Good Economics for Hard Times

by Abhijit V. Banerjee

  The alternative to restricting firing or banning the use of robots in some sectors is a tax on robots, large enough to prevent them from being deployed unless the productivity gains are sufficiently high. This is now the subject of a serious discussion. Bill Gates has recommended it.23 In 2017 the European Parliament considered, but ultimately voted down, a proposed “robot tax,” citing concern over stifling innovation.24 Around the same time, however, South Korea announced the world’s first robot tax. The Korean plan reduces tax subsidies for businesses investing in automation and combines it with a tax on outsourcing, so that the tax on robots does not lead to outsourcing.25

  The problem is that while it is easy to ban self-driving cars (whether or not it’s a good idea), most robots do not look like R2-D2 in Star Wars. They are typically embedded inside machines that will still have human operators, just fewer of them; how does the regulator decide where the machine stops and the robot begins? A robot tax would likely lead companies to find new ways around it, further distorting the economy.

  For some of these reasons, we suspect the current drive toward replacing human actions with robots cannot be prevented from taking a serious toll on the already dwindling stock of desirable jobs for low-skilled workers, first in the rich countries but very soon everywhere. This will add, to a greater or lesser extent, to what the China shock and the other changes described in previous chapters have done to the working class in much of the developed world. It could lead to a rise in unemployment or a multiplication of poorly paid, unstable jobs.

  This perspective deeply worries the elites who feel responsible for, and also threatened by, this state of affairs. This is why the idea of a universal basic income has become so popular in Silicon Valley. Most tend to think, however, that robot-induced despair will become a problem in the future, after technologies have improved even further. But the problem of high and rising inequality has already been staring us in the face in many countries, nowhere more so than in the United States. The last thirty years of US history should convince us that the evolution of inequality is not the by-product of technological changes we do not control: it is the result of policy decisions.

  SELF-INFLICTED DAMAGE

  By the 1980s, not only were the United States and the United Kingdom experiencing lower growth than they were accustomed to, but they also felt continental Europe and Japan catching up. Growth became a matter of national pride. It was important not just to grow but to win the “race” with the other rich countries. After decades of fast growth, national pride was defined by the size of GDP, and its continuous expansion.

  For both Margaret Thatcher in the UK and Ronald Reagan in the US, what was to blame for the slump in the late-1970s was clear (though we now know they really had no idea). The countries had drifted too far to the left—unions were too strong, the minimum wage was too high, taxes were too onerous, regulation was too overbearing. Restoring growth required treating business owners better through lower tax rates, deregulation, and deunionization, and getting the rest of the country to be less reliant on the government. As mentioned earlier, the idea that tax rates need to be low to avoid disaster is of recent vintage. In the United States, the top marginal tax rate was above 90 percent from 1951 to 1963. It declined afterward, but remained high. Under Presidents Reagan and George H. W. Bush, top tax rates came down from 70 percent to less than 30 percent. Bill Clinton pushed them back up, but only to 40 percent. Since then they have bounced up and down, as the US presidency passes between Democrats and Republicans, but they have never gone much higher than 40 percent. Lower taxes were accompanied, first under Reagan and then even more strongly under Clinton, by “welfare reform” (in other words, gutting welfare), which was justified both on grounds of principle (the poor must be more responsible and therefore welfare must become workfare) and out of budgetary compulsion (resulting from diminished tax collection). Unions were brought to heel, both by changing the laws and by directly using state power against them (Reagan, famously, called out the army to break an air traffic controllers’ strike). Union membership has been in decline ever since.26 Regulations were made less restrictive, and there was a new consensus that a very compelling justification should be required before the “heavy hand of the government” was allowed to intervene in business.

  In the UK, something similar happened. The highest tax rate went from 83 percent in 1978 to 60 percent in 1979 and then to 40 percent, and has remained close to that ever since. The very (too?) powerful unions of the postwar era were taken down with a firm hand—the miner’s strike of 1984 was a defining moment of Margaret Thatcher’s rule—and have never recovered. Deregulation became the norm, though the integration with regulation-friendly Europe limited how far it could go. The one difference between the UK and the US is that there was never a major attempt to cut welfare (Mrs. Thatcher apparently wanted to, but her cabinet colleagues dissuaded her). Public spending did fall from 45 percent of GDP to 34 percent during the Thatcher years, but it then partially recovered under subsequent governments.27

  The reason why such radical changes were possible probably had a lot to do with the anxiety that came with slowing growth. Despite the fact that there is no evidence massive tax cuts for the rich promote economic growth (we are still waiting for the promised turnaround in growth in both the US and the UK), at the time the evidence was much less clear. Since growth had stopped in 1973, the natural reaction was to turn to the critics of the Keynesian macroeconomic policies of the 1960s and 1970s, such as the (right-leaning) Chicago school of economics professors and Nobel Prize–winners Milton Friedman and Robert Lucas.

  Reaganomics, as the dominant economics of this period came to be called, was quite open about the fact that the benefits of growth would come at the cost of some inequality. The idea was that the rich would benefit first but the poor would eventually benefit. This is the famous trickle-down theory, never better described than by Harvard professor John Kenneth Galbraith, who claimed this was what used to be called the “horse and sparrow” theory in the 1890s: “If you feed the horse enough oats, some will pass through to the road for the sparrows.”28

  Indeed, the 1980s ushered a dramatic change in the social contract in the US and the UK. Whatever economic growth happened since 1980 has been, for all intents and purposes, siphoned off by the rich. Was Reaganomics or its UK version responsible for it?

  THE GREAT REVERSAL

  In the 1980s, while growth remained sluggish, inequality exploded. Thanks to the outstanding and painstaking work of Thomas Piketty and Emmanuel Saez, the world now knows what happened: 1980 is the year Reagan was elected. It is also almost exactly the year the share of national income that goes to the richest 1 percent reverses fifty years of decline and starts a relentless climb in the United States. In 1928, at the end of the Roaring Twenties, the richest 1 percent captured 24 percent of the income. In 1979, that number was about a third as big. In 2017, the last year to be included at the time of writing, that ratio was almost back where it was in 1929. The increase in income inequality was accompanied by a rise in wealth inequality (income is what people earn every year; wealth is their accumulated fortune), although wealth inequality has not yet reached its early 1920s level. The top 1 percent wealth share in the United States rose from 22 percent in 1980 to 39 percent in 2014.29

  The story for the UK is very similar. The turning point, like in the US, is somewhere very close to 1979, the year Mrs. Thatcher took over. Before 1979, the top income share falls steadily from 1920. After 1979, there is a similar rise, interrupted briefly by the global financial crisis of 2009. Unlike in the United States, inequality has not yet reached the 1920s levels, but it does not have that far to go.30

  In continental Europe the pattern is strikingly different. Before 1920, the top income share in France or Germany, Switzerland or Sweden, the Netherlands or Denmark was not too different from that in the US or UK. But sometime after 1920, inequality crashed in all of these countries, like in the United States, and stayed down,
unlike in the United States. There are small ups and downs, and Sweden actually has a significant upswing starting somewhere in the 1980s, but the levels remain very low by US standards.31

  These data are about pre-tax income, before the rich paid taxes and the poor received transfers. Therefore, they do not take into account any attempt to redistribute from the rich to the poor. Since taxes went down in the United States, we might have expected post-tax inequality to increase even more than pre-tax inequality after 1979. One does see a small blip up at the time of the Tax Reform Act of 1986, but for the most part the curves for pre-tax and post-tax income shares track each other.32 Taxes are important for redistribution, but the increase in inequality is a much deeper phenomenon than a mechanical effect of lower redistribution.

  At the same time, around 1980, wages stopped increasing, at least for the least educated. The average hourly wage adjusted for inflation for US workers who were not managers rose through the 1960s and 1970s, reached its peak in the mid- to late-1970s, and then drifted down through the Reagan-Bush years, before slowly turning around. As a result, the average real wage in 2014 was no higher than in 1979. Over the same period (from 1979 to today), the real wages of the least educated workers actually fell. Among high school dropouts, high school graduates, and those with some college, real weekly earnings among full-time male workers in 2018 were 10 to 20 percent below their real levels in 1980.33 If there had been any trickle-down effect of lower taxes, as its advocates claimed, one would expect wage growth to have accelerated in the Reagan-Bush years. But the opposite happened. The labor share (the share of revenues used to pay wages) has continuously declined since the 1980s. In manufacturing, almost 50 percent of sales were used to pay workers in 1982; it had fallen to about 10 percent in 2012.34

  The fact that this great reversal takes place during the Reagan and Thatcher years is probably not coincidental, but there is no reason to assume Reagan and Thatcher were the reason it happened. Their election was also a symptom of the politics of the time, dominated by anxiety about the end of growth. It is not impossible that if they had lost, whoever won would have gone some distance along the same path.

  More importantly, it is not a priori obvious that Reagan-Thatcher policies were the main reason why inequality went up. The diagnosis of what actually happened in this period, with its obvious implications for policy, has been and continues to be an active area of debate within economics, with some, like Thomas Piketty, squarely blaming changes in policies, while most economists emphasize that the structural transformation of the economy, and particular changes in technologies, also had a lot to do with it.35

  The reason why this is not an easy question is that this was also a period of momentous changes in the world economy. Starting in 1979, China launched market reforms. In 1984, India started taking baby steps toward liberalization. These countries would eventually become two of the largest markets in the world. Partly as a result, world trade expanded relative to world GDP by about 50 percent over this period,36 with the consequences we discussed in chapter 3.

  The advent of computing was the other characteristic feature of the era. Microsoft was founded in 1975; in 1976, the Apple I was released, followed by the much more widely sold Apple II in 1977; IBM released its first personal computer in 1981. Also, in 1979, NTT launched the first widely distributed handheld cell phone system in Japan. Mostly on the strength of selling cell phones, Apple became the first trillion-dollar company in August 2018.

  To what extent do technological change and globalization explain the pattern of increase in inequality in the US and the UK? To what extent did policy, tax policy in particular, play a role?

  With computerization came other technological change. This may not have been a revolution in the sense that the steam engine brought in a revolution, as Robert Gordon argued, but like the steam engine and its love child, the internal combustion engine, it killed a lot of jobs. No one probably makes a living by being a typist now, except the three lone men of uncertain age who sit under a tree near where Abhijit grew up in Kolkata, who for a small fee will type in your name and address into government-issued documents. There are few stenographers left. Even in the White House, their days appear to be numbered. And this technological progress was to a large extent skewed against the less qualified.

  This skill-biased technological change clearly explains the increase in the return to college education.37 But it cannot explain what happened at the very top of the income distribution, unless we think skills were suddenly transmogrified just for the very richest. We usually think of skills increasing relatively continuously with education and wage levels. So, if the explosion of top income inequality was just due to technological progress, the widening of the distribution of wages should have been not just for the ultra-rich but also for the merely rich. But, in fact, those making, say, between $100,000 and $200,000 a year have seen their pay increase only slightly more rapidly than the average, while those who are making more than $500,000 have seen their incomes explode.38

  This suggests that plausible changes in technology are unlikely to explain the stratospheric increase in incomes at the very top. Nor, for that matter, can they explain the difference between United States and continental Europe; technological change has been similar in all rich countries.

  WINNER TAKE ALL?

  However, technology has also changed the organization of the economy. A lot of the most successful inventions that came out of the high-tech revolution were “winner take all” products; there was no point in being on Myspace when the whole world was on Facebook, and Twitter is meaningless unless someone is retweeting your tweets. Technological innovations have also transformed existing industries, and created large benefits from being connected to industries where they used to be largely absent, like hospitality or transportation. For example, if drivers know that all passengers use a particular ride-sharing platform, they will choose to stay on that one. Conversely, if passengers know that all drivers use a particular platform, that is where they will go. These network effects explain in part the dominance of giant tech companies like Google, Facebook, Apple, Amazon, Uber, and Airbnb, but also of “old economy” behemoths, such as Walmart and Federal Express. In addition, the globalization of demand has increased the value of brands, as rich Chinese and Indian customers can now aspire to the same goods. And the ability to browse, compare, and boast on Facebook has made consumers more aware of differences in prices and quality, but also more sensitive to fads.

  The result is a winner-take-all (or if not all, most) economy, in which a few firms capture a large part of the market. As we saw in the chapter on growth, in many sectors sales have become more concentrated, and we see the increasing dominance of “superstar firms.” And in sectors that have become more concentrated, the share of revenues going to pay wages has gone down more. This is because those firms, which are monopolies or near monopolies, make more profits, and those tend to be distributed to shareholders. The increase in concentration thus helps explain a part of why wages are not keeping pace with GDP.39

  The rise of the superstar firms also offers an explanation for why overall wage inequality has been rising: some firms are now much more profitable than others and they pay higher wages. It is also true that profitability is more variable than it used to be, with more clear winners and clear losers, even outside the set of superstars.40 In fact, in the United States, the increase in inequality between the average salaries at different companies can explain two-thirds of the overall rise in inequality (increase in inequality between workers within the same company explains the rest). A lot of this increase in inequality between firms seems due to changes in who works where; the highest-paid workers in low-paying firms are moving to those that pay more. If one assumes that higher earnings reflect higher productivity (which is probably true on average), then the more productive workers are increasingly working with other high-productivity workers.41

  This is consistent with a theory in which superstar firm
s attract both capital and good workers.42 If more productive people benefit more from being paired with other productive people, then the market should drive such people to come together to form high-productivity firms that would, as a result, have higher wages and salaries than other firms. Moreover, once a firm has invested in a galaxy of talents, the CEO of such a firm is in a position to make a big difference; if he pushes them down the wrong path, he would waste a whole lot of productive capacity. Therefore, such firms should strive to get the best CEO possible even if that requires paying him or her what some may feel is an obscene salary.43 The rise in top incomes, in this view, is just the flip side of the rise of superstar firms that value getting the best top management and are willing to pay a lot for them.

  That the economy is sticky also contributes to the rise in inequality between firms. As production in some sectors gets concentrated in superstar firms, other firms in those sectors all over the country are shutting down (think the local department store versus Amazon), in addition to those that shut down because of the effect of new technology or trade. Since workers do not move out, wage growth in the affected area flattens or gets reversed, and rents do the same. This is good news for the surviving firms in those pockets, especially if their clients are elsewhere. The resulting windfall in profits may lead to greater investment in these companies, but probably not enough to halt the overall decline of the area. In other words, part of the distinction between good firms and bad firms may be purely happenstance. If you are a firm in a failing local economy lucky enough to be able to continue to sell to the national or world economy, you can do very well, at least for a while, until the overall drain in talent from these places, as the young and the ambitious move out, starts to hurt.