Joshua Herzig-Marx

Tyler Cowen at Marginal Revolution wonders Why is the top one percent earning more?

He quotes Brad DeLong indicating that between 1980 and 2004, the share of private national income earned by the top 1% of wage earners doubled from 8% to 16%. As usual, I have a few responses:

• After reading through the responses, I agree that single year rates can be misleading as many individuals may end up in the top 1% after cashing out an asset in which they had been investing earnings. For example, the small business owner who takes a smaller salary but sells for half a million dollars. A more interesting measure would look at lifetime earnings by some population cohort.
• Cost of living tends to have a more egalitarian distribution than earnings. Within a geography, health care, food, and transportation costs tend to be fairly equal. If anything, the wealthy tend to have better prices in the form of cheaper food, lower interest rates, and generally more choice (which may be offset through upscale brands, etc.).
• Finally, it’s worth noting that an increase in earning is very different from an increase in utility. In fact, those who make the most are best able to lose the most. I can’t spend $300k a year – therefore, it’s easy for me to set aside a third of that for a risky investment. Even if I make $100k per year–a very nice salary–I’ll be much less able to afford to lose any of that. My investments will be less risky and therefore, in general, less profitable.

Keeping in mind that I have absolutely no hard data to back me up, I think that Professor Cowen touches on one primary cause in mentioning, “[A]n increase in the ability of very smart and very wealthy people to buy up undervalued assets and turn them into greater value.” I’m not sure that smarts enters into the equation. What the wealthier have (and the wealthiest have lots of) is sufficient liquidity to take advantage of opportunities. Some of these opportunities will come in the form of real or financial assets, but others will take the form of moving cross country to follow job prospects, taking a few years off of school, or even deferring salary in the first place to start a company. See above with regard to risk and reward.

There’s also the nasty possibility of rent seeking behavior. Given the constant news of government bribery scandals and under performing firms getting generous government contracts we would expect that some amount of that excess income could be invested in bribery, graft, and lobbying.

Closely related is the principal-agent problem. Especially in an economy with rapidly advancing communications and information technologies, we would expect the cost (in terms of time as well as dollars) of identifying opportunities to increase. The “agents” in our economy: lawyers, realtors, other professionals and elected officials have pursued their own rent seeking behavior and those with the least excess are least well able to discern good advice from bad. Scandals with Ameriprise Financial, physician owned hospitals providing sub-par care, trial lawyers who take too large a share of a settlement, and graft-seeking congresspeople are some recent examples.

I see nothing inherently wrong with hard work and business success rewarded with wealth and I’m confident that most of the wealthy in this country have honestly earned that status. At the same time, concentration of wealth introduces and encourages some (economically) bad behaviors and it behooves us all to identify and correct them.