Wages of the Top 10% SHOULD Be Growing Faster Than Others

Today’s WSJ carries an article on page 2 with the headline, Wage Divide Grows Wider.  I don’t want to beat a dead horse, but it’s clear this horse ain’t dead yet.  Here’s what the headline should have said:  Wages Continue Growing.

WSJ reports that new Labor Department figures show wages of the top 10% of earners grew faster (7%) than wages of the bottom 90% (2.5%) between mid-2009 and the first quarter of 2012.  This is exactly what one would expect in a healthy, market-based economy.  The important question is whether the wages of ALL workers are growing. 

In a free market, workers are paid according to their contribution to their employer.  Those who are most productive are paid more than the others.  Over time the relative rates of change in wages among the most productive workers and the others will ALWAYS favor the most productive workers – it is a mathematical certainty.

Consider the following example.  Suppose an economy has total wages of $1,000 in year one, which is split equally among 10 workers, because each worker is just as productive as the next.  In year one, each worker earns $100.  Now suppose that over several years, one worker’s productivity improves such that the total wage pool grows to $1,060, and that worker is awarded one-half of the improvement in wages, so that her wages are now $130.  This leaves $930 available for the other nine workers, whose productivity has remained constant.  These workers will now receive their equal share of the $930, or $103.33.  Over the period, the wages of the most valuable worker have increased by 30%, while those of the other workers have grown by “only” 3.3%. 

What conclusions can be drawn from this little economy?  Well, first, the entire economy is better off than before – it now has more money to split among the same ten workers.  Second, every individual worker is better off than before, even those in the slightly less fortunate 90%.

The second point is worth elaboration.  The other nine workers, despite having added nothing – zero – to the incremental growth of the economy, have still enjoyed an increase in wages.  This increase is totally attributable to the single employee who worked a little harder and added more value than they did.  This is definitely a “rising tide lifts all boats” economy rather than the “trickle down” economy that is described by many on the left.  These workers got something for nothing!  Russian oligarchs would consider this downright stupid, but this is the way a free market economy works.

And yet these workers, the top 10%, are the target of criticism and ridicule because they earn more than the rest of us.  What a crazy notion of fairness.  Taxing them more, as the administration would like to do, taking a greater share of their productivity, and redistributing it to those who are not contributing to productivity growth in some cockeyed notion of fairness is either lunacy or intellectual dishonesty.

Of course, my example is only mathematical.  How does inflation affect this wage dynamic?  If our economy is, in fact, not providing an improving living for all citizens, it is a sign we are not managing it properly, that we have distorted the free market to the extent it cannot function as it should.  Fortunately, and despite some monumental economic mistakes of the past few years, it appears we are still on the right path.  Wages of all workers are growing, if too slowly.

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Boomers Behind Income Inequality

Does anyone find it puzzling that measures of income inequality in the U.S. generally begin around 1968, the year college-educated baby boomers began to enter the workforce?  Let’s put the pieces together.  Piece one:  income distribution is measured without regard to the age of those being measured.   Piece two:  the older one is, the greater their earnings are likely to be.

Income distribution is measured by income level (in quintiles).  It is possible that a 60 year-old resides in the lowest income quintile and a 20 year-old in the highest.  However, since income level is strongly related to age, it is likely that the highest quintile includes a greater concentration of older people, and the lowest, younger people.   So far, so good.

The “twist” comes when we try to measure changes in the distribution over time.  If an extra large proportion of the lowest quintile in 1968 consists of twenty-something college students, as those students age and their incomes grow, they will distort the income levels in each quintile they populate.  As we view income distribution today, we are witness to a significant income “bump” moving through the quintiles since 1968, making it appear that income is being concentrated in the upper quintiles. 

To see how the math works, imagine there are two age cohorts in society, ages 18-37 (Cohort A) and ages 38-57 (Cohort B).  All those in each cohort earn $50,000 per year.  Cohort A has 200 members, and Cohort B, 100.  Income distribution in this society is concentrated in Cohort A, since it has twice the income of Cohort B, and yet each member of society earns the same $50,000 per year.  In the future, the population of Cohort B will increase to 200, and that of Cohort A will shrink to 100.  At this point, income will be said to be concentrated in Cohort B, while all members of society are still earning the same $50,000.

Many factors influence the conclusions we should draw from measuring income distribution.  This is one that has not received much notice, but is likely to have a significant effect.  Don’t stand for the unquestioning acceptance of growing income inequality by press and pundits.  It is just not as simple as they want to make it.