A new theory of inequality

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Thumbing through the annual report of the White House’s Council of Economic Advisers (CEA) is always an education. This year’s 430-page edition is no exception. Crammed with tables and charts, it brims with useful facts and insights.
—On page 62, we learn that the growth of state and local government spending on services (schools, police, parks) has been the slowest of any recovery since World War II. One reason: Payments into underfunded pensions are draining money from services.
—The CEA says on page 72 that labor markets could tighten in 2016 even if job creation is well below last year’s monthly average of 228,000. A mere 78,000 new jobs a month would absorb new workers and keep the unemployment rate at 5 percent. With 141,000 new jobs a month, unemployment would drop to 4.5 percent (January’s actual rate: 4.9 percent).
—A chart on page 149 shows that U.S. exports have increased as a share of the economy (gross domestic product), from 10 percent of GDP in 2005 to 12.5 percent in late 2015. Unfortunately, slow economic growth abroad lately has dampened demand for American exports.
But the most fascinating discussion concerns economic inequality — a hot topic in the presidential campaign. To remind: The figures are stunning. From 1975 to 2014, the share of pretax income going to the “top 1 percent” grew from 8 percent to 18 percent. (Note: Counting fringe benefits, government transfers — say, Social Security — and taxes reduces the concentration.) We have a stock explanation for this. Corporate compensation committees overpay CEOs; hedge fund operators reap big windfalls from trading securities.
Although this undoubtedly occurs, the CEA modifies the standard portrait in two significant ways.
First — summarizing other studies — it attributes much inequality to differences between companies and not to individuals in the same firm. It’s not so much that the gap between the CEO and the janitor at company A has widened; it’s that company A is falling behind Company B, which is more profitable and pays both the CEO and the janitor better. Think General Motors (company A) and Google (B). The economy is splintering into increasingly and decreasingly profitable firms, argues CEA chairman Jason Furman.
Next, the CEA emphasizes the role played by “economic rents,” enjoyed mostly by highly profitable firms. An economic rent is a price or wage premium above what’s necessary for a company to sell its product or a worker to take a job. A company selling its gizmo at $50 when $30 would earn a reasonable return has a $20 rent.
Rents can result from market power (including monopolies), better products or technologies, favorable regulations and laws, import tariffs, corruption and much more. Rents earned by superior performance are defensible; rents created by preferential policies or industry consolidation are suspect.
The trouble is that rents are invisible and can only be inferred. In practice, they show up as strong profits and cash flows. However created, companies have to decide who should get them — top executives, workers, shareholders or some mix. A lot of the rents, the CEA suggests, go to top managers and
investors. If a CEO is paid $5 million when she’d work for $3 million, she’s receiving a
$2 million rent.
It’s also true that many middle-class workers have lost their ability, mostly through unions, to create their own rents — higher wages. In the 1950s and early 1960s, when roughly 30 percent of non-farm workers belonged to unions, this was possible. Companies could pass higher wage increases along to consumers, because many industries were dominated by a few large firms and competition was weak.
Even if today’s unionization rate exceeded 2015’s 11 percent, it would be hard to duplicate this feat. Competition has intensified in too many ways for too many firms: from foreign companies (autos, steel); from the Internet (retailers, movie studios); from deregulation (airlines, trucking and telecom firms). Companies with high labour costs that cannot be recovered in the market are likely to shrink or vanish.
What emerges is a complicated and exasperating picture of growing inequality. There’s a historic rearrangement of economic activity that’s generating more of it. It’s not just greed run amok via undeserved rents. Indeed, even greed is sometimes good, as the CEA says: “Large rewards can motivate innovators, entrepreneurs and workers and compensate them for taking large personal risks — choices that, in some cases, can benefit households more broadly.” Put plainly: The prospect of striking it rich can inspire socially beneficial behavior.
The CEA’s theory of inequality is admittedly incomplete. “The overall increase in income inequality in recent decades is large enough to accommodate many partial explanations,” it says. Poor schools, new technologies, family breakdown, immigration all play a role. Fear not: There will be plenty to write about in next year’s report.
— Washington Post Writers Group


Robert Jacob Samuelson is a columnist for The
Washington Post, where he has written about business and economic issues since 1977, and is syndicated by the
Washington Post Writers Group

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