Wednesday, March 15, 2006

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A follow-up on income inequality

A quick follow-up to a post on income inequality from earlier this month.

Part of the concern that some bloggers/economists have voiced about the rise in inequality is that it's a secular trend that shows no sign of stopping. Which brings us to an interesting fact -- in recent years, income inequality in the United States has been falling. Geoffrey Colvin explains in Fortune:

Rising income inequality has settled comfortably into America's big economic picture as a reliable--and much lamented--megatrend. Starting around the late 1960s, U.S. incomes started to become more disparate. The trend was remarkably steady. Recessions might slow it down or briefly reverse it, but mostly it just marched on....

But now it appears just possible--based on the latest research available--that the whole chain of causation is falling apart. Wait before you cheer.

The evidence is in a new Fed study of family finances, the latest in a triennial series. It shows modest but clear signs of incomes converging rather than diverging. Between 2001 and 2004 (the most recent year for which data are available), incomes of the poorest 20 percent of families increased while incomes of the richest 20 percent fell. Basically, the poorest families' share of total incomes grew, and the richest families' share shrank. Incomes became just a little less unequal.

What explains this? Colvin proposes... wait for it... offshore outsourcing:
What could that trend reversal mean? The most obvious explanation seems highly counterintuitive: The skill premium, the extra value of higher education, must have declined after three decades of growing. The Fed researchers didn't pursue that line of thought, but economists Lawrence Mishel and Jared Bernstein at the Economic Policy Institute did, and they found supporting evidence in the new Economic Report of the President, issued within days of the new Fed survey. It cited Census Bureau data showing that the premium had indeed fallen sharply between 2000 and 2004. The real annual earnings of college graduates actually declined 5.2 percent, while those of high school graduates, strangely enough, rose 1.6 percent.

That is so contrary to the conventional view of this major economic trend that it demands explanation. One possibility is that it's just a blip. Could be, but remember that 2004, when the readings started going haywire, was a year of strong economic growth, low unemployment, and rising productivity, offering no obvious reason to expect weird results.

The other main possibility is that something unexpected and fundamental is changing in the way the U.S. economy rewards education. We don't yet have complete data, but anyone with his eyes open can see obvious possibilities. Just maybe the jobs most threatened by outsourcing are no longer those of factory workers with a high school education, as they have been for decades, but those of college-educated desk workers.

Perhaps so many lower-skilled jobs have now left the U.S.--or have been created elsewhere to begin with--that today's high school grads are left doing jobs that cannot be easily outsourced--driving trucks, stocking shelves, building houses, and the like. So their pay is holding up.

Now, this would certainly be a reversal of course. Most economists allow that trade is responsible for a small increase in income inequality (though it's not all that important compared to other factors).

I'm pretty dubious of this assertion, since it's my understanding that IT salaries have been increasing again ever since demand for IT went up. So mu hunch is that Colvin is over-extrapolating from the reduction in income inequality that came with the brief 2001 recession.

Still, I eagerly await my reader's reaction to the offshoring hypothesis.

posted by Dan on 03.15.06 at 09:50 AM


As I understand there are gains, for the top 20%, but much of that is concentrated on the top 5% or less.

Colvin's conclusions do not seem to correspond to the reality I encounter daily.

posted by: save_the_rustbelt on 03.15.06 at 09:50 AM [permalink]

I believe IT salaries are increasing but by less than inflation so real salaries are still falling.

posted by: Lord on 03.15.06 at 09:50 AM [permalink]

Starting salaries for recent college graduates in this are still falling as well.

posted by: Lord on 03.15.06 at 09:50 AM [permalink]

Lower entrance requirement, lots of available money = college grads are more numerous and mostly mediocre. I don't think it's offshoring, but a dilution of college degrees' worth.
There is so much available loans that colleges are incentivised to accept more (and lower quality) students. Unfortunately, in order to keep those students, the rigor of colleges has also suffered.
To employers, have a degree has become less of a garauntee of quality, so pay is down (competition and training costs are up).
Plus, there has grown up around college (among students) an unseriousness that has fed into this.

I think too many kids are shuffled off to college with out serious consideration of why or what they expect out of it.

posted by: ElamBend on 03.15.06 at 09:50 AM [permalink]

The US slowdown early in this decade came despite fairly good growth in consumption. A good bit of the labor in the consumption chain takes place at the low end, so it may be that, while the recession worked its usual magic on the top 20%, it had less impact on the low end. Delivering consumer goods to retail shelves and homes is a low-skill job. Fed-Ex has put on lots of workers.

It might be worth looking at clustering of wages. In order for improvement at the low end to show up in quintile stats, the improvement has to be from the bottom of the bottom quintile to the top, but not lift too many of those lucky workers into the second quintile. When we deal with quintiles, don't the dividing lines between quintiles drift around as distribution of income changes, making the shifts tricky to track? Could it be that a chunk of second quintile workers slipped into the high end of the bottom quintile, so that a deterioration relative living standard for the former 2nd quintile group showed up as an improvement for the bottom quintile?

And yes to what save-the-rustbelt said. Not only is it the top 5% lifting the top quintile, but I think it was Krugman who argued that it is the top fraction of 1% lifting the top 5%. Krugman is arguing that changes within the top quintile are very important in the performance of the quintile as a whole. I'm suggesting, without evidence, the same thing may account for the apparent improvement in the bottom quintile.

posted by: kharris on 03.15.06 at 09:50 AM [permalink]

In my particular case, I have ridden the income roller coaster since the end of April 2001. In IT consulting, I saw rates plummet to a low by the summer of 2004. Rates in Dallas had been low since the Spring of 2001, and this was partly driven by the availability of cheap Indian software developers and by the financial condition of companies that caused them to want to drastically reduce spending on IT. The IT consulting market in Minneapolis was better for a longer time, but the expense of being there was almost prohibitive. My situation has improved only since August 2005, and has stabilized at a higher level. At least in the Dallas area, the market is still not anywhere near what it was prior to the Spring of 2001. Offshore outsourcing has not been a factor in the market in which I function. Rates have been driven by the dual factors of companies financial condition being worse than in the past, and by the availability lower-cost (even if lower capability) foreign workers, primarily Indian, who are willing to work for less.

posted by: Jim Bender on 03.15.06 at 09:50 AM [permalink]

Paul Craig Roberts has written extensively about the jobs shift. He, too, attributes much to outsourcing, as well as a steep increase in H1-B visas given to foreign workers to come and work (at a discount, naturally) in the US. Here's an excerpt from a recent column:

Information technology workers and computer software engineers have been especially heavily hit by offshore jobs outsourcing. During the past five years (Jan 01 - Jan 06), the information sector of the US economy lost 645,000 jobs or 17.4% of its work force. Computer systems design and related lost 116,000 jobs or 8.7% of its work force. Clearly, jobs outsourcing is not creating jobs in computer engineering and information technology. Indeed, jobs outsourcing is not even creating jobs in related fields.

We continue slowly toward a return to feudalism, with a few rich Barons (owners of capital) and a lot of poverty-stricken Techno-Peasants and service workers (notably domestic servants). This is the inevitable result of global mobility of capital + productivity effects of technology.

Vast income inequality is the corollary. I'd be interested to know whether the numbers used above (to compute income inequality) are after-tax?

Funny that Roberts, an inexorable critic of the current administration, was once in the Treasury under Reagan.

posted by: Econoclast on 03.15.06 at 09:50 AM [permalink]

Daniel raises an apparent paradox with IT salaries - they are falling but also rising. No paradox at all, however, when you look at what actually happened since late 2000.

In the 2001-2003 period, IT salaries fell off a cliff. How much they fell depended upon the particular specialty but a rule of thumb is that the more R&D oriented the IT specialty the worse the fall. The operations people running existing systems also took a whack but not as harsh.

We're talking about salary cuts averaging between 30 and 40% for the R&D types (programmers, analysts, and even architects. Possibly 15-25% for operations people.

After that there was a slight upturn in IT salaries with raises in the area of 2 or 3% a year. This has increased a bit over the last year or so.

Even so, all you have to do is a little math. Assume that your salary in 2000 was 100 and it fell to 65 by 2003. At a rate of increase of 3% a year how long will it take to get back to 100? Without whipping out a calculator I'd guess about 10 years or until about 2013. Even then you're not even because inflation is not considered.

Thankfully the story is probably better than that. I estimate that the true rebound might be as high as 10% a year - now. That still leaves many IT people with a lower salary than in 2000, a condition which may persist until 2009 or 2010 when inflation is factored in. Any way you look at it an effect like that is significant - and not only for individuals but also for labor markets.

posted by: Don S on 03.15.06 at 09:50 AM [permalink]

One more note: I don't believe that offshoring caused the crash in IT and other R&D salaries - it was at most an exacerbating factor.

The actual cause was a triple whammy. A mild recession combined with the boom and bust combined with the collapse of many of the traditional leading companies in the telecoms sector due to several technical revolutions all happening at once. Bankrupt companies and companies holding on by their fingernails don't spend money on R&D.

posted by: Don S on 03.15.06 at 09:50 AM [permalink]

I agree with Elam-I think college is just a growing expectation in the suburbs. Everyone I know goes to college-even if they have no goals in their life, or go just to party, or take 7 years to finish an under grad program. They still go..and I also see the low quality education that some of my peers are recieving at state schools, and wonder at how valuable a diploma really is!?

posted by: curious george on 03.15.06 at 09:50 AM [permalink]

This says increasing poverty between 200-2004. Who knows?

posted by: Mitchell Young on 03.15.06 at 09:50 AM [permalink]

Ddi see this... gates is such a rich dude -

Microsoft's Gates Ridicules $100 Laptop Project

posted by: noah on 03.15.06 at 09:50 AM [permalink]

As a trustee of a top ranked liberal arts college, I learned that for the last few years over half of the seniors are still looking for work when they graduate. The quality of the students measured by grades and SAT scores remains high and the popular majors - biology and economics - have application in the job market. However, their maturity and commitment to a career are not obvious.

posted by: Bob N on 03.15.06 at 09:50 AM [permalink]

college grads are more numerous and mostly mediocre

This hasn't stopped accounting and finance majors from getting ahead. One thing we can thank Ebbers and Skilling for, I guess.

posted by: Lord on 03.15.06 at 09:50 AM [permalink]

One thing about the thesis doesn't quite pass the sniff test - the magnitude of the supposed drop in real earnings of college grads:

The real annual earnings of college graduates actually declined 5.2 percent

A 5.2% drop is a helluva lot. Let's admit that IT workers and other R&D type workers took a helluva whack - perhaps as much as 30% on average. But how many of those workers are there? I think maybe as many as 4 or 5 million all told. Out of a US labor force of maybe 110 million?

How many of those are college grads? At least 40-45 million. The worst-affected workers amount to 10% or fewer of the total US college-educated workforce. A 30% cut in pay for 10% of the college-educated workforce works out to a 3% drop over the entire group. Which leaves a further drop of 2.2% to explain. It seems like an awful big gap.....

posted by: Don S on 03.15.06 at 09:50 AM [permalink]

Before analyzing why incomes are converging, first one must check the facts. The Census estimates of income disperison by household tell a different story. In their data income inequality peaks in 2001 falls in 2002 and then begins climbing again, with the Gini coefficient retruning to its 2001 level in 2004. Thus the clear trend claimed by Colvin in Furtune, is anything but clear. Most likely the source of any recent narrowing is the dropin interest rates and thedrop in interest income at the top end. Interest income is very concentrated at the top.

posted by: Glenn on 03.15.06 at 09:50 AM [permalink]

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