Capital in the Twenty-First Century
Page 35
Among the members of these upper income groups are US academic economists, many of whom believe that the economy of the United States is working fairly well and, in particular, that it rewards talent and merit accurately and precisely. This is a very comprehensible human reaction.30 But the truth is that the social groups above them did even better: of the 15 additional points of national income going to the top decile, around 11 points, or nearly three-quarters of the total, went to “the 1 percent” (those making more than $352,000 a year in 2010), of which roughly half went to “the 0.1 percent” (those making more than $1.5 million a year).31
Did the Increase of Inequality Cause the Financial Crisis?
As I have just shown, the financial crisis as such seems not to have had an impact on the structural increase of inequality. What about the reverse causality? Is it possible that the increase of inequality in the United States helped to trigger the financial crisis of 2008? Given the fact that the share of the upper decile in US national income peaked twice in the past century, once in 1928 (on the eve of the crash of 1929) and again in 2007 (on the eve of the crash of 2008), the question is difficult to avoid.
In my view, there is absolutely no doubt that the increase of inequality in the United States contributed to the nation’s financial instability. The reason is simple: one consequence of increasing inequality was virtual stagnation of the purchasing power of the lower and middle classes in the United States, which inevitably made it more likely that modest households would take on debt, especially since unscrupulous banks and financial intermediaries, freed from regulation and eager to earn good yields on the enormous savings injected into the system by the well-to-do, offered credit on increasingly generous terms.32
In support of this thesis, it is important to note the considerable transfer of US national income—on the order of 15 points—from the poorest 90 percent to the richest 10 percent since 1980. Specifically, if we consider the total growth of the US economy in the thirty years prior to the crisis, that is, from 1977 to 2007, we find that the richest 10 percent appropriated three-quarters of the growth. The richest 1 percent alone absorbed nearly 60 percent of the total increase of US national income in this period. Hence for the bottom 90 percent, the rate of income growth was less than 0.5 percent per year.33 These figures are incontestable, and they are striking: whatever one thinks about the fundamental legitimacy of income inequality, the numbers deserve close scrutiny.34 It is hard to imagine an economy and society that can continue functioning indefinitely with such extreme divergence between social groups.
Quite obviously, if the increase in inequality had been accompanied by exceptionally strong growth of the US economy, things would look quite different. Unfortunately, this was not the case: the economy grew rather more slowly than in previous decades, so that the increase in inequality led to virtual stagnation of low and medium incomes.
Note, too, that this internal transfer between social groups (on the order of fifteen points of US national income) is nearly four times larger than the impressive trade deficit the United States ran in the 2000s (on the order of four points of national income). The comparison is interesting because the enormous trade deficit, which has its counterpart in Chinese, Japanese, and German trade surpluses, has often been described as one of the key contributors to the “global imbalances” that destabilized the US and global financial system in the years leading up to the crisis of 2008. That is quite possible, but it is important to be aware of the fact that the United States’ internal imbalances are four times larger than its global imbalances. This suggests that the place to look for the solutions of certain problems may be more within the United States than in China or other countries.
That said, it would be altogether too much to claim that the increase of inequality in the United States was the sole or even primary cause of the financial crisis of 2008 or, more generally, of the chronic instability of the global financial system. To my mind, a potentially more important cause of instability is the structural increase of the capital/income ratio (especially in Europe), coupled with an enormous increase in aggregate international asset positions.35
The Rise of Supersalaries
Let me return now to the causes of rising inequality in the United States. The increase was largely the result of an unprecedented increase in wage inequality and in particular the emergence of extremely high remunerations at the summit of the wage hierarchy, particularly among top managers of large firms (see Figures 8.7 and 8.8).
Broadly speaking, wage inequality in the United States changed in major ways over the past century: the wage hierarchy expanded in the 1920s, was relatively stable in the 1930s, and then experienced severe compression during World War II. The phase of “severe compression” has been abundantly studied. An important role was played by the National War Labor Board, the government agency that had to approve all wage increases in the United States from 1941 to 1945 and generally approved raises only for the lowest paid workers. In particular, managers’ salaries were systematically frozen in nominal terms and even at the end of the war were raised only moderately.36 During the 1950s, wage inequality in the United States stabilized at a relatively low level, lower than in France, for example: the share of income going to the upper decile was about 25 percent, and the share of the upper centile was 5 or 6 percent. Then, from the mid-1970s on, the top 10 percent and, even more, the top 1 percent began to claim a share of labor income that grew more rapidly than the average wage. All told, the upper decile’s share rose from 25 to 35 percent, and this increase of ten points explains approximately two-thirds of the increase in the upper decile’s share of total national income (see Figures 8.7 and 8.8).
FIGURE 8.7. High incomes and high wages in the United States, 1910–2010
The rise of income inequality since the 1970s is largely due to the rise of wage inequality.
Sources and series: see piketty.pse.ens.fr/capital21c.
Several points call for additional comment. First, this unprecedented increase in wage inequality does not appear to have been compensated by increased wage mobility over the course of a person’s career.37 This is a significant point, in that greater mobility is often mentioned as a reason to believe that increasing inequality is not that important. In fact, if each individual were to enjoy a very high income for part of his or her life (for example, if each individual spent a year in the upper centile of the income hierarchy), then an increase in the level characterized as “very high pay” would not necessarily imply that inequality with respect to labor—measured over a lifetime—had truly increased. The familiar mobility argument is powerful, so powerful that it is often impossible to verify. But in the US case, government data allow us to measure the evolution of wage inequality with mobility taken into account: we can compute average wages at the individual level over long periods of time (ten, twenty, or thirty years). And what we find is that the increase in wage inequality is identical in all cases, no matter what reference period we choose.38 In other words, workers at McDonald’s or in Detroit’s auto plants do not spend a year of their lives as top managers of large US firms, any more than professors at the University of Chicago or middle managers from California do. One may have felt this intuitively, but it is always better to measure systematically wherever possible.
FIGURE 8.8. The transformation of the top 1 percent in the United States
The rise in the top 1 percent highest incomes since the 1970s is largely due to the rise in the top 1 percent highest wages.
Sources and series: see piketty.pse.ens.fr/capital21c.
Cohabitation in the Upper Centile
Furthermore, the fact that the unprecedented increase of wage inequality explains most of the increase in US income inequality does not mean that income from capital played no role. It is important to dispel the notion that capital income has vanished from the summit of the US social hierarchy.
In fact, a very substantial and growing inequality of capital income since 1980 accounts for ab
out one-third of the increase in income inequality in the United States—a far from negligible amount. Indeed, in the United States, as in France and Europe, today as in the past, income from capital always becomes more important as one climbs the rungs of the income hierarchy. Temporal and spatial differences are differences of degree: though large, the general principle remains. As Edward Wolff and Ajit Zacharias have pointed out, the upper centile always consists of several different social groups, some with very high incomes from capital and others with very high incomes from labor; the latter do not supplant the former.39
FIGURE 8.9. The composition of top incomes in the United States in 1929
Labor income becomes less and less important as one moves up within the top income decile.
Sources and series: see piketty.pse.ens.fr/capital21c.
In the US case, as in France but to an even greater degree, the difference today is that one has to climb much further up the income hierarchy before income from capital takes the upper hand. In 1929, income from capital (essentially dividends and capital gains) was the primary resource for the top 1 percent of the income hierarchy (see Figure 8.9). In 2007, one has to climb to the 0.1 percent level before this is true (see Figure 8.10). Again, I should make it clear that this has to do with the inclusion of capital gains in income from capital: without capital gains, salaries would be the main source of income up to the 0.01 percent level of the income hierarchy.40
FIGURE 8.10. The composition of top incomes in the United States, 2007
Capital income becomes dominant at the level of top 0.1 percent in 2007, as opposed to the top 1 percent in 1929.
Sources and series: see piketty.pse.ens.fr/capital21c.
The final and perhaps most important point in need of clarification is that the increase in very high incomes and very high salaries primarily reflects the advent of “supermanagers,” that is, top executives of large firms who have managed to obtain extremely high, historically unprecedented compensation packages for their labor. If we look only at the five highest paid executives in each company listed on the stock exchange (which are generally the only compensation packages that must be made public in annual corporate reports), we come to the paradoxical conclusion that there are not enough top corporate managers to explain the increase in very high US incomes, and it therefore becomes difficult to explain the evolutions we observe in incomes stated on federal income tax returns.41 But the fact is that in many large US firms, there are far more than five executives whose pay places them in the top 1 percent (above $352,000 in 2010) or even the top 0.1 percent (above $1.5 million).
Recent research, based on matching declared income on tax returns with corporate compensation records, allows me to state that the vast majority (60 to 70 percent, depending on what definitions one chooses) of the top 0.1 percent of the income hierarchy in 2000–2010 consists of top managers. By comparison, athletes, actors, and artists of all kinds make up less than 5 percent of this group.42 In this sense, the new US inequality has much more to do with the advent of “supermanagers” than with that of “superstars.”43
It is also interesting to note that the financial professions (including both managers of banks and other financial institutions and traders operating on the financial markets) are about twice as common in the very high income groups as in the economy overall (roughly 20 percent of top 0.1 percent, whereas finance accounts for less than 10 percent of GDP). Nevertheless, 80 percent of the top income groups are not in finance, and the increase in the proportion of high-earning Americans is explained primarily by the skyrocketing pay packages of top managers of large firms in the nonfinancial as well as financial sectors.
Finally, note that in accordance with US tax laws as well as economic logic, I have included in wages all bonuses and other incentives paid to top managers, as well as the value of any stock options (a form of remuneration that has played an important role in the increase of wage inequality depicted in Figures 8.9 and 8.10).44 The very high volatility of incentives, bonuses, and option prices explains why top incomes fluctuated so much in the period 2000–2010.
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Inequality of Labor Income
Now that I have introduced the evolution of income and wages in France and the United States since the beginning of the twentieth century, I will examine the changes I have observed and consider how representative they are of long-term changes in other developed and emerging economies.
I will begin by examining in this chapter the dynamics of labor income inequality. What caused the explosion of wage inequalities and the rise of the supermanager in the United States after 1980? More generally, what accounts for the diverse historical evolutions we see in various countries?
In subsequent chapters I will look into the evolution of the capital ownership distribution: How and why has the concentration of wealth decreased everywhere, but especially in Europe, since the turn of the twentieth century? The emergence of a “patrimonial middle class” is a crucial issue for this study, because it largely explains why income inequality decreased during the first half of the twentieth century and why we in the developed countries have gone from a society of rentiers to a society of managers (or, in the less optimistic version, from a society of superrentiers to a somewhat less extreme form of rentier society).
Wage Inequality: A Race between Education and Technology?
Why is inequality of income from labor, and especially wage inequality, greater in some societies and periods than others? The most widely accepted theory is that of a race between education and technology. To be blunt, this theory does not explain everything. In particular, it does not offer a satisfactory explanation of the rise of the supermanager or of wage inequality in the United States after 1980. The theory does, however, suggest interesting and important clues for explaining certain historical evolutions. I will therefore begin by discussing it.
The theory rests on two hypotheses. First, a worker’s wage is equal to his marginal productivity, that is, his individual contribution to the output of the firm or office for which he works. Second, the worker’s productivity depends above all on his skill and on supply and demand for that skill in a given society. For example, in a society in which very few people are qualified engineers (so that the “supply” of engineers is low) and the prevailing technology requires many engineers (so that “demand” is high), then it is highly likely that this combination of low supply and high demand will result in very high pay for engineers (relative to other workers) and therefore significant wage inequality between highly paid engineers and other workers.
This theory is in some respects limited and naïve. (In practice, a worker’s productivity is not an immutable, objective quantity inscribed on his forehead, and the relative power of different social groups often plays a central role in determining what each worker is paid.) Nevertheless, as simple or even simplistic as the theory may be, it has the virtue of emphasizing two social and economic forces that do indeed play a fundamental role in determining wage inequality, even in more sophisticated theories: the supply and demand of skills. In practice, the supply of skills depends on, among other things, the state of the educational system: how many people have access to this or that track, how good is the training, how much classroom teaching is supplemented by appropriate professional experience, and so on. The demand for skills depends on, among other things, the state of the technologies available to produce the goods and services that society consumes. No matter what other forces may be involved, it seems clear that these two factors—the state of the training system on the one hand, the state of technology on the other—play a crucial role. At a minimum, they influence the relative power of different social groups.
These two factors themselves depend on many other forces. The educational system is shaped by public policy, criteria of selection for different tracks, the way it is financed, the cost of study for students and their families, and the availability of continuing education. Technological progress depends on the pace of
innovation and the rapidity of implementation. It generally increases the demand for new skills and creates new occupations. This leads to the idea of a race between education and technology: if the supply of skills does not increase at the same pace as the needs of technology, then groups whose training is not sufficiently advanced will earn less and be relegated to devalued lines of work, and inequality with respect to labor will increase. In order to avoid this, the educational system must increase its supply of new types of training and its output of new skills at a sufficiently rapid pace. If equality is to decrease, moreover, the supply of new skills must increase even more rapidly, especially for the least well educated.
Consider, for example, wage inequalities in France. As I have shown, the wage hierarchy was fairly stable over a long period of time. The average wage increased enormously over the course of the twentieth century, but the gap between the best and worst paid deciles remained the same. Why was this the case, despite the massive democratization of the educational system during the same period? The most natural explanation is that all skill levels progressed at roughly the same pace, so that the inequalities in the wage scale were simply translated upward. The bottom group, which had once only finished grade school, moved up a notch on the educational ladder, first completing junior high school, then going on to a high school diploma. But the group that had previously made do with a high school diploma now went on to college or even graduate school. In other words, the democratization of the educational system did not eliminate educational inequality and therefore did not reduce wage inequality. If educational democratization had not taken place, however, and if the children of those who had only finished grade school a century ago (three-quarters of each generation at that time) had remained at that level, inequalities with respect to labor, and especially wage inequalities, would surely have increased substantially.