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Is inequality growing as American workers fall behind? There is a wealth gap due to falling real interest rates not declining compensation.

A popular and highly politicized theme today is that U.S. workers are falling behind as their real wages fall and income gets redistributed to the rich. Senator Jim Webb (2006) has been a leader in espousing this view, and the Hamilton Project at the Brookings Institution--led by Robert Rubin, Lawrence Summers, and Roger Altman--is dedicated to the study of this problem. Federal Reserve Board Chairman Bernanke (2007) recently accepted the thesis that there is a rising inequality problem and admonished his audience and readers to be careful not to attack inequality with tax increases or trade restrictions that would damage the overall economy. Alan Greenspan often warned of the seriousness of the rise in inequality. For example, in testimony before the Senate Banking Committee in June 2005 he said, "As I have often said, this is not the type of thing which a democratic society--a capitalist democratic society--can really accept without addressing."

Measuring inequality is difficult, however. Existing evidence is not strongly supportive that it has increased, and there is little consensus on why it might have changed.

In Section 1, research on rising income inequality, falling real wages, or changes in the personal or functional distribution of income or wealth is discussed in a manner that is consistent with supporting hypotheses that wealth and income are becoming more unequally distributed and that workers are falling behind because real wages are falling relative to past trends. Recent studies of the rise in income inequality, for example, do not ascribe the rise of inequality to any particular development nor do they argue that this reflects any particular change in the distribution of wealth or any particular changes in the functional distribution of income between labor and non-labor capital. Typically, the analytical focus is more limited in each of these studies. While there is a strong potential connection between arguments that workers are falling behind and that wealth or income is becoming more unequally distributed, neither result is required for the other to hold.

Section 2 explores whether in fact workers are losing out. Section 3 looks at the suggestion that workers are falling behind relative to recipients of income from capital. It also examines the evidence on whether all workers' real wages have been falling or perhaps only those of manufacturing workers. Section 3 also examines whether there is a growing wealth gap and whether it is due to falling labor compensation relative to wealth. Finally, in Section 5, the article examines the hypothesis that relatively inexperienced workers are falling behind by fixing an educational attainment level for inexperienced workers and seeing how real wages have changed over the recent past. The evidence here provides a perspective on why some analysts might believe that there is rising inequality or an emerging wealth gap, but it does not generally support these views.

1. Why Could Inequality Have Risen?

One of the principal explanations for the popular view that workers are falling behind at the expense of rich capitalists is based on another popular view that holds that more skilled, more experienced, and higher income workers have benefited from rapid technological change, boosting their incomes relative to the unskilled, inexperienced, and low-wage workers. (1) This explanation directly leads to the most popular solution to rising inequality, which is to boost the income levels of those who would otherwise be at the bottom by attempting to equalize educational opportunities. This has proven very difficult in recent years, as high school drop-out rates have risen; but it remains a key link to higher income of those otherwise destined to be relatively poor. Another popular view, certainly more questionable, is that rising inequality is due to globalization. The Economist (2007), among many others, suggests that rising inequality creates pressure for protectionism. Bernanke (2007) downplays the possibility, arguing that globalization plays a "moderate" role in accounting for inequality and that skill-biased technical change has been more important.

A key neglected factor affecting inequality is the aging of the population. In the United States, the baby boom has caused the median age of the population to increase from about 28 years old to about 36 years old today, and it will peak near 38.6 percent in 2040 as the baby boom is disappearing as the largest cohort in the U.S. population. What has this to do with inequality?

If we focus on only two sources of earnings, wage income and income from capital--profits, dividends, interest, and rents--the distribution of income depends upon the distribution of ownership of labor and capital resources. If there were no physical capital and all workers were age 20 and had the same basic educational levels, say just starting out in life, the sources of income variation would be very small, basically arising from differences in basic intelligence, learned skill differences, willingness to participate in the labor force, or inherited social capital. There would be relatively little inequality of income among this population.

As this group ages, however, the sources of inequality would multiply. Workers would invest in education and skills to different degrees leading to different occupational choices and in turn to different paces of wage gain due to industry or occupation-specific technological change. Larger wage dispersion among the workers would emerge over time. Moreover, even if the young workers had the same saving rate and inheritance prospects, differences in capital ownership and income from capital would emerge because of differences in asset allocation, especially risk tolerance, luck, and timing. Moreover, they would not have the same saving rates or inheritance levels at every point in time or income level, boosting the inequality among them.

If the population ages, inequality will increase as older less equal workers come to dominate the population. (2) Similarly, populations that become younger are likely to have more equal incomes, other influences remaining the same. During the 1950s and 1960s, as the population became younger, inequality fell, according to many estimates. Not surprisingly, as the median age began to rise--especially after the baby-boomers had fully entered the labor force around 1980--income inequality began to rise. There may be many other factors accounting for rising inequality, but this one is clear and potentially has huge effects on the distribution of income and wealth. Not surprisingly, then, both Japan and China--countries noted for relatively high levels of income equality but that also face rising median age levels--have begun to confront problems of rising income inequality. At least in China, the problem is pinned on a rural population that has not benefited proportionately from growth, according to The Economist (2006). Few have noted that a rising share of private income from capital is accruing to relatively older individuals.

Figure 1 shows the median age of the U.S. population at five-year intervals from 1950 to 2005, according to the United Nations Population Division of the Department of Economic and Social Affairs. It also shows the income received by the top one percent of income recipients, according to estimates by Piketty and Saez (1998) and their updates in the same years. The series shown excludes the imputations of capital gains, but the same picture and correlation holds for the series including capital gains. There is a strong positive correlation between the measures: 0.95. A regression of the share of income for the top one percent on median age shows that a rise in the median age by one year adds 0.929 (t = 3.17) to the share, so that the 7.9 per year rise in the median age from 1970 to 2005 accounts for 7.3 percentage points or about three-fourths of the rise in the share from 7.8 percent to 17.4 percent over the period. (3) With the UN's projected rise of the median age from 36.1 in 2005 to 41.1 in 2050, a simple extrapolation suggests that the share of income received by the top one percent could be expected to rise to 22 percent, almost triple its 1970 level. Of course, this extrapolation is well beyond the sample experience, but it does suggest that rising inequality will be a major concern for many years to come.

The estimates of inequality since 1913 by Piketty and Saez (1998) have attracted considerable attention because they show that inequality has risen back to levels last seen in the 1920s. (4) They rely on reported gross income measures from tax returns less government transfer payments. Most famously, both Webb (2006) and Alan Reynolds (2006, 2007) have taken up their charge that "the top one percent now takes in an astonishing 16 percent of national income, up from eight percent in 1980," the former acceptingly and the latter critically. Reynolds (2006, 2007) focuses on several problems with the income measure that Piketty and Saez use to assess growing inequality, including rising income in retirement accounts that is not taxed until it is distributed. In fact, what is more significant is the fact that the growing new retirement savings accounts have removed larger and larger shares of income from being reported by low- and middle-income earners, giving rise to the appearance that they are getting smaller shares of income. Also, more and more business income is shifted and realized on individual tax returns instead of business tax returns (to increase the apparent income of the rich, who are more likely to own businesses); and the use of reported income for tax purposes excludes transfer payments that are relatively more beneficial to the non-rich.

Piketty and Saez (2007) responded to Reynolds but appear to confuse many of his points, including that the reported income they use has been increasingly biased over time because more and more income is not reported for tax reasons. (5) One factor that Reynolds notes is the increasing share of income that accrues in IRAs, 401(k) programs, and other plans that allow income to accumulate without taxation. What is even more important is the growing omission of income on tax returns because pre-tax income is being invested in various defined-contribution plans. Also, neither Piketty and Saez nor Reynolds note that increasing amounts of income are now being realized through payments for fringe benefits, especially health care insurance, employer contributions for retirement income, vacations, sick leave, and other benefits. These benefits are relatively equally distributed across income levels. Thus, the rise in benefits is giving rise to the appearance that wages and salaries, excluding benefits, are rising much more slowly among lower wage workers and that higher income workers have disproportionately higher reported income for tax purposes. (6)

Focusing only on the employee contributions for health and retirement saving programs, especially for example, 401 (k) programs, the largest share of this "unmeasured" income accrues to the middle class, giving rise to the appearance of a disappearing middle class and a rising share of income among the top income recipients. In 2006, for example, a worker over 50 could contribute a maximum of $20,000 ($15,000 for employees under age 50) to a company-sponsored plan such as a 401 (k) program. This would reduce the measured income from tax reports by 40 percent for a worker earning $50,000 per year, but by only ten percent for a worker making $200,000. For some public employees and teachers, the case is even more impressive. They can contribute twice as much as other workers, resulting in double the understatement of their incomes for estimating shares of income. For the top one percent of workers, those making over $300,000, the maximum allowable contribution would lower their measured income by less than seven percent. The result is the appearance that relatively more measured income is accruing to those at the top. As Reynolds points out, other measures of income do not produce such a doubling of the share accruing to the top one percent, though many experts accept the notion that there is a rise.

2. Are Workers Falling Behind?

Real compensation per hour has been growing very rapidly in this decade, contrary to popular opinion. This should not be surprising because of the unusually rapid growth in productivity that has been occurring and the fact that real wage gains are tied to productivity advances. Compensation measures the cost of labor to employers and the value of payments to workers, whether received as benefits or take-home pay. It is the measure of wages against which employers and workers must compare foreign compensation and relative productivity in cross-country comparisons of labor cost or wages. Figure 2 shows that manufacturing compensation per hour is also rising rapidly, even compared with the business sector. The manufacturing data are only available since 1987.

Some analysts who think that workers are falling behind focus on manufacturing wages, where globalization might have taken its biggest toll on less well-educated and less-competitive workers. (7) In fact, however, manufacturing real wages, as measured by total compensation per hour, have risen at a three percent annual rate since mid-1997, somewhat faster than in the overall business sector where real wages rose at a 2.7 percent pace. Since the end of 2003, manufacturing real wage growth has been slow, but this only partially offsets the six percent annual pace of growth in 2002-03. Focusing only on the wage argument, manufacturing compensation has been rising faster than consumer prices (measured by the personal consumption expenditure deflator) and actually rising faster than in the overall business sector of the economy for almost ten years.

Manufacturing compensation per hour has been relatively high since 2002. From 1987 to the third quarter of 2001, it fell from over 112 percent of business sector compensation to about 106 percent. Since then it climbed to over 114 percent at the end of 2003. While relative wages fell subsequently, the ratio was higher in 2004-06 than in 1996-2001. At its lowest in 2006, manufacturing wages were over ten percent higher than the average level for the business sector, a level achieved in only a few quarters from 1987 to 2002.

3. Is There a Growing Wealth Gap?

Webb and others argue that workers are not keeping up with the wealthy, which is a key reason that inequality is rising. They focus on the ratio of wages to overall wealth, or what they call the "wealth gap." Figure 3 shows that employee compensation as a percentage of wealth has been falling recently and has been falling since the 1970s, except in the early part of this decade (1Q2000-3Q2002) when the stock market correction boosted the ratio.

The size of compensation relative to wealth can be thought of as the product of two measures, compensation as a share of income or GDP (Figure 4), and the size of GDP per dollar of wealth. This second measure is also shown in Figure 3. Its decline reflects the decline in real interest rates that has been going on for a long time, but especially since early 1995, when both lines in Figure 3 begin a more rapid pace of decline. Moreover, since compensation as a share of GDP has been virtually constant, movements in GDP relative to wealth account for the entire decline in compensation relative to wealth. The declining ratio of GDP to wealth is essentially the ratio of income to the assets that generate much of that income. Thus, it is an indicator of the rate of return on the nation's wealth, or the real rate of return on wealth. It is tied to the real rate of interest. (8)

Figure 5 makes this more clear. It shows the share of business sector compensation in total cost and the national income account measure of the compensation of employees as a percent of national income. The national income measures in the figure include the government, household, and foreign sectors; but the compensation measure excludes some components of benefits and proprietors' income. The line is included for comparison purposes only, although the compensation measure in the numerator is the same as that used in Figure 2 to show the wealth gap.

The share of labor in business sector cost has a long history of being nearly constant, fluctuating about its mean. This is expected from the original Cobb-Douglas (1928) production function that has seemed to describe well U.S. production for nearly 80 years and that implies a relatively stable functional distribution of income. Both lines in Figure 5 are relatively stable, illustrating the well-known relative constancy of the share of labor in cost and in the nation's output and domestic income. Most importantly, there is no significant drop in recent years. For the business sector share, augmented Dickey-Fuller tests--with lags chosen according to the Schwartz information criterion--consistently reject non-stationarity, whether a trend term is included or not. Similar tests supporting stationarity, based on the Kwiatkowski-Phillips-Schmidt-Shin statistic, provide similar results. In some periods, it does appear that there is a statistically significant negative trend, such as when the data set ends in mid-1997 or in early 2006; but statistical tests suggest that the share is "stationary."

Focusing on the business sector measure, it is the case that the labor share matched its lowest earlier level in the first quarter of 2006, but it was no lower than in the comparable cyclical period in mid-1997, before wages surged and moved the share up quickly. In early 2006, this share at 60.8 percent was not much below the 1947-06 mean of 63.7 percent. By the third quarter of 2006 it was 62.4 percent, only one standard deviation below the mean.

To be more accurate, the share of labor compensation in GDP implicit in the ratio of compensation relative to wealth in Figure 3 is not the same as either of the shares shown in Figure 5. The former ratio is shown in Figure 4. It differs from the share of labor in the business sector because of differences in the compensation measure and because of movements in the share of the business sector relative to overall GDP. The share of the NIPA measure of employee compensation in GDP is not a stationary series, unlike that for the business sector, not does it have a clear trend. Statistical tests of the stationarity of the ratio--that is whether it fluctuates around a given and fixed mean or perhaps is trend stationary (fluctuating around a constant trend)--show that it is neither. Presumably, this is the case because the share of the business sector output in GDP is not stationary.

But the share of employee compensation in GDP also has not fallen unusually in recent years, nor is it at historical lows as proponents of the "labor falling behind" hypothesis suggest, as shown in Figure 4. The most recent peak was 59.0 percent in 4Q2000. The lowest ratio shown in Figure 4 was in mid-1948, when the ratio hit 52.2 percent. So the level of compensation has declined 4.4 percent relative to GDP since the end of 2000, but the recent ratio is less than one standard deviation below its 1947-06 mean of 57.2 percent (standard deviation equals 1.32 percent). Note the ratio was lower in 1997 than it has been recently. Note also that when it was so low, it subsequently surged up beyond its mean, just as it has begun to do lately. Again, this slump and recovery are not simply due to vagaries in the data; instead, this pattern is based on standard economic behavior that boosts the demand for labor and wages whenever there is a discrepancy between real wages and productivity. More importantly, fluctuations in the share of compensation in GDP have not played any role in accounting for fluctuations in compensation relative to wealth.

The flip side of a "falling share of labor" hypothesis is a "rising share of capital income" hypothesis. The boom in corporate profits since the end of the 2001 recession incorrectly suggests some validity to both hypotheses. Corporate profit's share climbed to over 12 percent of GDP, a level not seen since occasional peaks from 1950 to 1965. But that issue has already been addressed, at least implicitly. The constancy of the share of labor, or the fact that its small decline since 2000 did not reduce it to unusually low levels, imply that the share of capital did not rise unusually either. Remember that corporate profits are not the only return to capital. Lower interest income and rental income relative to GDP have offset the rise in the return on equity (as a percent of GDP). (9) Moreover, lower real interest rates, in this case, on corporate debt, have played a role in redistributing income from creditors to owners of corporations. The net result has been little change in the share of business sector income accruing to capital.

While the share of labor compensation has been low recently, it is not unusually low relative to its past history. It certainly is not so low as to suggest that the hypothesis that it is essentially constant has been refuted, nor has its low level played a notable role in accounting for the decline in compensation relative to wealth. While there is some evidence that the labor share fluctuates around a slight negative trend for some sample periods ending after 1996, this would not alter the conclusions that the labor share of income is not unusually low in recent years or that its movements have not shown a significant break from past performance. Standard statistical tests show that it fluctuates around its mean, or sometimes around a slightly negative trend, with no tendency to drift off or fall sharply relative to its past behavior.

4. Have the Wages of the Least Experienced Workers Fallen?

Part of the story of workers falling behind suggests that workers with the least education or the least experience are suffering the largest relative decline in real wages. (10) If manufacturing workers are not falling behind, then perhaps it is entry-level workers with the least skills relative to average or median workers in their field. It is difficult to find data on wages of workers with a common level of experience, including no experience. Some individuals that are clearly middle class or destined to be so and that have little experience in their chosen field are new college graduates and beginning teachers. The latter are more homogeneous--at least in their chosen occupation, where they are likely to be the least experienced in their field. While relatively inexperienced, these workers are better educated than the average worker. Nonetheless, their wages may provide some insight about wage trends, skill, and inequality. The American Federation of Teachers collects information on beginning teacher salaries of new college graduates and their non-education major contemporaries. Figure 6 shows these wages, adjusted for price movements, from 1994 to 2004. Prices are measured by the personal consumption expenditure deflator, and wages are expressed in 2004 prices.

Both wage series show rising real wages over the period, although wages of non-education majors are more cyclical, rising more rapidly than those of teachers in 1998-2001 and falling in 2002-04. The real wage of beginning teachers also fell in 2002. For the whole period, wages of teachers started at 79.4 percent of non-education majors in 1994 and were little different, at 78.3 percent, in 2004, the latest data available. For the full period 1994-2004, wages of non-education majors rose at a 1.37 percent annual rate, slightly faster than the 1.23 percent rate for beginning teachers. Both figures are slower than the pace of real compensation growth over the same ten-year period in manufacturing (2.41 percent) or the business sector (2.28 percent), which suggests that relatively inexperienced college graduates may be falling behind relative to the average worker.

The comparison could simply reflect the fact that the beginning wage data ignore benefits such as health insurance, while the compensation data for manufacturing and the business sector do not. Since benefits are the fastest growing component of compensation, it is not clear that beginning wage data show that the less experienced receive lower compensation gains. The employment cost index for manufacturing "wages and salaries only," suggest that this is not the reason. From 1994 to 2004, the employment cost index for wages and salaries, deflated by the PCE deflator, in manufacturing rose at a 1.22 percent rate, about the same as for teachers and only slightly below the 1.37 percent pace for non-education college graduates. The Bureau of Labor Statistics employment cost index data show that benefits rose faster than wages and salaries over the period as well, about 0.62 percent to 0.85 percent per year faster, depending upon the group. Thus. it would appear that real wages and salaries, and probably real compensation, are growing at about the same pace for beginning teachers and other college graduates as for the manufacturing sector or the overall civilian sector. This result should be taken only as suggestive, but it is certainly not consistent with the notion that the least experienced workers are falling behind more experienced workers.

5. Conclusion

There are many reasons why inequality could have risen in recent years, but perhaps the most neglected one is the aging of the U.S. population. Older workers have more diversity in education, experience, accumulated wealth and income from wealth than young people. Not surprisingly, indicators of inequality declined following World War II, when the population became younger, and then the rose as the median age rose. But measures of inequality are suspect in themselves and certainly overstate the rise in inequality since the 1980s. This is because most measures of income that are used to assess distributional shares exclude the large share of income that lower and especially middle income workers are able to save as before-tax income. Moreover, the income from these assets is also not included in assessing the distribution of income. Similarly, health insurance and other benefits, which are distributed more equally across income levels at most firms, have dominated compensation trends in recent years, making comparisons of reported taxable or after-tax income biased in favor of observing rising inequality.

One of the most widely used measures that suggests rising inequality is occurring due to workers falling behind is the wealth gap or the declining ratio of compensation to wealth. Compensation has fallen recently relative to wealth, supporting the claim that there is a growing wealth gap. Except for a brief period associated with the stock market correction, recession, and recovery from early 2000 to mid-2002, however, the ratio of compensation to wealth has been declining for several decades. Indeed, it has been falling since the mid-1970s and fell especially sharply in the late 1990s and again since 2002.

Not only is the behavior of compensation relative to wealth not a new phenomenon, it does not merit being called a "wealth gap," at least not in the sense that it shows that workers are somehow losing out to the wealthy. Figure 4 shows that the share of compensation in national income is remarkably stable in the U.S. economy. Thus, the share going to labor fluctuates slightly but remains close to its average. More importantly, it has a tendency to return to its average so that when the share becomes low, wages then tend to grow faster than productivity, pulling the share up toward its mean; and when wages are relatively high compared with productivity, wage growth slows, pulling the share back down toward its mean. In recent years, the labor share has been somewhat lower than its historic mean. Thus, not surprisingly, wage growth is accelerating and the share of compensation in national income is rising, much as occurred after mid-1997, the last time the labor share of national income was somewhat lower than its historic mean.

A declining compensation-wealth ratio also does not imply that real wages are falling. The evidence here shows that wages overall and in manufacturing have shown healthy advances over the past seven years. Declining manufacturing wages, feared by some, have not occurred for manufacturing as a whole. Another theme, that rising inequality has occurred because the least experienced or least educated workers have fallen behind also does not get support from the data. Beginning wages for teachers and non-education college graduates, two groups with little or no experience in their chosen fields, have moved up for 1994-2004 at the same pace as earnings in manufacturing or the business sector as a whole.

The only meaningful driver of the ratio of compensation to wealth is the ratio of GDP to wealth. This is a rough indicator of the rate of return to capital in the economy. This ratio has been declining for many years and accounts for the wealth gap. Since the ratio of GDP to wealth is closely tied to the real rate of interest, one can conclude that it is the decline in the real rate of interest that accounts for the so-called wealth gap, not some weakness in compensation. Just as any weakness in compensation might suggest serious social problems and public policy issues, so too with the decline in the real interest rate. It matters whether a decline in the real rate of interest is occurring because of too much global saving or because of reduced demand for capital, and, in either case, whether the changes are policy-induced and reversible or more fundamental.

A low real interest rate can also explain why stock and other asset prices are relatively high; but it would also mean, for example, that the cost today of promised future retirement benefits are much greater than we might have expected in the past for the businesses and the governments that incur them. It also means that accumulating wealth to use in our retirement years, especially to make up for a current shortfall, will be much more difficult because the same saving effort will be met with much smaller returns than might have been the case in the past. Either way--weak compensation or weak returns to capital--some individuals are losing out relative to past expectations. And either way, it is important to know why and with what effects before dashing off to develop a public policy aimed at correcting a perceived problem. But most of all, it matters whether we have found the culprit in falling wages or whether the problem lies in some other direction.

ACKNOWLEDGEMENT

I am grateful to Ozer Erdem for his research support.

REFERENCES

Bailey, Martin J. 1962. "The Concept of Income." In National Income and the Price Level: A Study in Macroeconomic Theory, New York: McGraw-Hill Inc., Chapter 12, 247-74.

Bernanke, Ben S. 2007. "The Level and Distribution of Economic Well-Being," paper presented in remarks for the Greater Omaha Chamber of Commerce, Omaha, Nebraska, February 6.

Bhagwati, Jagdish. 2004. In Defense of Globalization. Oxford University Press.

Bhagwati, Jagdish and Marvin H. Kosters, eds.1994. Trade and Wages. AEI Press.

Cobb, Charles W. and Paul H. Douglas. 1928. "A Theory of Production." American Economic Review, 18(Supplement):139-165.

The Economist. 2007. "Rich Man, Poor Man." The Economist Newspaper, January 20:15-16.

The Economist. 2006, "Planning the New Socialist Countryside" and "How the Other 800m Live." The Economist Newspaper, March 11.

Feenstra, Robert C. 2007. "Globalization and Its Impact on Labor." Global Economy lecture 2007, Vienna Institute for International Economic Studies, February 8.

Gottschalk, Peter, and Robert Moffitt. 1994. "The Growth of Earnings Instability in U.S. Labor Markets." Brookings Papers on Economic Activity 2. 217-254.

Grafova, Irina, Kate McGonagle, and Frank Stafford. 2007. "Functioning and Well-Being in the Third Age, 1986-2001." In Jacquelyn B. James and Paul Wink, eds., The Crown of Life: Dynamics of the Early Post-Retirement Year, Springer.

Juhn, C. Chinhui, Kevin Murphy, and Brooks Pierce. 1993. "Wage Inequality and the Rise in Returns to Skill." Journal of Political Economy, 101(3):410-42.

Piketty, Thomas and Emmanuel Saez. 2003. "Income Inequality in the United States: 1913-98." Quarterly Journal of Economics, February. Updated data are available to 2004 at elsa.berkeley.edu/~Saez/TabFig2004prel.xls.

______. 2007. "How the Income Share of Top 1% of Families Has Increased Dramatically." Wall Street Journal, January 11,

Reynolds, Alan. 2007. "Has U.S. Income Inequality Really Increased?" Cato Institute Policy Analysis, No. 586, January 8,

______. 2006. "The Top 1% ... of What?" Wall Street Journal, December 14.

Webb, Jim. 2006. "American Workers Have a Chance To Be Heard." Wall Street Journal, November 15.

John A. Tatom is director of research at Networks Financial Institute and associate professor of Finance at Indiana State University. Formerly he was a visiting Professor at DePaul University, held a variety of positions at UBS in Zurich and Chicago, and was a research official at the Federal Reserve Bank of St. Louis. He holds a PhD from Texas A & M University. He is a past president of the St. Louis Gateway Chapter of the National Association for Business Economics.

(1) The term "capitalists" is used here because of the common distinction in the work on the distribution of income and wealth between income from labor and from non-human capital. Here the term refers to those who earn income from non-human capital. In reality, many workers are capitalists, too, in the sense that most workers own non-human capital and earn capital income.

(2) Grafova, McGonagle and Stafford (2007, Table 10) show the disproportionate growth in real net worth of those age 65-79 in the Panel Survey of Income Dynamics from 1984 to 2001 and to a lesser extent for those over age 80. Including home equity, the age 65-79 mean growth was 78.7 percent and the median growth was 64.3 percent. Comparable figures for those age 49 or less are 35.4 percent and 17.2 percent, respectively.

(3) The equation has an R-square of 0.91 and standard error of 1.118. The 1990 dummy variable has a coefficient of 1.704 (t = 1.05). The dummy was chosen by finding the one-time shift that maximized the R-square for all possible shifts from 1980 to 2000. The shift was motivated by Piketty and Saez emphasis on the presence of a large and significant shift in the 1980s.

(4) Updated data to 2005 can be found at http://emlab.berkeley.edu/users/saez/TabFig2005s.xls.

(5) For the 401 (k) issue they focus on the fact that the capital income accruing to workers is not reported until retirement and that this is no different than the treatment of income from earlier defined benefit programs. They do not address the larger point that a large share of labor earnings can be excluded from taxable gross earnings by contributing to various employee saving programs and that these programs typically have maximum levels of excludable gross income.

(6) An anonymous referee has pointed out to me that exclusion of deferred income would distort the Piketty-Saez measures in the opposite direction.

(7) Studies by Bhagwati and Kosters (1994), Bhagwati (2004), and by Feenstra (alone and with Gordon Hanson, discussed in Feenstra [2007]), have looked at whether globalization has accounted for declining real wages of unskilled workers and concluded that there has been little effect. Feenstra and others focus on the distinction between production and non-production workers in manufacturing to assess the effects on workers with different skills, assuming that production workers have less skill. Another way to look at workers with less skill is to use entry level salaries, as in Section 4 of this paper. The use of manufacturing workers is attractive because this sector is expected to be more affected by trade.

(8) Perhaps the clearest discussion of the link between income and wealth is that provided by Bailey (1962, Chapter 12). Income, correctly measured, is the maximum sustainable consumption level from a given stock of wealth. The measure of GDP is a gross approximation to this measure. The wealth measure used here does not include human capital so it is possible that the decline in the GDP-wealth ratio here reflects a shift in wealth from non-human to human capital instead of a decline in the real interest rate. According to the permanent income hypothesis, however, such a shift in wealth would result in a rise in the saving rate that has not occurred. More importantly, such a shift in wealth would presumably be reflected in a shift in the shares of income from wealth, and the evidence discussed below for the business sector does not support such a shift.

(9) A referee suggests that within capital income there could be a redistribution of income toward inequality if the share of corporate income rises more rapidly with income than does the share of rent or interest income.

(10) Some researchers have suggested that there was a rise in inequality in labor earnings in the 1970s and 1980s due to an increase in the demand for skilled workers relative to supply. See Juhn, Murphy and Pierce (1993). Others have suggested that this result may have occurred because of a rise in the variance of transitory shocks to wages. See Gottschalk and Moffitt (1994). Evidence from inexperienced college graduates would be more informative if the former argument is correct.
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Comment:Is inequality growing as American workers fall behind?
Author:Tatom, John A.
Publication:Business Economics
Geographic Code:1USA
Date:Jan 1, 2008
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