Wednesday, December 14, 2011

Occupy Wall Street and the movement’s discontent

In the recent months, we have seen protestors, in major cities globally, demonstrating against the growing income inequality between the “haves” and the “have-nots”. The movement started as “Occupy Wall Street”, which was initially aimed at the big banks and their top executives for the large bonuses paid, at a time when the American households were facing high unemployment and diminished prospects. However, the discontent has now turned more broadly toward the fact that, over the last 30 years, the high income group (the 1%) has experienced significant increase in real income, while the rest of the workforce (99%) has had relatively stagnant growth. 

It is interesting to note that many of the protestors currently hold or have walked away from positions with wages that are better than high-income executives in developing countries and enjoy a standard of living that is unmatched in many countries. This is not a movement of the impoverished and displaced, but a movement of the middle working class. What is at the center of the discontent, I believe, is not the absolute level of income and the associated standard of living but is the relative participation in the growth of American prosperity—a sense that the sharing of the pie has been “inequitable” more so than “insufficient”.

What drives income disparity?
There is no disagreement that the top income earners have increased their share of the total “output” that we collectively produce. What drives this phenomenon? We know that wages to workers (salaries + bonuses + stock options) in a free market are set by the invisible hand, given the demand and supply for different skills. If we let emotions subside, for the moment, we must acknowledge that the economy pays high wages to the high income individuals because we desire their skills and because there is a scarcity in those skills. In a free market, high income earners are not friends and relatives of the ruling elites, receiving special payments from the State and thereby robbing the general population. Instead, high income is a result of the consumers bidding up prices on various scarce talents.

By definition, there can only be a small collection of people with scarce skills; therefore only a small fraction (perhaps only 1%) who earn high wages! Income disparity is almost unavoidable; as long as we wish to have free markets and subject ourselves to the prices resulting from supply and demand dynamics!

However, we still need to address the concern that the income disparity has grown significantly over time.

The age of the superstars
An explanation for the rapidly accelerating income disparity is related to the rapid improvement in technology. Below are easy examples to help us understand the theory.

At the dawn of humanity, we had no technology; all of us farmed and hunted with our bare hands and simple tools. There was relatively small difference in the production of food between one fellow man from another—most of them barely produced enough to survive; stronger and healthier men were perhaps a bit more productive than their peers, but certainly not by a wide margin. However, with modern technology, one technology savvy farmer, working on a modern mechanized farm, could produce enough food for a million people. This level of production could not have been achieved by 1000 farmers using 19th century hand tools and fertilizer. The result of the improvement to farming technology meant a dramatic improvement to farming productivity and to the income of the mechanized and technology savvy farmers. However, it almost meant the permanent displacement of farm laborers, who used to supply hard physical labor.

Similarly, before the invention of filmmaking and movie technologies, theater was the most popular form of performance. Across the world, teams of actors and actresses performed Shakespeares, Greek tragedies, Chinese folklores, etc. The local actors made good but not extraordinary livings. However, with the advent of filmmaking and movies, local performances worldwide have largely been replaced by big budget Hollywood and Hong Kong movies. Today, there are a handful of internationally known stars, like George Clooney, Brad Pitt and Jacky Chan, who make millions per movies; through technology, they can extend their presence and appeals to billions of people globally. For the average actor in Hollywood, he needs to work two part-time waiter jobs to support his theatrical pursuit. Is Brad Pitt 100 times better looking or talented than the average actor? However, because of technology ability to leverage the top performers, small differences between individuals can become an income gap that is as wide as the Grand Canyon.

Technology has created the age of superstars. Technology essentially allows a star to shine so much brighter than it ever could and to allow the radiance to reach more people than it ever was possible, and, in the process, eliminating the society’s need for the lesser talents.

Technology not Capitalism is the cause of growing income disparity
Capitalism simply allows the greater talent to earn a higher income. While capitalism generates income disparity as a natural consequence of talent disparity in the population, it does not lead to greater disparity over time; capitalism cannot somehow cause a greater dispersion in human genetic attributes over time.

The improvement in technology, which allows talent to be leveraged aggressively, does lead to very significant increased difference in the wage for talent over time. However, it does not seem like a sensible path to recommend against technological advancements or capitalism, simply because technology, coupled with capitalism, can lead to widening income gap.  Capitalism has much to be disliked; supporting this system for resource allocation does not mean we love every aspect of this system.  It simply means that other choices seem even less desirable.  It is not a trivial exercise to address the observed growing income inequality. Until both sides of the conversation (the protestors and the 1%) have a solid understanding of the nature of income disparity and propose a good solution to this very hard question, the emotionally charged around income disparity will not likely result in a productive outcome.


by jason c hsu

18 comments:

Anonymous said...

Observed data point:
Different countries have very different levels of income disparity. It is very distinctly not uniform across 1st-world countries: Denmark and Sweden have vastly less income inequality than the United States.

Jason Hsu's thesis:
Technology, not social structures, are the cause of growing income disparity.

Necessary factual claim made by Jason Hsu's thesis:
Because Denmark and Sweden have vastly less income inequality than the United States, and because technology and not social structures are the cause of income inequality, we must conclude that Denmark and Sweden have a vastly inferior level of technology compared to the United States.

But Denmark and Sweden do not have an inferior level of technology compared to the United States.

Contradiction. Therefore, Jason Hsu's thesis is incorrect.

Anonymous said...

I think you are interpreting these comments too rigidly. The point here is technology is *a* factor driving growth, not *the* factor. Assuming there is only one factor driving income disparity is pretty dumb, and I think you'd agree that isn't what is being argued here.

jason c hsu said...

Clearly taxation policy, natural endowment of resources and the capital structure of a country matters greatly in income inequality. I was hoping to speak on "growing" income inequality rather than the "level" of income inequality.

So a better empirical test would be measuring the growth in income inequality as a country become more capital intensive.

Howard Stover said...

I went over to occupy LA on a few occasions to speak with the kids there. There was no one with whom I spoke who had walked away from a cushy job. Several were facing large school loan balances with no prospects for paying on them. A number had had family members lose homes, savings, jobs and/or health insurance. Well aware that their prospects were worse than those of preceding generations, they were struggling to live a decent life in the worlds wealthiest country. They know that they are getting a raw deal from the 1%; they are trying to figure out how it happened.
As to Dr. Hsu’s primary thesis that technology has created a generation of superstars that, presumably, justifies the dramatically skewed income distributions we see emerging all over the globe, I think a few numbers will help clarify the situation. We see that talented individuals often do well, sometimes remarkably well, under our current system. Recent forms of technology, one could even argue, are more democratically accessible than some in the past and this has created new opportunities. Fair enough. However, the dot com millionaires have not created the enormous skew in wealth and income distribution. It has been the financial/managerial sector which, as Paul Wegener pointed out, has hollowed out the economy. The last time incomes were this skewed was the result of the activities of the robber barons prior to the great depression. At least they left behind real wealth. Of the now infamous 1%, over 54 % are top management, financial professionals or attorneys. Engineers, scientists, entrepreneurs and academics are under 9%, and arts media and sports figures as exemplified by Dr. Hsu are 1.6%.
When I was kid, the top 1% earned around 8.3% of all the income. That seemed a bit unfair. Now it is 24%. The top 10% earns around 50%. Personally, that seems absurdly unfair and unreflective of of the contributions those groups make to the society. Emotions aside, I would suggest that it is not a practical condition for the long-term health of society. The economy cannot be robust unless ordinary people have disposable income and a modicum of opportunity. The period from 1947 until the beginning of the Reagan “revolution” was one in which, for all its other faults, most regular folks had a chance. This was largely due to a more realistic distribution of wealth and income.
What has changed? Please refer to the article by Zavodny of the Atalanta Fed (Pub ACF98) chart 2. which I can’t reproduce here. This statistic suggests that since the late 1970s wages have not kept pace with worker productivity. This is the mechanism by which technology helps to create our skewed income distribution, though outsourcing certainly contributes as well.
Worker productivity has risen by 70% since 1960, but wages are up 45%, 35% occurring prior to the Reagan era. Wages have not kept pace because the pressure of competition for labor that previously had “a rising tide lifting all boats” has been blunted by outsourcing, falling union membership and a reduced need for labor.
The superstar CEOs have convinced their boards that they have “mad skills” as the kids who work for me say. Really, they have simply figured out how not to pay workers a share of the pie proportional their output.
The economy, despite of some natural law-like mechanisms, is not a natural system, it is created by statutes, taxes, operating rules, and the existence of faith and good (or ill) will. From the New Deal into the 1970’s the rules were engineered to prevent powerful individuals and institutions from garnering an unfair share of the general wealth. This, I would argue, was good for everyone, even the wealthy, over the long term. Since that time, the rules have been systematically, statute by statute and regulation by regulation, re-designed to permit those sectors to become wealthier at the expense of the rest of us. This direction is unsustainable; it just does not work as a system unless one has a Dickensonian society as the goal.

jason c hsu said...

Howard,

Great comments. Huge appreciation. I agree with a lot of what you say. I will speak to one point here.

Most of the technology has been developed to replace workers and to allow management to leverage technology to negotiate wage concessions. It should not surprise you that managers are paying for research and technology to improve the return on capital and return on management.

It used to take a good programmer or two to do a website. With all of the new technology, even I can design a neat looking website. So programmers are being commoditized and all of the value is being captured by the business users of the technology.

I am not defending the outcome as desirable. I am saying that technology plays a pivotal role in eliminating jobs (either substituting technology for workers or allowing for effective outsourcing to India and China).

The fact that technology has such an important role doesn't mean that technology people capture the value of technology. it is usually captured by the people who finance the development of that technology and the people who commission those technologies for specific business uses. So at the end of the day, the top managers, the investment bankers and PE/VC investors are the prime beneficiaries.

Again, I don't defend this outcome. I am interested in pointing out that this is the consequence of technology.

As an economist, I am just not trained to judge whether an outcome is fair. I tend to agree with you that concentration of wealth leads to social unrest eventually, which is undesirable.

Peter Millington said...

"Changes in technology"seems a rather broad brush with which to portray the dynamics of our economy since 1980. Changes in the labor component of the US economy might have equal or correlated claim. Perhaps the ascension of the Chicago School of monetarist economists at the federal level in the service of President Reagan ignited Wall Street capitalism to pursue different models for financial success and fiscal policy.

I use 1980 as the limen that separates the US economy before the Friedman-Reagan economic policies were implemented and the downturn in domestic manufacturing output due to globalization and NAFTA-like trade agreements, the rise of Japan's post-war industrial expansion and the opening of the Asian labor markets for US manufacturers.

In manufacturing, tremendous economies of scale, as shown in the 70% increase in productivity, increased output resulting from a combination of reduced labor hours made possible by automation technology, downsizing personnel ranks and more efficient distribution practices.

In accounting and other financial work, productivity gains from new data systems technology, work redesign and automated information reporting significantly shifted clerical labor hours to lower skilled tasks such as data entry, scanning of invoices and other documents, increased use of short-term cash investments using operating funds, etc., allowed hiring practices to shift and to be outsourced. More jobs required college graduate level skills in analytical thought, information technology, financial modeling and analysis,and engineering.

Automation/technology allowed a reduction in number-crunching middle management staff, and an increase in highly trained supervisory and analytical personnel for ensuring the integrity of the IT systems and for adjusting the entry level clerical staff costs accordingly.

While some of the middle managers continued to find better jobs within their corporations, the major change for ambitious employees after 1980 was to seek their next jobs with a different employer at a higher wage. Instead of working for one employer to become vested in defined retirement and health plan benefits, the ethos of personal advancement became the salary figure, with many deciding to fund their own retirement and other savings plans from higher salaries and not from employer matching funds or other non-transferable benefits.

One must wonder if the touted rise of the American Middle Class following World War II, and essentially halting in 1980, could have happened at all without the strength of organized labor forces in plants and offices, and the ability of white collar workers to be promoted from within a single corporation. The pressure brought by the unions for defined benefits and upward pressure on wages pushed everyone along. Maybe the 1950-1980 heyday of the Middle Class was an unusual and unsustainable economic anomaly in capitalism.

Could or can a comparable "Middle Class" culture develop in today's economy without organized labor?

How shall we define the contemporary Middle Class looking forward?

jason c hsu said...

I am all for organized labor. You are right that an economy with organized labor and no organized labor will look very different. Yes, United and American Airlines might still be in business if not for their unions, but then again, there is no tangible proof that the social benefit is maximized with these airlines staying in business.

Now, I don't think unions are as influential as we make them out to be--certainly not to the extent that they are the reason behind the thriving middle class today.

Peter Millington said...

Perhaps I was unclear about the role of unionization of employees post WW II to which I attributed the diminishing Middle Class's expectations. The economy's social benefit from union labor has been the constant pressure on the wage-benefit packages that Management has had to embrace to retain its best employees in all ranks. As a result, there has been an overall, greater distribution of personal income than would have been without this pressure. With more personal income came the growth of several additional industries: advertising, leisure and travel, health and property insurance, entertainment, large and small appliances, to name a few. My use of organized labor is meant to illustrate what I believe was the driving force for the period of 1950-1980.

I agree with you about the lack of influence of unions for public policy today. Part of their fall from grace was due to the abuses fostered by irresponsible and sometimes criminal leadership within unions.

Also, organized labor contracts are unable to cope with variations in the business cycle caused by credit crunches, new technology, better competitors, and other external economic forces that Management encounters. Indeed, the very idea of a labor contract is to protect employee income despite the vagaries of markets.

In government and non-profit organizations, there are more examples, such as, the role of organized teachers in K-12 education, faculty and staff unions, and faculty tenure traditions, with their upward cost effects in that portion of our economy. The health care industry has similar inefficiencies and upward cost pressures due to an inability to reconcile personnel requirements and established, organized employee groups with new technological advances available today.

What I do not understand is your reference to a "thriving middle class" today. I believe the OWS and its imitators reveal the fact that the middle class do not feel good about their current situations, that so many people are no longer thriving.

What continues to escape us seems to be how to recreate American capitalism in a way that rewards values such as efficiency, individual merit, productivity, innovation and opportunities for retaining key elements for personal satisfaction with life and community well-being.

jason c hsu said...

I mean a thriving middle class relative to other countries. While our middle class has felt squeezed and OWS certainly reflect their angst and unhappiness, other countries do not have the same "middle class" anchoring their economies. Our middle class has experienced a much higher level of standard of living as well as earned higher wages relative to the international peer group. Our Gini coefficient also measures extremely well relative to other countries. So our middle class is certainly not relatively worse off than their international peers in capitalistic, socialistic, communistic or dictatorial countries.

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