A Few Notes on Income Inequality

PK

March 13, 2006

By: Paul Krugman

I’ve written a couple of columns recently focusing on growing income inequality, and intend to write more. Until then, however, I thought readers might find a few further notes on the subject useful.

Personal history

Self-serving things first. Some readers have written in saying, in effect, “Oh, so now you’re worried about the middle class. Where were you until now?” The answer is that I’ve been worried about rising inequality for a long time now. In fact, my first popular book, “The Age of Diminished Expectations,” published in 1989, contained a chapter on growing income inequality — and that wasn’t easy to pull off. For complicated reasons, that book was initially a Washington Post project. And my editors at the Post tried to pressure me into taking the income distribution chapter out, saying that nobody cared about that issue.

The chapter stayed in. If you want a sense of what I had to say about income inequality back then, a 1992 article I wrote for The American Prospect titled “The Rich, The Right, and The Facts,” is available online. I think the piece holds up pretty well.

Globalization

Some people on both sides of the aisle think that if you care about inequality, you must be a protectionist. Although that’s false, it contains a grain of truth: both textbook economic theory and the evidence says that growing international trade, especially trade with labor-abundant countries like China and India, is a contributing factor to growing inequality in the United States. But there’s also clear evidence that while globalization contributes to inequality, it’s at best a supporting actor in the overall story

How do we know this? First, to the extent that globalization explains rising income inequality in the United States, it’s through the effect of international trade on the “skill premium”, the gap between the incomes of college-educated workers and those without a college degree. What we know, however, is that rising inequality isn’t mainly about the rising skill premium. Decomposing the sources of inequality involves calculations that don’t belong in a family newspaper, but basically it seems that only around a third of the rise in inequality over the past generation is associated with a rising premium for education.

And what accounts for the rising skill premium? Just about all economic estimates indicate that the widening of the skill premium itself is more a result of “skill-biased technological change”, a growing demand for highly educated workers due to the rising importance of information technology, than a result of globalization. An example is work by William Cline of the Institute for International Economics.

So growing international trade plays some role in growing inequality, but it is, literally, a fraction of a fraction of the story. That’s cold comfort for the factory worker whose plant has just been closed because it couldn’t compete with imports from China, or the software engineer whose job has just been outsourced to India – and unless we can do something to provide more economic security, protectionist forces will become unstoppable. But I still believe that we can increase economic security and reduce inequality without shutting down international trade.

The real winners

One of the truly strange features about discussions of inequality is the way people shy away from talking about the extent to which the gains from rising inequality have gone to a tiny, wealthy elite.

Here’s a mild example. A few days ago Steve Pearlstein of the Washington Post — a good guy, and sensible — wrote about income inequality. As I did in my column just a few days earlier, “Feeling No Pain,” he emphasized the “retrospective income” distribution data released by the I.R.S. (Paper at http://www.irs.gov/pub/irs-soi/04asastr.pdf. Tables at http://www.irs.gov/pub/irs-soi/04asastr.xls.)

As he pointed out, those data show that the share of income received by the top 10 percent of taxpayers rose from 33 percent in 1979 to 44 percent in 2003. And for his pains, he was smeared by someone at the Cato Institute who needs help — technical help. Hint to Alan Reynolds: check which table you’re looking at before claiming that Congressional Budget Office data refute a statement you don’t like.

But Pearlstein stops there, leaving the impression that everyone in the top 10 percent was a big winner. In fact, there was hardly any rise in the share of income going to people between the 90th and 95th percentiles: almost all the gain went to the top 5 percent. And most of the gain went to a very small elite. The income share of the top 1 percent went from 9.6 to 17.5 percent, accounting for more than 70 percent of the top decile’s gain. The income share of the top 0.25 percent went from 4.9 to 10.5, accounting for a bit more than half the total gain.

Why stop with data that convey the false impression that the winners from inequality are a fairly large group? Does talking about the reality that a very small elite has gotten the lion’s share of the gains sound too, um, shrill?

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3 Responses to “A Few Notes on Income Inequality”

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  2. William Brouine Says:

    This is a good blog. Keep up all the work. I too love to blog. This is great everyone sharing opinions.

  3. Kurt Says:

    An intriguing discussion is definitely worth comment. I think that you need to write more
    on this subject matter, it may not be a taboo
    subject but typically people don’t speak about such issues. To the next! Many thanks!!

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