Tuesday, August 22, 2006

Productivity and Inequality: Observations from the Peanut Gallery

by Tom Bozzo

There's been a quite interesting free-for-all going on in the upper reaches of the econoblogosphere, summarized by Brad DeLong here, originating in Treasury Secretary Paulson's 'close your eyes and think of England' comment that rising inequality "is simply an economic reality, and it is neither fair nor useful to blame any political party [for it]."

Much of the question boils down to whether there's reason to believe that an increase in relative productivity accompanies the increase in payments to the inhabitants of the nosebleed section of the income distribution. For reasons I'll explain in additional detail once I have some blogging time, I'm inclined to side with Paul Krugman and Mark Thoma and say that on balance there isn't.

My two cents — and I'm calling myself the 'peanut gallery' from a position I'd characterize as informed but non-expert on the subject — is that there are prima facie flaws with the main stories that purport to explain the increasing inequality. This is not to say that these cannot be overcome by careful analysis; it's just that I'd need to see compelling analysis on the subjects before changing my mind.

One is that increased returns to education can explain why the working classes are falling behind but not why narrower segments of the educated classes are pulling ahead. Assuming the coporate executives, investment bankers, and top-tier professionals were highly educated to begin with, the relative marginal education effects should be stronger for people whose next best alternative is a blue-collar vocation.

The other is that high-income elites also aren't obviously the greatest beneficiaries in relative marginal productivity of IT improvements. That is, can someone refute a claim that the largest relative marginal productivity increases have been for, e.g., office workers who, armed with a computer and common commercial software, can carry out the function of rooms-full of drones with adding machines?

So when DeLong observes:
To a good neoclassical economist, the statement that the relative price of a factor of production--like the labor of the elite top 1% of America's wage and salary distribution--has risen is the same thing as the statement that the relative productivity of that factor of production has risen[,]
the relative part is critically important. High-income elites can enjoy large absolute productivity increases which, if they're outstripped in relative terms by the masses, would be predicted to reduce inequality, other things equal.

Another economics 301 point to keep in mind is that a really good neoclassical economist has to acknowledge that this result is not totally robust to imperfectly competitive factor markets. So it's necessary to decompose productivity, market power, and other structural change effects.

These effects can work in various directions. For example, the pro athlete division of the high-income set has benefited from 'technological change' increasing their 'marginal revenue product' (much wider mass-media distribution of their product) which reinforces a market power effect (having greater claims to the proceeds of their services via free agency and unionization). The latter effect, it would seem, is moving in the opposite direction for office and production-line workers.

And this should, thank heavens, get Nixon off the top of the main page.
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