this leads to zero growth. Even with high investment, countries cannot grow because they are missing 2/3 of their growth recipe. This 2/3, according to Solow, is contributed to technology. Unfortunately, access to technological change is not available in many countries with already slow or even negative growth rates.

It's a shame that the IMF and World Bank do not acknowledge a different theory of growth besides outdated and evidently wrong theories. Although it is very easy to continue business as usual, particularly when it looks so good. Treatment of AIDS, for example, looks much more admirable than prevention. Prevention involves birth control and family planning-- which have most definitely been pushed aside by the Bush administration, if not the rest of the world. Unfortunately, what we are dealing with is not numbers and data and theories. It is the lives and suffering of people who do NOT have what you have, and do NOT know what it is like to always have food and always have a safe place to go to sleep at night. It may sound clicheed, but it shouldn't. It should give you chills. It should make you want to do something, to be outraged. At the very least, be the most grateful you can possibly be if your situation is better than most of the world's, and you never have to worry about your children starving in front of you.