Point of Inflection

The Great Compression
The chart above (click on it for a larger version) is from Paul Krugman’s inaugural post on his new blog and I commend it to your attention for reflection. I agree with Dr. Krugman that the dramatic change that occurred in the late 1970’s is a consequence of policy (“I believe that politics has also played an important role in rising inequality since the 1970s”); I also agree that the change is socially and politically corrosive (“it was an era in which Democrats and Republicans agreed on basic values and could cooperate across party lines”) . While I agree with the diagnosis I believe I disagree with the prescription which Tyler Cowen has somewhat mercilessly characterized as:

How about this for an alternative story: “Crush the incomes at the top and then make the fat cats pay much higher wages to protect the world and become a superpower. Impose wage and price controls as well. See how long it takes before these distributional effects — which don’t exactly match the distribution of economic talent– reverse themselves in the aggregate.” I’m not sure that’s right but at least it seems to match more of the history.

I blush to say this but I think that Drs. Krugman and Cowen are both considering the matter rather simplistically and to understand why I think that, please consider where the point of inflection, the point at which the curve changes from going down or remaining flat to going up, occurs in the graph. Dr.Krugman might maintain that the curve changes with the election of Ronald Reagan to the presidency and Republican control of the Senate.

There are a number of factors which suggest to me that interpretation isn’t the correct one:

  1. To my eye the change actually takes place in the mid to late 1970’s, when Democrats controlled the presidency, both houses of Congress, and the Supreme Court.
  2. Democrats continued to control the House throughout most of the period under consideration.
  3. Republicans controlled both houses of Congress during the brief period in the 1990’s in which the trend reversed itself.
  4. Neither Dr. Krugman nor Dr. Cowen take note of an extremely important driving factor for domestic economic change: automation through low-cost micro, mini, and personal computers.

I agree with Dr. Krugman that the change was a consequence of policy change but not a change in U. S. economic or social policy. In 1979 China renounced the policy of autarky that had prevailed since the Revolution and the increasing availability of the large Chinese labor pool to Western companies wreaked a profound change in the world economy. Unskilled or semi-skilled labor began to assume, from a Western standpoint, essentially zero cost.

The other profound development, reflected in a second great change in the curve, was the opening of the Internet to commercial traffic in 1988. This revolution in telecommunication, spurred along by the introduction of the World Wide Web (best thought of as taking place in 1993). This allowed companies all over the world to interact in ways that had never been possible before and provided the groundwork for the remarkable globalization we see now.

The implication of globalization is that looking at the graph above doesn’t tell the whole story since it ignores the millions (or even billions) lifted from the most abject poverty over the last several decades. And that was a good thing.

I agree that there needs to be a policy change in the United States but I think I disagree over its nature. I don’t think the U. S. needs to be more union-friendly or that we need to go back to the high marginal tax rates on upper income levels that we had 25 years ago. I think that we need to do two things:

  1. Provide incentives for U. S. companies to invest in the United States (that may include removing incentives to invest overseas).
  2. Require more due diligence and oversight by U. S. companies with respect to their foreign suppliers. Ignorance should not be a defense.

I believe we should think long and hard before taking the first course of action. It might be good for the U.S.A. but would it be good for the world?

Longing for a return to the halcyon days of the 1950’s when Big Business, Big Labor, and Big Government in the Fordist compromise actually could exert substantial control over the economy and society may be a pleasant nostalgic exercise but I don’t think it’s anything more than that. That’s what I think that Alan Greenspan was getting at the other day when he remarked that he didn’t envy Ben Bernanke’s situation in which the tools that Greenspan had wielded to control growth and inflation weren’t nearly as effective as they had been. My concern about Democrats is that their nostalgia is getting too far afield from the way the world actually works nowadays.

6 comments… add one
  • PD Shaw

    It’s always difficult to look at a graph and extrapolate cause. How far do you go?

    Personally, I see two great economic dislocations. The first in the 1930s moved large numbers from agriculture to the cities. I don’t see Krugman’s sources, but historic agricultural economics (with self-consumption and bartering) have been difficult to value. The second in the 1970s brought about the shift from manufacturing to services. I would say it is the nature of the economies being observed and not particular policies.

    (I know these changes are not immediate. I do believe the shift out of agricultural employment in my family came in the 37-44 time period and ’79 was a particularly significant year for the shift out of manufacturing)

  • I agree with your explanation, PD, but you need to take one more step: why was there a shift out of manufacturing? My answers are globalization and automation, neither of which trends can or should be altered materially by, say, a reinvigoration or unions or a more sharply graduated taxation system.

    I also think there’s a more complex answer having to do with decreasing returns to domestic capital spending, but that’s the fodder for another post.

  • PD Shaw

    Dave, I would agree with answers, though I probably place more emphasis on technology than globalization. I haven’t read Krugman’s book so I don’t know how disproves it. A vague reference to the situation in other countries overlooks a lot of differences between when and how other countries developed economically, integrated into the global economy and were able to use technology. Apples and oranges I say.

    I don’t know the answer to Krugman’s problem though, but I would never look at it from this angle. I want to know whether the economic situation of the lower class is getting worse relative to basic human needs and relative to the previous condition of the working class.

  • PD Shaw

    BTW/ looking at the Gini Index for income disparity, inequality has risen more gradually in the U.S. than in Krugman’s chart and at least to my eye looks like it began increasing around 1968 (though with greater pace from 1982-1993).

    http://en.wikipedia.org/wiki/Gini_coefficient

  • He’s not using the Gini index as his measurement but something he’s calling “share”.

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