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April 21, 2008

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Adam Smith

How is Mankiw's piece off base? He cites all the right people who aren't exactly Cheney and Bush neo-cons. This is from solid research. Though I also like the Levy piece. Unfair Dani.

David Ricardo

Do you really expect fairness from a blog that calls anyone opposing the views as expressed here a trade fundamentalist??

ZH

There is an easy answer to your question Dani, although many economists, perhaps including yourself, will not like it. The answer is luck. I think Taleb in Fooled By Randomeness did a good enough job showing how many, if not most, cases of extreme success (not moderate success) can be primarily attributed to luck/randomness. Admittedly, Taleb takes this a bit far, but from a logical standpoint, his basic thesis on this matter is fairly sound.

ZH

Just to clarify, I was referring to your issues with the data Mankiw uses, and the extreme upper end of the income distribution not your original issues with regard to Adam Smith.

Dani Rodrik

ZH --

And how do you explain why luck all of a sudden began to exert so much more influence after 1980?

Arun Garg

The shape of the 1% curve is like a "U" over the century. This seems to me to rule out simple explanations related to technology or education which don't have a well-known U-shape to the best of my knowledge.

I'm puzzled why Mankiw ignores this aspect of the data. Is he claiming that education levels of the top 1% fell backwards until 80s and then rose from then on? Or was there another factor pre-80? It seems also unlikely that technological progress followed a U shape over the century.

That leaves political and/or trade related explanations as the only viable ones.

Does anyone know the corresponding curves for Europe?

Gavin Kennedy

I always recommend the above quotation from Wealth Of Nations to those who assert that Adam Smith was in favour of laissez faire and, though he never used the words, often confuse references to Adam Smith’s assertions of Natural Liberty as ‘proof’ of his ‘libertarian’ views, showing simultaneously that they neither understand Smith’s aversion to laissez faire, taken literally, nor to the philosophical content of Natural Rights theory, which Smith learned from Francis Hutchesion, and through him, from Carmichael, Pufendorf and Grotius.

The chapter in Wealth Of Nations to which Dani Rodrick refers demonstrates the authentic Adam Smith who was never an ideologue of any kind. What worked was more important than what fitted a ‘theory’ of what ought to work.

The problem of bank paper (cuurency notes) was compounded by the behaviours of individuals – not all expressions of self-interest lead to socially beneficial outcomes, as students of Adam Smith know, but Nobel Prize winners in economics sometimes don’t, let alone legions of ‘top’ academics who pontificate on ‘his’ alleged theories with all the arrogant certainties of what Smith called ‘men of system’.

conundrum

on the topic of finance, i fully agree with the excellent post of ricardo hausman. yes, we need regulation but we also need financial innovation. even though finance is not always a force for good, i think dani (in his role as skeptic) does not attach enough weight to the benefits of finance.

on mankiw, kudos to dani for pointing out the inconsistency in mankiw's article. mankiw is an excellent writer but even he cannot mask his complete U-turn. he motivates his article by the super-rich and ends up at plain-old college education as the culprit. to paraphrase mankiw, the real question is why has the value of these choclate-bar lottery tickets risen so far?

robertdfeinman

If Mankiw was really sure of his economic pronouncements he would allow comments on his blog so that those who disagree could debate his claims.

His short-lived experiment with open debate ended quickly when he discovered that his pronouncements weren't taken as gospel by those outside his circle.

I don't know how highly regarded his textbook is, but when it comes to public policy he is widely regarded as a GOP flack and apologist. In this role the normal rules of scientific verifiability of data need not apply.

Tim Worstall

One explanation would be superstar economics. Globalisation offers said superstars a larger stage upon which to strut their stuff and thus raises their incomes faster than those earning purely from the domestic economy.
http://www.globalisation.eu/blog/labour-market/one-explanation-for-rising-inequality-200804231330/

ZH

Dani,

Overall, many (though not necessarily most) of the people on the extreme upper end of the wealth distribution made their money in financial markets, even those who started companies such as Bill Gates, because most of their wealth was created through their companies going public which provided them with greater wealth than living off their companies profits (as a privately held company) would have. Given the extreme rise in the financial markets over the past 25 or so years relative to the the previous 50 years (post 1929 crash period), it makes sense that the extreme upper end of the income distibution has seen the greatest gains. If someone or a few someones got lucky over this period of time, then we should see a much greater growth in their wealth relative to everyone else. And given how many people invest, it is not surprising that a few got to that point of extreme wealth purely by luck, given how much easier it is for luck, as opposed to skill, to play a role in financial markets.

wjd123

I'm trying to reconcile these two pieces of information.

From Gregory Mankew's "The Wealth Trajectory: Rewards of the Few."

"The best diagnosis so far comes from two of my Harvard colleagues, Claudia Goldin and Lawrence F. Katz, in their forthcoming book “The Race Between Education and Technology” (Harvard University Press). Professor Goldin is an economic historian, and Professor Katz is a labor economist who briefly worked in the Clinton administration. Their bottom line: “the sharp rise in inequality was largely due to an educational slowdown.”

"According to Professors Goldin and Katz, for the past century technological progress has been a steady force not only increasing average living standards, but also increasing the demand for skilled workers relative to unskilled workers. Skilled workers are needed to apply and manage new technologies, while less skilled workers are more likely to become obsolete.

"For much of the 20th century, however, skill-biased technological change was outpaced by advances in educational attainment. In other words, while technological progress increased the demand for skilled workers, our educational system increased the supply of them even faster. As a result, skilled workers did not benefit disproportionately from economic growth.

"But recently things have changed. Over the last several decades, technology has kept up its pace, while educational advancement has slowed down. The numbers are striking. The cohort of workers born in 1950 had an average of 4.67 more years of schooling than the cohort born in 1900, representing an increase of 0.93 year in each decade. By contrast, the cohort born in 1975 had only 0.74 more years of schooling than that born in 1950, an increase of only 0.30 year a decade.

"Because growth in the supply of skilled workers has slowed, their wages have grown relative to those of the unskilled. This shows up in the estimates of the financial return to education made by Professors Goldin and Katz. In 1980, each year of college raised a person’s wage by 7.6 percent. In 2005, each year of college yielded an additional 12.9 percent. The rate of return from each year of graduate school has risen even more — from 7.3 to 14.2 percent."


From "The Wage that Meant Middle Class."

"The nation’s political leaders — Democrats and Republicans alike — have argued that education and training are a route back to middle-class wages for those who have fallen out. But the demand isn’t sufficient to absorb all the workers that the leaders would educate. Even now, roughly 15 percent of college-educated workers find themselves in jobs for which they are overqualified, the Economic Policy Institute reports, and many of these jobs pay less than $20 an hour."


I would think that Goldin and Katz would argue that if we increased the number of those with higher education we would just depress the wage gains to be had from technology.

But isn't the number of people with higher educations expanding world wide? Isn't it easier for us to tap into them? And wouldn't many skilled workers come here for higher pay if we would let them?

Education not keeping up with technology and causing higher wages for skilled labor doesn't make sense to me unless worldwide supply hasn't kept up with worldwide demand?

How can a slowdown in education be a reason for higher wages when worldwide supply seems to be underbidding the wages of Americans with higher education even when the skills of Americans aren't being fully utilized?

gordon

Unions are another institution which used to help keep incomes more compressed. Those interested should try Card, Lemieux and Riddell (2004) (.pdf)
http://www.econ.ubc.ca/ine/papers/wp005.pdf

Unwho

I find Tim Worstall's explanation for the rise and fall of the income shares of the top 1 percent plausible. If one scales the DJA by an index of nominal GDP, it tracks the peaks and valleys before the 1940s and after the 1970s rather well. But not the 30 year period in the middle. What would explain that? Remember we are talking pre-tax income here. My hunch is that high marginal taxes greatly influenced income recognition during that period. That is, we are talking about tax avoidance and evasion and, perhaps, some real effects as well, depressing the reported income of folks in the top income percentile.

Ronald Hillbrecht

Dani,

With respect to your comment on Adam Smith, it appears that the most celebrated libertarians are skepticals. I've found the following from F. Hayek:
The liberal argument is in favor of making the best possible use of the forces of competition as a means of co-ordinating human efforts, not an argument for leaving things just they are. It is based on the conviction that, where effective competition can be created, it is a better way of guiding individual efforts than any other. It does not deny, but even emphasizes, that, in order that competition should work beneficially, a careful thought-out legal framework is required and that neither the existing nor the past legal rules are free from grave defects. "

"The functioning of a competition not only requires adequate organization of certain institutions like money, markets and channels of information - some of which can never be adequately provided by private enterprise - but it depend, above all, on the existence of an appropriate legal system, a legal system designed both to preserve competition and to make it operate as beneficially as possible."

"To create conditions in which competition will be as effective as possible, to supplement it where it cannot be made effective, to provide services which, in the words of Adam Smith, "though they may be in the highest degree advantageous to a great society, are, however, of such nature, that the profit could never repay the expense to any individual or small number of individuals," - these tasks provide, indeed, a wide and unquestionable field for state activity. "
Hayek (1944), "The Road to Serfdom", chapter 3, "Individualism and colletivism"

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Just to clarify, I was referring to your issues with the data Mankiw uses, and the extreme upper end of the income distribution not your original issues with regard to Adam Smith.

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