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Friday, March 9, 2012

The Global One Percent: Economic Growth, Not Redistribution, Drives Income Equality

Wall Street Journal op-ed, A Look at the Global One Percent, by Allen H. Meltzer (Carnegie Mellon University, Tepper School of Business):

While the Occupy Wall Street movement may be waning, the perception of growing income inequality in America is not. For those on the left, the widening gap between the top 1% of earners and the remaining 99% is proof that American capitalism is unjust and should be traded in for an economic model more closely resembling the social democracies of Europe.

But an examination of changes in income distribution over nearly 100 years, not just in the United States but elsewhere in the developed world, does not bear this out. In a 2006 study titled The Evolution of Top Incomes in an Egalitarian Society, Swedish economists Jesper Roine and Daniel Waldenström compared the income share of the top 1% of earners in seven countries from the early 1900s to 2004. Those countries—the U.S., Sweden, France, Australia, Britain, Canada and the Netherlands—all practice some type of democratic capitalism but also a fair amount of redistribution.

As the nearby chart from the Roine and Waldenström study shows, the share of income for the top 1% in these seven countries generally follows the same trend line. That means domestic policy can't be the principal reason for the current spread between high earners and others. Since the 1980s, that spread has increased in nearly all seven countries. The U.S. and Sweden, countries with very different systems of redistribution, along with the U.K. and Canada show the largest increase in the share of income for the top 1%.

WSJ

The main reasons for these increases are not hard to find. Adding a few hundred million Chinese and Indians to the world's productive labor force after 1980 slowed the rise in income for workers all over the developed world. That's the most important factor at work. The top 1% gain relatively because they are less affected by the hordes of newly productive workers.

But the top 1% have another advantage. Many of them have unique skills that are difficult to replicate. Our top earners include entrepreneurs, rock stars, professional athletes, surgeons and lawyers. Also included are the managers of large international corporations and, yes, bankers and financiers. (Interestingly, the Occupy movement seldom criticizes athletes or rock stars.) ..

The big error made by those on the left is to believe that redistribution permits the 99% or 90% to gain at the expense of top earners. In much current political discussion, this is taken as an unchallenged truth. It should not be. The lasting opportunity for the poor is better jobs produced by investments, many of which are financed by those who earn high incomes. It makes little sense to applaud the contribution to all of us made by the late Steve Jobs while favoring policies that reduce incentives for innovators and investors. ...

The chart shows that policies that redistribute wealth and income have at most a modest effect on income shares. As President John F. Kennedy often said, the better way is "a rising tide that lifts all boats."

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"the share of income for the top 1% in these seven countries generally follows the same trend line. That means domestic policy can't be the principal reason for the current spread between high earners and others."

No, it means it might not be the only reason. There are clearly very dramatic differences between the Netherlands and Sweden on the one hand and the U.S. and U.K. on the other.

If you look at after-tax, after-transfer income inequality, the huge difference domestic policies can make becomes even clearer.

Posted by: Anon | Mar 9, 2012 8:42:22 PM

Download the original article by the Swedish Economists from SSRN. The summary of the article provided by the Wall Street Journal is pretty much exactly the opposite of what the article actually says. According to the WSJ, domestic policy doesn't make a difference in inequality.

From the actual article:

"The third fact that stands out in Figure 12 is the divergence after 1980 between one group of countries with significantly increasing top shares; Australia, Canada, U.K. and the U.S., and another group; France, the Netherlands and Spain, where the top shares remain virtually constant. This division between the “Anglo-Saxon” and “Continental European” experience has received a lot of attention in the previous literature."

In other words, the differences between European social democracy and the U.S. are huge, especially since U.S. policies and taxes changed dramatically in the 1980s during the Reagan revolution while the Europeans became more socialist.

The WSJ also claims high wages for the top 1% are caused by skill and education. But, from the actual article:

"the fact that so much of the increase in the top happens in the very top (top one percent) has made many skeptical of a return-to-education story. Our data for Sweden also seems to indicate that a skill-biased technological change story is not the most likely explanation for the observed changes."

"One possible interpretation of our data is that top income earners in Sweden have not increased their income share over the past decades through higher earnings but instead by making the right investments."

In other words, the rich make money from their money, not from their labor.

This is not the first time the WSJ has misrepresented the contents of scholarly articles they claim to be citing. Trust the WSJ at your peril.

Posted by: Anon | Mar 9, 2012 8:57:55 PM