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Krugman raises a false alarm

Posted By Russ Roberts On July 21, 2006 @ 4:13 pm In Inequality | Comments Disabled

I’m a week late getting to this Krugman column [1] (SR) (discussed here [2] and here [3] among many places) but it makes such important errors that it is still worth discussing. Krugman begins by saying that the economy may look healthy but appearances can be deceiving. He quotes an archetypal informed economist:

Informed economist: “But it’s not a great economy for most Americans.
Many families are actually losing ground, and only a very few affluent
people are doing really well.”

He continues:

Many observers, even if they acknowledge the growing concentration
of income in the hands of the few, find it hard to believe that this
concentration could be proceeding so rapidly as to deny most Americans
any gains from economic growth.

Yet newly available data show that that’s exactly what happened in 2004.

Why
talk about 2004, rather than more recent experience? Unfortunately,
data on the distribution of income arrive with a substantial lag; the
full story of what happened in 2004 has only just become available, and
we won’t be able to tell the full story of what’s happening right now
until the last year of the Bush administration. But it’s reasonably
clear that what’s happening now is the same as what happened then:
growth in the economy as a whole is mainly benefiting a small elite,
while bypassing most families.

That’s a very strong statement. Is it true? Krugman bases his claim on work by Piketty and Saez:

The answer comes from the economists Thomas Piketty and Emmanuel Saez,
whose long-term estimates of income equality have become the gold
standard for research on this topic, and who have recently updated
their estimates to include 2004. They show that even if you exclude
capital gains from a rising stock market, in 2004 the real income of
the richest 1 percent of Americans surged by almost 12.5 percent.
Meanwhile, the average real income of the bottom 99 percent of the
population rose only 1.5 percent. In other words, a relative handful of
people received most of the benefits of growth.

Wow. No wonder Krugman’s alarmed–the average income of the top 1% grew a whopping 12.5% while everyone else is just limping along.

Krugman then dismisses the usual explanation for rising inequality–increasing returns to education. Curiously, perhaps, he doesn’t give his own explanation. He simply states that the current administration and current Congress is unlikely to do anything about it.

There are two reasons to ignore Krugman’s angst. The first I have written about before—it’s incredibly misleading to talk about the top 1% gaining this much or that much year-to-year. 

THEY’RE NOT THE SAME PEOPLE.  Even if Piketty and Saez’s numbers are perfectly estimated and analyzed, their numbers do not mean what Krugman implies–if you took the people in the top 1% in 2003 and added up their income, then did the same thing in 2004, the average rose by 12.5%. Piketty and Saez don’t follow individuals. They just take the top 1% in each year. So what the numbers mean is the people in the top 1% earn, on average, 12.5% more than the people who were in the top 1% the year before.

Some of them, of course, are the same people. But it’s not like the top 1% are sitting off to the side in their own guarded compound living like kings at the expense of everyone else, making the rules of the economic game that somehow let them do well while punishing others.

And because it’s not the same people [4], you have to be very careful drawing conclusions about changes in the average American’s well-being over time. As I’ve written before [5], those numbers are affected by immigration, divorce and demographic changes. The median can fall but the median person can still do better over time.

The other mistake in the Krugman analysis is that you really don’t want to base a big policy conclusion on one data point. Do you really want to look at one year (one!) and draw big conclusions about something complex as the distribution of income?

Let’s look at more than one year.

Here are the increases by decade, in the average incomes of the top 1% using the Piketty and Saez calculations (go here [6] to read their original paper and click on the word "NEW" to download the file I used–it’s Table A4 column 3 in the excel spreadsheet):

1920-1930   23%    
1930-1940     0      
1940-1950   15      
1950-1960   -5      
1960-1970   23      
1970-1980     1
1980-1990   71
1990-2000   46
2000-2004   -6%

What do you conclude from these numbers? One interpretation is that in times of strong economic growth–the 1920′s, the 1960′s, the 1980′s and the 1990′s for example, some people do really well, and that pushes up the incomes measured in the top 1%. Mediocre or negative economic growth is not good for the rich or other living things.

And in case you’re wondering, excluding 2000—a very good year for the economy—and looking at just 2001-2004, the first four years of the Bush administration, you get an increase of 4%, a dramatically slower rate of increase than in the previous two decades.

The bottom line is that how the incomes of the top 1% move around is a complex phenomenon. it is foolish to look at one year and conclude that a small elite is keeping all the economic growth. I would also note that even if you wanted to change the distribution of income, it’s hard to know which policy levers would be effective other than improving the educational system, a solution that Krugman seems to think is absurd.

Perhaps, but for absurdity, turn to Krugman’s first recommendation for improving the problem he perceives of the richest of the rich getting all the growth. Krugman wants to RAISE THE MINIMUM WAGE [7]. I’m not making this up:

Can anything be done to spread the benefits of a growing economy more
widely? Of course. A good start would be to increase the minimum wage,
which in real terms is at its lowest level in half a century.

Earlier in the article, he wrote:

There are a couple of additional revelations in the 2004 data. One is
that growth didn’t just bypass the poor and the lower middle class, it
bypassed the upper middle class too. Even people at the 95th percentile
of the income distribution — that is, people richer than 19 out of 20
Americans — gained only modestly. The big increases went only to people
who were already in the economic stratosphere.

And the first thing to solve the problem is an increase in the minimum wage?  No, if you really think that somehow the American economic system has been rigged to reward the rich then the first step to take is to double the marginal tax rate on the rich and use the money to increase the earned income tax credit or expand welfare programs. But increase the minimum wage? What was he thinking?

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URL to article: http://cafehayek.com/2006/07/krugman_raises_.html

URLs in this post:

[1] this Krugman column: http://select.nytimes.com/2006/07/14/opinion/14krugman.html

[2] here: http://delong.typepad.com/sdj/2006/07/the_pattern_of_.html

[3] here: http://gregmankiw.blogspot.com/2006/07/lazear-vs-krugman.html

[4] because it’s not the same people: http://cafehayek.com/2006/01/please_do_your_.html

[5] As I’ve written before: http://cafehayek.com/2005/07/immobility.html

[6] here: http://elsa.berkeley.edu/~saez/

[7] RAISE THE MINIMUM WAGE: http://cafehayek.com/2006/06/testing_the_log.html

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