1

An international political view emphasizes the constraints imposed on national states by the global

geostrategic and diplomatic environment within which they operate. It focuses on the inherent

conflict among states in a hostile world, within which cooperation, although often desirable and

feasible, can be difficult to achieve.

The international economic perspective similarly emphasizes the importance of constraints external

to individual nations, but it highlights global socioeconomic factors rather than political ones.

Accordingly, international developments in technology, telecommunications, finance, and

production fundamentally affect the setting within which national governments make policy.

Indeed, these developments can matter to the point of making some choices practically impossible

to implement and others so attractive as to be impossible to resist.

Domestic approaches look inside nation-states for explanations of the international political

economy. The domestic institutional view turns its attention to states, as does the international

political perspective, but it emphasizes the role and institutions of the state in a domestic setting

rather than in the global system. This view, which at times is called simply institutionalism, tends to

downplay the impact of constraints emanating both from the international system and from

domestic societies. National policymakers, and the political institutions within which they operate,

are thus seen as the predominant actors in determining national priorities and implementing policies

to carry out these goals. Some variants of institutionalism emphasize the autonomy of states from

societal actors, while others focus on how state institutions mediate and alter social forces.

The domestic societal perspective shares with domestic institutionalism an emphasis on

developments within national borders but looks first and foremost at economic and sociopolitical

actors rather than political leaders. This view, which at times is known simply as societal, tends to

minimize international constraints and to emphasize socioeconomic pressures that originate at

home. Accordingly, the determinants of national policy are the demands made by individuals,

firms, and groups rather than independent action by policymakers.

The contending perspectives can once again be illustrated by recalling their approaches to the

example of trade policy tendencies. International political interpretations would rely on geopolitical

trends among states at the global level to explain changing patterns of trade relations. An

international economic view would emphasize trends in market forces, technologies, and the like

that alter the environment in which governments make trade policy. The domestic institutional

approach focuses on the goals and actions of the government within the national political system,

for which foreign trade can represent ways to help politicians stay in power. Finally, a domestic

societal perspective looks primarily at the pressures brought to bear on policy by various

socioeconomic groups, some desirous of trade liberalization and others interested in protection from

imports

2

Article 1:

Exceptionally Unequal: US Income Inequality in Comparative Perspective

(Domestic societal and Domestic political)

Article 2:

ECONOMIC GLOBALIZATION AND INCOME INEQUALITY IN THE UNITED STATES

(Domestic political vs. International economic)

Article 3:

Globalization and Inequality, Past and Present

(International political / international economic)

Article 4:

Public Policy and Economic Inequality: The United States in Comparative Perspective

(International Political / International economic / Domestic Political / Domestic Societal)

Article 5:

The Causes and Consequences of Changing Income Inequality

(International Economic among others)

Article 6:

Income Inequality and Financialization in the United States

(Domestic political and societal)

Article 7:

WEALTH INEQUALITY IN THE UNITED STATES

(Domestic political and societal)

3

Article 8:

Growing World Trade: Causes and Consequences

(International Economic)

Article 9

THE RACE BETWEEN EDUCATION AND TECHNOLOGY

(Domestic political and economic)

Other international economic / political possible texts: Burtless, Wood

Exceptionally Unequal: US Income Inequality in Comparative Perspective

(Domestic societal and Domestic political)

Over the past forty years, the US has seen a steep increase in income inequality, even as many other

advanced democracies have seen their income distribution decline or remain steady. A country’s

income distribution results from domestic political decisions, as countries have similar levels of

inequality before taxes and redistributions but vastly different levels afterwards.

Scholars have offered various explanations for why income inequality has risen in the U.S, including

the unrepresentative nature of American political institutions, Americans' attitudes

toward inequality, declining levels of unionization, and the partisan polarization of

elites. This paper explores the merits of these explanations from a comparative perspective.

First, I find that although the American political system has the highest number of anti-

majoritarian features among advanced industrial democracies, those features have not

changed significantly over time are not sufficient to explain why income inequality has

increased in the U.S.

Second, although Americans may be somewhat more permissive about economic

inequality than Europeans, Americans' attitudes have remained largely unchanged over

the past 35 years and so cannot during the increase in inequality during that period.

Third, the low percentage of workers covered by collective bargaining agreements in the

United States compared to other democracies bolsters the argument that the decline in

unions contributes to rising income inequality.

4

Finally, the most striking correlation has been the increase in political polarization in

Congress. This polarization has made it inordinately difficult to pass legislation that would

lessen inequality

Article 2: ECONOMIC GLOBALIZATION AND INCOME INEQUALITY IN THE UNITED STATES

(Domestic political vs. International economic)

The federal government, long viewed as a key actor in the amelioration of poverty, is now

increasingly seen as a causal element in the trend of increasing income inequality in the

United States. As noted in other chapters in this book, the size and scope of the national

government are now being questioned and changed at the same time as the U.S. economy is

more permanently embedded in the world economy. Growing inequality in the U.S. is

occurring despite, or maybe because of, strong macro-economic factors such as low

unemployment rates and high GDP (gross domestic product) growth rates.

In this chapter, I wish to examine the hypothesis that the increasing globalization of the U.S.

economy, through increased trade and immigration, is an important element in the

development of inequality and, by implication, in the role of national government.

In the second section of the chapter, I present the key arguments over the causes of

economic inequality in the U.S. This debate is delineated between those who emphasize

processes at the domestic scale versus those who identify processes of economic change

at the global scale. I conclude that the evidence is strongest for the role of economic

processes related to globalization, but that these processes interact with domestic changes

rather than stand in isolation. In the third section of the chapter, I wish to make the case

that, while economists treat the U.S. economy as a unit, geographers are more careful to

differentiate the relative impact of globalization on the fortunes of regional and local labor

markets in a rapidly changing global economic environment.

THE EVIDENCE FOR GROWING INEQUALITY IN THE UNITED

STATES.

Trends in income inequality are typically examined over the past quarter-century, since

about 1970. This starting date is very important since the early 1970s mark the beginning

of the global economic downturn.

Benjamin Disraeli’s comment about “lies, damned lies and statistics” comes quickly to mind

as one slogs through the morass of evidence on the scope and extent of social inequality in

the U.S. Different statistical indicators are adopted by commentators depending on the

picture they wish to paint. The statistical debate can be easily seen in the dispute about the

use of a key index, median family income, which has been stable or slightly falling in real

terms over the past quarter century.

5

It should be remembered that the “median family” has changed, with both more single-

parent and dual-income household. On an optimistic note, non-income indicators show

that Americans are living better than ever; using more general measures of well-being

such as amount of free time, number and quality consumer goods, real cost of basic

necessities, and health and educational measures, the population generally is better off

than ever before, even at the bottom of the income spectrum.

Evidence of “meritocratic inequality” (Bluestone, 1994, 87) is compelling; the traditional U.S.

emphasis on equal opportunity, not equal outcome, shines clear. There was never a majority

for equal outcome though there has been a national agreement for equal opportunity for

over 20 years. Politicians across the political spectrum seem to agree with the recent

position of the Federal Reserve Bank in Dallas which takes the position that “inequality is

not inequity” and that “America as a Land of Opportunity lost... is just plain wrong”.

The pessimists who make the case of an increasingly-unequal society use indicators that

show a) that the U.S. is the most “unequal” of the set of rich countries, b) that median

family income in the U.S. has been stagnant for over 2 decades, c) that while the rich get

richer, the relative gap with the poor grows, and d) that growing inequality is happening

despite greater productivity per worker in all sectors, especially in the manufacturing

sector.

Using Gini Coefficients of income, the U.S. is the most unequal of all rich OECD countries

(Left Business Observer, 1996). Unlike other countries with high inequality scores (Ireland

and Switzerland), the rich in the U.S. are better off than anywhere else; the poor (bottom

10 percent) in the U.S. are significantly worse off than any other country. The welfare net

is lower (and will get lower with passage of the 1996 Welfare Reform Act) in the U.S. than

any other rich country except Portugal.

Between 1980 and 1995, U.S. wage inequality (the ratio of the lowest wage

decile to the median wage), grew by 15%. By contrast, the wage inequality in

Germany declined by 7% (Economist, 1996, 62).

Median family income in the U.S. rose steadily from 1950 to 1975 but has been stagnant for

the past 20 years while GDP continues to grow at the same rate as the 1950s and 1960s. 14%

of new jobs created in the most recent expansion are in the “help-supply” services, up from

5% in the early 1980s expansion (David, 1995).

U.S. Census Bureau data provide the evidence for growing income inequality by quintile.

The richest 20% of the population now own 48.5% of the income pie compared to 40.6% in

1969 while the poorest 20% have gone from 5.6% in 1969 to 3.6%. The middle categories

are quite stable. The percentage of the income enjoyed by the top fifth of families is the

highest ratio since the 1920s.

6

To sharpen the argument between the optimists and the pessimists, there seems little

doubt about growing inequality in the U.S. when one compares income quintiles or

examines individual circumstances while controlling for educational qualifications. The

income gap measures can be misleading unless the wage gap is compared to the rate of

return to education. Between 1963 and 1987, the ratio of earnings of college graduates to

high-school dropouts changed grew from 2.11 to 2.91. In the 1980s, the real income of high-

school dropouts fell by 18%, high-school graduates fell by 13%, while that of masters (6+

years of college) graduates increased by 9%.Three of four U.S. workers have not finished

college so that, in total, only 15% of the workforce has seen increased wages in the past

decade. More than half of all workers (high-school diploma or less) have experienced a loss

of income in the past decade (Data from Mishel and Bernstein, 1993; see also Kosters, 1994).

The economic predicament of the American worker is only fully captured when

productivity is considered as well as income. Real wages within a sector are stagnant at

the same time as worker productivity is growing (David, 1995). In the past decade, U.S.

productivity growth has skyrocketed. Radical changes have occurred in the American way of

business and vast numbers of people have been affected by “downsizing”, “re-engineering”,

“delayering” and “creative destruction”. The World Economic Forum now ranks the U.S.

economy as the most competitive and U.S. workers are the most productive in the world.

Profits of companies have again risen after stagnancy in the early 1980s, but these profits

have been disproportionately turned over to shareholders, corporate executives, or used for

further investment.

Compensation for workers has been relatively flat and the gap between compensation and

productivity continues to widen. The business mantra of the day is “productivity”.

“Productivity is not everything, but in the long run, it is almost everything” (Paul Krugman)

Consideration of productivity suggests that the growing

embeddedness of the U.S. in the global economy is a key

component of the income inequality debate. However,

though there are scholars who argue that globalization is to

blame for growing income inequality, others point to

changes within the domestic economy. In the next section, I

summarize the debate between these two competing

arguments and conclude that there is strongest evidence for

the role of factor price equalization, itself a key component

of globalization, in the trend of growing income inequality.

7

GLOBALIZATION AND RISING INCOME INEQUALITY IN THE UNITED STATES.

(International economic vs. Domestic social)

Given the evidence for the growth of income disparities in the United States, various

attempts to account for the development have failed to come to any sort of consensus on its

causes. The main cleavage is between those who believe that the main culprit is the

changing nature of the domestic economy, from manufacturing to service jobs, and those

who emphasize the increased incorporation of the American economy into the global

markets through trade, immigration and investment.

Freeman and Katz (1994) have tried to account for the various domestic and international

factors leading to rising wage inequality in the U.S. and their list has been extended by

Bluestone (1994). Of the 10 possible “culprits”, nine can be considered as“globalization”

factors, derived from the growing integration of the U.S. into the world economy or

sectoral shifts due to the changing nature of jobs as a result of employment relocations.

Two components of domestic change are often cited as causes of income inequality,

technological change and deunionization. After showing that there is no conclusive

evidence for these arguments, I will turn to the processes of globalization, namely, the trade

deficit, factor price equalization and immigration.

The loudest advocate of the “changing technology” explanation for U.S. inequality is Paul

Krugman. Like world-systems theorists, he believes that “in 1973, the magic went away”

(Krugman, 1994c, 3). Krugman is honest in his assessment that the causes of rising inequality

are still unclear, though he believes that the political implications of rising malaise lie in the

interplay of economics and politics. Krugman argues that the new information technologies

tilt the earnings distribution by rewarding skilled, highly-educated labor while reducing the

demand (and therefore, the wages) for the products of the uneducated and unskilled

workers (Krugman 1994 a,b,c; 1995; Krugman and Lawrence, 1994; Krugman and Venables,

1995). Even within the same sector, there is a widening gap between the top and the bottom

of the educational spectrum. As machines replace workers, consumers are buying relatively

fewer goods and more services (Krugman and Lawrence, 1994).

There is little empirical support for the technological change thesis; the impact of

technological change on income inequality varies widely depending on the form of the

statistical model and the type of data (Leamer, 1994). Most businesses are not

introducingtechnologies that require new skills; if anything, there has been a deskilling of

8

tasks. The formerly low-level secretarial job of typing has decentralized by word-processing

to all employees.

Related to the “technological” explanation is “deindustrialization”, advanced by Barry

Bluestone (1994) and Borjas and Ramey (1993), among others. The high service ratio in the

U.S., now over 75%, has important inequality repercussions since the wage gap in this sector

is large. (more facts given)

The difference in the rate of income inequality between the U.S. and continental Europe is

large and so is the rate of unionization. The “deunionization” thesis claims that as the rate

of worker unionization in the U.S. has plummeted since the 1960s to 13%, the ability of

unions to pursue their consistent position of narrow wage differentials has been

undermined (Freeman and Katz, 1994). Unions have not been very successful in penetrating

either the new flexible (postfordist) manufacturing sectors nor the new service economy.

Earnings inequality in the services sector is higher than earnings inequality in the

manufacturing sector, when one controls for educational and skills levels. Waving the threat

to move off-shore can undermine unionization efforts, recognized even by those who do not

believe the movement offshore has any appreciable effect on U.S. wage levels (Krugman,

1995, 242). Bluestone (1994, 91) thinks that U.S. labor law is deliberately inimical to the

organizational efforts of unions and needs reform; stronger unions would help to redress

the negotiating balance in favor of wage-earners (see Herod, this volume).

It is increasingly common for rising inequality to be blamed on “economic globalization”,

which has two related elements, the persistent U.S. trade deficit (Bluestone, 1994;

Prestowitz, 1991) and “factor price equalization”. Increased U.S. imports have contributed

to the decline in manufacturing, the sector that helped to restrain earnings inequalities by

paying higher-than average wages. The import surplus into the U.S. is significantly composed

of products made by low-skilled and modestly-skilled labor in Asia and Latin America,

depressing the relative wages of U.S. workers at the bottom of the skills distribution.

Krugman (1995) has tried to undermine this thesis, showing that the U.S. terms of trade

has not changed in the past 25 years and that most of the increased imports are not from

low-wage countries. Further, American consumers benefit from lower import prices and can

then spend disposable income on other goods and services. Krugman stresses the

accounting identity: domestic production = domestic consumption +exports - imports.

Growing imports of manufacturing goods is almost matched by growing exports in most

manufacturing countries and, consequently, the impact of trade on the size of the domestic

manufacturing sector is small. By Krugman’s (1995) calculations, the trade deficit accounts

for no more than one-tenth of the decline in the number of U.S. manufacturing jobs.

9

Lawrence and Slaughter (1993) state boldly that international factors had nothing to do

with America’s wage performance in the 1980s, a position also supported by Bhagwati and

Dehejia (1994) who conclude that increased U.S trade did not hurt wages in the 1980s,

despite the theoretical claims of factor price equalization and the contradictory empirical

data. Contrary to expectations, the relative prices of imported-unskilled-labor goods rose in

the 1980s, rather than falling as the theory would predict.

Factor price equalization theory offers a theoretical explanation for the globalization

hypothesis. Since the mid-1970s, world trade has expanded, despite the rise in non-tariff

barriers in the U.S. and other countries. Under the wing of GATT (General Agreement on

Tariffs and Trade) and now the WTO (World Trade Organization), the global neo-liberal

trading regime is triumphant. According to factor price equalization theory, without

intervention of the states to control imports, there will be equalization of wage rates across

the globe, even in the absence of multinational capital investment or low-wage worker

immigration. Factor price equalization is expected to continue as trade barriers fall,

transport costs are reduced, communications improve and the newest innovations in

production techniques diffuse worldwide. As factor price equalization develops (wages in

the U.S. will become more similar to those in China and Mexico in the same unskilled

categories), earnings inequalities grow as wages in high-skill jobs are not subject to the same

global downward wage pressures.

Leamer (1996a) estimates that free trade will reduce the wages of unskilled U.S. workers

about $1000 per year, a development spurred by the 1993 NAFTA agreement. Expecting

these wage trends , it is no wonder that U.S. unions strenuously opposed NAFTA.

An examination of the relationship of industrial wages against the population size of

countries making up the world economy is very dramatic and shows vividly the pressures

for factor price equalization (Leamer, 1996a). The size of the populations in rich countries

(the U.S. and Western Europe) with wages above $9/hour (1985 dollars) is tiny compared to

the massive numbers with wages in the range of $1 and less/hour (China and India

especially). Leamer (1996a,1) states that “if this is a global labor pool, it is a very strange one

indeed, with the liquid piled high at one end and hardly present at the other”. Trade barriers

are, of course, one reason why the situation persists but with falling trade barriers under the

new WTO regime, the pool is expected to develop the same depth everywhere (factor price

equalization). The support for the globalization hypothesis is bolstered by the strong

temporal correlation between hourly manufacturing wages and trade dependence for the

U.S.

Immigration is also often cited by politicians and commentators as a key cause of

depressed wages for native U.S. workers. A more accurate picture is that immigration is

just another consequence of the deeper integration of the U.S, into the world economy

and plays a relatively minor role when compared to factor price equalization. There are

also, undoubtedly, strong regional and local effects in the influence of immigration on

prevailing wages as cities that act as major destinations for immigrants will experience

10

greater wage competition between native and immigrant unskilled workers. The economic

processes of income inequality are embedded within the creation of new geographies of

globalization, including immigration flows (see Wright, this volume).

The cause-by-cause analysis of the processes that I have discussed give some indication of

each one’s role in the trend towards growing income inequality in the U.S. However, a

more informative picture is provided if the interaction of the processes operating at the

domestic and the global scales is considered. In trying to estimate the effects of different

factors in accounting for rising inequality in the U.S., Freeman and Katz (1994) compared

two groups of male workers in the 1980s, those with high-school and with college-

education. (I can read their article on education instead)

Technological change accounted for 7% to 25% of the change in respective wages,

deindustrialization accounted for between 25% and 33%, deunionization accounted for

about 20%; trade and immigration (aka globalization) accounted for 15% to 25%; and

finally, the trade deficit accounted for 15% of the relative changes in wages. These

estimates for the 1980s show that every major economic trend affecting the U.S. at the

present time contributes to the growing inequality of the society

Economic processes at both the global and domestic scales are adversely affecting income

inequality. With fewer and fewer institutional constraints on market forces and the “great

society” tradition in rapid retreat in the 1990s, we can expect the inequalities to worsen

and social unrest to worsen.

A GEOGRAPHY OF INEQUALITY IN THE UNITED STATES

In this section, I show that processes of globalization require a conceptualization of the U.S.

economy as a mosaic of regional and local labor markets. Each of these labor markets are

trying to compete within a global economy through the definition of geographically-specific

attributes.

The internationalization of the U.S. economy had led to the collapse of the traditional

integrated production sectoral firms that heretofore dominated a region. Manufacturers

contracted out operations, frequently to companies in other countries; some moved

offshore or to a more “competitive” location in the United States. A new polarization

between the growth regions of the West and South and the traditional heartland of

manufacturing developed and it was paralleled by a more localized polarization within

metropolitan areas as “citadels” developed in many downtowns as the command centers of

the new business services, banking and financial operations, and multinational

manufacturing.

In the rush to study globalization, we should continue to take the traditional geographic tack

of examining the dialectical relations of the local and the global while not neglecting the

actions of the national government, as it seeks to mediate between the losers and winners

of greater global involvement. The national government has endeavored to engage in a

11

balancing act between local economic interests (winners and losers in globalization) as well

as continuing to balance the accumulation interests of American capitalists against the need

for legitimation of the political-economic system that is increasingly seen as a failure by

many workers suffering a decline in real wages and in standard of living. One political-

geographic solution to these dilemmas is to decentralize the operations of the national

government to the states and localities so that each can pursue its own individual economic

policies (see Flint, this volume). Otherwise, the government remains caught in the conflict

between the free trade interests of states like California and the protectionist interests of

states like Arkansas. Therefore, government restructuring is an essential response to the

economic processes operating at the global, domestic and local scales. in the next section,

I conclude my argument by highlighting some of the important themes of the political

debate and how they relate to government restructuring.

THE POLITICS OF INCOME INEQUALITY

The presidential campaigns in 1988, 1992 and 1996, social inequality at home was related to

a variety of foreign policy and trade issues, indicating that changes within the global

economy stimulated domestic political initiatives.

Indeed, in the bigger global picture, these concerns are not unique to the

U.S.; other rich Western countries have the same worries and show similar

trends towards greater inequality, though only the United Kingdom has

values as extreme as the U.S.

The expression “Zwei-Drittel-Gesellschaft” (two-thirds society) aptly

characterizes the present situation of inequality in France and Germany

(O’Loughlin and Friedrichs, 1996) and Canada (Levine 1995).

All countries feel the same globalization pressures (Barnet and Cavenagh, 1994) and

governments generally adopt the same policies of trying to shield their populations and

companies from the negative aspects of globalization (legitimating role of government)

while promoting their national industries who have a relative advantage (accumulating role

of government).

In considering economic policies to promote the competitiveness of U.S. industry in the

global environment, two issues are paramount. If the problem is globalization, then the

answer is“upgrading skill levels” and more education. There are two obvious legitimization

options for the state to pursue in the new realities of the global economy. The first option

would erect trade barriers and other devices to protect “uncompetitive industries” and their

workers. In the U.S., there are still over a million workers in the garment, textile and apparel

industries.

The local imperative of economic competitiveness in the global economy promotes the

second option, education, in which the state invests in human capital to allow upskilling for

12

all workers. The costs of this option are enormous and take a long time to have a noticeable

effect.

Current political discontent in the U.S. focuses upon the role of the government in the

production of wealth and the amelioration of poverty. In this chapter, I have shown that

income inequality has both spatial and social manifestations which are recursively linked.

In addition, government policies aimed at increasing “economic competitiveness” are

likely to enhance geographic inequities. There is substantial evidence to suggest that,

while the macro-economic indicators look fine, it is the stagnation and decline in the

standard of living of a majority of Americans that is the source of anger and

disappointment with politicians of all stripes and the basis of the support for politicians

such as Patrick Buchanan (Phillips, 1994) The swing of ideological cycles, now in a

conservative phase, is clearly evident Over time, geographic differences between “winners”

and “losers” might exacerbate sectional political rivalries to the point of generating regional

parties of protest, as in the U.S. earlier in this century as well as contemporary Europe. Such

a development would indeed turn American politics on its head.

Article 3:

Globalization and Inequality, Past and Present (1997)

(International political / international economic)

The late nineteenth and late twentieth centuries shared more than globalization and

economic convergence. The trend toward globalization in both centuries was accompanied

by changes in the distribution of income as inequality rose in rich countries and fill in poor

ones. Between one-third and one-half of the rise in inequality since the 1970s in the

United States and other member countries of the Organization of Economic Cooperation

and Development OECD) has been attributed to global economic forces, about the same as

a century earlier. It appears that the inequality produced by global economic forces before

World War I was responsible in part for the retreat from globalization after the war. What

does this retreat imply for the future? Will the world economy once again retreat from

globalization as the rich OECD countries come under political pressure to cushion the side

effects of rising inequality?

Because contemporary economists are now debating the impact of the forces of

globalization on wage inequality in the OECD countries it is time to.

Globalization and Inequality in the Late Twentieth Century

From 1973 through the 1980s, real wages of unskilled workers in the United States fell as a

result of declining productivity growth and an increasing disparity in wages paid to workers

13

with different skills (Kosters 1994; Freeman 1996). This difference was manifested primarily

by higher wages for workers with advanced schooling and age-related skills.

The same trends were apparent elsewhere in die OECD in die 1980s, but the increase in

wage gaps was typically far smaller. The widening of wage inequalities coincided with the

forces of globalization, both in the form of rising trade and increased immigration, the

latter characterized by a decline in the skill levels of migrants.

Trade as a share of gross national product in the United States increased from 12 percent

in 1970 to 25 percent in 1990 (Lawrence and Slaughter 1993), while exports from low-

income countries rose from 8 percent of total output in 1965 to 18 percent in 1990

(Richardson 1995, p. 34). These developments coincided with a shift in spending patterns

that resulted in large trade deficits in die United States.

Globalization in poor countries should favor unskilled labor; globalization in rich countries

should favor skilled labor. Lawrence and Slaughter (1993) explored this wage inequality

and concluded that there was little evidence to support die standard trade model

explanation. Instead, the authors concluded that technological change was an important

source of rising wage inequality. Hot debate ensued, with no resolution in sight.

Between the 1960s and the 1980s, an increasing proportionof immigrants to die United

States were from developing nations, which meant that a far higher fraction were

relatively unskilled just when there were more immigrants.

These shifts in the supply of labor produce the desired qualitative result for the purposes

of this study—wage inequality between skill types. The quantitative result, at least in

George Borjas' (1994) hands, also seems to be large: he estimates that 15 to 25 percent of

the relative decline in the wages of highschool graduates compared with those of college

graduates is attributable to globalization forces, of which trade accounts for one-third,

immigration, twothirds. He also estimates that 30 to 50 percent of the decline in the wages

of high-school dropouts relative to the wages of all other workers is attributable to these

same forces. Hatton and Williamson (1995; 1997) show that a century earlier, immigration

was a far more dominant influence on U.S. inequality than was trade, and furthermore,

that trade and migration influenced relative wages in practically every country involved in

the globalization experience.

This is where Adrian Wood (1991,1994, ch. 6; 1995b) enters the debate. Wood was one of

the first economists to systematically examine inequality trends across industrial and

developing countries.

Wood distinguishes three skill types: uneducated workers, those with a basic education,

and the highly educated. The poor South has an abundance of uneducated labor, but the

supply of workers with basic skills is growing rapidly. The rich North, of course, is well

endowed with highly educated workers; its supply of labor with basic skills is growing

slowly. Wood assumes that capital is fairly mobile and that technology is freely available.

14

As trade barriers fall and the South improves its skills through the expansion of basic

education, it produces more goods that require only basic skills, while the North produces

more high-skill goods. It follows that the ratio of the unskilled to the skilled wage should

rise in the South and fall in the North. The tendency toward the relative convergence of

factor prices raises the relative wage of workers with a basic education in the South and

lowers it in the North, producing rising inequality in the North and falling inequality in the

South.

Wood concludes that the decline in the relative wages of less-skilled northern workers is

caused by the elimination of trade barriers and the increasing abundance of southern

workers with a basic education. He also dismisses skill-using technological change as a

potential explanation for rising inequality because labor and total factor productivity growth

both slowed during the period. Wood also argues that the pattern of increasing wage

inequality in the North favors a trade explanation because there is no cross-country

association between inequality trends and technological progress.

Wood's research has met with stiff critical resistance.1 Since his book appeared in 1994,

more has been learned about die link between inequality and globalization in developing

countries. Economic theory argues that poor countries should become more egalitarian in

die face of globalization, unless demographic or industrial revolution forces offset it. A

recent review by Davis (1996) reports the contrary, and a study of seven countries in Latin

America and East Asia shows that wage inequality typically did not fall after trade

liberalization but rather rose (Robbins 1996).

Public Policy and Economic Inequality: The United States in

Comparative Perspective

Over the last four decades, the United States has seen large increases in economic

inequality. In this, it is not unique; many developed countries have experienced at least

modest increases in the inequality of market and disposable income, but none so sustained

as in the United States, which began this period with the highest level of inequality in the

rich nation OECD world.

This heightened interest has led to greater efforts to assemble comparable cross-national

measures of economic inequality and better measures within any one country (like the

United States). Researchers have not only been able to address the factual question of

whether inequality has grown in other countries, but also to start to probe more deeply

into causes―the influences of different trade or labor market policies, of industrial

structures, or of unionization, for instance.

This article compares recent economic inequality in industrialized nations, largely those

belonging to the Organization for Economic Cooperation and Development (OECD). We find

that the United States has the highest overall level of inequality of any rich OECD nation in

15

the mid- 1990s. We also find that the increases in the dispersion of total household income

in the United States have been as large as, or larger than, those experienced elsewhere

between 1979 and 2000, despite the fact that our nation began the period with the highest

level of inequality. We also look at the trend in inequality within the United States using

various series from published and unpublished data to examine exactly how our inequality

changed over the past several decades.

Next, we examine the effects of government policies and social spending efforts on

inequality, finding that the United States has lesser effects than any other rich nation, and

that both low spending and low wages have a great impact on the final income

distribution, especially among the non-elderly. We then are in a position to answer a

number of questions. What role does policy; therefore, play in the final determination of

income inequality? Can these differences be explained by demography (more single parents;

more immigrants; or more elders?) or can they be attributed to American institutions and

lack of spending effort on behalf of low-income families? And finally, does inequality of

before tax and benefit income itself have anything to do with low social spending?

Methodological Details

Our analysis concentrates on income inequality among households and does not directly

address the issue of individual earnings inequality. Granted that earnings are generally the

largest part of income, nevertheless, these are very different phenomena. Earnings refers to

persons, and income to households. Income pools the earnings of household members,

taxes, transfers, pensions, and capital income, each of which is liable to make the

distribution of household income very different from the distribution of individual or

household earnings.

We measure disposable money income. For most families, the primary income source is

market income, which includes earned income from wages, salaries, and self-employment

and other cash income from private sources―from property, from pensions, from alimony

or child support. To reach disposable income, governments add public transfer payments

(retirement, family allowances, unemployment compensation, and welfare benefits) and

deduct income tax and social security contributions from market income. The cross-national

comparable definition of income is hardly comprehensive, typically excluding much of capital

gains, imputed rents, home production, and in-kind income. Measure on annual basis.

The answer to the question “distribution among whom?” is “among individuals.” Some

surveys focus on the individual as the unit of analysis, some on the household as the unit of

income sharing. The most common unit of analysis is the household, defined as all persons

sharing the same housing unit, regardless of any familial relationship. We, therefore,

estimate individual disposable income by aggregating the income of all household

members and using an equivalence scale to arrive at individual equivalent income.

16

Differences in Inequality across Nations and in the United States: Levels and

Trends

A large body of research has documented comparative levels of inequality among nations

and also the substantial increases in inequality in the United States, beginning in the 1970s.

How do other industrialized nations measure up?

(explanation of figure 1)

Figure 1 shows us that the United States is indeed an outlier among rich nations. Only Russia

and Mexico have higher levels of inequality and these nations are thought of as still

‘developing’ by most analysts.

Among the richest OECD nations (all but Eastern Europe and Mexico in Figure 1), we have

the highest level of inequality by far. A low-income American at the 10th percentile in 2000

had an income that is only 39 percent of median income, whereas a high income American

in the 90th percentile had an income that is 210 percent of the median. The income of the

high-income American is over five and a half times the income of the low-income American,

even after we have adjusted for taxes, transfers, and family size (the decile ratio is 5.45).

The United States differs, above all, in the relative disadvantage of its poorest residents. Our

poorest residents have incomes only 39 percent of the median—in other rich nations they

are much higher.

Absolute Differences in Income Inequality across Nations

Does the higher average United States standard of living extend to all levels of the income

distribution? We examined this question by converting the incomes of a set of rich nations

(from Figure 1) into real 2000 United States dollars, using a standard measure of purchasing

power parity (PPP). We then recomputed low-, median-, and high incomes in these countries

as a fraction of the United States median (“real incomes”) and present them in Figure 2.

Overall, lower-income Americans are no better off and often worse off than the low-income

persons in other nations. Of course, our richness extends to high the high end as well, and

here we far surpass the rich in any other nation observed and are far above the other

country average.

We can also measure the income distance between top and bottom, all in US 2000 PPP

adjusted dollars now. The gap in the United States is $42,000 per person—the lower-income

person has resources of about $9,500 per person, while the rich person has about $51,500

per person.

The claim that “the United States enjoys the world's highest living standard” must be

evaluated alongside the equally valid claim that the United States enjoys the greatest level

of real income inequality among the countries we study. And the social costs of low

absolute incomes may be quite high, especially for families with children. From other

17

research, we know that young children living in households with incomes at 75 percent of

the official United States poverty line that is, households at roughly the 10th percentile in

the income distribution are at severe risk of poor health, subsequent poor educational

performance, and diminished achievement.

Cross-National Trends in Inequality

Do the differences in economic inequality among the OECD countries in the early 1990s

reflect convergence to a common level of inequality, or are countries that are already

more unequal, such as the United States, the United Kingdom, and Canada becoming even

less equal? To answer this question, we first compare relatively short-term trends in

inequality, from the late 1970s to 2000.

The largest percentage changes took place in two different countries, the United Kingdom

and the United States. In the United Kingdom, between 1979 and 1991-1992, the Gini

coefficient rose by more than 30 percent, more than double the decline that the country had

experienced from 1949 to 1976 (not shown here but see Gottschalk and Smeeding 1997;

2000 for longer trends). But British inequality has remained roughly constant since 1992. In

the United States, the increases in inequality began in the 1980s and continued

throughout the 1990s up to at least 2000 (even removing the discontinuity in the Census

Bureau time series).

In some countries, employment policy, tax and transfer policy, and other factors such as

increased work by married women have muted the effects of these market influences on the

distribution of disposable income. In the countries which exhibited the largest rise in

inequality, e.g., in the United Kingdom, these increases may have reached a plateau.

However, they have not plateaued in the United States, which began the series with the

highest level and then continued throughout the late 1990s, the strongest period of

economic growth in our nation since the 1950s.

The United States in Greater Detail

By 2001, the 95th percentile family had an income 3.2 times that of the middle family—

roughly $125,000 compared to $40,000 in that year. In contrast, the same middle (or 50th

percentile) family has incomes about 2.0 to 2.2 times that of the 20th percentile family.

The real earnings of low-wage households only recovered in a serious way in 1997 and then

mushroomed in relative terms though the strong recovery of the late 1990s. Much of this

growth in earnings among the poor was a result of the strong economy (low joblessness)

which pushed more single mothers into the labor force and welfare reform. In any case, real

earned income boomed over this period. In fact, low-income Americans, especially single

mothers, now work roughly twice as many hours as do their counterparts in the United

Kingdom, Germany, Canada, and other similar nations (Smeeding 2003). The middle-

18

income family had flat income until after the 1991-1993 recession and then experienced

modest real earnings growth (about 20 percent) after 1994. The high-income family saw a

steady growth in real earned and other market incomes through most of the period and

especially in the late 1990s.

The beauty of the CBO data is that it allows us to look further within the top income groups

with some degree of accuracy not afforded by other data. Here we see that indeed the very

top gained most of all. Before tax (market) incomes rose most for the top quintile, but even

within that group the richest did better than the others. The after tax changes were smaller

than the before tax changes because the rich pay the highest share of income taxes.

According to Johnston (2003) the top 1 percent of taxpayers, about 129,000 households paid

about 37 percent of all income taxes in 2000. Thus before tax and after tax incomes differ

substantially for the rich. Still, on a percentage basis, the top income earners gained more in

after tax income than in pre tax income over this period.

Conclusions So Far

Americans have the highest income inequality in the rich world and over the past 20-30

years Americans have experienced greatest increases in income inequality among rich

nations. The more detailed the data we can use to observe this change, the more skewed

the change appears to be. While income mobility has surely shifted many of the top 1

percent to slightly lower income levels over this period, the majority of large gains are in

deed at the top of the distribution.

But these figures beg an explanation—how does government affect income distribution in

America and elsewhere? We now turn to this explanation.

III. Why is the United States so Different?

Our understanding of levels and trends in income is necessarily incomplete because of the

complex interactions among markets, demographic, institutional, and policy forces and

behavioral change by individuals, families, and households.

And governments respond to changing levels of market income with very different kinds of

macroeconomic and redistribution policies. Germany, Italy, and the Scandinavian countries,

for example, have fairly centralized wage-setting institutions, and a high proportion of their

workforce is covered by collective bargaining. At the other extreme, unionization rates have

declined in the United States and the United Kingdom, and wage bargaining has become

less centralized in many OECD countries.

We have noted that the United States stands out in the relative position of those at the

bottom of the distribution. This reflects relatively low wages at the bottom of the

distribution in the United States compared to other developed nations. But it also reflects

19

the relative weakness of the income support system for families with children and for the

low-income elderly in the United States.

Macroeconomic Comparisons

Table A-1 shows that the

United States is far and away the richest nation that we observe among our set, with 2000

GDP per capita of $34,100. With the exception of the Netherlands, the United States also

enjoyed the lowest unemployment rate of all nations during the 1997-2000 period. Canada,

Finland, and Belgium all had unemployment rates more than twice the United States rate,

with the variance in unemployment far exceeding the differences in incomes across these

select nations.

While the United States is unique in both its high standard of living and its low

unemployment rate, it is also unique in the tiny amount of its resources devoted to cash

and nearcash social transfer programs. In 1999 (latest year available), the United States

spent less than 3 percent of GDP on cash and nearcash assistance for the nonelderly

(families with a head under age 65, with and without children, and the disabled). This is less

than half the amount spent by Canada or the United Kingdom; less than a third of

spending Germany, the Netherlands, or Belgium; less than a quarter of the amount spent

in Finland or Sweden. While there is a rough correlation between social spending and

unemployment, the differences we see here are not cyclical, but are rather structural.

Patterns of Redistribution

Every nation’s tax and benefit system reduces market income inequality, but not all are

equally effective in doing so.

In all nations disposable income inequality is less than market income inequality, suggesting

that the tax and benefit system reduces overall inequality. The gini for market incomes

varies only from 39 to 50 across these 11 nations and the United States at 45 is right in the

middle of these nations. Yet after tax and transfer disposable income inequality measures

range from 24 to 37 and the United States has the most remaining inequality at 37,

consistent with Figure 1 earlier in the paper. The percentage reduction in before tax and

benefit inequality in the United States is only 18 percent, the lowest in the table. Only

Switzerland with a 20 percent reduction and Canada and the United Kingdom at 24 are even

close. And in each of these nations the level of final income inequality is far below that in the

United States.

The Antipoverty Effect of Taxes and Transfers

20

As one might expect based on the previous analyses, the United States shows the least

antipoverty effect of any nation. We reduce poverty by 28 percent compared to the

average reduction of 62 percent in Figure 9 .

Our social insurance and direct (payroll and income) tax system is weak, while our safety net

and social assistance system produces only a small additional amount of poverty reduction

(including the effect of the EITC in the social assistance category). All other nations get a

much larger poverty reduction from social insurance, In heavily insured countries like

Sweden, Belgium,and Germany, social insurance (unemployment and workers’

compensation, disability benefits, paid family leave) reduces poverty by over 70

percent.(more facts listed)

There is no one program or one type of policy instrument that is universally generous and

common across these eight nations. Yet they all are more effective than the United States.

Explaining the Differences

There have been few attempts to explain the differences we find in economic inequality

across the rich nations, so what we have here is a piecemeal (but still instructive)

explanation of our initial explorations of these differences.

The effects of government on inequality can come from two sources. Either direct effects

of redistribution ( as shown above) or via indirect effects created by institutions and

regulations such as minimum wages, unionization and collective wage bargaining. Each of

these has an effect on the United States income distribution.

First, it is important to note, that explanations of differences in inequality across countries

differ according to which end of the income distribution one is addressing. That is, rather

than adhoc decompositions of aggregate indices, often more can learned from addressing

the explanations of the differences in incomes at each end of the income distribution

separately.

For instance, low incomes (10-50 ratios or poverty rates) are quite well correlated with the

prevalence of low-wage workers within each nation (Figure 10) and with levels of non-

elderly social transfers within each nation (Figure 11). The effects of different policies to

raise wages, e.g., by administrative fiat (minimum wages) or by increasing labor productivity,

or by collective bargaining are clearly raised in Figure 10.

Countries that have many jobs at low wages, United States, Canada, and the United

Kingdom, tend to have lower 10/50 ratios than do nations with higher wages at the

bottom end. Of course, many nations with higher minimum wages also suffer higher rates of

unemployment. But unemployment is not highly correlated with 10/50 ratios (or gini

coefficients) across OECD nations, largely because those nations with the lowest fractions of

low-wage workers have generous income transfer systems which provide low-income,

21

unemployed workers with high net disposable incomes (see also Gustafsson and Johansson

1997; Gottschalk and Smeeding 1997, 2000).

Similarly, the relationship between cash social transfers to the non-aged and low incomes

as measure by the 10/50 ratio is also strong (Figure 3). Countries that spend less on their

safety nets suffer higher levels of inequality as measured by the 10/50 ratio (just as they

suffer higher after tax and transfer poverty ratio in Figure 9. Mexico and Russia are just two

examples of what one would find were we able to extend this chart to other middle-income

nations. Clearly both wage levels and social benefits affect low incomes.

Other Explanations

Hours worked (come back to this if necessary)

Closely tied to the number of hours worked and earnings patterns are demographic

differences in household composition across nations. In general, nations with relatively

higher levels of immigrants and relatively more single parents will have greater inequalities,

especially at the lower end of the income distribution, than do nations which have fewer

single parents and lower levels of immigration, all else equal. Comparisons of the high

immigrant, high single-parent, Anglo–Saxon countries (e.g., Canada, Australia, the United

Kingdom) with the United States suggest that immigrants and single parents alone do not

account for differences in the level of inequality. In fact Australia and Canada have higher

fractions of foreign born than in the United States but lower overall inequality. Trends in

inequality find the same pattern—while more immigrants contribute to higher inequality,

inequality has also increased amongst non-immigrants (Leonhardt 2004). And income

inequality has increased much more in the United States than in Canada, despite similar

levels of immigration

The most comprehensive study of demographic effects was carried out by Rainwater and

Smeeding (2003). They took the demography of each nation (relative numbers of single

parents, elders, families with children, childless adults, etc.) and its income package (taxes

and benefits) and simulated the United States demography with the packages of each

nation. The effects of demography were very small—the effects of the income package

accounted for over 90 percent of the differences across nations. Thus the United States

redistributive package is the prime explainer of the differences between market and

disposable income that see observe here, not our demographic make up.

Other factors are less easily accounted for. Many authors find that labor market institutions,

especially collective bargaining, wage setting, levels, and penetration of minimum wages, are

important for determining the level of inequality in wages and earnings across nations.

22

Differences in educational attainment are also important as the better educated earn more

than the less well-educated, all else equal, in every country.

But recent evidence suggests that it is the former (institutions) rather than the latter (skills

per se) that is more important in explaining differences in the cross-section. Blau and Kahn

(2001) find that workers within single categories of education and adult test scores in the

United States (e.g., high school graduates with median level skills as measured by the OECD

individual adult cognitive literacy survey), have distributions of wages and earnings which

differ amongst themselves by more than does the entire distribution of wages differ in

Germany, Netherlands and Sweden.

Summary

We are not in a position to determine how much of the United States position is attributable

to each factor. It is clear that differences in the wage distribution must have a strong effect

on family income inequality, for earnings make up about 70 percent of all household income.

Whereas wage inequality is clearly mitigated by government transfer policy, the original

wage inequality may itself partially reflect the generosity (or lack thereof) of the social

welfare system.

While explanations of these different levels and trends in inequality and their periodicity

must be high on any research agenda, the basic facts of American inequality and the effects

of policy on inequality remain clear-cut. America has more inequality and less redistribution

(lesser amounts and less effective as an anti-poverty device) than in any other rich nation.

Large numbers of low-skill workers and inadequate safety nets are two important reasons

for these outcomes.

IV. Overall Summary and Conclusions

We have found that the United States has the highest level of inequality amongst the rich

nations of the world. Our direct income transfer polices do less to redistribute overall and

to lower income persons than do the polices in other nations. America began the last

quarter of the 20th century with higher inequality than in any other nation and our

inequality increased by more than in any other nation over this period, through expansion

and contraction of the economy.

The effects of other direct and indirect policies are harder to nail down, but they also affect

well being in unequal ways. We have all but eliminated welfare in America and in so doing

have turned the welfare poor into the working poor. But poverty rates did not go down

along with welfare rolls. Instead we have the hardest working low income single parents,

who also have the highest poverty rates in the rich world.

23

(Bush vs. Blair) The lesson is clear—if oned ecides to make poverty or inequality an active

policy goal they can make a difference. We have more inequality and poverty than other

nations because we choose to have more. But why do we make these choices?

In a recent paper argue that as the “rich” become more distant from the middle and lower

classes, they find it easier to opt out of tax financial public redistribution programs and to

either self insure or to buy substitutes in the private market. The implication is, therefore,

that “two income” households with two highly educated parents have little need for

redistributive cash and near cash social benefits because they are very unlikely to directly

benefit from such transfer programs. High income parents can also find better schools or

buy private schooling if the public schools do not measure up. They have good employer

health insurance so the need for better public insurance is not a relevant consideration

(except perhaps for Medicare).

The conclusion is that higher economic inequality produces lower levels of those publicly

shared goods which foster greater equality of opportunity and greater upward mobility:

income insurance, equal educational opportunity, and more equal access to high quality

health care.

Having greater numbers of rich in a nation does not lead to additional redistribution

because the lower and middle classes do not have the political power, voice and access to

legitimize these claims. Dissimilarities in the institutions that represent social and economic

rights in the political arena may well determine redistributive government spending. Our

analyses suggests that ideology and efficacy may both matter. Ideology—in the sense of

national understanding of the meaning of “fairness,” altruism and basic human rights—

may play a crucial independent role in defining the acceptable domains of inequality. But

efficacy in the ways in which social institutions and political parties can influence

government, is likely to be crucial in understanding whether demands are made of the

political system to reach these “fairness” objectives.

The many factors that effect public social expenditures are complex and intertwined.

Certainly, social values and institutions in the United States differ from those found in other

nations, and our belief in the market system is much more central and critical to social

outcomes than in other advanced nations. Yet even within these beliefs, it seems clear that

we do not possess the social institutions or political movements which might bring about

greater levels of redistribution, even for those who are more clearly deserving because of

their work effort or other factors. In the end, it is clear that the high level of market driven

economic inequality which we tolerate is in large part a determinant of the relatively poor

social outcomes and social policy outcomes which we observe.

Article 5:

The Causes and Consequences of Changing Income Inequality

(International Economic among others)

24

DAVID G. BLANCHFLOWER AND MATTHEW J. SLAUGHTER

The chapter has three goals. First, it attempts to synthesize the research to date on the

contribution of international trade to rising income inequality in the United States and to

labor market develop-ments in other countries. The basic conclusion is that despite

usingvery different methodologies, to date, on balance, most labor and tradeeconomists

agree that trade has accounted for a relatively small share of rising U.S. income inequality

across skill groups.

Second, the chapter attempts to sketch out where research on tradeand labor markets

might go from here. In particular, we emphasize thatresearch into how globalization has

affected labor markets is far fromcomplete.

Moreover, future researchalso should try to explain better the sharp rise in within-group

(or"residual") wage inequality. Most of the research to date has focused onwage inequality

across groups, but within-group inequality has been amajor part of the overall inequality

picture. To the extent that trade,technology, or other hypotheses cannot address this

issue, our overallunderstanding of the causes of rising inequality will be limited.

Finally, the chapter discusses whether public policy solutions to rising inequality depend

on understanding the exact causes. While the ongoing academic debate about the causes

of rising inequality might help policy, an accurate understanding of these causes is not

necessarily a precondition for most well-targeted policies. If policymakers want to help

those whose relative (and, in many cases, real) incomes have fallen, sensible policies can

be formulated without knowing these causes. The ongoing disagreement about causes

does not imply there is disagreement about possible solutions.

The Research to Date

THE BASIC FACTS

Since the early 1970s the U.S. labor market has changed in three distinct ways. First,

earnings have become much more unequal between more skilled and less skilled workers.

For example, in 1979 male college-educated workers earned on average 30 percent more

than male high school-educated workers. By 1995 this premium for college-educated

workers had risen to about 70 percent. Within the class of male high school-educated

workers, workers at the 90th percentile of the wage distribution earned 60 percent more

than workers at the 50th percentile ein 1979. By 1995 this"90/50" gap had reached 83

percent. The overall wage distribution reveals a similar picture of rising inequality.

Between1979 and 1994 the ratio of the earnings of a male worker at the ninth decile

compared with one at the median rose from 1.73 to 2.04. At the same time the earnings of

that median male worker rose from 1.84 to 2.13times the earnings of a worker at the first

decile.

25

The rise in U.S. earnings inequality observed is far from a global phenomenon. While many

member countries of the Organization for Economic Cooperation and Development (OECD)

experienced increases in earnings inequality during the 1980s, with the exception of the

United Kingdom, the orders of magnitude were well below those experienced in the United

States.

Table 3-1 reports average five-year changes in theratios of the ninth decile to the median

and the median to the firstdecile. Only the United Kingdom and the United States have

continuedto experience a rapid rise in inequality into the 1990s, albeit it at aslower rate

than occurred in the 1980s

It should also be noted that the rise in U.S. inequality appears to pre-date increases

occurring elsewhere.

The second important change in the U.S. labor market has been that average real earnings

have been growing much more slowly. In the 100 years to 1973, real average hourly

earnings rose by 1.9 percent per year.

Since 1973 Consumer Price Index (CPI)-deflated real wages have fallen by about 0.4 percent

per year. The combination of flat average wages and rising inequality means that tens of

millions of American workers have experienced stagnation or even absolute declines in their

real earnings in recent decades. U.S. workers at the low end of the earnings distribution

have suffered the most, particularly those in the lowest decile.

In contrast, there has been considerable growth in real earnings at the top of the earnings

distribution. Senior managers and executives have experienced large increases in real

earnings over the last couple of decades, especially when total compensation, including

stock options, is included.

The third important fact is that in most countries, the rise in inequality has occurred not only

between workers of different skill levels but also among workers within a given skill level.

Among workers in the same occupation or with the same years of schooling and age, the

higher-paid ones had larger increases in earnings than the lower-paid ones. Moreover, it

appears that earnings inequality has risen within virtually all occupations.

Movements in inequality within groups, sometimes called residual inequality tracks closely

overall change. It rose steadily in the United States from the 1970s. In the United States

rising residual inequality accounts for approximately half of the overall rise in wage

inequality.

In our view, any comprehensive explanation for the changes in wage inequality that have

occurred over the past two decades has to be consistent with the rather different

experiences that have occurred across countries. Moreover, it also must address rising

inequality within skill groups as well as across groups. In what follows we examine possible

explanations.

26

THE FRAMEWORK OF CAUSES: DEMAND, SUPPLY, AND INSTITUTIONS

There are three main candidates to explain rising inequality: shifts in relative labor demand,

shifts in relative labor supply, and changes in labor market institutions. Within the set of

demand-side and institutional explanations, those that have received the most attention are

international trade, technological change, the composition of aggregate demand, the decline

in the real minimum wage, and deunionization.

On the supply side, changes in the supply of educated workers have been emphasized as an

importance influence. Presumably some combination of all of these has contributed to

increased wage dispersion.

One broad point of consensus is that a primary cause of risinginequality has been a shift in

relative labor demand toward moreskilled workers. Lawrence F. Katz and Kevin M. Murphy

documentthat for the U.S. economy overall, supply changes alone cannotexplain rising

income inequality

That even though the relative wage of more skilled workers has been rising, within most

industries firms have been employing relatively more of these workers.12These facts point

strongly toward a shift in labor demand.

THE INFLUENCE OF INTERNATIONAL TRADEON LABOR DEMAND

Both trade and labor economists have studied whether international trade has contributed

to the demand shift away from less skilled workers.

To date, the majority of trade economists working in this area have tested trade's role in a

Heckscher-Ohlin framework. The standard assumptions are that all countries make the

same sufficiently diversified mix of products under perfect competition and with all factors

(in particular, skilled and unskilled labor) perfectly mobile across industries. In this context

the Stolper-Samuelson theorem predicts that international trade influences relative factor

demands and thus factor prices.

The basic idea underlying all versions of the Stolper-Samuelson theo-rem is straightforward.

International trade affects the prices of products,which, in turn, affect factor prices by

changing relative factor demands

On balance, then, these product-price studies generally find little evi-dence that trade

contributed much at all to increased income inequality during the 1980s. Some studies do

find evidence of relative price declines for unskilled-labor-intensive products during the

1970s and the 1990s.However, on many measures these were not periods of rapidly rising

earnings inequality.

(This part is an essential examination of the literature on trade on inequality)

27

Other studies have focused on trade volumes. Paul R. Krugman cal-ibrates a simple

general-equilibrium model of the U.S. economy toconsider what changes in relative

product prices and wages would beconsistent with the observed increase in imports from

less developed countries (LDCs).24In his model, the small amount of imports that enterthe

United States from LDCs (1.6 percent of total OECD output in 1990)corresponds to very small

changes in relative product prices and rela-tive wages—magnitudes he terms well within

measurement error.

Borjas, Freeman, Katz- Imports from developing countries are treated as anincrease in the

U.S. relative endowment of less skilled labor whileexports reduce it.25Using input-output

tables to infer from observedU.S. trade flows the implicit quantities of factor services

embodied inthese flows, they calculate that the large U.S. trade deficits from 1980 to1985

can account for approximately 15 percent to 20 percent of the totalrise in income inequality.

But they also conclude that this effect dissi-pated in later years as the trade deficit shrank

relative to total output.Using a similar methodology, in a later paper they conclude that

U.S.trade—particularly trade with less developed countries—accounts forless than 10

percent of either the rise in the college/high school wagedifferential or the drop in relative

wages of high school dropouts.

Nevertheless, what is important to emphasize is that the large majority of studies to date—

regardless of their methodology—find only a small role for international trade in rising U.S.

income inequality. Product prices, labor shifts, trade flows: All these data have been

analyzed in different ways, and the recurring conclusion is that trade has not mattered

much.

OTHER INFLUENCES ON LABOR DEMAND:SKILL-BIASED TECHNOLOGICAL CHANGE

It is fair to say that, at present, many economists think that the biggest single cause of

changes in the U.S. income distribution is technological change. In most studies, the

conclusion that technology is the main culprit has not been drawn from direct observation or

measurement.

Rather, it is the residual explanation—it is largely a name for our ignorance. The often-made

argument is "it isn't X, Y, or Z so it must be skill-biased technical change.

And Autor, Katz, and Krueger analyze several plausibly direct measures oftechnological

change (e.g., rising investment in office equipment) and find a high correlation across

industries between these direct measures and indirect measures such as rising skilled labor

shares of the totalwage bill.

THE ROLE OF SUPPLY CHANGES

Current research does indicate that differences among countries ingrowth in the supply of

workers has contributed to the greater rise inskill premiums in the United States than in

other countries. In theUnited States in the 1970s, the baby-boom cohort moved from college

28

tothe labor market, increasing the relative supply of more skilled work-ers. But in the 1980s

the baby boom busted and growth in the relativesupply of more skilled workers slowed

considerably. These changeshelp explain why the U.S. college—high school wage differential

fellduring the 1970s and then reversed around 1979.

Some of the supply changes might reflect a nontrade aspect of glob-alization: immigration.

There are two key facts here. First, immigra-tion rates have risen sharply since around

1970. Second, since aboutthat time U.S. immigrants' average skill levels have been

declining.Today one-third of U.S. high school dropouts are foreign-born.3sRecent

immigrants might have helped expand the relative supply ofless skilled workers during the

1980s and thus put downward pres-sure on the wages of less skilled U.S. natives who

compete with theseimmigrants for jobs.

The evidence on immigration's contribution to rising incomeinequality is mixed. Some

studies find that immigration-driven sup-ply shifts havenotcontributed very much to wage

dispersion. DavidCard cites many papers that report very small effects of immigrantson

native wages: The ballpark figure is that a 10 percent increase in thefraction of immigrants

in an area reduces native wages by less than1 percent

To measure accurately the impact of immigrants on wages, the entire United States must be

studied. With this national perspective, Borjas, Freeman, and Katz find that immigration

has sharply pressured the earnings of the least skilled Americans.3SSpecif-ically, post-1979

immigration can account for between 27 and 55percent of the decline in the relative wages

of high school drop-outs. However, immigrants can explain no more than 10 percent of the

decline in the wages of high school graduates relative to college graduates.

Immigration seems to have mattered less in the rest of the OECD. Immigration flows have

been small in the United Kingdom since1980,yet they were substantial in the period of

declining wage inequalitybefore1970.Similarly, immigrant flows into France and Germany

appear to have coincided with a narrowing, not a widening, of the earnings distribution.

THE ROLE OF LABOR MARKET INSTITUTIONS

In addition to supply and demand, a third possible influence on relative wages is labor

market institutions interacting with supply and demand. The two most important ones are

unions and minimum wages. And the broad evidence here is that both have mattered: In

the two OECD countries with the strongest rise in inequality during the 1980s (the United

States and the United Kingdom), both of these institutions weakened in ways that tended

to exacerbate inequality.

The decline in trade unions might be an important explanation of rising inequality. Unions

reduce inequality by standardizing pay rates among workers within an establishment and

across establishments. The threat of unionization also forces nonunion employers to raise

pay or benefits to keep unions out. Thus, strong unions generally mean less inequality.

29

Table 3-4 reports union density rates across countries. In the United States, union density

has declined dramatically since 1970. The U.S. decline is greater than in other countries and

predates declines elsewhere—as does the nation's rise in inequality. Moreover, the decline

in earnings inequality inthe1990sthat occurred in a number of countries (Belgium,

Canada,and Germany) is associated with stabilizing or even slight increasesin density in a

number of countries (Japan, Netherlands, Norway,Canada, and Germany).

Minimum wages obviously tend to reduce inequality, at least among the employed. The

fall in the real minimum wage also seems to have contributed to rising inequality in the

United States and United King-dom. The real value of the minimum wage in the United

States declined substantially over the period 1970 to 1990, and even with recent increases it

remains very low by historical standards.

Here again the United States and the United Kingdom look different from other OECD

countries. For example, strong rises in France's minimum wage appear to have prevented a

sharp erosion in real wages at the low end of the French wage distribution.

Overall, then, the timing of changes in these institutions and wage inequality suggests a

link between them. More systematic research has supported this view. Freeman argues

that one-fifth of the total rise in inequality can be attributed to declining union power. Blau

and Kahn argue that more decentralized wage-setting mechanisms in the United States

account for the greater rise in male wage inequality in the United States than in other

countries. And Nicole Fortin and Thomas Lemieux (and, relatedly, John E. DiNardo, Fortin,

and Lemieux) argue that one-third of the total rise in U.S. wage inequality in the 1980s can

be attributed to declines in unionization and the real minimum wage along with economic

deregulation.

Conclusion About the Current Evidence on Inequality Causes

Research to date does not allow the precise allocation of the relativecontribution of

demand, supply, and institutional forces to rising U.S.wage inequality. However, at this time

most economists agree that tradehas not been a major factor in the shift in labor demand

away from lessskilled and toward more skilled workers. Other factors playing animportant

role seem to be demand shifts from skill-biased technologi-cal change, a deceleration in the

growth of the skilled-labor supply, andinstitutional factors such as declining unionization and

falling real min-imum wages.

Public Policy Responses to RisingInequality: Do the Causes Matter? (Come back to these if

you’re interest in solutions).

Article 6:

30

The Race between Education and Technology: The Evolution of U.S. Educational Wage

Differentials, 1890 to 2005

(Domestic political and societal)

A. Two Tales of the Twentieth Century

Long ago America was deemed the “best poor man’s country.” By the turn of the twentieth

century the distribution of wealth was extremely unequal.

In the years from around 1890 to 1910 earnings in occupations that required greater levels

of schooling were far higher than those that required little education, as shown in Chapter 2.

In addition, the economic return around 1915 to a year of high school or college was

substantial. The return to education in 1915 greatly exceeded that in 1940 and was

sufficiently high that it greatly exceeded returns in subsequent years

According to Douglas several factors were acting in concert to compress wages. One was the

deskilling of clerical workers through the substitution of office machinery for skill. Another

was the reduction in the flow of immigration, which, to Douglas, led to an increase in the

earnings of the less educated. Finally, the supply of educated and trained workers qualified

to assume various white-collar positions greatly increased thus depressing their earnings

The wage structure began to collapse a short time before 1920 and continued to narrow in

various ways until the early 1950s. The earnings of the more educated were reduced relative

to the less educated. Those employed in skilled occupations saw their earnings increase less

than did those in the lower-skilled jobs. For every skilled and professional series we

uncovered, the wage structure narrowed relative to wages for a lesser skilled or lower

educated group. The series we presented included professors of all ranks, engineers, office

and clerical workers, and craft positions in many industries.

The returns to a year of schooling, not surprisingly, also plummeted from 1915 to the early

1950s. Our estimates of the decrease in the pecuniary returns to a year of education are

robust to the level of schooling and also to the age and sex of the individuals. The returns to

schooling were so high prior to the narrowing that even after the initial decline, the returns

to education remained substantial.

Our point is that inequality and the pecuniary returns to education were both

exceptionally high around the turn of the twentieth century. But America remained the

destination of choice for the world’s people, and immigration was at record high levels just

before the 1920s when Congressional legislation severely reduced the flow.

It was still the “best poor man’s country,” but the moniker was no longer used because

America had a narrow income distribution. To the contrary, America’s income distribution

was probably far wider than it had ever been. The description was still applicable because

31

America had a considerably higher average income than did other nations. More important

was the fact that the United States was a society with fairly open educational access and had

more equality of opportunity than existed in Europe. Certain groups, in particular African

Americans living in the U.S. South, remained left out for some time. But even they gained

access to improved schooling during the mid-twentieth century and moved into higher

paying jobs in the 1960s.

2. Integrating the two tales of the twentieth century

By the early 1970s one could say that America “had it all.” The U.S. economy had grown at

a record pace in the 1960s when labor productivity expanded at 2.75 percent average

annually. The wage structure widened only slightly from the late 1940s and the income

distribution had remained relatively stable. Each generation of Americans achieved a level

of education greater than the preceding one, meaning that the average adult had

considerably more education than its parents.

The nation’s economy was strong. Its people were sharing relatively equally in its prosperity

regardless of their position in the income distribution. Racial and regional differences in

educational resources, educational attainment, and economic outcomes had narrowed

substantially since the early twentieth century.8 Upward mobility with regard to education

characterized American society

Had we continued to grow at the rate we did from the end of World War II to the mid-1970s

and had inequality remained at the level it had attained by the early 1950s, this volume

would tell a rather different story. But the American economy did not stay the course.

Inequality soared from the late-1970s to the early 2000s. Productivity, moreover, did not

continue to advance at the rate it once had. It slowed considerably beginning in the mid-

1970s and it remained low for about two decades. Although productivity growth eventually

resumed its previous rate, rising inequality magnified the impact of the sluggish economy on

the vast majority of Americans.

The full twentieth century contains two inequality tales—one declining and one rising.

These tales can be seen in the almost century-long view of key components of wage

inequality in Figure 1, which shows the college graduate wage premium (relative to those

who stopped at high school) and the high school graduate wage premium (relative to

those who left school at eighth grade) from 1915 to 2005.

The college wage premium shows a sharp decline from 1915 to 1950, jaggedness from 1950

to 1980, and a rapid increase after 1980. At century’s end the premium to college graduation

was about the same as at century’s beginning. The wage premium for high school graduates

shows an equally sharp decrease in the pre-1950 era but less of an increase during the rest

of the century. We will discuss why interest should center on the college premium for most

of the century and the high school premium for only the first half. The premium to

32

education, therefore, came full circle in the twentieth century and by 2005 had returned to

its high water mark at the beginning of the high school movement in 1915.

We will now complete the task we began in Chapter 3 and decompose the change in relative

wages by education for the 1915 to 2005 period into its sources. Why did education returns

fall in the first half of the twentieth century but rise at the end of the second half? One

factor that is common to both parts of the century is technological change that increased

demand for skilled and educated workers. But vicissitudes in the rate of growth in the

supply of educated labor, we will soon demonstrate, played a key role in altering

inequality trends. The race between technological change and education resulted in

economic expansion and also determined who received the fruits of growth.

The returns to education and other components of wage inequality do not always move in

lock step, but we do know that in recent decades the lion’s share of rising wage inequality

can be traced to an increase in educational wage differentials.

B. The Supply, Demand, and Institutions (SDI) Framework

The framework we employ to decompose the impact of various factors influencing the

returns to education is an extension of that introduced in Chapter 3. The two most

important forces in the framework concern the change in the relative supply of more-

educated workers, which has mainly occurred through changes in schooling, and the change

in the relative demand for more-educated workers, which has been driven by skill-biased

technological change

We also incorporate institutional factors, such as changes in union strength and the effects

of war-time wage-setting policies. In this sense we combine the usual supply and demand

framework with institutional rigidities and alterations. As we will see, the broader

framework is most important in understanding changes during the 1940s and the late 1970s

to the early 1980s.

It is likely, for example, that the wage compression of the 1940s went far beyond what can

be accounted for by market forces alone and was driven, as well, by institutional factors of

the World War II era, such as the greatly expanded role of unions and the residual impact

of the wartime wage setting policies.

C. Why the Premium to Skill Changed: 1915 to 2005

The college wage premium (col. 1) collapsed from 1915 to 1950 but subsequently increased,

especially after 1980. By 2005 the college wage premium was about back at its 1915 level. As

we noted in describing Figure 1, the returns to college have come full circle.

Because the premium to education at the end of the century was approximately equal to its

level at the start, our supply-demand framework implies that the relative demand for skill

across the entire century must have grown at about the same rate as the relative supply of

skill.

33

Even though the race between technology and education over the long run was about even,

the long run hides crucial short run changes. What changed across the past century that

caused the returns to education to decline and then rise?

We will soon see that fluctuations in the supply of college workers, relative to other workers,

together with stable demand growth can explain the shorter-run movements in the college

premium to a substantial degree.

The most important result from the analysis is that changes in the relative supply of college

workers had a substantial and significant negative impact on the college wage premium

across the entire period. Most of the specifications yield similar coefficients for the relative

supply variable.

Overall, simple supply and demand specifications do a remarkable job explaining the long-

run evolution of the college wage premium. The predictions from specifications (2) and (3),

graphed in Figure 2 alongside the actual values for the college wage premium, show that

most of the shorter-run fluctuations can be tracked as well. But two short-run fluctuations

are more complicated. One is the 1940s and the other is the late 1970s.

Thus various institutional factors may have led to a larger decline of the college wage

premium in the 1970s than warranted by the supply and demand fundamentals and, in

consequence, to a catch-up increase in the early 1980s. The continued decline of unions and

the erosion of the real value of the federal minimum wage in the 1980s may have increased

the college wage premium by more than was justified by market factors alone.

As the college educated group became a larger share of the labor force, it also became more

heterogeneous. Demand for those who graduated from more selective institutions as well as

those with post-B.A. degrees is still soaring and they are doing spectacularly well. But

demand for the remaining group is less strong and they are not doing as well.

Computing supply and demand shifts

Across the entire period supply and demand forces kept pace with each other, as we noted

before. Neither education nor technology won the race. The same was true for the 1960 to

1980 sub-period.17 But for other sub-periods it was not. Across the earliest periods listed,

1915 to 1940 and 1940 to 1960, supply ran ahead of demand by about 1 percent average

annually.18 For the most recent period, 1980 to 2005, demand outstripped supply. Most

important is that for both the earlier and later sub-periods changes in educational supply are

the tail wagging the wage-premium dog.

Technology has been racing ahead of education in recent decades but the primary reason is

that educational growth has been sluggish. We summarized the point in Chapter 3 with the

quip “it’s not technology – stupid.” We will soon demonstrate that the inequality culprit is

also “not immigration.”

34

E. Recapitulation: Who Won the Race?

Technological change is the engine of economic growth. Yet, it also has a potentially dark

side. We do not mean pollution, crowding, and other disamenities. Rather we mean that

technological change creates winners and losers and can sometimes have adverse

distributional consequences that may foment social tension. Such distributional problems

are more likely when technological change is skill biased, that is when new technologies

increase the relative demand for more skilled and more advantaged workers.

A nation’s economy will grow more as technology advances, but the earnings of some may

advance considerably more than the earnings of others. If workers have flexible skills and if

the educational infrastructure expands sufficiently, then the supply of skills will increase as

demand increases for them. Growth and the premium to skill will be balanced and the race

between technology and education will not be won by either side and prosperity will be

widely shared.

External factors can also alter the demand and the supply of skills. The immigration of

workers who are disproportionately at the bottom of the skill distribution could greatly

impact the earnings of those who are their closest substitutes. Globalization factors

affecting international trade patterns and off-shoring opportunities can also alter skill

demands.

By the 1960s America was growing rapidly and the fruits of economic growth were being

shared fairly equally across the income scale. But the story quickly and abruptly changed in

the late 1970s and early 1980s when rapidly rising inequality took hold and productivity

growth was sluggish at best. The twentieth century, then, contains two inequality stories.

What can explain why that has been the case?

In search of an explanation, we have used our estimates of relative skill supplies provided in

Chapter 1 to uncover why the relative premium to skill changed. We did so by estimating the

elasticity of substitution between various groups of workers by skill or education. We then

used these estimates to compute the degree to which relative labor demand and supply

shifted.

The supply and demand framework we employed does an extremely good job in explaining

changes in the premium to skill. There are times in the analysis when we have appealed to

institutional changes and rigidities. But, by and large, the framework allows us to tell a

consistent and coherent story to reconcile the two inequality tales of the twentieth century.

We will summarize the major findings of that analysis and begin with the college wage

premium.

Over the very long run, from 1915 to 2005, the college wage premium has remained the

same. Thus, over the very long run supplies and demands for relative skill were balanced.

35

But that does not help us understand the two tales. Only a detailed analysis of the sub-

periods will. From 1915 to 1980 education raced far ahead of technology and that served to

reduce skill premiums and to lessen the economic power of Douglas’s non-competing groups

From 1915 to 1940 supply outstripped demand by 1.41 times (3.19 versus 2.27); from 1940

to 1960 it did so by 1.47 times (2.63 versus 1.79). In both periods supply increased by about

1 percent per year more than demand. In Section II we discussed the many reasons for the

surge in education including the high school movement in the pre-1940 era and the increase

in college going in the post-World War II period.

But a big reversal occurred around 1980. Had the relative supply of college workers

increased from 1980 to 2005 at the same rate that it had from 1960 to 1980, the college

premium, rather than rising, would have fallen. The race had been lost to technology.

We questioned whether some of the supply changes we measured were really due to

changes in immigration rather than to education. The issue is most important for the earliest

of the periods we studied, when immigration was high and then restricted, and also for the

most recent period, when immigration surged again.

We noted that during the critical period 1980 to 2005, when the college premium increased

by an astonishing 23 percent, immigration could account for only 10 percent of the surge or

just 2.4 log points. Most of the increase was due, instead, to the slowdown in college going

among the native-born population. In fact, educational changes to the native-born

population were nine times more important than was immigration for the rise in the college

wage premium.

Immigration was more important for the relative decline at the bottom end of the skill

distribution. But even in that calculation, educational slowdowns among the U.S. born were

more important quantitatively.

We noted that the wage structure and the returns to skill have exhibited important

discontinuities. Most of the narrowing in wage differentials, for example, took place in the

1910s and the 1940s, periods close to or coinciding with the two world wars. They were

times of increased demand for the lower skilled, great innovation, and union activity. But

although the discontinuities in the wage structure suggest a structural change, the fact that

the wage structure remained in place though the institutions changed suggests the

importance of fundamental changes in both education and technology.

Our central conclusion is that when it comes to changes in the wage structure and returns to

skill, supply changes are critical, and education changes are by far the most important on the

supply side. The fact was true in the early years of our period when the high school

movement made Americans educated workers and in the post-World War II decades when

high school graduates became college graduates. But the same is also true today when the

slowdown in education at various levels is robbing America of the ability to grow strong

together. We now address what it takes to win the race for the long run.

36

WEALTH INEQUALITY IN THE UNITED STATES

(Domestic social and institutional)

Since the early 1920s, the top 1% of wealth holders has consistently owned an average of

30% of total household sector wealth. During economic downturns, the distribution of

wealth has appeared more equal. However, studies of wealth mobility suggest that upward

movement is rare and that eras of relative equality reflect deflated asset prices more than

they do improvements in the financial well-being of the majority of the population.

The top 1% of wealth owners owned nearly 40% of net worth and nearly 50% of financial

assets in the late 1980s and 1990s. During this same period, the top 1% enjoyed two thirds

of all increases in household financial wealth, and movement into the top segments of the

distribution was nearly nonexistent. Moreover, while inequalities of wealth were

consistently more extreme throughout Europe for many decades, by the early 1990s, the

United States had surpassed all industrial societies in the extent of inequality of family

wealth.

Despite extreme inequalities in wealth ownership, however, researchers have paid relatively

little attention to wealth inequality and its causes. There are important exceptions, but

wealth has largely been ignored in studies of inequality.

Sociologists typically focus on income, or the flow of money received by an individual or

household, as an indicator of financial well-being. In contrast, wealth, or net worth, is the

value of assets owned by the household. More precisely, net worth is the difference

between total assets (including real assets such as houses, real estate, and vehicles; and

financial assets such as checking and savings accounts, stocks, and bonds) and total liabilities

or debt (such as mortgages, car loans, student loans, and credit card debt).

In this chapter,w e review recent literaturet hatd escribest rendsi n wealth ownership nd the

distributiono f wealth among households.W e also examine research that proposes

explanations of wealth inequality. We begin with an examination of the reasons that wealth

inequality has received little empirical attention from sociologists, including difficulties that

arise in the collection of data on wealth ownership

MEASURES OF INEQUALITY: Wealth Versus Income

Using income alone to indicate the financial well-being of families would be adequate if

income and wealth were highly correlated. In reality, however, the correlation between

the two indicators is relatively low. Estimates from survey data during the 1980s suggested

that the correlation between income and wealth was about 0.50, and that much of this

already-weak correlation was attributablet o the inclusion of asset income (income

generatedb y wealth) in the definition of total income. When asset income was removed

from total income, the correlation between income and net worth dropped to 0.26 (Lerman

37

& Mikesell 1988:779). Family wealth is a critical component of well-being. Omitting wealth

from studieso f inequalityl eaves an importantp arto f the stratifications toryu ntold

There are several reasons that wealth and income are not more highly correlated. Many of

the truly wealthy have rather low earnings because they are able to support current

consumption with income derived from assets (Wolff 1995a). In addition,r etiredp ersonso

ften have low incomes but substantialn et worthb ecause their wealth continues to

accumulate after retirement when earnings cease (Radner 1989b).

Moreover, wealth is even more unequally distributed than income. According to Wolff

(1995b), in 1989 the top 1% of wealth owners held 38.9% of total household wealth, while

the top 1% of income earners received 16.4% of total household income. The top quintile of

wealth holders owned almost 85% of total household wealth, and the top quintile of income

recipients received just over 50% of total family income.

EXPLANATIONS OF WEALTH INEQUALITY

Explanations of wealth inequality typically fall into two camps: those that focus on

aggregate-, or macro-, level influences, and those that focus on processes at the level of

individuals and families. It is nearly impossible to discuss the wealth accumulation of

individuals and families without speculating about the implications that this has on

inequalities in the macrolevel distribution of wealth. Likewise, it is difficult to discuss the

aggregate-level distribution of wealth among families without speculating about how the

behavior of members of the society affects this distribution.A lthough most would agree that

processes at both levels of aggregation are important, researchers seldom integrate the two

levels. In this section, we review literature that takes each approach, and we conclude with a

discussion of efforts to integrate macro and micro approaches

Individual and Family Processes

The effect of age on wealth ownershiph as attractedp erhapsm ore attentiont han any other

single process, particularlya mong economists workingf rom a life cycle model. Keynesian

economics, the predominant approach to economic behavior in the 1930s and 1940s,

emphasized the role that individual saving played in the larger economy and held that

current income was the sole determinant of saving

Family structurea lso plays an importantr ole in creatinga ndm aintainingd ifferences in

wealth ownership. Some researchers have argued that a relatively small percentage of the

increase in poverty in the 1970s through the 1990s was accounted for by changes in family

structure (Gottschalk & Danziger 1984). Two separate studies contended that the

"feminization of poverty" between 1960 and the mid-1980s was a result of changes in

relative poverty rates for various household compositions rathert han changes in family

structure,p articularlyf or blacks (Bane 1986, Danziger et al 1986). Yet evidence continues to

mount that suggests some role for change in family structure. Few wealth researchers

address issues of family structure, but both survey and simulated estimates suggest that

38

gender and family structurea ffect both cross-sectionalw ealth ownershipa nd longitudinal

patterns of wealth mobility (Keister 2000b). These estimates suggest that at any given point

in time, family structure is highly correlated with wealth ownership, net of income,

education, and race. In particular,t here is evidence that marriage and widowhood increase

wealth ownership, while increased family size and family dissolution through divorce or

separation have the opposite effect. Researchersh ave also shown that family structure

continues to affect poverty when it is defined in income terms (see McLanahan & Kelly 1999

for a review of the literature on the feminization of poverty.

The Great Divergence

That was when the richest 1 percent accounted for 18 percent of the

nation's income. Today, the richest 1 percent account for 24 percent of

the nation's income. What caused this to happen? Over the next two

weeks, I'll try to answer that question by looking at all potential

explanations—race, gender, the computer revolution, immigration,

trade, government policies, the decline of labor, compensation policies

on Wall Street and in executive suites, and education. Then I'll explain

why people who say we don't need to worry about income inequality

(there aren't many of them) are wrong.

The trend then reversed itself. Incomes started to become more equal in

the 1930s and then became dramatically more equal in the 1940s.2

Income distribution remained roughly stable through the postwar

economic boom of the 1950s and 1960s. Economic historians Claudia

Goldin and Robert Margo have termed this midcentury era the "Great

Compression." The deep nostalgia for that period felt by the World War II

generation—the era of Life magazine and the bowling league—reflects

something more than mere sentimentality. Assuming you were white, not

of draft age, and Christian, there probably was no better time to belong to

America's middle class.

The Great Compression ended in the 1970s. Wages stagnated, inflation

raged, and by the decade's end, income inequality had started to rise.

Income inequality grew through the 1980s, slackened briefly at the end of

the 1990s, and then resumed with a vengeance in the aughts. In his 2007

book The Conscience of a Liberal, the Nobel laureate, Princeton

39

economist and New York Times columnist Paul Krugman labeled the post-

1979 epoch the "Great Divergence."

During the late 1980s and the late 1990s, the United States experienced

two unprecedentedly long periods of sustained economic growth—the

"seven fat years" and the " long boom." Yet from 1980 to 2005, more than

80 percentof total increase in Americans' income went to the top 1

percent. Economic growth was more sluggish in the aughts, but the

decade saw productivity increase by about 20 percent. Yet virtually none

of the increase translated into wage growth at middle and lower incomes,

an outcome that left many economists scratching their heads.

Today, incomes in the U.S. are more unequal than in Germany, France,

and the United Kingdom, not less so. Eugenics (thankfully) has fallen out

of fashion, and the immigration debate has become (somewhat) more

polite. As for income inequality, it's barely entered the national political

debate.

Few of these experts have much idea how to reverse the trend. That's

because almost no one can agree about what's causing it. This week and

next, I will detail and weigh the strengths and weaknesses of various

prominent theories as to what has brought about the income inequality

boom of the last three decades

Entry 2: The United States of Inequality

She might have asked the same about the modern, postindustrial family.

The declining economic value of men as Ward Cleaver-style breadwinners

is a significant reason for the rise in single parenthood, which most of the

time means children being raised by an unmarried or divorced mother.

The percentage of children living with one parent has doubled since 1970,

from 12 percent to more than 26 percent in 2004

40

Also, single parenthood isn't as damaging economically as it was at the

start of the Great Divergence. "That's mostly because the percentage of

women who are actually working who are single parents went up," Jencks

told me. In a January 2008 paper, three Harvard sociologists concluded

that the two-thirds rise in income inequality among families with children

from 1975 to 2005 could not be attributed to divorce and out-of-wedlock

births. "Single parenthood increased inequality," they conceded, "but the

income gap was closed by mothers who entered the labor force." One

trend canceled the effects of another (at least in the aggregate).

Entry 3: Immigration

Since 1970, the foreign-born share of the U.S. population (legal and

illegal) has risen from 4.8 percent to 11 percent. More than half of U.S.

immigrants now come from Mexico, Central and South America, and the

Caribbean. Although a substantial minority of immigrants are highly

skilled, for most immigrants incomes and educational attainment are

significantly lower than for the native-born.

Did the post-1965 immigration surge cause the Great Divergence?

But when economists look at actual labor markets, most find little

evidence that immigration harms the economic interests of native-born

Americans, and much evidence that it stimulates the economy. Even the

1980 Mariel boatlift, when Fidel Castro sent 125,000 Cubans to Miami—

abruptly expanding the city's labor force by 7 percent—had virtually no

measurable effect on Miami's wages or unemployment.

That creates a "spurious positive correlation between immigration and

wages," he wrote in a 2003 paper. Immigration looks like it is creating

opportunity, but what's really happening is that immigrants are moving to

places where opportunity is already plentiful. Once a place starts to

become saturated with cheap immigrant labor, Borjas wrote, the unskilled

American workers who compete with immigrants for jobs no longer move

there. (Or if they already live there, they move away to seek better pay.)

41

Borjas gathered data at the national level and sorted workers according

to their skill levels and their experience. He found that from 1980 to

2000, immigration had reduced the average annual income of native-

born high-school dropouts ("who roughly correspond to the poorest

tenth of the workforce") by 7.4 percent.

In a subsequent 2006 study with Harvard economist Lawrence Katz, this

one focusing solely on immigration from Mexico, Borjas calculated that

from 1980 to 2000, Mexican immigrants reduced annual income for

native-born high-school dropouts by 8.2 percent. Illegal immigration has

a disproportionate effect on the labor pool for high-school dropouts

because the native-born portion of that pool is relatively small. A

Congressional Budget Office study released a year after Borjas' study

reported that among U.S. workers who lacked a high-school diploma,

nearly half were immigrants, most of them from Mexico and Central

America.

Immigration clearly imposes hardships on the poorest U.S. workers, but

its impact on the moderately-skilled middle class—the group whose

vanishing job opportunities largely define the Great Divergence—is

much smaller. For native-born high-school graduates, Borjas calculated

that from 1980 to 2000, immigration drove annual income down 2.1

percent. For native-born workers with "some college," immigration drove

annual income down 2.3 percent

To put these numbers in perspective (see Figure 1), the difference

between the rate at which the middle fifth of the income distribution

grew in after-tax income and the rate at which the top fifth of the

income distribution grew during this period was 70 percent. The

difference between the middle fifth growth rate and the top 1 percent

growth rate was 256 percent.

Another obstacle to blaming the Great Divergence on immigration is that

one of Borjas' findings runs in the wrong direction. From 1980 to 2000,

immigration depressed wages for college graduates by 3.6 percent (see

Table 3). That's because some of those immigrants were highly skilled. But

42

the Great Divergence sent college graduates' wages up, not down. To

reverse that trend would require importing a lot more highly skilled

workers

But while Burtless' methodology was more expansive than Borjas', his

calculation of immigration's effect was more modest. Had there been no

immigration after 1979, he calculated, average annual wages for all

workers "may have risen by an additional 2.3 percent" (compared to

Borjas's 3.7 percent).

The conclusion here is as overwhelming as it is unsatisfying. Immigration

has probably helped create income inequality. But it isn't the star of the

show. "If you were to list the five or six main things" that caused the Great

Divergence, Borjas told me, "what I would say is [immigration is] a

contributor. Is it the most important contributor? No."

Entry 4: Did computers create inequality?

Such a dystopia may yet one day emerge. But thus far traditional

economic theory is holding up reasonably well. Computers are eliminating

jobs, but they're also creating jobs. The trouble, Levy and Murnane

argue, is that the kinds of jobs computers tend to eliminate are those

that require some thinking but not a lot—precisely the niche previously

occupied by moderately skilled middle-class laborers. The moderately

skilled workforce is hollowing out.

What is it that's so special about computers? Harvard economists Claudia

Goldin and Lawrence Katz offer an interesting answer: Nothing! Yes,

Goldin and Katz argue, computer technology had a big impact on the

economy. But that impact was no larger than that of other technologies

introduced throughout the 20th century.

Between 1909 and 1929, Katz and Goldin report in their 2008 book, The

Race Between Education and Technology, the percentage of

manufacturing horsepower acquired through the purchase of electricity

43

rose sixfold. From 1917 to 1930, the proportion of U.S. homes with

electricity increased from 24 percent to 80 percent. By contrast, from

1984 to 2003, the proportion of U.S. workers using computers increased

from 25 percent to 57 percent. Computer use has spread quickly, but not

as quickly as electric power did during the early part of the 20th century.

"Skill-biased technological change is not new," Katz and Goldin wrote in

a 2009 paper, "and it did not greatly accelerate toward the end of the

twentieth century."

But (with the possible exception of radio) none of these consumer

innovations coincided with an increase in inequality. Why not? Katz and

Goldin have a persuasive answer that we'll consider later in this series.

Entry 5: Can we blame income inequality on Republicans?

Liberal politicians and activists have long argued that the federal

government caused the Great Divergence. And by "federal government,"

they generally mean Republicans, who have controlled the White House

for 20 of the past 30 years, after all. A few outliers even argue that for

Republicans, creating income inequality was a conscious and deliberate

policy goal.

Brad DeLong, a liberal economist at Berkeley, expressed the prevailing

view in 2006: "[T]he shifts in income inequality seem to me to be too big

to be associated with anything the government does or did."My Slate

colleague Mickey Kaus took this argument one step further in his 1992

book The End of Equality, positing that income inequality was the

inevitable outgrowth of ever-more-ruthlessly efficient markets, and that

government attempts to reverse it were certain to fail.

Taxation is the most logical government activity to focus on, because it

is literally redistribution: taking money from one group of people

(through taxes) and handing it over to another group (through

government benefits and appropriations). Another compelling reason to

focus on taxation is that income-tax policy has changed very

dramatically during the last 30 years. Before Ronald Reagan's election in

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1980, the top income tax bracket stood at or above 70 percent, where it

had been since the Great Depression.

Throughout the Great Compression, as the economy boomed and income

inequality dwindled, the top bracket resided at a level that even most

Democrats would today call confiscatory. Reagan dropped the top bracket

from 70 percent to 50 percent, and eventually pushed it all the way down

to 28 percent. Since then, it has hovered between 30 percent and 40

percent. That's how much Reagan changed the debate.

Reagan lowered top marginal tax rates a lot, but he lowered top effective

tax rates much less—and certainly not enough to make income-tax policy

a major cause of the Great Divergence.

But in recent years a few prominent economists and political scientists

have suggested looking at the question somewhat differently. Rather

than consider only effective tax rates, they recommend that we look at

what MIT economists Frank Levy and Peter Temin call "institutions and

norms." It's somewhat vague phrase, but in practice what it mostly means

is "stuff the government did, or didn't do, in more ways than we can

count.

Proponents of this theory tend to make their case not by measuring the

precise impact of each thing government has done but rather by charting

strong correlations between economic trends and political ones.

Bartels came to this conclusion by looking at average annual pre-tax

income growth (corrected for inflation) for the years 1948 to 2005, a

period encompassing much of the egalitarian Great Compression and all

of the inegalitarian Great Divergence (up until the time he did his

research). Bartels broke down the data according to income percentile

and whether the president was a Democrat or a Republican. Figuring the

effects of White House policies were best measured on a one-year lag,

Bartels eliminated each president's first year in office and substituted the

year following departure.

45

Overall, pre-tax income increased 1.42 percent annually for the 20th

percentile (poor and lower-middle-class people) and 2 percent annually

for the 95th percentile (upper-middle-class and rich people). The White

House during this period was occupied by five Democrats (Truman,

Kennedy, Johnson, Carter, Clinton) and six Republicans (Eisenhower,

Nixon, Ford, Reagan, Bush I, Bush II). Bartels plotted out what the

inequality trend would have been had only Democrats been president. He

also plotted out what the trend would be had only Republicans been

president. (KEY)

In Democrat-world, pre-tax income increased 2.64 percent annually for the poor and lower-

middle-class and 2.12 percent annually for the upper-middle-class and rich. There was no

Great Divergence. Instead, the Great Compression—the egalitarian income trend that

prevailed through the 1940s, 1950s, and 1960s—continued to the present, albeit with

incomes converging less rapidly than before. In Republican-world, meanwhile, pre-tax

income increased 0.43 percent annually for the poor and lower-middle-class and 1.90

percent for the upper-middle-class and rich. Not only did the Great Divergence occur; it was

more greatly divergent. Also of note: In Democrat-world pre-tax income increased faster

than in the real world not just for the 20th percentile but also for the 40th, 60th, and 80th.

We were all richer and more equal! But in Republican-world, pre-tax income increased

slower than in the real world not just for the 20th percentile but also for the 40th, 60th, and

80th. We were all poorer and less equal! Democrats also produced marginally faster income

growth than Republicans at the 95th percentile, but the difference wasn't statistically

significant.

Jacob Hacker and Paul Pierson, political scientists at Yale and Berkeley,

respectively, take a slightly different tack. Like Bartels and Krugman, they believe

that government action (and inaction) at the federal level played a leading role in

creating the Great Divergence. But the culprit, they say, is not so much partisan

politics (i.e., Republicans) as institutional changes in the way Washington does

business (i.e., lobbyists). "Of the billions of dollars now spent every year on politics,"

Hacker and Pierson point out in their new book, Winner-Take-All Politics, "only a

fairly small fraction is directly connected to electoral contests. The bulk of it goes to

lobbying…." Corporations now spend more than $3 billion annually on lobbying,

according to official records cited by Hacker and Pierson (which, they note,

understate true expenditures). That's nearly twice what corporations spent a decade

ago.

Academics who believe that government policies are largely responsible for the

Great Divergence don't breeze past the relevant mechanisms. Bartels writes at

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length about repeal of the estate tax, and the decline of the minimum wage; Hacker

and Pierson about financial deregulation. But their approach to them is more

impressionistic than comprehensive.

Part 6: The Great Divergence and the Death of Organized Labor

The Great Divergence coincided with a dramatic decline in the power of organized labor.

Union members now account for about 12 percent of the workforce, down from about 20

percent in 1983. When you exclude public-employee unions (whose membership has been

growing), union membership has dropped to a mere 7.5 percent of the private-sector

workforce. Did the decline of labor create the income-inequality binge?

Harvard economist Richard Freeman demonstrated in a 1980 paper that at the national

level, unions' ability to reduce income disparities among members outweighed other

factors, and therefore their net effect was to reduce income inequality. That remains true,

though perhaps not as true as it was 30 years ago, because union membership has been

declining more precipitously for workers at lower incomes. Berkeley economist David Card

calculated in a 2001 paper that the decline in union membership among men explained

about 15 percent to 20 percent of the Great Divergence among men. (Among women—

whose incomes, as noted in an earlier installment, were largely unaffected by the Great

Divergence—union membership remained relatively stable during the past three decades.)

It's possible, however, that labor's decline had a larger impact on the Great Divergence than

Card's estimate suggests. To consider how, let's return to the "institutions and norms"

framework introduced by MIT's Frank Levy and Peter Temin * and further elaborated by

Princeton's Paul Krugman and Larry Bartels.

According to Levy and Temin, labor's influential role in the egalitarian and booming post-

World War II economy was epitomized by a November 1945 summit convened in Detroit by

President Harry Truman. The war had ended a mere three months earlier, and Truman knew

the labor peace that had prevailed during the war was about to come to an abrupt end. To

minimize the inevitable disruptions, Truman promised labor continued government support.

To summarize: Taft-Hartley slowed and then halted labor's growth and then, over many

decades, enabled management to roll back its previous gains. Big manufacturing's desire

to do so grew more urgent in the 1970s as inflation spun out of control, productivity fell,

and the steel and auto industries faced stiffer competition from abroad. Even before

Ronald Reagan's election, Levin and Temin write, the Senate signaled the federal

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government was rapidly losing interest in enforcing Truman's 1945 pact when it killed off, by

filibuster, a pro-labor reform bill aimed at easing union organizing in the South.

Raising the minimum wage, for instance, reduces income inequality to a degree

that some experts judge negligible and others judge substantial. Where Levy and

Temin (who lean toward the "negligible" characterization) and Princeton's Bartels

(who leans toward the "substantial" one) agree is that policies like setting the

minimum wage don't occur in a vacuum; they are linked to a host of other

government policies likely to have similar effects. Bartels emphasizes partisan

differences and Levy and Temin emphasize ideological ones that occur over time,

but both constitute changes in the way Washington governs. Levy and Temin

concede that the ideological shift was influenced by changing circumstance (inflation

did rise; productivity did fall; Rust Belt manufacturers did face increased foreign

competition). But they argue that the policies embraced, and the increased income

inequality that resulted, were not inevitable. The proof, they argue, lies in the fact

that other industrialized nations faced similar pressures but often embraced different

policies, resulting in far less income inequality.

Geoghegan's latest book, Were You Born On The Wrong Continent?: It's no accident

that the social democracies, Sweden, France, and Germany, which kept on paying

high wages, now have more industry than the U.S. or the UK. … [T]hat's what the U.S.

and the UK did: they smashed the unions, in the belief that they had to compete on

cost.

Entry 7: Trade Created Inequality and then it didn’t

Did China—and growing trade competition from other low-wage nations—cause the

Great Divergence?

Two decades ago, Adrian Wood, a British economist, started arguing that trade

with low-wage countries lowered wages for unskilled workers in developed

countries. "There is a clear inverse association," Wood wrote in a 1995 paper.

"Countries with larger increases in import penetration experienced larger falls in

manufacturing employment." But in the United States, Wood had to concede,

imports of manufactured goods from low-wage countries still totaled less than 3

percent of gross domestic product. By itself, that wasn't enough to displace many

workers. Wood answered by arguing the effects were subtle and indirect. For

example, he wrote that imports from low-wage countries required more labor than

other goods, and therefore displaced more U.S. workers than imports from high-

wage countries.

48

Most leading economists in the United States didn't buy it. Paul Krugman (then at

MIT, now at Princeton) and Robert Z. Lawrence (then at the Brookings Institution,

now at Harvard), argued that international trade had played a much smaller role in

U.S. manufacturing's decline than had domestic considerations. Among these,

ironically, was the U.S. manufacturing sector's own efficiency, which had lowered

prices on consumer products and therefore on the proportion of U.S. spending on

goods (TVs, refrigerators, groceries) as opposed to services (CT scans, legal advice,

college tuition). From 1970 to 1990, the prices of U.S. goods relative to services had

fallen by nearly one-quarter. "Although the effect of foreign competition is

measurable," Krugman and Lawrence concluded, "it can by no means account for

the stagnation of U.S. earnings."

A decade later, Krugman decided his earlier analysis no longer held up. "My argument

was always yes, in principle" imports from low-wage countries could affect income

inequality, Krugman told me. But in the 1990s there simply weren't enough of them.

That changed in the aughts. In a December 2007 New York Times column and a 2008

paper for the Brookings Institution, Krugman observed that the United States had in

2006 crossed "an important watershed: we now import more manufactured goods

from the third world than from other advanced economies." (See Figure One.)

Imports of manufactured goods that came from less-developed nations had more

than doubled as a percentage of gross domestic product, from 2.5 percent in 1990 to

6 percent in 2006. Moreover, the wage levels in the countries ramping up U.S. trade

the fastest—Mexico and China—were considerably lower than the wage levels in the

countries whose increased U.S. trade had created worry in the 1990s—South Korea,

Taiwan, Hong Kong, Singapore. The Southeast Asian nations had, in 1990, paid

workers about 25 percent of what U.S. workers received. By 1995 they paid 39

percent—demonstrating, reassuringly, that low-wage developing countries that

undergo rapid economic growth don't stay low-wage for long. But as of 2005, Mexico

and China paid 11 percent and 3 percent, respectively. "It's likely," Krugman

concluded, "that the rapid growth of trade since the early 1990s has had significant

distributional effects.

Lawrence, looking at the same new data, continued to believe that trade did not

affect U.S. income inequality to any great extent. Lawrence focused on the fact that

China was increasingly exporting computers and other sophisticated electronics. To

depress the wages of lower-skilled workers in the United States, Lawrence reasoned,

China would have to compete with American firms that employed lower-skilled

workers. But the U.S. tech sector doesn't, for the most part, employ lower-skilled

workers. It employs higher-skilled workers. If trade with China were throwing

anybody out of work, Lawrence concluded, "it is likely to be … workers with relatively

49

high wages." And in fact, Lawrence wrote, during the first decade of the 21st century

there was very little measured increase in income inequality "by skill, education,

unionization or occupation." Income inequality did increase through the aughts, but

that was because incomes soared at the tippy top of the income-distribution scale. It

didn't increase because less-skilled workers got squeezed—or rather, it didn't

increase because less-skilled workers got squeezed any more than they did during

the previous two decades. At the very bottom, incomes actually edged up slightly.

Krugman wasn't convinced by his former collaborator's argument. "There is good

reason to believe that the apparent sophistication of developing country exports is,

in reality, largely a statistical illusion," he answered in his Brookings paper.

Unskilled laborers paid a pittance in China weren't really doing high-tech work,

Krugman wrote. They were grabbing sophisticated components manufactured in

more advanced and higher-paid economies like Japan, Ireland, and—yes—the United

States, and they were slapping them together on an assembly line. That couldn't be

good news for less-skilled workers in the United States, though Krugman said he

couldn't quantify the effect without "a much better understanding of the

increasingly fine-grained nature of international specialization and trade."

Where does that leave us? Trade does not appear to have contributed much to the

Great Divergence through the mid-1990s. Since then, it may have contributed to it

more significantly, though we don't yet have the data to quantify it. With trade more

than with most topics, the economics profession is struggling to interpret a reality

that may not fit the familiar models.

Entry 8: The Stinking Rich and the Great Divergence

He's French, he looks like a movie star, and he's the single most influential theoretician of

the Great Divergence, which began when Saez was un très petit écolier. What Saez (in

collaboration with another Frenchman, Thomas Piketty) brings to the discussion is a deeper

and more complex understanding of high-income subcultures.

Saez and Piketty replaced income data from the census with income data from the Internal

Revenue Service. They then broke that down more precisely than anyone had before. This

yielded three discoveries.

The American aristocracy is less different from you and me than it was in Fitzgerald's day.

"Before World War II," they wrote, "the richest Americans were overwhelmingly rentiers

deriving most of their income from wealth holdings (mainly in the form of dividends)." But

today, they found, the top of the heap are overwhelmingly job-holders deriving most of their

income from their wages. Did it become posh to have a job ? Not exactly. Having a job—the

right job, anyway—became the way to get posh. That's encouraging in one sense: To roll in

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the dough you now have to work for a living. But it's discouraging in another sense: You can't

blame enormous income disparities on non-working coupon-clippers who exist outside the

wage structure (and reality as most of us understand it). The wage structure itself is grossly

misshapen.

The share of national income going to the top 1 percent (the Rich) more than doubled

during the Great Divergence and now stands at about 21 percent. The chart showing this

found its way into President Obama's first budget (see Figure 9), prompting Wall Street

Journal columnist Daniel Henninger to call it "the most politically potent squiggle along an

axis since Arthur Laffer drew his famous curve on a napkin in the mid-1970s." But where

Laffer's squiggle was an argument to lower taxes, Piketty and Saez's (the conservative

Henninger noted with some dismay) was to raise them on the Rich.

The share of national income going to the top 0.1 percent (the Stinking Rich) increased

nearly fourfoldduring the Great Divergence. "The [inequality] phenomenon is more

extreme the further you go up in the distribution," Saez told me, and it's "very strong once

you pass that threshold of the top 1 percent." Canada's and the United Kingdom's Stinking

Rich followed a similar (though less pronounced) trend, but Japan and France did not; in the

latter two countries, the Stinking Rich received about the same proportion of national

income (about 2 percent) as the Stinking Rich did in all five countries prior to the Great

Divergence. In a 2009 paper, Saez and Piketty surveyed several other industrialized nations

(Table 5); in none of them did the Stinking Rich come anywhere near the 7.7 percent share

of national income found in the United States.

For all three groups—Sort of Rich, Rich, and Stinking Rich—the truly dizzying gains have

occurred since the early 1990s (see figures 1-3), the trend interrupted only by the dot-com

bust of the late 1990s and the sub-prime bust of the late aughts. The part of the Great

Divergence attributable to high-income growth—economists call it the upper tail—is exempt

from most of the analysis presented thus far in this series.

Princeton's Bartels told me his theory that partisan difference accounts for the Great

Divergence can't really be applied to the upper tail because Democrats have been no more

eager than Republicans to redistribute money away from the Stinking Rich (again: my

term, not his). The new financial regulation law (which hadn't yet passed when we spoke)

may change that calculus, but probably not by much.

A different logic applies to Jacob Hacker and Paul Pierson's theory that inequality was

created largely by a growth in corporate lobbying that influenced both Republicans and

Democrats. Their construct is a conscious effort to incorporate Saez and Piketty's research

into a government-based model. In Hacker and Pierson's view, if you can't explain the rise

of the Stinking Rich then you can't explain the Great Divergence—or at least what I'll call

the Great Divergence Part II, which began in the 1990s and continued through the aughts

as the more humdrum quintile-based divergence essentially halted (the bottom 20 percent

51

actually crept up a little). Egalitarians could have declared victory if incomes for the Stinking

Rich hadn't continued spurting upward like Old Faithful.

This logic doesn't apply to Wall Street, whose incentive structure, as documented in Michael

Lewis' books Liar's Poker and The Big Short, simply went berserk starting in the 1980s with

the development of ever-more-complex financial instruments increasingly divorced from

traditional notions of value. An explanation of how finance came to take over the U.S.

economy would require its own Slate series. But Saez, Hacker, and Pierson argue plausibly

that the industry's deregulation (and the protection it received from a few well-placed

Democrats like Sen. Chuck Schumer of New York) played a large role.

Entry 9: How the Decline in K-12 Education Enriches College Graduates

Computerization eliminated many moderately skilled jobs, and it increased demand for

workers with a college or graduate-level education. But for various reasons cited in Part 4 of

this series, computers don't seem by themselves to be a major cause of the Great

Divergence. Katz and Goldin argue in their 2008 book, The Race Between Education and

Technology, that lots of other technological advances throughout the 20th century created

comparable (sometimes greater) demand for a better-educated labor force. Yet these earlier

changes didn't typically generate income inequality. Why was the advent of computers

different?

For Katz and Goldin, the solution to this riddle isn't that computerization created a larger

demand for better-educated workers than did previous innovations. Rather, it's that

during the earlier upheavals the education system was able to increase the necessary

supply of better-educated workers. During the Great Divergence, the education system has

not been able to increase the supply of better-educated workers, and so the price of those

workers (i.e., their incomes) has risen faster relative to the general population. At a time

when the workforce needed to be smarter, Americans got dumber. Or rather: Americans

got smarter at a much slower rate than they did during previous periods of technological

change (and also at a much slower rate than people in many other industrialized

democracies did). That was great news for people with college diplomas or advanced

degrees, whose limited supply bid up their salaries. It was terrible news for everyone else.

Europeans, Katz and Goldin observe, thought that America's egalitarian approach to

education was soft-hearted and wasteful. They preferred a system that selected only the

most promising adolescents for further schooling, and even then the child's parents usually

had to pay for it. As late as the 1930s, Katz and Goldin note, "America was virtually alone in

providing universally free and accessible secondary schools." But while Continental

sophisticates scoffed, America's better-educated masses became a vital component to its

superior performance in a world economy that could no longer easily accommodate

anyone whose education stopped at age 12 or 13.

52

Throughout the first three-quarters of the 20th century a growing supply of better-educated

workers met the demand created by new technologies. The 1944 G.I. Bill, which paid tuition

for returning servicemen, played an important role; so did the Sputnik-inspired National

Defense Education Act, which increased federal spending on schools at all levels and created

(at the suggestion of Milton Friedman!) a student-loan program for colleges. With the

passing of each decade, the average 24-year-old had close to one additional year of

schooling. These gains virtually halted starting with 1976's cohort of 24-year-olds.

Educational attainment started growing again in the 1990s, but at a much slower rate.

Here's another way to put it: The average person born in 1945 received two more years of

schooling than his parents. The average person born in 1975 received only half a year more

of schooling than his parents.

The abrupt halt and subsequent slowdown of gains in educational attainment began at

about the same time as the Great Divergence. Before the Great Divergence, the country

enjoyed at least three decades of growing income equality, an epoch that Goldin and Boston

University economist Robert Margo have termed "The Great Compression." Between 1900

and the mid-1970s, U.S. incomes became dramatically more equal while educational

attainment climbed. But starting in the mid-1970s and continuing to today, incomes

became dramatically less equal while educational attainment stagnated. Katz and Goldin

believe this is not a coincidence.

Unlike the computerization trend, the slowdown of educational attainment gains is not

occurring in all industrialized nations; it is uniquely American. Remember those Europeans

who scoffed at the Yanks' misty-eyed commitment to universal education? Around the

middle of the 20th century they started to wise up and expand educational opportunities

in their own countries. By the end of the century Europe had caught up with or exceeded

average educational attainment in the United States. According to the Organization for

Economic Cooperation and Development, the United States has proportionally fewer high

school graduates (measured as the percentage of young people at the typical graduation

age) than Germany, Greece, the United Kingdom, Ireland, and Italy (see Table A2.1)."We

have the most-educated 55 year-olds in the world," Katz told me. "But we're in the middle

of the pack for 25 year-olds."

The trend was likely kicked off by the end of the Vietnam draft in 1973. College students had

received deferments. Until 1968 graduate students received deferments, too. The

deferments had the effect of inflating college and grad-school enrollment, already enlarged

by the baby boom, thereby lowering the market price for college graduates. From 1970 to

1976 college enrollment increased by 50 percent; it would be three decades before college

enrollment increased that much again. In 1976 the Harvard economist Richard B. Freeman

published a book titled The Overeducated American that argued the monetary return on a

college education—what economists call the "college premium"—had dropped to its

lowest level since World War II. But with the Vietnam draft gone and the last of the baby

boomers graduating from college, that trend began to reverse itself. It was no longer

53

necessary to enroll in college if you wanted to stay out of Khe Sanh, and fewer kids were

reaching college age. As a result, the college premium began to grow. It's been growing

ever since. Goldin and Katz calculate that it accounts for two-thirds of the increase in

income inequality during the Great Divergence.

Katz and Goldin blame America's colleges and universities, too—not for any educational

failing (the United States is a global leader in higher education) but rather for tuition costs,

which took off in the 1980s and have accelerated well in excess of general inflation ever

since. High school graduates aren't receiving a significantly better education, on average,

than their parents did, partly because elementary, middle, and high schools are

inadequate, and partly because the cost of a college education is increasingly prohibitive.

We have now reviewed all possible causes of the Great Divergence—all, at least, that have

thus far attracted most experts' attention. What are their relative contributions? Here is a

back-of-the-envelope calculation, an admittedly crude composite of my discussions with and

reading of the various economists and political scientists cited thus far:

Race and gender are responsible for none of it, and single parenthood is responsible for

virtually none of it.

Immigration is responsible for 5 percent. (International economic / domestic institutional)

The imagined uniqueness of computers as a transformative technology is responsible for

none of it.

Tax policy is responsible for 5 percent. (Domestic institutional)

The decline of labor is responsible for 20 percent. (Domestic institutional)

Trade is responsible for 10 percent. (International economic / domestic institutional )

Wall Street and corporate boards' pampering of the Stinking Rich is responsible for 30

percent. (Domestic societal / Domestic institutional)

Various failures in our education system are responsible for 30 percent. (Domestic

institutional)

Most of these factors reflect at least in part things the federal government did or failed to

do. Immigration is regulated, at least in theory, by the federal government. Tax policy is

determined by the federal government. The decline of labor is in large part the doing of the

federal government. Trade levels are regulated by the federal government. Government

rules concerning finance and executive compensation help determine the quantity of cash

that the Stinking Rich take home. Education is affected by government at the local, state,

and (increasingly) federal levels. In a broad sense, then, we all created the Great Divergence,

because in a democracy, the government is us.

Entry 10: Why We Can't Ignore Growing Income Inequality

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Among industrialized nations, those that have achieved the greatest social equality are the

same ones that have achieved the greatest income equality. France, for example, has a level

of income inequality much lower than that of most other countries in the Organization for

Economic Cooperation and Development. It's one of the very few places where income

inequality has been going down. (Most everywhere else it's gone up, though nowhere to the

degree it has in the United States.) France also enjoys what the World Health Organization

calls the world's finest health care system (by which the WHO means, in large part, the most

egalitarian one; this is the famous survey from 2000 in which the U.S. ranked 37th.

Paul Krugman- Trade and Wages Reconsidered

(International Economic / Domestic Poliitcal?)

Standard textbook analysis tells us that to the extent that trade is driven by international

differences in factor abundance, the classic analysis of Stolper and Samuelson (1941) –

which says that trade can have very strong effects on income distribution -- should apply.

In particular, if trade with labor-abundant countries leads to a reduction in the relative

price of labor-intensive goods, this should, other things equal, reduce the real wages of

less-educated workers, both relative to other workers and in absolute terms. And in the

1980s, as the United States began to experience a marked rise in inequality, including a large

rise in skill differentials, it was natural to think that growing imports of labor-intensive goods

from low-wage countries might be a major culprit.

But is the effect of trade on wages quantitatively important? A number of studies conducted

during the 1990s concluded that the effects of North-South trade on inequality were

modest. Table 1 summarizes several well-known estimates, together with one crucial aspect

of each: the date of the latest data incorporated in the estimate.

For a variety of reasons, possibly including the reduction in concerns about wages during

the economic boom of the later 1990s, the focus of discussion in international economics

then shifted away from the distributional effects of trade in manufactured goods with

developing countries. When concerns about trade began to make headlines again, they

tended to focus on the new and novel – in particular, the phenomenon of services

outsourcing, which Alan Blinder (2006), in a much-quoted popular article, went so far as to

call a second Industrial Revolution.

Yet the problem is obvious, and was in fact noted by Ben Bernanke (2007) last year:

―Unfortunately, much of the available empirical research on the influence of trade on

earnings inequality dates from the 1980s and 1990s and thus does not address later

developments.‖ And there have been a lot of later developments.

55

Figure 1 shows U.S. imports of manufactured goods as a percentage of GDP since 1989,

divided between imports from developing countries and imports from advanced countries. 1

It turns out that developing-country imports have roughly doubled as a share of the

economy since the studies that concluded that the effect of trade on income inequality was

modest. This seems, at first glance, to suggest that we should scale up our estimates

accordingly. Bivens (2007) has done just that with the simple model I offered in 1995,

concluding that the distributional effects of trade are now much larger.

China, in particular, is estimated by the Bureau of Labor Statistics (2006) to have hourly

compensation in manufacturing that is equal to only 3 percent of the U.S. level. Again, this

shift to lower-wage sources of imports seems to suggest that the distributional effects of

trade may well be considerably larger now than they were in the early 1990s.

But should we jump to the conclusion that the effects of trade on distribution weren’t

serious then, but that they are now? It turns out that there’s a problem: although the

―macro‖ picture suggests that the distribuXonal effects of trade should have goYen

substantially larger, detailed calculations of the factor content of trade – which played a

key role in some earlier analyses – do not seem to support the conclusion that the effects

of trade on income distribution have grown larger. This result, in turn, rests on what

appears, in the data, to be a marked increase in the sophistication of the goods the United

States imports from developing countries – in particular, a sharp increase in imports of

computers and electronic products compared with traditional labor-intensive goods such

as apparel.

Lawrence (2008), in a study that shares the same motivation as this

paper, essentially concludes from the evidence on factor content and

apparent rising sophistication that the rapid growth of imports from

developing countries has not, in fact, been a source of rising inequality.

But this conclusion is, in my view, too quick to dismiss what seems like

an important paradox. On one side, the United States and other

advanced countries have seen a surge in imports from countries that are

substantially poorer and more labor-abundant than the third-world

exporters that created so much anxiety a dozen years ago. On the other

side, we seem to be importing goods that are more skill-intensive and

less labor-intensive than before. As we’ll see, the most important source

of this paradox lies in the information technology sector: for the most

part there is a clear tendency for developing countries to export labor-

intensive products, but large third-world exports of computers and

electronics stand out as a clear anomaly.

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The changing pattern of trade

Figure 1 showed the dramatic rise in U.S. imports of manufactured goods

from developing countries since 1989. One qualification that needs to be

made right away is that to some extent this rise reflects the overall

movement of the United States into massive trade deficit. The theoretical

analysis later in this paper suggests that the average of imports and exports may be a better

guide to likely distributional effects than imports alone. Figure 2 shows this number for

U.S. trade in manufactured with developing and advanced countries; the rise

in developing country trade is slightly less dramatic, but still impressive. Also

note that 2006 marked a watershed: in that year, for the first time, the

United States began doing more overall trade in manufactured goods with

developing countries than with other advanced countries

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This rapid growth in U.S. trade with developing countries mainly took the form of

increased trade with countries that were only minor players in the early 1990s. At the time

of the original literature on trade and income distribution, North-South manufactured

trade was sXll, to a large extent, trade involving the original four Asian ―Xgers‖: South

Korea, Taiwan, Hong Kong, and Singapore. Since then, however, U.S. trade growth with

developing countries has principally involved China, Mexico, and some smaller player.

Figure 3 is an area chart of U.S. manufactured imports from developing countries, again as a

percentage of GDP; it shows a modest relative decline for the original tigers and a large rise

for Mexico and especially China.

This changing direction of North-South trade has one immediate implication: the aspect of

this trade that initially attracted so much (often hostile) attention – the fact that we were

now importing manufactured goods from countries with low wages by advanced-country

standards – is much more extreme now that it was in the early 1990s.

In 1990, according to BLS estimates, the four original tigers had average hourly

compensation in manufacturing equal to 25% of U.S. levels. By 1995 that had risen to 39%

of U.S. levels. But as of 2005 the BLS estimated that Mexico had hourly compensation only

11% of the U.S. level, and China only slightly more than 3%.

What accounts for the rapid growth of manufactured imports from these new players?

China’s economy, at least, has grown very rapidly, and one might imagine that the growth

of China’s exports is simply a reflection of its overall growth. Simple gravity models, in

which the trade between any pair of countries reflects the product of their GDPs, adjusted

for the distance between them, generally work quite well and have become a standard tool

for interpreting the overall pattern of trade. And such a model would lead us to expect U.S.

imports from China as a percentage of GDP to rise, other things equal, in proportion to

Chinese GDP as a share of U.S. GDP.

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In fact, however, U.S. imports from China have risen much more rapidly than the growth of

the Chinese economy, on its own, would have led us to expect. Table 3 compares the

growth in Chinese and Mexican GDP as a share of US GDP with imports from each country

as a percentage of US GDP. Chinese GDP, at market exchange rates, has tripled relative to

the United States – but US imports of manufactured goods from China have increased

more than eightfold as a share of GDP. Mexico’s GDP as a share of US GDP has risen about

40 percent, but manufactured exports have tripled relative to US GDP.

The obvious explanaXon of this ―excess growth‖ in manufactured exports is that it

reflects reduced barriers to trade, which have led to greater international specialization

and hence greater trade. In the case of Mexico, it’s natural to guess that NAFTA has played

an important role, although much of the growth in Mexican exports may also reflect two

other factors: the delayed effects of Mexico’s dramatic unilateral liberalization of trade

between 1985 and 1988, and the weak peso that followed the 1994-5 financial crisis.

Modeling the effects of trade on income distribution

As a result, most analysis of this issue continues to rely on the simple perfectly competitive

factor-proportions model.

The first key insight from this model is the Stolper-Samuelson relationship between goods

prices and factor prices. Consider a world in which there are two factors of production,

skilled labor and unskilled labor, and two goods produced competitively under constant

returns to scale, a skill-intensive good X and a labor-intensive good Y. Assume that workers

move freely between firms and industries, so that all workers of each type receive the same

wage. Finally, assume provisionally that an economy produces both goods. Then there is a

one-to-one relationship between the relative prices of the two goods and the relative wages

of the two types of labor.

Figure 6 completes the story. The left panel shows the relationship between relative goods

prices and relative factor prices. The right panel shows the relationship between factor

prices and the ratio of skilled to unskilled labor used in production. In each industry, a rise in

the relative wage of skilled workers leads to a fall in the ratio of skilled to unskilled workers.

This is one way to see the logic behind the Stolper-Samuelson result. As long as the country

continues to produce both goods, a rise in the relative price of the skill-intensive good must

lead to a rise in the relative wages of skilled workers. This implies a fall in the ratio of skilled

to unskilled workers in both industries – and hence a fall in the marginal productivity of

unskilled workers in terms of both goods. And that, in turn, means that the real wage of

unskilled workers unambiguously falls

But the focus of this paper is on a somewhat longer period – the years since the early

1990s, whose data were the basis for the relatively benign estimates of the effect of trade

on wages that still dominate discussion. Are the data since then consistent with a strong

Stolper-Samuelson effect?

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At first glance, the answer appears to be yes.

Consider first how prices have changed. The Bureau of Labor Statistics offers data on the

prices of manufactured imports from developing and advanced countries. If we assume that

developing countries export labor-intensive goods to the United States while advanced

countries export skill-intensive goods (an assumption that we’ll confirm with a major asterisk

– the case of computers and electronics -- in the next section), the ratio of these prices

should offer a measure of the relative price of labor-intensive goods. Figure 7 shows the log

of this ratio, normalized so that 1995=0. It seems that there has indeed been a substantial

decline in the relative price of labor-intensive goods since the mid-1990s.

Consider next changes in relative wages. Figure 8 shows two widely used indicators of

wage differentials: the 90-50 ratio of hourly wages, and the college-noncollege ratio. Both

are shown for men only, to abstract from changes in sex differentials; both are also

expressed in logs, normalized so that 1995=0. Both measures have risen substantially since

1995.

It should be pointed out that Lawrence (2008) reaches a

different conclusion, arguing that trends in relative wages

are not consistent with a trade-driven story. This different in

interpretation arises, I believe, from two factors. First,

Lawrence uses earnings data aggregated across sexes, which

does not show as strong a rise in inequality as the male-only

data. Second, he focuses on the period since 2000 rather

than the longer stretch since the mid-1990s.

I would argue that this short-term focus is problematic in two respects. First, on general

principles it’s not clear what one learns from very short-term movements in relative wages.

As argued above, the implied adjustment from Stolper-Samuelson involves a complex

reallocation of resources across industries, making it unsuitable for short-term analysis.

Second, more specifically, the period since 1995 includes a major boom-bust cycle in high-

technology industries. The technology bubble of the late 1990s probably elevated the

education premium, while the subsequent bust caused that premium to deflate. As a result,

inferences from the movement in inequality during the first few years after the tech bust

should be taken with a grain of salt.

Perhaps the more general point is that Stolper-Samuelson is a ceteris paribus proposition,

and cannot be refuted – or, to be sure, confirmed – based on the movement of relative

wages alone.

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That said, the combination of the price changes shown in Figure 9 and the wage changes

shown in Figure 10 does look reasonably supportive of the proposition that rapid growth

in North-South trade since the studies of the mid-90s has made the effects on inequality

substantially larger. There is, however, a big problem with that conclusion: the result of

using the methods I and others applied to the subject of trade and wages in the 90s to

more recent data does not, at least on first appearances, fit the story.

There was a fairly heated dispute in the 1990s over the appropriate way to analyze the

effects of North-South trade on wages. Some economists, notably Leamer (1994) argued

that since the relationship shown in Figure 6 is between goods prices and factor prices, the

only legitimate approach is to rely on price information, rather than on the volume of trade,

which is endogenous. Others, myself included, argued that this represented a confusion

between the question of how best to present models with the question of constructing the

appropriate thought experiment for analysis – it makes sense to present Stolper-Samuelson

as a goods-price-factor-price relationship, but in the real world prices are as endogenous as

trade volumes. The appropriate method, I argued in Krugman (1995), was ―but for‖

analysis: compare goods and factor prices with an estimate of what they would have been

but for the opportunity to engage in manufactures trade with developing countries. And this

but-for analysis inevitably leans strongly on calculations involving trade volumes.

The obvious explanation lies in the trends illustrated in Figures 4 and 5: although the

traditional manufactured exports of developing countries to the United States are labor-

intensive goods like apparel, the growth in developing-country exports has been

concentrated in nontraditional sectors, especially computers and electronics.

As we’ll see next, the apparent strong comparative advantage of developing countries in

these industries seems anomalous – unless the exports of developing countries are

concentrated in labor-intensive sub-sectors within the industries

Within-industry specialization and the problem of interpretation

A useful overview of the seemingly anomalous nature of some developing-country exports

can be obtained by using a technique suggested by Romalis (2004). Romalis provided

impressive evidence of the continuing relevance of Heckscher-Ohlin trade theory based on

an analysis of the sources of U.S. manufactured imports. He showed that the United States

does tend, systematically, to import skill-intensive goods from advanced countries and labor-

intensive goods from developing countries, although the relationship is far from perfect.

The industries at the lower left pose little puzzle: the paper and wood products industries

aren’t very skill-intensive, but U.S. imports within these industries are, for reasons of

resource abundance and geography, dominated by Canada.

Computer and Electronic Products? In U.S. data it ranks as the most skill-intensive of

industries, yet it is also an industry in which more than three-quarters of imports come

from developing countries, especially China

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All of this indicates that data showing a rapid rise in developing country exports, and

Chinese exports in particular, within sectors that are skill-intensive in the United States

need to be taken with large doses of salt

The broad picture, then, is that the apparent sophistication of imports from developing

countries is in large part a statistical illusion. Developing countries in general, and China in

particular, are probably specialized in very different niches within industries than the United

States. But how does all of the bear on the question of

whether rising trade with developing countries has led to

rising wage inequality in the United States?

Several recent analyses, notably Schott (2004) and Lawrence (2008) have argued that such

specialization in effect protects advanced-country workers from distributional effects of

trade by placing OECD countries in a different ―cone of diversificaaon‖ from developing

countries.

The famous proposition that trade leads to equalization of factor prices – a proposition

closely linked to the Stolper-Samuelson effect -- applies only if countries lie in the same

cone. So the suggestion that developing and advanced countries lie in different cones may

seem to obviate concerns about the distributional effects of trade. Thus Schott (2004)

asserts that

“If all countries produce all goods, unskilled workers in the U.S. can be adversely affected

by a drop in the world price of labor-intensive products …Specialization, however, means

that U.S. firms produce a capital-intensive mix of goods and are therefore not threatened

by cheap imports.”

But the evidence on specialization within industries, and vertical

specialization in particular, calls this interpretation into doubt. The

shock behind rapid growth in developing-country exports of

manufactured goods does not appear to be developing-country growth

leading to falling prices of traditional exports such as apparel. Instead,

what we seem to be looking at is a breakup of the value chain that

allows developing countries to take over labor-intensive portions of

skill-intensive industries. And this process can have consequences that

closely resemble the Stolper-Samuelson effect.

Nonetheless, the analysis presented here indicates that the

rapid rise in manufactures imports from developing

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countries probably is, indeed, a force for growing inequality,

and that factor content calculations suggesting otherwise

are missing the essence of what is happening.

Implications of the analysis

The starting point of this paper was the observation that the consensus that trade has only

modest effects on inequality rests on relatively old data – that there has been a dramatic

increase in manufactured imports from developing countries since the early 1990s. And it

is probably true that this increase has been a force for greater inequality in the United

States and other advanced countries

What really comes through from the analysis here, however, is the

extent to which the changing nature of world trade has outpaced our

ability to engage in secure quantitative analysis—even though this paper

sets to one side the growth in service outsourcing, which has created so

much anxiety in recent years. Plain old trade in physical goods has

become remarkably exotic.

In particular, the surge in developing-country exports of manufactures involves a peculiar

concentration on apparently sophisticated products, which seems at first to put worries

about distributional effects to rest. Yet there is good reason to believe that the apparent

sophistication of developing country exports is, in reality, largely a statistical illusion,

created by the phenomenon of vertical specialization in a world of low trade costs.

How can we quantify the actual effect of rising trade on wages? The answer, given the

current state of the data, is that we can’t. As I’ve said, it’s likely that the rapid growth of

trade since the early 1990s has had significant distributional effects. To put numbers to

these effects, however, we need a much better understanding of the increasingly fine-

grained nature of international specialization and trade.

Trade and inequality: The role of economists

However, for purposes of this discussion, I will ignore the possibility that unemployment

may in fact often be a problem and that trade may be a factor contributing to higher

unemployment. Instead, I want to focus on three issues that follow directly from the

standard trade models in which all the assumptions are chosen to support the gains from

trade conclusion:

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1) Trade does create winners and losers, and given current patterns of trade, the

winners are likely to be owners of capital and highly educated workers, with the

rest of the population ending up as losers.

2) It is possible to redistribute from the winners to the losers. However, the taxes

necessarily to pay for any redistributions are themselves distortionary. It is not

possible to determine a priori whether the distortions created by taxes to finance

redistribution are more or less distortionary than the trade barriers that were

eliminated.

3) There are trade barriers that have the effect of protecting workers in the most highly

paid professions, such as doctors, lawyers, and accountants. There are large potential

economic gains from eliminating these barriers. Removing these barriers would both

increase economic efficiency and reduce inequality.

The growth of wage inequality since 1979 has meant that most workers have seen

almost no real wage growth over this period. In the years from 1979 to 2005, the median

hourly wage has risen by just 9 percent. The wages of workers at the 30th have risen by

just 3.5 percent and they have fallen by 2.3 percent for worker sat the 10th percentile.

Even workers at the 70th percentile have seen real growth of just 10.4 percent over this

period. In other words, the vast majority of the workforce have seen only minimal gains

in real wages over a period in which net productivity has risen by more than 40 percent.

The only real question is the extent to which the growth in inequality can be attributed

to increased trade. There has been extensive research on this topic, which has

produced a wide range of estimates. At the high-end, Cline (1997) estimated that trade

and immigration together explained 40 percent of the growth in wage inequality over

the last quarter century.4 Krugman (1995) used a simple computable general equilibrium

model to conclude that trade accounted for 10 percent of the increase in inequality over

this period, coming in near the lower end of the range of estimates. Based on the

increase in trade with developing countries in the last decade, Bivens (2006) uses the

same methodology to conclude that trade would explain 14 percent of the change in

relative wages over the period since 1980.

While the additional growth attributable to trade may partially offset these losses, most

of the workforce is likely to end up as serious losers from trade.

Economists have been especially notably for their silence on this issue. With very few

exceptions they have eagerly embraced the trade agenda of recent administrations. They

have been quick to denounce opponents of this agenda as “protectionists” who should

not be allowed in polite circles. Yet, they rarely acknowledge the unavoidable implication

of trade theory – that a large segment of the U.S. workforce will have to endure lower

living standards as a result of the current course of trade liberalization. Apparently,

64

economists believe that these people have an obligation to sacrifice in the interests of

economic efficiency.

Professional protectionism: the barriers to trade in highly paid professional services

While economists can be criticized for failing to be forthcoming about the fact that

most of the workforce likely ends up losing from current trade policies, and that the

distortions created by policies designed to compensate losers may be larger than the

efficiency gains from trade liberalization, these are not the worst sins of the economics

profession when it comes to trade policy. The biggest failing of the economists concerns

what they have kept off the table, specifically the large array of legal and practical

barriers that protect workers in highly paid professions (e.g. doctors, lawyers,

economists) from competition with their counterparts in the developing world.

Conclusion

To sum up, economists have been extraordinarily dishonest in their interventions in

public debates over trade policy. They have not been straightforward on the

implications of standard trade models.

First, they have acted to conceal the fact that a substantial group of workers, quite likely

a majority of the workforce, can be expected to be losers from the recent path of trade

liberalization. This is not an accidental outcome; it is literally the mechanism through

which the economy experiences gains from trade. The vast majority of these workers will

not actually lose their jobs as a direct result of trade. Rather they will receive lower

wages in the same jobs. If no compensation is paid from winners to losers, then a large

segment of the work force can be expected to be losers from the current trade agenda.

Finally, economists have been very wiling to ignore the trade barriers that protect the

wages of highly educated professionals. For the most part, obstacles to trade in highly

paid professional services do not even get discussed in the context of trade debates,

even though the potential gains from reducing barriers in this area are likely to swamp

the gains from removing the remaining barriers in merchandise trade. In this case, the

effect of trade liberalization would be equalizing, since it would push down the wages of

the most highly paid workers.

Increasing Inequality in the United States

Dean Baker

However, the benefits of this growth have gone overwhelmingly to the richest 10

percent of families, and among this group, disproportionately to the richest 1 percent.

Most households have had very modest gains in income over this period, and the gains

they did experience have been largely the result of the growth in two-earner households.

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The growth of inequality in the United States is widely acknowledged in policy debates.

While there is little dispute about the general pattern of rising inequality, there is

considerable debate about the cause

A strong argument can be made that the driving force has been a series of deliberate

policy choices. This article describes some of the key policies that have fostered an

upward redistribution of income over the last quarter century.

US Trade and Immigration Policy – a Major Cause of Inequality?

In the United States, trade and immigration policy has been quite explicitly focused on

placing less educated workers that do not have a college degree in competition with

workers in the developing world, while leaving the most highly educated workers such as

doctors, lawyers, accountants and economists largely protected

This has been done, first and foremost, by making it as easy as possible for companies to

establish manufacturing operations in developing countries and ship their output back to

the United States. Recent trade agreements have been focused on establishing an

institutional structure that protects corporations against expropriations or restrictions on

repatriating profits by developing country governments, while also prohibiting tariff and

non-tariff barriers that could exclude manufactured goods from the United States. The

effect of such agreements is to place U.S. manufacturing workers in direct competition

with their counterparts in the developing world.

Anti-Inflation in Favor of Social Policies

In effect, this means that less-educated workers are being called upon to sacrifice by

facing higher unemployment rates, and also earning lower wages, in order to keep the

inflation rate under control. In prior decades, the government had tried to maintain

some equality of sacrifice through wage-price guidelines. As the OECD has recently

documented in its new Jobs Strategy, many European countries still effectively use

centralized wage bargaining as a mechanism to control inflation without resorting to

high levels of unemployment.

Anti-Unionism in the United States

A third important force placing downward pressure on the wages of large segments of

the work force has been the anti-union policies that were put in place in the last quarter

century. Partly as a result of these policies, the share of the private sector work force

that is unionized fell from more than 20 percent in 1980 to less than 8 percent in 2005.

Furthermore, the unions that continue to exist have far less power due to a change in

tactics by employers

66

The other major change in labor-management relations during this period has been the

practice of hiring replacement workers to take the jobs of workers on strike. This was an

extremely rare practice prior to 1980. The turning point came in 1981, when President

Reagan brought in military air traffic controllers to replace the civilian air traffic

controllers who were out on strike. Most of the striking controllers permanently lost

their jobs.

The Costs of Health: Sky-High and ever Increasing

A fourth major area of public policy that has led to rising inequality has been the

failure to contain the growth of health care costs. While rising health care costs have

posed problems in all developed countries, no country has experienced a health care

cost explosion comparable to that experienced in the United States. Health care costs

rose from 8.8 percent of GDP in 1980 to 15.3 percent of GDP in 2005, in spite of the

country’s relatively young demographic structure. Health care costs are projected to

rise by another 4 percentage points of GDP over the next decade.

There are other policies that have played a role in the rise of inequality over the last

quarter century. For workers near the bottom of the wage distribution, the decline in

the real value of the minimum wage has been an especially important factor.4 The real

value of the minimum wage was 30 percent lower in 2005 than it had been in 1980,

even though average productivity had risen by more than 70 percent.

Together these policies have led to an economic structure in which the bulk of the

gains from economic growth go to those at the top, and disproportionately to those at

the very top of the income distribution. Until recently such policies could be justified

by the relatively low unemployment rate in the United States, but even this rationale

appears to be disappearing. The most recent data from the OECD show the

employment to population ratio for prime age workers between 25 and 54 years of age

in the EU-15 is almost identical to the ratio in the United States. And, the EU-15 has

actually generated jobs at a more rapid pace than the United States since 2000.

Inequality as Policy John Schmitt

While the United States has long been among the most unequal of the world’s rich

economies, the economic and social upheaval that began in the 1970s was a striking

departure from the movement toward greater equality that began in the Great

Depression, continued through World War II, and was a central feature of the first 30

years of the postwar period.

My argument is that the high and rising inequality in the United States is the direct result

of a set of policies designed first and foremost to increase inequality. These policies, in

67

turn, have their roots in a significant shift in political power against workers and in favor

of their employers, a shift that began in the 1970s and continue through today.

Inequality as Policy: Changing Power Relations

From the late-1980s, however, the mainstream of the economics profession had turned

its attention instead to explaining the rising inequality. The bulk of the profession fairly

quickly settled on two likely suspects: “skills-biased technical change” and, to a lesser

degree, “globalization.”

According to the first explanation, the diffusion of computers and related technology in

the early 1980s steadily increased the demand for skilled workers relative to less-

skilled workers, driving up the wages and incomes of more-educated workers and

depressing the wages and incomes of lesseducated workers. From a political

perspective, the skills-biased technical change view had several convenient features.

The skills-biased technical change explanation also put significant limits on the terms of

policy debates: the problems of the three-fourths of the U.S. workforce without a

university degree were either the result of the poor personal decision not to pursue

enough education, or, at most, a sign that, as a society, we needed to invest more in

education

The second standard, though less favored, explanation for rising inequality was the

elusive idea of “globalization.” In the most common view, globalization is supposed to

have lowered the earnings of less-educated workers by putting them in direct

competition with low-wage workers around the world. This competition put pressure

on wages through international trade in goods and services; through the relocation or

threat of relocation of production facilities to overseas locations; through competition

with immigrants in local labor markets; and through other channels.

Globalization is the less favored explanation in the standard political discourse not

because it does not offer what is at face value a coherent explanation of the rise in

inequality, but because, by acknowledging the social costs of the increased integration

of markets, the globalization explanation threatens to derail an important economic

project of the elite. Economists and politicians in the United States spent much of the

1980s and 1990s arguing that the expansion of trade was the only path to national

prosperity. In this context, blaming widening inequality on the same process of

globalization that was supposed to be making us richer became quite awkward. (As an

aside, I note that globalization has proved itself to be a flexible political tool in the U.S.

and European debates. On the one hand, it seems, U.S. and European workers are told

that their future prosperity depends on more globalization. On the other hand, they are

also told that globalization means that our societies can no longer afford a generous

welfare state.)

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But the main problem with globalization as an explanation for rising inequality is that the

typical ways in which the discussion is framed obscure the underlying process through

which globalization actually acts on inequality. The standard framing presents

globalization, like technological process, as an exogenous force, something that happens

to us. In reality, globalization is a complex process of integrating capital, product, and

labor markets, where almost every characteristic of those newly integrated markets is

the subject of, or should be the subject of, political and regulatory debate. Contrary to

the standard framing, which presents globalization as something that no nation can

escape or even attempt to shape, we can choose the terms under which we integrate

capital, product, and labor markets across countries. Over the last 30 years we have

indeed “chosen” a particular form of globalization in the United States – a form that

benefits corporations and their owners at the expense of workers and their

communities. If we had chosen globalization on different terms, however, economic

integration would not have required rising inequality. Another globalization is possible.

In opposition to these two standard explanations for the recent rise in inequality, I

want to offer an alternative view, one that explains inequality as a function of power,

sustained by politics, and implemented as policy. In this alternative view, it is not

technological progress nor the inevitable march of globalization, but rather the sharp

shift in the strength of capital and employers relative to workers that explains the

increasing concentration of wages, income, and wealth over the last three decades.

By the end of the 1970s, however, employer opposition coalesced and the economic

disruption caused by two oil crises in the 1970s gave capital and employers a political

opening. Even while Jimmy Carter, a Democrat, was in the White House, a subtle but

important shift in U.S. politics occurred – a shift away from the core constituency of the

Democratic party (labor, women, racial minorities, and environmentalists) – and toward

employer interests.

The backlash was sold as a response to the economic crisis of the 1970s and the

emphasis was overwhelmingly on improving the efficiency of the U.S. economy, which

was described (and is still described today by many on the right) as sclerotic, overly

unionized, and overly regulated.

Each of the major policy initiatives of the last three decades claimed to offer important

efficiency advantages. The long decline in the inflation-adjusted value of the minimum

wage was supposed to correct a distortion in the low-wage labor market. The

deregulation (more accurately, re-regulation) of the airline, trucking, railway, financial,

and telecommunications industries was supposed to lower consumer prices in those

markets. The liberalization of foreign trade through a plethora of bilateral and

multilateral trade agreements was similarly supposed to lower consumer prices on

imported goods. The privatization of many federal, state, and local government functions

– from school bus drivers to the administration of welfare policy and even much of the

U.S. war in Iraq and

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Afghanistan – was supposed to lower the cost of government. The steady, policy-

enabled, deterioration of unionization in the private sector – from over one-third of

workers in the 1950s to about eight percent today – was supposed to improve the

competitiveness of U.S. firms.

These policies, sold as ways to enhance national efficiency, however, also had another

common thread. They all worked to lower the bargaining power of workers relative to

their employers. In many cases, the alleged efficiency gains have not materialized.7 In

every case, however, the negative impact on workers has been obvious and substantial.

Privatization has been a windfall for the companies who win government contracts,

while their main efficiency gains hinge on their ability to pay nonunionized, private-

sector workers less than more unionized public-sector employees. The huge decline in

unionization in the private sector has decimated the U.S. working class, which depends

on the union wages and benefit premium to secure a middle-class standard of living.

Taken together, these policies – a low and falling minimum wage; the de- or re-

regulation of major industries; the corporate-directed liberalization of international

capital, product, and labor markets; the privatization of many government services;

the decline in unionization; and other closely related policies – are the proximate cause

of the rise in inequality. Of course, the underlying cause is a shift at the end of the

1970s in the balance of economic and political power following almost five decades of

ascendancy of labor and other social movements.

I am not simply arguing that the explosion of inequality was a side-effect of these

policies. I am arguing, rather, that the explosion of inequality – what is, effectively, the

upward redistribution of the large majority of the benefits of economic growth since

the late 1970s – was the purpose of these policies. The purported efficiency gains,

which were realized in some cases but not in others, were merely a political distraction.

Wages for large swaths of workers, particularly for non-college-educated workers who

make up about three-fourths of the U.S. workforce, have trailed far behind growth in

productivity over the last thirty years, and, for many groups of workers, wages have

actually stagnated or even fallen in inflation-adjusted terms. While raising wages for

workers at the middle and bottom is important, increasing wages will not be enough.

Restoring real wage growth to the two or even three percent per-year rates experienced

during the first thirty years of the postwar period would certainly help. But the main

problems that U.S. workers face cannot be solved simply with faster real wage growth.

To be clear, in the overwhelming majority of cases, U.S. employers can fire a worker

without reason or advanced notice and without any legal obligation to provide

severance pay. The major exceptions to this arrangement are the 13 percent of the

workforce that is unionized and a small share of high-end workers such as company

officers who negotiate individual contracts with their employers.

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All of these non-wage issues – the lack of legal job protections, the lack of a safety net

for most of the unemployed, the strong dependence of workers on their employers for

health insurance, the lack of paid time off, and others – are major challenges for workers

at almost all levels of wage distribution. But these problems are particularly acute for

low-wage workers, who are not just the worst paid, but also the least likely to have

union-representation, the least likely to have employerprovided health insurance (or

insurance of any kind), and the least likely to have any form of paid time off.

Conclusion

In the standard neoclassical economics framework, low wages are simply a symptom of

low levels of skill. Wage levels, however, are also a function of unionization rates; the

level of the minimum wage; the entire regulatory framework governing the terms and

conditions of employment, from job security legislation to paid time off; the size and

scope of the public sector; the degree of competition in national and international

product markets; and other fundamentally political issues, all of which have little or

nothing to do with workers’ skills.

The sharp and sustained increase in economic inequality in the United States over the

last 30 years is not a reflection of a national preference for inequality (discussed more

blandly as “flexibility”), and not the continuation of an inexorable increase in inequality

from 1776 to the present. The last 30 years, in fact, mark a significant departure from a

five-decade trend toward greater economic and social equality. What changed was not

the demand for skilled workers, but the balance of power between workers and their

employers.