Structural Issues In The Economy - A Personal View

One thing I believe the vast majority of parents have in common, irrespective of their politics, is to care about the welfare of their children.  This is surely true when the kids are very young, continues to be true when they are young adults, and persists even after that.  In my way of thinking the parental responsibility extends to getting the kids through college, perhaps assisting with post-baccalaureate education as well, and then into the first real job. If that job appears to be solid perhaps the responsibility ebbs at that point, though not completely.  The parents' obligation persists thereafter as possible insurance for the children against life's vicissitudes.  And if there are grandchildren then helping to assure for their education is, if not an obligation, certainly remains a strongly felt desire. 

With one child in college and the other preparing to start in the fall, both in Engineering at Illinois, the prospects of my wife and I being able to satisfy those responsibilities seem reasonably good.  Nevertheless, there remains a concern that as adults living on their own the kids may backslide income-wise relative to the expectation we have for them, which is to have a decent job and be able to live comfortably as a consequence.  It is from the perspective of the possible backslide for the adult children that I'd like to consider the structural issues in the economy.

In order to do this I'm going to use some Census data on income distribution to provide a benchmark.  For the year 2010, I've modified a table that gives household income distribution in $5,000 increments, up to $250,000.  My modification, has two additional columns, Cumulative and Percentile.  So you can readily see where your household lies in the distribution.  This was the year I retired from Illinois so I received a large one time payment.  That plus the rest of our earnings put us in the highest income row.  Our 2011 numbers are more representative of our current income and our likely income for the next few years.  Then we don't make the highest income row, but we're still doing quite well, making it to the row next to it. I'll explain how that came about in a bit.

I also want to look at historical data.  What I've found, table H3 for all Races from this page of Historical Income Tables, is not as granular as the first table.  The income distribution is divided into quintiles only.  But it does that annually going back to 1967.  In my modified table (click on the worksheet H03) I've added the columns that include the ratio of income between the top fifth and the middle fifth and again for the ratio of the top 5% and the middle fifth.  Those data appear twice.  The top rows provide the information in current income.  If you scroll down to row 50, beyond that all dollars have been converted to 2010 dollars.  This way you can make comparisons over time, with inflation being controlled for.

Here's my own pattern of income historically.  In 1980 at age 25 I started at Illinois with income in the range of the 50th - 60th percentile.  I was ABD then, but I was on the tenure track.  I would get the PhD the next spring.  That milestone did nothing for salary since it was built into the expectation when I got the job.  But other things did.  Getting promoted, simply sticking around, and switching to learning technology and administration in the mid 1990s.  By 2010, I was in the 94th percentile based on just my salary alone.  There's also the fact that I got married in 1990 and my wife is a PhD as well.  She's also employed by the University.  Our household income is therefore the sum of our two salaries (plus a bit of capital income).  Even being retired now and getting a pension rather than a salary, we're still in the high 90s regarding the percentile in the income distribution.

If you go down the columns of the H03 table (do this for the inflation adjusted data starting in row 51) you will see very modest income growth in the the lowest fifth, the next lowest fifth, and the middle fifth, with a bit of back sliding in the last few years due to the recent downturn.  There has been bigger growth in the next highest fifth, and still more growth in the highest fifth.  The consequence is that the upper fifth is distancing itself more from the middle fifth. Prior to 1980 the ratio of the top 5% to the middle fifth did not grow at all.

It's not right to extrapolate for the next 40 years based on the patterns from the previous 40, but if the future is similar in these respects then the backsliding I've referred to will happen not just because of where the kid starts with the first job (perhaps in the second fifth  rather than in the middle fifth), but also because as the kid gets older he never makes it to the top two quintiles and so doesn't get to experience real income growth in mid life. 

All of this is meant as prelude to ask the following question.  Suppose there is a tradeoff between income growth for the economy overall and the flatness of the income distribution.  Rapid growth is associated with a skewed distribution, with the higher end of the distribution receiving a disproportionate amount of the gains.  Flattening the distribution is possible, but that will slow overall growth.  What type of solution do you then want?

As I said earlier, my concern is about my children backsliding income-wise, which might occur sometime in the indefinite future.  So I care more about how the lowest fifth, the second fifth, and middle fifth in the income distribution than I care about the rest of the table.  For that reason, I'd rather see a flatter income distribution in the future, even if that means slower growth.  And I want to note that this is a conclusion arrived at based on purely selfish reasons, simply a concern for my progeny.   Coming to this conclusion doesn't require altruism at all.  It has been noted that Liberals tend to over estimate their own empathy for their fellow citizens.  While I do have some empathy, I want to make the point that the argument can be made absent those concerns entirely.  Or put a bit differently, many of us want to see the system work for others because it's the only way we can be assured that it will work for the people we do care about.

Yesterday, David Brooks in his column took on Paul Krugman, arguing that the current economic malaise is mainly structural rather than a business cycle slump and therefore the cure should not be the typical Keynesian one, but rather needs to address the underlying problems.  For the record, I think Brooks is wrong and Krugman is right.   More stimulus would help a lot to lower the high unemployment rate.  (The one piece of seemingly damning evidence to the contrary is that there appear to be good jobs that are vacant because the employer can't find somebody to hire with the right skills.  But this also might be that such job vacancies are still too rare for unemployed workers to acquire those specific skills, or it might be that the employer is just low balling the wages for the job, or that the employer is too risk averse to take on a employee who needs to be trained on the job before being productive.)   There clearly are issues related to the aging of society and the cost of the entitlement programs, particularly Medicare, so I don't want to argue that there aren't any structural problems.   But the issues about jobs being automated out of existence and increased competition due to globalization making it harder to achieve full employment are overblown.  Anyone remember the Allan Sherman song Automation?  That was 1963.  How about The Reckoning by David Halberstam, where the Japanese company Nissan looks far superior to the American company Ford?  That was 1986.  That movie has had many remakes.  What's so different now?

But there is an issue in being all high and mighty as Krugman has done in that those arguing for structural reform are not engaged on their own terms.  One of those making these sorts of arguments is Raghuram Rajan, a Finance Professor at the University of Chicago.  Brooks links to a Rajan piece in Foreign Affairs, to make his case about the structural issues.  (Yesterday following that link I could access the full article.  Today there's only a snippet and then a request to buy.  I did find that the University subscribes to Foreign Affairs via Ebsco Host and I was able to locate the full text of the article that way.)   I found the analysis lacking.  The claim is that deregulation was a mixed bag because trickle down didn't work; the gains in increased economic growth went largely to the 1%.  (One purpose of the early part of the essay is to show that they really went to the top 5%.  Professional types like me benefited quite a bit, because we were in fields in demand.  Though a lot was captured by the 1%, much of the rest of the 5% did well too. )  That much I agree with.  But then, what should be done about it?   Doesn't Rajan recognize that the answer to the question might depend on where you sit?  If your lot in life is the middle quintile of the income distribution, would you agree with Rajan's recommendations?

At the same time, since new business ventures are what will create the innovation that is necessary for growth, the United States has to preserve its entrepreneurial environment. Although the political right is probably alarmist about the downsides of somewhat higher income taxes, significantly higher taxes can reduce the returns for entrepreneurship and skill acquisition considerably -- for the rich and the poor alike. Far better to reform the tax system, eliminating the loopholes and tax subsidies that accountants are so fond of finding in order to keep marginal income tax rates from rising too much.

Culture also matters. Although it is important to shine the spotlight on egregious unearned salaries, clubbing all high earners into an undifferentiated mass -- as the "one percent" label does -- could denigrate the wealth creation that has served the country so well. The debate on inequality should focus on how the United States can level up rather than on how it should level down.

Finally, even though the country should never forget that financial excess tipped the world over into crisis, politicians must not lobotomize banking through regulation to make it boring again. Finance needs to be vibrant to make possible the entrepreneurship and innovation that the world sorely needs. At the same time, legislation such as the Dodd-Frank act, which overhauled financial regulation, although much derided for the burdens it imposes, needs to be given the chance to do its job of channeling the private sector's energies away from excess risk taking. As the experience with these new regulations builds, they can be altered if they are too onerous. Americans should remain alert to the reality that regulations are shaped by incumbents to benefit themselves. They should also remember the role political mandates and Federal Reserve policies played in the crisis and watch out for a repeat.

I sure don't.  I think this is hokum.  (For example, in the middle paragraph he talks about the wealth creation that has served the country so well, though earlier in the piece he argues that the trickle down didn't work.)  The structural argument is being advanced, in my view, to allow this hokum to pass as solid recommendations deriving from sensible analysis.   Instead, somebody concerned with structural issues could more credibly argue for these recommendations:

(1) Return to the tax rates when Bill Clinton was President AND close the loopholes.  Then you can tackle entitlements with a reasonable amount of revenue to address the issues. 

(2) Maybe not lobotomize banking but rein it in substantially so there aren't all these financial assets out there that nobody knows how to value.  And restrict the predatory lending to the poor.

(3)  Invest in basic research and infrastructure with a long term - 50 years - view.  We don't know what the next big growth innovation will be.  But we should diligently be planting the seeds so that it is likely to happen.  

It's clear that Conservatives won't like these recommendations.   That's too bad.  If they're going to insist on playing the structural card, that's what they'll get in return.