A Question of Power

Thomas Pailey
tompaine.com, October 18, 2006

Thomas Palley runs the Economics for Democratic and Open Societies Project. He is the author of  Plenty of Nothing: The Downsizing of the American Dream and the Case for Structural Keynesianism. His weekly economic policy blog is at www.thomaspalley.com

There has been growing recognition recently of the enormous increase in U.S. income disparities in the last 25 years, bringing back levels of inequality not seen since 1929. Paul Krugman has written of the danger of a new oligarchy, whose wealth is such that it may be able to control an economy and society as large as the United States.

So real is growing income inequality that even libertarian-minded Alan Greenspan has mused on its dangers to “democratic society.” Greenspan’s fear is not the undemocratic character of oligarchy—rather, Greenspan worries that too much inequality may promote economically disruptive political rebellion from below.

This expanding awareness by the prominent and powerful of the acute income distribution problem is extremely welcome. Now that we have their attention, advocates of an equal opportunity society have an opening to influence the debate over how the gap between America’s haves and have-nots became so wide.

The short answer is that economic power between workers and corporations has shifted, affecting both workers’ leverage over wage bargaining and whether workers’ or corporations’ interests get priority in business and economic policy decision-making. This explanation differs dramatically from the standard economist’s explanation. The popular story to explain America’s rise in income inequality is that technology has increased the productivity and wages of workers with higher levels of skill and education.

The economic power theory torpedoes the standard explanation of income distribution—which asserts that workers are paid the value of their contribution to production. Understanding the recent shift in economic power also sinks other standard claims about how trade unions have an adverse effect on employment, the idea that there’s a natural rate of unemployment we as a nation should tolerate, and many claims about the benefits of globalization.

In truth, the power theory is not so new. But the economic data have now become so clear the business-friendly economics profession is having trouble ignoring its relevance. For example, a recent research paper by Becker and Gordon of Northwestern University, “Where Did the Productivity Growth go?” reports that growth in the nation’s productivity has benefited primarily those Americans at the top of the income pyramid, especially those in the top one-tenth of 1 percent. Wage and salary income of educated individuals at the 90th percentile in terms of income grew 34 percent in the 30 years between 1972 and 2001. That’s about the rate of productivity growth. It means that as a college graduate making more than 90 percent of the workforce you’ve kept pace with the economy, but not gotten a ticket to the income stratosphere.

The notion of enormous increasing returns to education is a myth. For the past two decades the Economic Policy Institute has documented rising income inequality in its bi-annual publication, “The State of Working America.” The 2004 edition reported that hourly wages of those with less than a college degree fell between 1979 and 2003; wages of college degree holders rose by less than one percent a year over that period; and those of advanced degree holders grew by less than 1.1 percent per year.

Despite these facts, economists have continued touting the argument that workers enjoying the massive financial rewards of education have caused the rise in income inequality. That’s simply not true. More educated workers have not received massively increased returns. They have simply gotten a fairly normal share of productivity growth.

What most economists are missing—and thus, the pundits and lawmakers who listen to them—is that income inequality has increased because those with less education have not gotten the share they once got, which is instead going to those at the very, very top of the pyramid.

The education story fits neatly with conventional economic theories about the fairness of the free market. In these theories, the belief is that technology has increased the productivity of more educated workers. Thus firms operating in competitive markets have supposedly increased wages of these workers. The only problem is the facts don’t fit the theory. Returns to workers with higher education have not been stellar and cannot explain the shift in income distribution to the very top.

The conventional theory of economists has always appealed to elites, being a combination of explanation and justification for unequal income distribution. Free markets supposedly pay workers what they are worth, justifying wages. Furthermore, free markets supposedly prevent exploitation, making unions and minimum wages unnecessary. Indeed, the theory allows the rich and powerful to claim that these essential worker protections are bad and increase unemployment by pricing workers out of jobs.

The education story of rising income inequality works within that frame. It implicitly blames workers for their condition, having been too stupid or lazy to finish high school and go to college. It dismisses amazingly skilled welders, mechanics and blast furnace operators as unskilled with glib ease. It allays fears about globalization and rising corporate power because these supposedly have little to do with rising inequality, which is instead attributed to skill-rewarding technological change. And of course, investing in education as the sole response to America’s employment problem provides a convenient solution for elite policymakers.

The conventional economic theory of income distribution has always been a stretch. Like beauty, a worker’s contribution is in the eye of the beholder. Now it has become clear that the theory also fails to explain our worsening income distribution. That means another theory is needed—one that admits the role of power, institutions and socially created perceptions of who adds value.

Unions, the minimum wage, full employment, social safety nets, economic insecurity and global competition all matter for determining wages and income distribution, because they affect workers’ bargaining power. So too do ideas, because they affect what we will all put up with. The erosion of worker bargaining power and public acceptance of the new pay patterns is the real explanation for the dramatic changes in income distribution. Rather than skilled welders and machinists needing re-education, it is economists that need the re-education.