Rich Man, Poor Man: Are ‘the 1%’ worth it?

David and Victoria Beckham at their secret hideaway
David and Victoria Beckham at their secret hideaway

In the last of three postings on wealth distribution, we ask who benefits from the relentless rise of the rich.

Even in the world of high-flying soccer salaries, the deal announced late this summer between Real Madrid and Welsh player Gareth Bale was eye-popping – £85 million (about $120 million). The 24-year-old will now earn at least 10 times more in a week than the average British worker earns in a year.

Gosh.

Mr Bale is rich – not Bill Gates-rich – but rich. He’s also typical of many of today’s high-earners in that he’s making his own money. In previous centuries, high incomes typically came from inherited wealth. That’s why so many of Jane Austen’s characters never seem to work – they don’t need to: Their wealth is invested instead in government bonds that reliably pay an income of between 4 and 5% a year. In Pride and Prejudice, a would-be suitor reminds Elisabeth Bennet that unless she marries, her wealth will produce an income of only £40 a year: “… one thousand pounds in the 4 per cents, which will not be yours till after your mother’s decease, is all that you may ever be entitled to.”

If she were alive today, Lizzy Bennet might be running her own business and earning her own money. In that, she would be a typical member of today’s set of top earners – the 1% – which as Chrystia Freeland has written, “consists, to a notable degree, of first- and second-generation wealth. Its members are hardworking, highly educated, jet-setting meritocrats who feel they are the deserving winners of a tough, worldwide economic competition …”.

Over the past few decades, these winners have done quite nicely for themselves, most notably in English-speaking countries: In 1980, the top 1% of income recipients in the U.S. earned 8% of all pre-tax income; by 2008, their share had risen to 18% and it rose in many other OECD countries too. Several factors have worked in their favour: lower taxes; technological advances that reward skilled workers; the emergence of a global market for talent; and rising executive salaries.

But here’s a question: Are all these jet-setting meritocrats really worth it?

Historically, various justifications have been offered for income inequality – in other words, people earning more than others. As Branko Milanovic notes in The Haves and the Have-Nots, J.M. Keynes retrospectively justified 19th century inequalities by arguing that the rich had not wasted their money on fripperies but, instead, “like bees, they saved and accumulated”, so providing capital for investment, which ultimately benefited everyone.

Arguments today aren’t all that dissimilar. T.J. Rodgers, founder of Cypress Semiconductors, recently defended his own wealth by pointing to the money he had reinvested in his own firm and in new businesses, such as a restaurant in his home town that created 65 jobs. “How much more do I need?” he asked. “How many more jobs do you want?”

In essence this is an appeal to the idea of “economic efficiency” – inequality may not always be popular, the argument goes, but it ensures a society’s economic resources are put to their best use. The most influential thinker in this area was probably the economist Arthur Okun, who in the 1970s argued that there was a “big trade-off” between equality and efficiency: Reduce the wage gap by raising taxes or minimum wages and you kill people’s incentives to work hard and risk losing some of that tax money in the “leaky bucket” of government.

That argument still appeals to many, but it has its detractors. Based on an analysis of growth patterns in a number of countries, IMF economists Andrew Berg and Jonathan Ostry concluded that “when growth is looked at over the long-term the trade-off between efficiency and equality may not exist.” While some inequality is necessary to ensure markets run efficiently, the economists argue, too much can destroy growth.

Among the downsides of rising inequality, they say, are that it may pave the way for financial crises, as many argue it did in the run up to the 1929 Wall Street Crash; it may also fuel political instability, as in Brazil earlier this year; and it “may reflect poor people’s lack of access to financial services, which gives them fewer opportunities to invest in education and entrepreneurial activity.”

Indeed, that last point is increasingly invoked. As Joseph Stiglitz has written, “growing inequality is the flip side of … shrinking opportunity,” a view echoed earlier this year by Alan Krueger, then-chairman of the U.S. President’s Council of Economic Advisers: “In a winner-take-all society, children born to disadvantaged circumstances have much longer odds of climbing the economic ladder of success.”

But if we accept the idea – and not everyone does – that too much inequality benefits the rich and hurts the poor we’re left with another question: How much inequality is “too much” inequality? Economists may have their own views but, ultimately, that’s a question only politicians and societies can answer.

Previous articles in Rich Man, Poor Man:

Useful links

Reducing income inequality while boosting economic growth: Can it be done – from the OECD’s Going for Growth 2012

Less Income Inequality and More Growth – Are they Compatible? Part 4. Top

Incomes, by Peter Hoeller (OECD, 2012)

Divided We Stand: Why Inequality Keeps Rising (OECD, 2011)

OECD work on  income inequality

Hourglass job markets and earnings inequality

Education, union membership, gender and employment status influence wage distributions

Today’s post is contributed by Craig Holmes from the ESRC Centre on Skills, Knowledge and Organisational Performance (SKOPE) at Oxford University

It’s becoming more and more common to hear both researchers and policymakers across the OECD talking about the polarisation of labour markets. This is the idea that, because of technical progress, many middle-skill, middle-wage jobs (such as assembly line operators and clerical workers) have been replaced by machinery, hollowing out the labour market. This leads to increased employment in either high skill jobs – managers, professional and technician – or low wage work, particular in personal or retail services. This pattern of change has been particularly noted in the US (through the work of David Autor and colleagues) and the UK (most prominently in the work by Alan Manning and Maarten Goos). There is growing evidence of this phenomena occurring, to a greater or less extent, across Europe as well.

While we readily see this change in the types of jobs people are doing, it is less clear what effect this had had on the distribution of earnings. If everything else in the labour market had stayed the same, this hollowing-out would certainly be the cause of rising wage inequality. However, over the past thirty years, polarisation is just one of a number of changes which have impacted what people are paid. So the question is: what impact has it really had on earnings?

In a new report for the Resolution Foundation, Professor Ken Mayhew and I look at this question in the UK. We find that, when looking at wage distributions from the mid-1980s until the early 2000s, there is a surprising lack of evidence that work is polarising into high paid and low paid jobs. Certainly, there has been an increase in the gap between low and middle earners which means that if the definition of a low-paid job is some proportion of the median wage, then the share of workers in this part of the distribution has increased.

Similarly, the share of workers in jobs earning multiples of median earnings has also increased as wage growth at the top outstrips that at the middle. However, there is a more interesting picture of how pay has changed if we consider the range of wages being paid as a scale along which all jobs are placed. In that case, whether we think of a job as good or not depends on its placement on this scale. In particular, the very rapid growth in wages for the top 10-15% of workers that has seen them pull away from the rest has meant that the majority of jobs earning above median wages more closely resemble middle wage jobs, rather than top jobs.

What accounts for these changes? The report breaks down the changing shape of the wage distribution into the individual contributions from a wide range of factors that are related to earnings. An increase in educational attainment, particularly through a growth in the number of graduates, has pushed all wages upwards, but this effect is largest at the top of the distribution. Similarly, the decline in union membership has pulled wages down, but this effect is larger at the bottom and middle of the distribution. By comparison, the hollowing out of certain types of jobs has had a smaller effect – not as large (and positive) at the top, or as large (and negative) at the bottom as the changes caused by these other two factors.

The second thing that has changed is the way different worker characteristics correspond to wages – what economists call rates of returns or wage premia. The wage differentials between different occupations have changed, but these changes are not the same across the distribution. The relative earnings of managerial workers, for example, have grown particularly around the 75th percentile of the distribution, but much less elsewhere. Rates of return to a degree also appear to have fluctuated at different points in the wage distribution. Our analysis shows that the graduate premium has grown sharply for the top 15% of earners, but has remained relatively constant (or even declined) for everyone else.

The overall result is that the growing group of the apparently good, high skill jobs are becoming increasingly heterogeneous in their earnings, with many of them simply replacing the old middle skill jobs in the earnings distribution. To illustrate this further, consider the gross weekly earnings of managers in three different industries: healthcare, retail and financial services.

According to the polarisation concept, the growth of theses job, with their higher average earnings, should have increased high wage employment and driven up earnings inequality. However, while many of the new managerial jobs created in healthcare continue to exhibit high earnings, those created in retail are increasingly much lower paid. Between 2000 and 2008, the proportion of these jobs earning below £400 per week – adjusting for inflation – increased from 37% to 58%. In financial services, a sector which has performed relatively well over this time period, there has clearly been a growth in high wage managerial jobs. Jobs earning over £1,500 per week increased from just a couple of percent in 1993 and 2000, to 10% in 2008. However, there was also a growth in the proportion of managers in this sector earning less than £400 (from 24% to 30%).

Perhaps this should not be surprising – why should someone moving from a middle-wage, routine job to a managerial or technician occupation be as likely to earn as much as someone who had previously self-selected into those occupations? Their capacity to do a job through formal education and training and differences in unobservable abilities are an important contributor to eventual earnings.

Two major implications come from this report.

First, the findings suggest an important constraint on the belief that technological progress will continue to create good, high-skill jobs for an increasingly well-educated workforce. The lower-than-expected pay for many of these workers is related to their value-added and their productivity, suggesting either a shortage of specific skills in new hires or a significant underutilisation of these skills by employers creating and designing these jobs.

Second, these conclusions are also relevant to the growing concern that median incomes are stagnating, relative to growth (as highlighted by the Resolution Foundation’s report last year). In the past, the polarisation notion has been used to attempt to explain this, with increasing wages for higher end jobs, and decreasing wages for the declining middle jobs. Our research frames the argument differently. As around 44% of jobs would be classified as higher end jobs, the median worker is now quite likely to be working in one as well. Therefore, it is the growing disparity within this one group of occupations, rather than the widening of earnings between the two groups of occupations, that may offer a better explanation of the phenomenon.

Useful links

The OECD’s Going for Growth 2012 has a chapter on Reducing income inequality while boosting economic growth: Can it be done?