Why get rich?

You might have seen this chart, which shows different professions’ household income during childhood vs their income now:

A lot of people have focused on the fact that artists’ incomes ‘fall’ more than any other group. It reminded me of this quote from the American Founding Father John Adams:

I must study politics and war that my sons may have liberty to study mathematics and philosophy. My sons ought to study mathematics and philosophy, geography, natural history, naval architecture, navigation, commerce, and agriculture, in order to give their children a right to study painting, poetry, music, architecture, statuary, tapestry, and porcelain.

Equality: as cheap as 50p?

Peter Oborne argues that Ed Balls’ pledge to raise the 45p top tax rate back up to 50p is a good idea. While the extremely high marginal rates (top main rate 83%, plus a 15% surcharge for “unearned income”) of the 1960s and ’70s might have been driven by “socialist envy”, George Osborne’s dropping the rate from 50p to 45p in was “profoundly shaming and offensive”, Oborne contends. This is because, echoing Stanley Baldwin and his brand of Toryism, the conservatives should represent the whole country, not the rich or any other factional interest.

Apparently the Coalition has “devoted a great deal of effort to lowering the living standards of the poor”, and this move to “make the rich richer” is inappropriate when the poor are getting poorer. I contend this by arguing that inequality is down to 90s levels under chancellor Osborne, while the worst-off in society are the only group to actually see their living standards improve the since the recession hit. And the (ugly, unpleasant, and regrettable) attitudes that have emerged towards benefits claimants are probably driving government rhetoric in that area, rather than vice versa.

In general, it annoys me when a columnist writes something apparently trading on what everyone just knows. Sometimes the common view is incorrect. Funnily enough, politics is the area where people err most profoundly and with the most regularity. And I would argue that Oborne is trading on falsehoods in his piece; would it still be a coherent argument if it started with the factual premise that inequality in the UK fell back below its 1997-8 low in 2011-12, 0.34 measured by the GINI coefficient? That the top 10% of earners endured the biggest blow to their incomes since the onset of the recession? And that the bottom 10% by income were the only one to see a rise in living standards taking inflation into account? I don’t think so.

The IFS reports I link above predict that by 2015-16 inequality will rise back to roughly its pre-recession level, so perhaps Oborne could refocus his attack on the future inequality Osborne possibly has a hand in. But in all likelihood there is probably little the government can do about inequality over the long-term, caused as it is by very fundamental trends and robust as it is to institutions even such as the USSR’s. Most of the extra inequality since the 60s and 70s has come from couples engaging in much more assortative mating. And very long-term trends are mainly dominated by heritability of social class—those with Norman surnames are 28% more likely than a random sample of similar others to get an Oxford place.

Bubbles and balloons

Quite a few people criticised the title of my last post — There was no British housing bubble — on the basis that, even if there was no overconstruction of housing (and thus no Austrian-style distortion in the structure of production), there was a bubble in the sense that prices rose rapidly, and so on.

But is this right? I suppose it depends on what you mean by a ‘bubble’. As far as I can tell, there are at least three different meanings of the word ‘bubble’:

  1. A speculative bubble, like the Beanie Baby craze. As Arnold Kling put it recently, “If investors who are buying the asset have estimates of the discounted present value of the income from that asset that imply a negative real return, then it is a bubble.”
  2. An Austrian-style bubble that distorts the real economy by incentivising production in an area where much of the demand is illusory (typically created by credit expansion, according to the Austrians).
  3. A government-created rise in price above ‘real’ (or endogenous) factors.

Take the third kind of bubble, which I think is what we are currently seeing in the British housing market. A ban on the construction of new houses would cause the price of housing to rise significantly, for instance (and this isn’t a million miles away from current government policy). Though the government policy is probably very harmful, given that it exists it is perfectly rational for markets to drive the price up, and that price should stay up for as long as the political factors dictate. The policy might be crazy, but the market’s reaction isn’t.

Let’s take a look at historical UK house prices (in real terms).

Clearly, prices were above trend in the 2000s and then fell after 2008, but compared to the early 1990s prices are still extremely high. I’m willing to believe that quite a bit of that rise was a type-1 or type-2 bubble, but unless you think we’re still in the midst of that kind of bubble (which could pop at any time), it’s not the whole story and doesn’t even seem to be most of the story. (As some commenters have pointed out, some aspects of this price increase were likely attributable to foolish financial wizardry, probably driven by regulation.)

More likely, that rise in house prices since the 1990s, since it is still high, is a type-3 bubble — a sensible reaction by markets to foolish government policies constraining the construction of new homes. I can’t explain why this rise only took place in the 1990s (population growth and decreases in household sizes may explain this, but I don’t know), but unless you’re saying that right now markets are wrong and you know better, that rise doesn’t seem like the sort of unsustainable bubble that leads to sudden crashes.

Type-3 bubbles are different to type-1 and -2 bubbles in that they do not run the risk of sudden crashes. A type-3 bubble is created by government fiat and it can only be undone by government fiat. This difference is sufficiently great that I suggest a new term for type-3 bubbles: “balloons”. A term like that might communicate the fact that prices have been blown up by human agency and, unlike bubbles, require an active popping or disinflating before they go away.

There’s no such thing as a free minimum wage hike

Paul Kirby, who was head of the No. 10 Policy Unit until last year, has a long post calling for a “dramatic, historic increase” to the minimum wage, bringing the levels from the current £6.10/hour to £10/hour in London and £8/hour in the rest of the country. It’s a bold post, but ultimately most of his arguments fail. In this post I try to address the key points he makes in favour of a hike.

Low wage earners are, overwhelmingly, providing services for domestic consumers within the UK economy. They work in shops, cafes and hotels. They cut our hair, they clean our houses, they look after our kids and they care for our elderly.  They are not  in manufacturing, competing on the price of their labour with other countries. What they do has to be done in this country. Nor is it tradable with other countries. If the Minimum Wage increases, it impacts equally on all of an employer’s competitors, so there is no disadvantage.

Even though nobody can switch to a cheaper hairdresser in India, they can get their hair cut less often, or have their homes cleaned less frequently, or send their children to creches with fewer minders per child or their parents to care homes with fewer carers. Kirby is assuming that demand for domestic services is inelastic – that is, it does not change much according to price. Obviously, this may differ between different services, but in without evidence to the contrary (Kirby gives none) it does not seem reasonable to assume that people’s demand for services will stay the same even if the prices of those services rise.

Bear in mind that a minimum wage increase would only affect the bottom of the market, where you would expect customers to be the most price-sensitive. The economic evidence suggests that increases in the minimum wage lead to slower job growth, particularly for young workers and in industries with a high proportion of low-paid staff.

Raising the lowest wages does not mean that employers simply have to, or will, just cut jobs or working hours to keep the wage bill constant. The evidence is clear that employers find a variety of solutions.  Firstly, they restrain pay growth for their better paid staff. Secondly, they increase prices to consumers. Thirdly, they improve productivity and get more out of each hour that they are paying for. And then they squeeze their profits. Through productivity gains, they either earn more revenue or cut the amount of labour they need.

Employers do not try to ‘keep the wage bill constant’. They try to make a profit on the labour they hire. If hiring an extra manager led to extra profits, it wouldn’t matter that doing so also increased the overall wage bill. A minimum wage imposes a price floor on labour, so any worker whose total productivity is less than the minimum wage floor represents a net loss to their employer – which a profit-maximising firm will respond to by firing the worker. It makes no difference whether or not that firm has ‘restrained pay growth’ for its other workers: if an employee is loss-making at the lowest wage a firm can pay them, a profit-maximising firm will fire them. (Or simply not hire additional workers who would be loss making on net.) Even if firms can only tell the average productivity of their workers, because of information problems, they will demand less labour in total.

On the possibility of raising prices to make the worker profitable, see the previous point: if demand for the service is price inelastic, this might work, but it’s quite a claim to say that this is the case for most minimum wage-supplied labour.

Wages are not the only cost of labour to firms, either. Firms may reduce costs in response to minimum wage increases by cutting back on perks like lunch breaks and sick leave, as Starbucks did after it agreed to pay additional corporation tax in 2012.

Increasing low pay has a limited impact on the overall costs of most businesses. In some sectors, very few earn less than the living wage, e.g only 6% in manufacturing. Even in hotels and catering, which is one of the biggest sector for the Minimum Wage, only 17% of jobs are below the living wage and raising the Minimum Wage to the Living Wage would only add 6% to the wage bill. This is the highest impact for any sector. More importantly, labour is only a proportion of all costs, e.g. 25-35% for restaurants.

Is a 2.1% increase in costs for labour-intensive firms not something to be concerned about? The fact that ‘most businesses’ would not be affected seems beside the point. (The reverse of this is true too: if Kirby’s other points were correct, would his suggested minimum wage hike be a bad idea because it would affect “only” 17% of workers?)

There is no real evidence of any minimum wages in the world adversely effecting employment levels.

This is totally wrong. In 2006 Neumark and Wascher reviewed over one hundred existing studies of the employment impact of the minimum wage. Of these, two-thirds showed a relatively consistent indication that minimum wage increases cause increases in unemployment. Of the thirty-three strongest studies, 85 per cent showed unemployment effects. And “when researchers focus on the least-skilled groups most likely to be adversely affected by minimum wages, the evidence for disemployment effects seems especially strong”.

Few people stay on low-wage jobs for their whole lives: minimum wage work is usually a stepping-stone to something better where employees can acquire human capital. There is evidence that suggests that minimum wages deter young workers from acquiring these skills that allow them to get better jobs in the long run. Note also that minimum wages have been used explicitly to kick away the ladder for minorities: by whites in pre-Apartheid South Africa; by anti-Hispanic campaigner Ron Unz in California; and by, er, Polly Toynbee in a recent Guardian column.

Tyler Cowen reminds us to make sure our views of sticky wages and minimum wages are consistent: if “worker-imposed minimum wages” (sticky wages) lead to unemployment, as most Keynesians (among others, including me) believe, why would “state-imposed minimum wages” not also do so? (“Have you no respect for the law (of demand)?”, asks Will Wilkinson.)

Given that we know that minimum wage increases usually cause some unemployment, why take this chance when we could just give money to poor people directly? As we’ve been saying for years, the difference between the current pre-tax minimum wage and the post-tax “living wage” is roughly as much as a minimum wage worker pays in income tax and national insurance: in other words, if that worker didn’t pay tax, they would be earning a living wage. It looks as if the personal allowance will soon rise to the minimum wage level, but the national insurance contribution threshold needs to rise too.

But let’s go even further: if we replaced the tax credit and welfare systems with a Negative Income Tax (or Basic Income – call it whatever you want), we would top-up the wages of low-paid workers directly. Jeremy Warner calls for this in the Telegraph today, and I outlined something similar a few weeks ago. Yes, I’d like all the standard supply-side deregulations as well, but a Negative Income Tax would act as an insurance policy against the potential down-sides of such deregulations, strengthening workers’ bargaining power and addressing the fears of those who worry that deregulations will hurt some workers.

I understand that many Conservatives are coming to see a minimum wage hike as a political ‘free lunch’ – a popular and surprising way of showing an interest in the welfare of the poor that does not affect the government’s balance sheet. I hope this is not true. Contrary to Kirby’s claims, there are good empirical and theoretical reasons to think that raising the floor on the price of labour will cause more unemployment. And unemployment destroys lives. There are lots of things we can and should do to help the poor right now. Raising the minimum wage isn’t one of them.

Old Economy Steven would have been better off now

An interesting essay from Chris Maisano over at Jacobin Magazine drifts over many topics—full employment, growth since the 1970s and neoliberalism, worker activism and the 40-hour week. Its essential case is that full employment is important, because it makes workers better off in lots of ways, including giving them more leisure time. There are some interesting points in the piece, and I agree that full-ish employment is an important goal, but overall I think it rests on a huge number of misconceptions—indeed data is used in very weird ways, with what I see as obvious questions left entirely uninterrogated.

Maisano points to the “Old Economy Steven” meme, which looks back to an idealised post-war era:

Steven pays his yearly tuition at a state college—with his savings from his summer job! He graduates with a liberal arts degree—and actually finds suitable entry-level employment! … But Steven doesn’t just enjoy the material comforts of Old Economy abundance. He possesses a degree of everyday power scarcely imaginable by working people today. Steven can tell his boss to shove it, walk out and get hired at the factory across the street.

The contrast with popular views about today’s economy, at least since the recession, is obvious. But full employment policies have been demoted—indeed since the late 1970s and especially since central bank independence most developed countries have centred their macroeconomic policies around stable inflation, not high employment. In fact, central banks now see a Non-Accelerating-Inflation Rate of Unemployment (NAIRU) as the optimal situation. But is this an “ideological response” as Maisano suggests?

There will always be some unemployment, from the numerous supply side restrictions on labour, and from job switching, especially with sectoral shifts. Inducing unexpected inflation can temporarily take unemployment below this “natural” level, for example through money illusion—where workers think nominal pay is actually real pay—but it is unsustainable. Once unions and individual workers compute this level of demand growth into their calculations the natural rate will return and the monetary authorities will need to push inflation yet higher to subvert this equilibrium.

Many economists, including Milton Friedman, argue that something like this caused the rampant, out of control inflation of the 1970s, something that was only reigned in by harsh recessions in both the UK and USA (attempting to control wages and prices was an abject failure everywhere). Acknowledging this means acknowledging that aiming for unemployment as close as possible to zero is a bad idea; it is better to aim for the lowest level of unemployment achievable without acceleration inflation. It’s certainly possible to argue that monetary policymakers have failed to do this—but it hardly seems like a specifically ideological development, more like progress in economics.

A second sticking point is how growth has declined since neo-liberalism replaced the post-war consensus as the dominant political framework in at least the US and UK. This is true. But it’s also true that every developed country saw a growth slowdown in the 80s and 90s relative to the post-war era. Economic historians are divided on the causes but since the most neo-liberal countries grew much faster than the more left-leaning states, one’d be hard placed to see that as a key cause. But even though growth has slowed down it has not stopped—and despite a few bumps we are much much richer today than in the 1970s. Just think, if had the opportunity to be whizzed to the 1970s to have the same standard of living as someone in your income percentile did then, would you?

My third disagreement is on hours worked. Maisano heavily implies that the consistently looser labour markets since the 1960s and 1970s have resulted in workers forced to work longer hours. He’s clearly looked at the numbers, since he compares the US’s average 1,778 in 2010 (1,742 on the FRED numbers I’ve seen) worked unfavourably to “continental European and the Scandinavian social democracies”. But is that a germane comparison? To me it seems like the best way to compare the wellbeing of workers now, following decades of neo-liberalism and below-full-employment, and workers then, is to directly compare them. On average, during the 1970s, an employed person worked 1,859 hours (in 1970 it was 1,912 hours), in the ten years up to and including 2011 the average was 1,772.9. Maybe Maisano believes that with a greater focus on full employment incomes would have grown even more and hours would have fallen even faster—but if he thought that maybe he should say it.