Week 9 Inequality 2

A The empirical strategy in the paper on the first IT revolution (Autor, 2019) is directly inspired by Dinardo et al. (1996). You can find David Autor's paper here, and Dinardo et al. (1996) here (in both cases the working paper version that is free to access).

Are the empirical approaches of the above paper on the effect of de-unionization on wages and of the paper on the effect of the first IT revolution on wages (Autor (2019), discussed in clip 6 of Inequality I) similar?? Yes, both papers estimate counterfactual wage distributions by holding the wages by profession/unionization constant. No, they investigate different phenomena using different strategies.

C, D As the share of financiers and their earnings increases at the top, the finance sector plays an important role for the increase in income inequality. At the same time, their earnings increases do not seem to be due to increases in technology but highly related to institutional characteristics such as financial regulation and the mechanisms behind CEO payments.

Based on the discussed evidence, what can be said about the role of the financial sector for inequality? Financiers are paid in line with their productivity. The share of financiers in the top 1% of the income distribution decreased in the U.S. In the U.K., the income increase in the top 1% mainly accrued to financiers. The high pay of CEOs in the finance sector seems to spill-over to CEOs in other sectors.

The solid lines indicate concentration in the top 4 firms in sales and employment, respectively, and correspond to the vertical axis on the left. The concentration in the top 20 firms includes the top four firms and is represented by the vertical axis on the right. The retail trade sector has become substantially more concentrated. As shown in the full figure on the slides, this is the case throughout most major sectors of the U.S. economy.

CR4 describes concentration among the biggest 4 firms and CR20 among the top 20 firms. The figure above shows that in the retail trade sector of the U.S. economy (on average, across the different industries belonging to that sector) the share of the biggest four firms in sales has increased more than 2 -fold between 1982 and 2012. The share of the biggest twenty firms in sales has increased around 1.5 - fold. Of total employment in the sector in 2012, the biggest four firms employed 28 % and the subsequent 16 firms 14 %.

F It seems unlikely that top income earners become lazy if they are paid less.

Evidence suggests that the efforts of highly paid people are a direct function of their income. True False

A The nominal value of the minimum wage is its dollar value (e.g. 12USD). The real value is the nominal value adjusted for inflation, it reflects the actual purchasing power. For instance, if the nominal minimum wage stays the same while inflation is above zero, the real value decreases and people are able to afford fewer purchases with the same nominal minimum wage. Even though the nominal minimum wage was lifted from time to time, it has not increased sufficiently to compensate for the increase in prices (inflation) so that the real minimum wage often has decreased in the past. DiNardo and co-authors show for 1979-1988 that both the decrease of the real minimum wage as well as de-unionization are important explanations for the rise in wage inequality during this period.

Fill in the blanks: DiNardo et al. (1996) apply the same strategy to investigate the role of the decrease in the ___ value of the minimum wage. They find that both the changes in unionization and minimum wage are ____ factors for the explanation of the increase in wage inequality in the Reagan years. real, important real, negligible nominal, important nominal, negligible

In the U.S. and the U.K. wealth and income inequality have increased since 1980.

How has income and wealth inequality developed in the U.S. and U.K.? In the middle of the last century the top 1% in the U.S. earned less than the bottom 50%, today they earn more . Among the richest, the wealth share has increased between 1980 and today at all levels. In the U.K. the development is parallel .

A, B High taxes on the very top incomes decrease post-tax income because they tax away a higher share of the income. They can also decrease pre-tax income because they can reduce incentives to pay astronomical sums.

How might high taxes on the very top incomes decrease income inequality? They decrease pre-tax income of the top earners. They decrease post-tax income of the top earners. They increase pre-tax income of the top-earners. They increase post-tax income of the top-earners.

F The U.K. and the U.S. are particular and not simply a reflection of a world-wide, exogenous development.

In continental Europe increases in wealth and income inequality since 1980 are observed to the same extent as in the U.S. and U.K. True. False.

F Income and wealth inequality measure two different types of economic inequality. Income inequality captures how unequal the total income of an economy is distributed between its participants. This can be measured, for instance, by dividing total income in the U.S. between the top 10 percent of income earners and the bottom 50 percent and comparing the sizes of the respective shares. In a completely equal economy, these shares would be 10% and 50%, respectively. Wealth inequality can be measured equivalently. However, while income inequality captures the concentration of income, wealth inequality measures the concentration of wealth, that is the distribution of all assets of the economy. While income and wealth might be linked in various ways, they are not the same. For instance, two accountants might have the same income, but one of them might live for rent while the other inherited a house from their parents, making the latter substantially more wealthy.

Income and wealth inequality by definition always move together. True. False.

In the United States of today, the share of overall wage inequality that is due to differences in average wages between firms (rather than differences in wages within the same firm) is much more important than in the past. The concentration of the economy has contributed to this in two ways: first, if some superstar firms are making all the profits, they are able to pay their workers more than other firms. Secondly, a lot of the increase in inequality between firms seems due to changes in who works where: the highest-paid workers in low-paying firms are moving to the firms that pay more. This development might be a product of new technologies that make it more worthwhile for certain types of workers to work together.

Income inequality does not only arise from the difference in the shares of total income paid to laborers and capital holders, it also comes from variance in wages. If all wages are exactly the same, the variance of wages is 0 and there is no wage inequality. The higher the variance of wages, the higher the wage inequality. The graph on the slides shows that since 1980, total wage inequality has increased . This is to a lesser extent due to an increase in within firm inequality and to a greater extent due to the rise in between-firm inequality.

While automation has positive aspects like the replacement of dangerous jobs we must keep in mind that it is disruptive.

Like trade, automation wil bring disruption. The winners are expected to be those who are already rich today, and the losers those who are poor .

F The average taxes are higher in general in France than in the U.S. This allows the building of a social state to which the rich contribute more in total than the poor which creates much more redistribution. However, progressiveness of taxes, defined as the relative contributions increasing with income, does not exist throughout the income distribution in France, just like in the U.S. The share of income paid as taxes even decreases with income in the top percentile where the tax code is regressive.

Taxes in France are much more progressive than taxes in the U.S. today. True False

T In the U.S. of 1970, the tax code is very progressive in the range of high incomes: average share of income paid as taxes increases substantially with income.

Taxes in the U.S. were much more progressive in 1970 than they are today. True False

T The idea is that technological change caused the transformation into a winner take all economy which has increased income inequality through the mechanisms discussed above.

The evidence presented in this clip supports the idea that technological change could be the root cause of the increase in inequality. True False

B An increase in the share of national income that accrues to capital owners exacerbates income inequality, because capital is mostly owned by income-rich households. Think of a typical poor household that receives most of its income from wages and holds no capital versus a typical rich household that holds capital in the form of stocks, companies and deposits. If the share of the economy's income that is paid to capital owners increases at the cost of the share paid to laborers, the households that were already richer in the first place are receiving even more income relative to poor households. As a result, income inequality increases.

The high increase of incomes at the very top relative to the rest is thus explained... purely by an increase in relative productivity and therefore of wages at the very top. to a large extent by the increase in the capital relative to the labor share.

F CEOs hugely benefit from the institutional way in which their payments are defined. For instance, CEOs who are paid in stock options are often rewarded for pure luck: when the stock market valuation of the firm goes up, even if it is due to pure chance (e.g., world crude oil prices went up, the exchange rate moved in the firm's favor), their salary increases.

The payments of CEOs strictly depend on their performance. True False

T While today there is no evidence that massive tax cuts for the rich promote economic growth (we are still waiting for the promised turnaround of 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.

The reason for why the radical policy changes of the Reagan and Thatcher eras were possible probably had a lot to do with the anxiety that came with slowing growth. True. False.

The pure technology explanation cannot account for everything that happened in the U.S., if the same technology did not have similar effects in Denmark.

The same global change in technology did not have identical effects in the U.S. and in continental Europe. For example, in Denmark income inequality increased less since 1980 and then stabilized. Generally, there is no law implying that what happened in the U.S. needs to happen as a consequence of technological change. There does seem to be room for an important role of institutions.

F It seems very unlikely that the highest income workers have become so much more productive than the other high income workers. It is, for instance, hard to imagine a technology that would make the top 0.01% so much more productive relative to all the rest.

The stark increase of the very high incomes (relative to the high incomes) between 1980 and 2014 can easily be explained by an especially high increase of productivity of these workers. True False

F The effect on society (e.g. on inequality) is not only determined by the technologies but also by the political institutions.

This prospect means that we cannot do anything about the effects of automation. True. False.

T This is the goal of today's lecture.

We can see how inequality has developed in the past to infer what we can do about it today and in the future. True. False.

B The dotted line is the same as in panel a), it shows the actual wage distribution in 1988. The authors obtain the solid line by calculating the wages of 1988 assuming the level of unionization had remained constant since 1979. The effect of de-unionization between 1979 and 1988 is then given by the difference between the observed and the counterfactual wage distribution: the counterfactual distribution is to the right of the actual wage distribution.

What does the figure above show? That there were more workers in 1979 than in 1988. That wages in 1988 would have been higher if the level of unionization from 1979 would have been preserved.

A The x-axis shows real log wages. The curves illustrate the wage distribution of all male workers with a high-school diploma and 10-30 years of experience (dotted line) and the distributions of unionized and non-unionized workers, in the form of densities. The curve of unionized workers is to the right of the curve of non-unionized workers, where wages are higher.

What does the figure above show? That wages of unionized workers in 1988 were higher than those of non-unionized workers. That there were more unionized workers in 1988 than non-unionized workers.

B The labor share is the share of national income that goes to workers in the form of labor income. The remaining part goes to capital owners, in the form of capital income such as profits, dividends, interests and realized capital gains. Together, both make up 100% of the production, or value added, of the economy. While the labor share was pretty much constant around 70% over large periods of the past century, it has declined since the 1980s and 1990s in many of the world's largest economies, including the United States.

What is the labor share? The share of people working in the economy vs. those not working. The share of the national income that is paid in form of wages to laborers. The share of the national income that is paid in form of returns to capital owners.

A, B, C All of these reasons make it difficult to judge to which extent the Reagan policies are the causal reason behind the increase in inequality. It seems theoretically possible that the first IT revolution might have been the root cause for both the change in inequality as well as the change in political institutions.

What makes it difficult to causally establish the reasons for the increase in inequality in the U.S. since the 1980s? Many things happened at the same time. Causality often goes both ways: the election of Reagan was also a symptom of the time and the change in the political institutions also a reaction to what was going on. The discussed studies have illustrated to which extent certain factors could account for the observed increase in inequality (if they were causal). However, one factor is often correlated with the other and there might also be other factors that could be the actual causal reason.

A, B, C, D, F High concentration in a sector means that there are few firms capturing most of the market. If, for instance, Amazon sells almost all books, economists speak of a monopoly. A firm that has a monopoly has the power to set higher prices because it does not need to fear that customers buy from another firm. Similarly, if a company is the only employer of a certain type of worker (let's say that Microsoft was the only firm employing software engineers), then this company has the power to ask laborers to work for lower wages. Because in this case, the powerful firm is not the seller but the buyer (of labor), economists do not speak of a monopoly but use another term: monopsony. The final consequences of higher profits (which tend to be distributed to shareholders) and lower wages due to concentration are that the capital share goes up and the labor share goes down. Income inequality increases.

Which of the following are consequences of high concentration in sectors? For sales, firms have more power and can increase prices. Profits increase. On the labor market, firms have more power and can buy labor at smaller prices. Wages go down. The capital share goes down. The labor share goes down.

F The average federal tax rate for the top percentile decreased from 74.6 in 1970 to 59.3 in 1980 and 35.4 in 1990. At the same time the average tax rate for the overall population increased by 2.5 percentage points.

Who benefitted the most from the Reagan tax cuts? The percentiles 20 to 40 (P20-40). The percentiles 95-99 (P95-99). P99-99.5 P99.5-99.9 P99.9-99.99 The top 0.01 percentile.