The rise of good inequalities

I have recently submitted an entry for a Fraser Institute contest, below you will see my submission:

The rise of “good” inequalities

Vincent Geloso

The author is a PhD candidate in Economic History at the London School of Economics

A commonly held view asserts that it is impossible for free markets to foster a greater amount of equality amongst men. To the general public, it seems hard to fathom that profiteering bred by free markets might lead to anything less than a growing gap between the rich and poor. The empirical evidence seems to support the view that the gap between rich and poor has grown in the past decades. For example, the share of total income that comes from the richest 0.1% of the Canadian population rose from below 2% in 1980 to above 5% in 2000.[1] A similar but more pronounced trend has been observed in the United States where that share rose from slightly above 2% to over 7% in 2000.[2] At first sight, the gap between rich and poor does seem to widen.

However, we should not assume that a growing gap is a problem in itself. The real questions that we should ask ourselves are whether or not workers stay in the same income group and how choices made by individuals affect their incomes.

Poor from cradle to grave?

First of all, if we wish to know if economic condition is permanent, the best tool economists can use is longitudinal data – tracking individuals over time. Using such data, it is estimated that somewhere between 42.3% and 57.6% of Americans in the poorest quintile of the population in 1996 had risen to a higher quintile by 2005.[3] A similar upward mobility has been observed over the period from 1987 to 1996.  Over the sixteen years period lasting from 1975 to 1991, over 80% of those who were in the poorest quintile in 1975 had risen by more than one quintile in 1991.[4]  In Canada, it is estimated that 43% of those in the poorest quintile in 2005 had moved up to a higher quintile by 2010.[5] Overall, this indicates a high level of upward mobility.

What about living standards? Measuring income adjusted for living costs is a tricky business. However, many economists have observed that when they compute prices for goods and services bought at discount outlets where poorer individuals tend to shop, real incomes are more accurately measured while a large part of the gap between rich and poor disappears[6]. The use of such data has allowed economists to realize that the poverty figure for the United States is half that of the official figures.[7] Moreover, the average real wages of the poorest continue to rise and poorer households now possess amenities like dishwashers, televisions and the internet in similar proportions to richer households.[8]

All of this is consistent with the observation made by economists that the share of the earnings gap that is explained by circumstances – being born in a particular family or area – stood at only 18% in 2001, a figure that has declined since 1968.[9] The remaining share is explained by factors that each individual can control, namely schooling and labour supply decisions. In other words, effort and personal choices are the dominant factors in determining income and wages.

Choices matter

How can we reconcile these observations with the growing gap in earnings? In the opening article of the American Economic Review of 1999, economist Finis Welch proposed that income inequality was – in a free economy – to be welcomed.[10] The disparities between wages and earnings of different individuals lead to “increased opportunities for specialization and increased opportunities to mesh skills and activities”.[11] Wages convey information about which skills, goods and services are needed by consumers and businesses. In other words, they inform individuals about the possibilities for self-accomplishment.

It is with such a viewpoint in mind that we should look at the rise of the demand for knowledge and skills that occurred in the 1980s. This rise in demand led to higher returns from schooling which benefitted those who had already acquired their education and widening the gap between them and those who acquired less schooling.[12]

However, the prospect of greater earnings from schooling pushed young individuals to opt in greater numbers to pursue a college degree or technical degree.[13] Since wages and earnings respond to foregone present income in order to invest in enhanced future prospects, the longer years spent on school benches could provide observers with the illusion that the earnings gap is growing. In fact, it is estimated that once we account for changes in returns to schooling and in university participation, an important part of the earnings gap disappears.[14] Were it not for the gap that emerged in the 1980s because of higher returns from education, fewer individuals would now be interested in pursuing higher education.

The earnings gap is also the reflection of labour supply decisions. All workers face a trade-off between leisure and work. Many workers will establish an income target for themselves to sustain their living standards and they will not work after they have reached that target. Once they have reached that target, they believe that the value of their free time is worth more than the extra income they would gain. In other words, most individuals work in order to live, not the other way around.

On the other hand, some individuals prefer to work longer hours. Many of them can be found in the richest amongst us: business executives, attorneys and bankers – to name just a few. These individuals understand that long hours are a condition for the higher incomes they covet. Hence, they will put in longer hours at the office and accept more responsibilities in their quests for personal achievement. Considering the accelerating trend towards performance pay that has been observed in recent decades, financially ambitious workers would have tended to head towards jobs that were more likely to allow them to reach their goals.[15]  The gap in earnings reflects how workers chose to use the opportunities presented to them given each worker’s individual preferences.

Conclusion

The existence of a growing gap between rich and poor does not mean that workers are left worst off. In fact, it is the reflection of different choices in schooling and labour supply according to individual preferences. We should be rejoicing at the fact that many workers feel that they do not need to work too long before enjoying fully the fruits of their labour. We should also encourage those who wish to labour longer and harder to accomplish themselves in a different manner. Rather that bemoaning the rise in earnings gap, we should remove all barriers to the unregulated acquisition of skills and education for workers who see openings in the market. As long as workers are left free and are not hindered in their abilities to make decisions regarding which paths best advance their desire for individual self-accomplishment, there is no need to worry about a growing earnings gap.

 


[1] Emmanuel Saez and Michael R. Veall, “The Evolution of High Incomes in Northern American: Lessons from Canadian Evidence,” American Economic Review, Vol. 95 (June 2005), No. 3, pp. 836.

[2] Ibid, p. 836

[3] Gerald Auten and Geoffrey Gee, “Income Mobility in the United States: New Evidence from Income Tax Data,” National Tax Journal, Vol. 62 (June 2009), No. 2, pp.307-308.

[4] Michael Cox and Richard Alm, Myths of Rich and Poor (New York: Basic Books, 1999), pp.69-90.

[5] Yanick Labrie, Should we worry about income gaps? Montreal Economic Institute, May 2012, p.3-4.

[6] Robert Gordon, Misperceptions About the Magnitude and Timing of Changes in American Income Inequality National Bureau of Economic Research, Working Paper No.15351, September 2009.

[7] Christian Broda, Ephraim Leibtag and David Weinstein, “The Role of Prices in Measuring the Poor’s Living Standards,” Journal of Economic Perspectives, Vol. 23 (Spring 2009), No. 2, pp. 77-97.

[8] Yanick Labrie, Should we worry about income gaps? Montreal Economic Institute, May 2012, p.2-3.

[9] Nicolas Pistolesi, “Inequality of Opportunity in the Land of Opportunities, 1968-2001,” Journal of Economic Inequality, Vol. 7(2009), pp. 411-433.

[10] Finis Welch, “In Defense of Inequality,” American Economic Review , Vol. 89 (May 1999), No. 2, pp.1-17

[11] Ibid, p.2

[12] Gary Becker and Kevin Murphy, “The upside of income inequality”, The American Magazine, May-June, 2007.

[13] Ibid.

[14] Thomas Lemieux, “Increasing Residual Wage Inequality: Composition Effects, Noisy Data, or Rising Demand for Skill,” American Economic Review , Vol. 96 (June 2006), No. 3, pp.461-498.

[15] Thomas Lemieux, W.Bentley MacLeod and Daniel Parent,“Performance Pay and Wage Inequality,” Quartely Journal of Economics , Vol. 124 (January 2009), No. 1, pp.1-49.

On leisure, income and happiness

In a recent paper titled “Well-Being in America” in the Review of Economics and Statistics, Andrew Oswald and Stephen Wu point out that when they “control for incomes (of states), satisfaction with life is lower in richer states”.

I am not surprised, but I don’t believe that we should derive much about inequality and wealth. I know, I just jumped to the guns because I expect people to tell me that this is proof that income distribution is important for happiness. While it is true, as Gore Vidal said, that a part of me dies when my neighbour gets a better car (all though my neighbour gets an ipad and that really really really irks me!), we should be careful in extrapolating conclusions from this study.

This is because happiness is not linked with income; it is linked with getting the income we desire to experience life the way we want. As I pointed out in an earlier post, I really like to get home early and read while my better half works until late in the evening. Yet, we are both happy.

Once I get the revenues I need to buy the books I want and to get the quality leisure time that I desire, I won’t work one more minute! My girlfriend’s happiness is closely linked with her work. In fact, her work is closely linked with what makes her happy because of self-accomplishment.

If we are really interested in “well-being”, should we not use databases to look at changes in hours worked per week and the income derived out of each hour worked relative to changes in expenditures linked to leisure and time spent at home? Not only these expenditures, but how much those expenditures buy (a trip to the cinema is more expensive in San Francisco than in Baton Rouge).

For example, Oswald and Wu point out that Louisiana – a pretty poor state – is happier than California – a much richer state. Considering that Americans move a lot around their country, could it be that those who wanted adrenaline-pumped jobs went to California while those who enjoy free time decided to stick around in Louisiana? Could these geographic differences the result not only of factor allocations but also preference allocations of workers linked with the relative rewards of labour (relative to leisure).

Maybe another idea for a research paper…no idea on how to operationalize though.

How Canada paid for Quebec’s Quiet Revolution

Below, you will find an opinion piece submitted to the Financial Post derived from my research on Quebec’s economic history and the transition between the liberal approach of the 1940s and 1950s to the social-democratic setting of the 1960s. I argue in this piece that Quebec’s construction of a welfare state, which is one of the most generous in North America and even more generous than some European countries, would have been impossible without federal transfers.

How Canada paid for Quebec’s Quiet Revolution

Vincent Geloso

The author is a PhD candidate in Economic History at the London School of Economics (LSE) in London, England.

On June 22nd, Quebec celebrated the 52nd anniversary of the 1960 election that marked the beginning of its “Quiet Revolution” – a period marked by rapid modernization and the elaboration of a modern welfare state. Quebeckers feel pride at the mention of this period of their history and rightfully so since they were not known anymore as the “priest-ridden” province. However, few are those in Quebec who will point out that the rest of Canada contributed largely to Quebec’s Quiet Revolution.

Between 1945 and 1955, the federal government opted to reduce its transfers to Quebec. Indeed, federal transfers to Quebec fell from 101$ per person in 1945 to 37$ in 1955. Relative to Gross Domestic Product (GDP), federal transfers fell from 1.1% to 0.3%. During that period, the provincial government opted to keep its spending under control at around 5.3% of GDP. Its total revenues also stayed stable at 5.5% of GDP. Each time the province ran a deficit, it compensated by a much larger surplus in following years, so that the debt burden adjusted for inflation fell from 1,245$ per person in 1945 to 679$ in 1955. In this era of fiscal discipline, the provincial government opened up the economy to foreign investors and turned the province into one of Canada’s most fiscally competitive provinces. This was quite impressive especially when contrasted to the pre-war period when expenditures rose to 8.95% of GDP in 1938, the highest point it would reach before 1961.

However, this would begin to change in the mid-1950s as federal transfers began to rise. During the 1950s the federal government began to multiply its interventions in the domain of welfare by attempting to fund numerous social programs for the provinces. This drive to insure an equal basket of public services to Canadians – regardless of the fiscal capacity of the province they resided in – led to the creation of numerous federal transfers and ultimately to the equalization program. In spite of its virulent opposition to federal intrusion in areas of social welfare, the province of Quebec did benefit from a huge surge in federal transfers of all sorts. By 1960, federal transfers per person adjusted for inflation had risen to 172$ or 1.5% of GDP.

Throwing fiscal discipline through the window, the provincial government embarked on a spending binge. Between 1955 and 1960, real expenditures per person increased by 51% (to 8.3% of GDP). In fact, 62% of the increase in spending per person for healthcare and education between 1945 and 1960 took place after 1955.

Autonomous revenues– revenues that did not come from federal sources – did not rise during this period. Relative to GDP, the tax burden imposed by the provincial government virtually did not rise between 1955 and 1960 and stayed close to a 5.6% share of GDP.

Some argue that the foundations of Quebec’s Quiet Revolution were laid during the 1950s. Indeed, the vast surge of government spending between 1955 and 1960 for education, health care and social welfare became the foundation upon which Quebec’s modern welfare state would be built. What has been less emphasized in Quebec is how important federal transfers have been in funding those foundations.

The additional layers that were to be attached to Quebec’s welfare state in the 1960s were also funded in large part by other Canadian taxpayers. After 1960, federal transfers to Quebec kept rising without any limit. By 1969, real transfers per person had risen to 581$ or 3.4% of GDP. In that same year, real spending per person reached 2,726$ or 15.9% of GDP. This was the result of Quebec’s drive to build a modern welfare state (both corporate and individual).

In spite of numerous tax increases in Quebec, Canadian taxpayers had to pay a growing share of Quebec’s welfare state. In 1955, they had to fork out a mere 5.6% of Quebec’s revenues. In 1960 and 1969, 20.3% and 22.7% respectively of Quebec’s revenues came from Canadian taxpayers. According to a different data set from Quebec’s department of finances, that share had grown to 26.4% by the first year of the Parti Québécois’ stay in office.

Economically, Quebec has lagged behind the richest parts of Canada for many decades. Hence, its tax base is smaller, but its welfare programs have been amongst the most generous in Canada, since the 1960s. On its own, Quebec would never have been able to construct such a large welfare state. Thanks to federal transfers, Quebec has been able to live beyond its means for decades and that is not a 52nd anniversary gift to be proud of.

A response to Daniel Kuehn: Austerity as credible commitment

A few days ago, I posted a comment on austerity measures as a complement to supply-side measures. One of the economist that I quoted, Daniel Kuehn, has replied in earnest about the 1920-21 recession:

I still wished I had explained the supply shock argument a little better (i.e. – reproduce with ample citation Romer’s excellent treatment and share a few other things on agriculture at the time that I dug up). The tight money policy was an aggregate demand shock, and the tight money policy did really put the economy into a nose-dive, so you have to be careful in talking about it as a supply-side downturn. And there was a good reason why they did that: to bring the price level back in line. The reason why it doesn’t really give us much guidance about fiscal policy is that monetary policy had a ridiculous amount of maneuvering room (which it took advantage of even before Harding came into office), and their was no demand shock to speak of except for the one that Benjamin Strong was already in the process of removing.

It seems that, indeed, I might over-emphasized the role of the drop in aggregate supply in Kuehn’s excellent paper in the Cambridge Journal of Economics. However, I am not convinced that monetary policy had much to do with that recession, the recovery was still “supply-side-led” (if that word exist, I am coining it…) and the austerity measures acted as “credible commitments”.

When one looks at the United States relative to other countries like Canada, we can see how supply-side constraints and shocks led the economy to nose-dive. For example, Canada announced in early 1919 that all price controls would be released and that some taxes would be cut down. The government of Canada also commited itself to austerity and debt reduction via the curtailment of public expenditures. Meanwhile, the Wilson administration announced that it would keep many price controls and actually announced a month after Canada that a Post-War Price Board would be kept to continue price controls. As much as inflation played a role after the war in the US, price controls created shortages and industrial shutdowns (combined with industrial transformation back to peacetime industry) that probably fuelled strikes and lockouts. Moreover, during the war there was  – as Albrecht Ristchl pointed out – the Clayton Act which allowed collective bargaining on a large scale (hence more union power that could collaborate with businesses to hike real wages and reduce employment). It was only after the Clayton Act was invalidated in court and that the Harding and Coolidge Administrations began to eliminate constraints on supply that growth took off. Here, I believe that Kuehn and me agree. So the recession was mostly a supply-side contraction and the recovery was the increase in aggregate demand (and a part of monetary policy).

However, my point is that austerity is not a measure for short term recovery. It is a measure for sustaining growth rates. Most of the spending cuts occured indeed in the Wilson years, but were mostly linked with returning troops being “laid off” and military spending returning to pre-war levels. However, the Wilson “cuts” returned spending to a higher steady path than prior to the war. Economic actors saw this and their expectations were negatively affected (see 1920: The Year of the Six Presidents for a discussion of the events and people of the time). The austerity measures of Harding combined with tax cuts provided what we can call “a credible commitment” to an institutional setting in which actors could steadily form expectations, invest and expand their activities.

The reason is that  I don’t think individuals in the US at the time lived via Ricardian Equivalence. They had expected the government to return to prior size and commit to reduce the debt by not using higher taxes. The Harding-Coolidge commitment was believed and the “return to normalcy” was seen as credible. In a sense, “austerity measures” had an impact on expectations.

P.S. : My friend John Gent of the LSE made a similar point with regards to William Pitt’s sinking fund and the return to the gold standard as a credible commitment after the Napoleonic Wars to reassure financial actors.

 

Sécurité des travailleurs 1945-1960

À force de parler de la Grande Noirceur, j’ai reçu des courriels qui affirment que mes chiffres sont trompeurs puisqu’ils sont des aggrégats qui ne différencient pas entre anglophones et francophones. La critique est valide, mais elle ne change pas la narration que je présente. Premièrement, les salaires augmentent dans toutes les industries et même en comparant les salaires des travailleurs non-spécialisés du Québec à ceux de l’Ontario ou du Canada, le rattrapage du Québec est très présent. Pour ajouter à mon argumentaire concernant le bien-être des Québécois pendant la Grande Noirceur, je pense que les accidents sont une excellente statistique à utiliser.

Considérant que la majorité des travailleurs employés dans des secteurs à risque d’accidents de travail grave étaient francophones, il est pertinent de regarder l’évolution du nombre d’accidents de travail au Québec. En 1945,  l’ancêtre de la Commission de la Santé et Sécurité au Travail a rapporté 23,24 accidents par 1,000 Québécois. La même année, l’Ontario avait une proportion de 29,56 accidents par 1,000 Ontariens. En 1960, la proportion avait diminuée au Québec mais avait augmenté en Ontario. Les travailleurs Québécois bénéficiaient donc non seulement d’une meilleure sécurité au travail que les Ontariens mais ils ont vu leur travail devenir encore plus sécuritaires au cours de la période allant de 1945 à 1960.

A note on austerity and aggregate supply

In a recent paper in the Cambridge Journal of Economics, Daniel Kuehn storms into the face of austerity hawks by arguing that the 1920-21 recession – heralded by many as a poster-boy for austerity measures – is not applicable.

Strangely, even if I am an austerity hawk, I agree with his view. In short, Kuehn that the recession of 1920-21 was the result of a contraction in the aggregate supply caused by a series of strike and the reallocation of ressources following the end of the Great War which was hampered by numerous regulatory and fiscal controls.

Kuehn is right that it was indeed an issue linked with liberating aggregate supply from the chains that held it back.  Indeed, Nicholas Crafts and Kent Matthews, in their respective studies of the Great Depression in the United Kingdom, found that it was the ability of the supply side to adapt rapidly (mainly in housing construction) which allowed the country to exit the recession earlier than the United States.

However, when he claims that austerity measures probably had no effect in the short run, they surely had an effect in the long run.  The fiscal consolidation that began under Harding and continued under Coolidge sent a strong signal to financial markets about the commitment of the government with regards to its huge debt obligations and the fiscal environment it would create to repay them. In the long run, the austerity measures allowed to liberate resources in the private economy and reduce tax rates. In turn, this allowed the economy to grow even more.

In short, as I have argued elsewhere (albeit in French), austerity measures are not a driver, they are complements to supply side liberalization in order to sustain long term growth. Rather than arguing about austerity measures, we should argue about where to cut first in complement with liberalization policy.

Naissances hospitalisées au Québec, 1931-1957

Parmi les indicateurs important du développement (et de santé publique), on retrouve le pourcentage de naissances qui sont hospitalisées. Il ne s’agit pas de la mesure la plus importante et la plus puissante, mais lorsqu’elle est combinée à un éventail de données démontrant une amélioration de la qualité de vie, elle contribue à illustrer les débordements positifs de la croissance économique dans des domaines d’ordre social. Comme par hasard, j’ai des données sur l’écart des naissances hospitalisées au Québec relativement au reste du Canada. En 1931, moins de 10% des femmes québécoises accouchent dans des hôpitaux. Le Québec est alors dernier, derrière le Nouveau-Brunswick à 12%. Après avoir vécu un bond important pendant la guerre, comme toutes les autres provinces, le Québec effectue un rattrapage impressionnant jusqu’en 1957 et l’écart se ferme progressivement (en ratio).  Il demeurait dernier, mais les progrès étaient collosaux. Considérant la vitesse des changements entre 1951 et 1957, je suis convaincu que l’obtention de données pour 1958 à 1960 renforceraient cette tendance.