Hat tip to Tim Fowler:
[T]he main point is that the Democratic campaign rhetoric
is taking on a life of its own, and drifting further away
from reality. Feeding off pessimism about the war and
anger at Washington, candidates now compete to tell dark,
angry and conspiratorial stories about the economy.
Brooks on the Economy
A prominent Harvard economist emails me to recommend David Brooks's column from a few days ago. He calls it "truly fantastic and obviously correct."
With such a strong recommendation from a colleague, I took a break from J.K. Rowling to read Brooks. While not quite as magical as the story of Harry, Ron, and Hermione, the Brooks piece is well worth reading. It is far more informed by cutting-edge economic research than most things you find on the op-ed pages.
In case you missed it, here is Brooks:
A Reality-Based Economy
If you've paid attention to the presidential campaign, you've heard the neopopulist story line. C.E.O.'s are seeing their incomes skyrocket while the middle class gets squeezed. The tides of globalization work against average Americans while most of the benefits go to the top 1 percent.
This story is not entirely wrong, but it is incredibly simple-minded. To believe it, you have to suppress a whole string of complicating facts. The first complicating fact is that after a lag, average wages are rising sharply. Real average wages rose by 2 percent in 2006, the second fastest rise in 30 years.
The second complicating fact is that according to the Congressional Budget Office, earnings for the poorest fifth of Americans are also on the increase. As Ron Haskins of the Brookings Institution noted recently in The Washington Post, between 1991 and 2005, ''the bottom fifth increased its earnings by 80 percent, compared with around 50 percent for the highest-income group and around 20 percent for each of the other three groups.''
The third complicating fact is that despite years of scare stories, income volatility is probably not trending upward. A study by the C.B.O. has found that incomes are no more unstable now than they were in the 1980s and 1990s.
The fourth complicating fact is that recent rises in inequality have less to do with the grinding unfairness of globalization than with the reality that the market increasingly rewards education and hard work. A few years ago, the rewards for people earning college degrees seemed to flatten out. But more recent data from the Bureau of Labor Statistics suggests that the education premium is again on the rise.
Fifth, companies are getting more efficient at singling out and rewarding productive workers. A study by the economists Thomas Lemieux, Daniel Parent and W. Bentley MacLeod suggests that as much as 24 percent of the increase in male wage inequality is due to performance pay.
Sixth, inequality is also rising in part because people up the income scale work longer hours. In 1965, less educated Americans and more educated Americans worked the same number of hours a week. But today, many highly educated people work like dogs while those down the income scale have seen their leisure time increase by a phenomenal 14 hours a week.
Seventh, it's not at all clear that the big winners in this economy are self-dealing corporate greedheads who are bilking shareholders. A study by Steven N. Kaplan and Joshua Rauh finds that it's not corporate honchos who are filling up the ranks of the filthy rich. It's hedge fund managers. Or, as Kaplan and Rauh put it, ''the top 25 hedge fund managers combined appear to have earned more than all 500 S.&P. 500 C.E.O.'s combined.'' The hedge fund guys are profiting not because there's been a shift in social norms favoring the megarich. It's just that a few superstars are now handling so much capital.
Eighth, to the extent that C.E.O. pay packets have thickened (and they have), there may be good economic reasons. The bigger a company gets, the more a talented C.E.O. can do to increase earnings. Over the past two and a half decades, the value of top U.S. companies has increased 500 percent, according to Xavier Gabaix and Augustin Landier. The compensation for the C.E.O.'s of those companies has also increased 500 percent.
Ninth, we're in the middle of one of the greatest economic eras ever. Global poverty has declined at astounding rates. Globalization boosts each American household's income by about $10,000 a year. The U.S. economy, despite all the bad-mouthing, is chugging along. Thanks to all the growth, tax revenues are at 18.8 percent of G.D.P., higher than the historical average. The deficit is down to about 1.5 percent of G.D.P., below the historical average.
All of this is not to say everything is hunky-dory. Inequality is obviously increasing. There's evidence that global trade is producing more losers.
Instead, the main point is that the Democratic campaign rhetoric is taking on a life of its own, and drifting further away from reality. Feeding off pessimism about the war and anger at Washington, candidates now compete to tell dark, angry and conspiratorial stories about the economy.
I doubt there's much Republicans can do to salvage their fortunes by 2008. But over the long term a G.O.P. rebound can be built by capturing the Bill Clinton/Democratic Leadership Council ground that the Democrats are now abandoning. Whoever gets globalization right will have a bright future, and in the long run, the facts matter.
gregmankiw.blogspot.com
Selected comments
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Isocrates said...
The obsession one sees on the left with inequality of wealth is not rational. What matters is absolute progress, not relative progress. If Bill Gates's wealth is rising 4% a year and my wealth is rising 3% a year, I am better off absoultely (though worse of relatively) and will be able to afford better housing, better health care, better food, and a better education for my children. Unless my view of life is distorted by envy, I will delight in the progress I am making.
It is unseemly to permit envy to infect one's economic judgments. The rational course is to pursue policies that promote growth (e.g. free trade, low marginal tax rates, etc...) and to ignore, as inconsequential, all concernes raised about gini coefficients and the like. 9:22 AM
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Clayton said...
"...the outrage is typically pointed towards those companies who's share prices have eroded and their CEO still gets a ridiculous pay out"
Lets take a simple example where there are two strategies:
- One that's certain to produce $1b in value for shareholders
- Another that's got a 50% chance of producing $10b and a 50% chance of losing $3b. (average of $3.5b)
The CEO is paid to maximize shareholder value. Assuming the return exceeds the risk in the latter choice, half of the time the *smart* CEO is going to lose $3b for their company.
Another example with two scenarios:
- Choice 1 destroys $10b in value for shareholders
- Choice 2 destroys $3b in value for shareholders
In this scenario, the smart CEO loses $3b *gasp* but saves shareholders $7b when compared to the "bad choice". Again, a CEO can create value in a negative condition.
Naturally, this is extremely difficult to sort out in the real world. However, we have to recognize that a less skilled CEO could make a worse choice (like losing $10b instead of losing $3b) and a smart gamble doesn't always pay off.
Despite the payout, the guy who bought the winning lottery ticket was no less stupid then all the people who lost. 12:03 PM
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young economist said...
I can't speak to the accuracy of Brooks' claims in the op-ed, but I agree with his lessons for the Democrats. They've moved way too much to the populist left.
12:11 PM
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mvpy said...
The only reason the left are bemoaning inequality is that theyve got nothing else to moan about. Six years ago they said the Bush tax cuts would cause interest rates to soar. We dont hear much about that anymore. Four years ago, they changed the subject and said unemployment was in fact markedly higher than revealed in statistics. We dont hear much about that anymore. Three years ago, they said the dollar would collapse, and we'd face an Argentina like meltdown. We dont hear much about that anymore either. (Are you spotting a pattern here?) Two years ago, they started the great "inequality debate". The debate was about how the gains from the Bush Boom were being distributed. I think Ill stop there.
Let me say that economic theory has nothing to say about the relative distribution of wealth/income. Nothing. Serious economists are concerned with what actually matters for welfare - absolute income (really consumption) levels. And there is nothing more pathetic that people claiming that they "cant keep up". That there are so many fruits of the economy to attain is the ultimate sign of progress. Let these people head to say, North Korea, and theyll assuredly have no problem "keeping up".
12:36 PM
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happyjuggler0 said...
anon @12;32pm is correct, you can't trust what people say, or what they do in a silly lab experiment for a couple of bucks. Actions speak louder than words, and people choose the path that they perceive will maximize their absolute standard of living and quality of life from their perspective.
To the poster who think those in Ethiopia are happier than most people are, feel free to go to Ethiopia and improve your happiness. The fact that you haven't (I'm assuming you'd have mentioned it if you had) tells me that deep down you realize that that Ethiopia stat is bunk, and that you are using it to forward your bias, perhaps unconsciously.
mvpy is correct, the target keep moving as the economy keeps improving the farther and farther we get away from the 2001 recession. Interestingly, the economy in the 90's also similarly improved the further and further it moved away from the 90-91 recession as well. Somehow all the apoplectic posters (here and on other blogs) regarding Brooks' article manage to "overlook" this.
Comparisons from the height of the unsustainable peak economic bubble years of 1998-2000 to today's numbers are incredibly disingenuous for those who know that a proper comparison is economic trough (e.t.) to economic trough (e.t.), and from e.t. +x (in the 90's) to e.t. +x (in the 00's).
1:19 PM
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anon@1:41 pm,
Good point. Clearly people, or at least some people, care about economic inequality. I personally think it is an incredibly unhealthy obsession that leads to destructive actions, as those "silly" experiments I was alluding to demonstrate, where study participants hurt themselves (nominally) financially if it could also hurt someone else even more.
I am glad you concede the point that absolute measures of wealth (or the lack thereof) definitely matter though. This is what people ought to be concentrating on in my opinion. The poor really are better off if they stop being poor, even if Bill Gates becomes even richer by a greater percentage over the same time frame.
In fact, it may in fact be the case that the rich person got richer precisely because the poorer person got better off, which is the exact problem with focusing on inequality. beating up the rich doesn't help the poor, it merely hurts the rich.
Assume a properly run legal system where theft (by any name, including fraud for example) is essentially a bad risk/reward proposition and is usually punished. Under such a scenario the only ways you can get rich are 1: inherit, or otherwise receive a similar gift or 2: create it. Also assume that the government doesn't pick winners and losers, but merely sets a level playing field.
Under scenario 2, you can't do it by yourself, you need to leverage other people's work as well, be they co-workers, bosses, or employees. Assume you are a business owner, then you don't get rich(er) until you first make lots of other people better off. First,you have to risk your own money that you could've spent on yourself. Then you have to hire other people, combine them with an idea(s), combine them with outside suppliers, and take that output and find customers who are willing to trade their output (call it money, or paycheck) for yours because they feel they are better off. Only then if your inputs are priced smaller than their combined output, do you make a profit and get rich(er).
The employees you hire are better off than otherwise would have been or they wouldn't have taken your job offer. Your suppliers (and their employees) are better off than they would've been, or they wouldn't have traded with you. Your customers are also similarly better off of they would've spent their money elsewhere.
Therefore to get rich you have to make a lot of other people better off before you improve. You also have to risk current consumption for the possibility of higher consumption later in order to get rich. People (economists excepted, usually anyway I would hope) who want government to take away from the rich to give to the non-rich totally miss this calculus and don't realize they pretty much have to be hurting the non-rich in the process. Fewer profits equals fewer investments, and less money available for reinvesting. Personally I think the efficiency vs equality tradeoff is to a huge extent an illusion, it is really a choice between most everyone being better off or most everyone being worse off, respectively.
To make a long story short (oops, too late), it is incredibly important to have a policy at its focus that helps people in general and the poor in particular, and to not have a policy that aims to reduce unequality. If the aim is to reduce inequality, then this leads to policies that also hurt the poor and middle class, and thus is destructive for everyone.
2:27 PM
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jim said...
Economic growth of 3.4% in this last quarter.
Where is this doom recession the left wing keeps predicting?
2:27 PM
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