Superstars, O-rings and lemons

Paul Krugman had a powerful column on income inequality in America recently. Here are some extracts.

What we’re seeing isn’t the rise of a fairly broad class of knowledge workers. Instead, we’re seeing the rise of a narrow oligarchy: income and wealth are becoming increasingly concentrated in the hands of a small, privileged elite. …

Highly educated workers have done better than those with less education, but a college degree has hardly been a ticket to big income gains. The 2006 Economic Report of the President tells us that the real earnings of college graduates actually fell more than 5 percent between 2000 and 2004. Over the longer stretch from 1975 to 2004 the average earnings of college graduates rose, but by less than 1 percent per year.

A new research paper by Ian Dew-Becker and Robert Gordon of Northwestern University, “Where Did the Productivity Growth Go?,” gives the details. Between 1972 and 2001 the wage and salary income of Americans at the 90th percentile of the income distribution rose only 34 percent, or about 1 percent per year. . . .

But income at the 99th percentile rose 87 percent; income at the 99.9th percentile rose 181 percent; and income at the 99.99th percentile rose 497 percent. No, that’s not a misprint.

Just to give you a sense of who we’re talking about: the nonpartisan Tax Policy Center estimates that this year the 99th percentile will correspond to an income of $402,306, and the 99.9th percentile to an income of $1,672,726. The center doesn’t give a number for the 99.99th percentile, but it’s probably well over $6 million a year. . . .

The notion that it’s all about returns to education suggests that nobody is to blame for rising inequality, that it’s just a case of supply and demand at work.

The idea that we have a rising oligarchy is much more disturbing. It suggests that the growth of inequality may have as much to do with power relations as it does with market forces. Unfortunately, that’s the real story.

Should we be worried about the increasingly oligarchic nature of American society? . . . Both history and modern experience tell us that highly unequal societies also tend to be highly corrupt. There’s an arrow of causation that runs from diverging income trends to Jack Abramoff and the K Street project….

I’m with Alan Greenspan, who surprisingly, given his libertarian roots has repeatedly warned that growing inequality poses a threat to “democratic society.”

From the article Krugman is quoting

Our most surprising result is that over the entire period 1966-2001, as well as over 1997-2001, only the top 10 percent of the income distribution enjoyed a growth rate of real wage and salary income equal to or above the average rate of economy-wide productivity growth. Growing inequality is not just a matter of the rich having more capital income; the increasing skewness in wage and salary income is what drives our results. . . .

The paper concludes with a review of issues related to income mobility, consumption inequality, and the sources of growing income inequality. We argue that economists in their explanations of growing income inequality have placed too much emphasis on “skill-biased technical change” and too little attention to the “economics of superstars,” i.e., the pure rents earned by the top CEOs, sports starts, and entertainment stars. This source of divergence at the top, combined with the role of deunionization, immigration, and free trade in pushing down incomes at the bottom, have led to the wide divergence between the growth rates of productivity, average compensation, and median compensation.

I have a question and a comment.

The question: Why is it that the push for tax cuts to the rich seems to strengthen as the chips in the marketplace are falling ever more heavily in their favour?

The comment. My sympathies are entirely with (what I take to be) the sympathies of the authors of these passages. But one caveat. Notice the list of things that are driving down wages at the bottom end. I’d change the list quite a bit. I’m not sure deunionisation belongs there unions have typically compressed wage outcomes it’s true. But they’ve typically assisted those above the minimum wage, not those at the bottom of the pile. I’d add social breakdown the loss of social capital. And it’s very odd that ‘technology’ is not there. But rather than just machines replacing people, spare a thought for Michael Kremer’s ‘O-ring’ theory of economic development.

Named after the O-ring of the Shuttle the failure of which sent seven astronauts to their deaths the theory shows how the demand for work of lower skill or discipline can plummet precipitously if low quality work can prejudice higher value work as the faulty O-ring did on the Shuttle. As the workplace gets more highly skilled and interdependent, the productivity of those below a certain level of skill can fall way below the basic wage, and indeed turn negative without too much trouble.

In a sufficiently sophisticated workplace or supply chain, it may not even be safe to try people out. Add to this Akerlof’s idea of the market for lemons. As a businessperson you spend your time when hiring low skilled people trying to avoid the lemons. It produces discrimination on a grand scale as the employer tries to pick up cues – from clothes, accent, grade, school, suburb, race, religion, whatever whether the person they’re thinking of hiring is going to be a lot worse than useless.

This entry was posted in Economics and public policy. Bookmark the permalink.

25 Responses to Superstars, O-rings and lemons

  1. meika says:

    I am one of the lemons, I’d like to put forward introversion as both a cue and a general factor get work. Are there any studies on long-term unemployment and introversion?

    Recently I’ve met somone who has had three jobs (one by application, the other two by offers (random meeting and friend of a friend) in the last six months, they seem to come quite easily to him. He’s a personable extravert, a footy captain type. No lemony whiff there. Unitl he moves on I guess.

    I’ve had one lot of work which brought in about $1000 before costs.

    When I listen to his luck I sit there stunned. He does not even try. How can I compete with that, … I don’t even get a try out when the workplace (Tasmania) is not sophisticated, …mind you it doesn’t really help to be able to read in Tasmania, illiterate cap-doffing logging families rule here… with their grammar school oligarchy overseers at Gunns…

    Of course the go-getter small business types in Tasmania then complain about how they cannot get any decent skilled, and I sit they thinking why dont they approach me, I am just sitting there wondering..

    Why don’t I get off my backside and approach them you might obviously say. Lazy bastard.

    Truth is I do but do not get through. I look all yellow and sour.

    it feels like I exist for people to feel entitled to complain.

    Don’t blame me, the market made me (not) do it.

    You see lemons have a purpose afterall.

    Rejecting the lemon allows people to think less, and feel good about themselves and their ability to do stuff, sell stuff, consider what they do as ‘work’. ‘Work’ allows you to feel entitled to your gripes/perspective/politics, its how we justify our consumption. By rejecting the lemon we reinforce our own worth, by doing that we can remain confident, and with confidence comes optimism comes the smile that sells. Which is what all that ‘motivated’ ‘enthusiastic’ crap in wanted adds is about.

    Which is basically extraversion, introverts need not apply. They’d have to fake it, and how can a fake compete with the real thing?

    Back to the entitlement to work given to workers…

    “I’ve worked hard. I’ve reject six or seven lemons today. Damn pestering losers!”

    There’s more going on in the marketplace than efficiency and productivity, power relations and the rise of an oligarchy protecting its position by limiting real competitioin is another ( eg australian cross-media laws ), but its the little everyday decisions of rejection, by all of us, that feed this beast. An oligarchy is the outcome pattern, a strange attractor, but the attractor is not the seed.

    And lemons, and lemon mimics like me, are just not wanted in the secret sauce of that ‘success’.

    And so we are not allowed to disappear. Who would be rejected then?

    The problem with discimination analyses is that its not really about picking on people with funny eyes, but rejecting them.

  2. Meika,

    it’s interesting that you raise the issues you do. I was thinking of introversion (amongst other things) in a thread I started on discrimination a week or so ago here http://www.clubtroppo.com.au/2006/02/26/discrimination/. We choose some forms of discrimination to get very excited about and in most cases justifiably so. And other forms of discrimination we pretty much ignore. I don’t know why, but in this case, one reason is that it’s hard to imagine the practical details of some action trying to stop discrimination against introverts.

  3. meika says:

    Might not be introvert aversion, so much, as assuming one size fits all (tall smily extraverts) in structural discussion of labour markets, while I think rejection (John West’s fish) is more important that activ eselection, there is a grey zone in where we just do not noticed how we choose…

    Choice is not is not greatly understood, I reckon, if it was advertising would not be so bloody annoying.

    introverts are also less likely to leave once they do find a place, been at my vineyard work for seven years now…

    a friend of mine just left her wedding dress workplace after ten years because she noticed she did not know anyone new in that time…. in aged care now.

    i once hung out with a group of people who went off apple picking every year and live off of that instead of the dole (hard core activists) and the second year i wondered why they had not asked me, we got along okay, the third year I noticed them ask some smiley people to go even though they had onyl known them for a few weeks (maybe they neded) rescuing?? and I appear resourcefull (sneaky??)) an dnot in need of help.

    In the fourth year i invited myself along.

    It took four (4) seasons for me to do that though! I still wince at the thought of being so shy.

    God this comments thread is now a counselling session!!

  4. Jason Soon says:

    Are you kidding, Meika? I’d say introverts are disproportionately suited to well paying jobs in the economy – patent attorneys, solicitors, economists, business analysts, management consultants, software engineers, etc. Of course they’re probably less likely to end up as CEO, MD etc but they don’t do too shabbily.

  5. meika says:

    don’t do any of them, i’m trying to write, i am talking bill paying dullard work not necessarily those dullard positions with good pay and career prospects, those jobs would steal inspiration and gestation creatiity from me, or just sap it…

    also they are in those jobs because they don’t leave them, you’ve supplied more evidence supporting my flip-side case

  6. Jason Soon says:

    and a lot of introverts *enjoy* those kinds of jobs, meika. so it matters not whether they are reluctant to leave, in that sense they are enthused by them, i don’t get your point that introverts are less capable of enthusiasm and motivation.

    also see this
    http://www.wired.com/wired/archive/9.12/aspergers.html

    The New Economy is adapted for introverts

  7. Don Arthur says:

    "Add to this Akerlof’s idea of the market for lemons. As a businessperson you spend your time when hiring low skilled people trying to avoid the lemons. It produces discrimination on a grand scale as the employer tries to pick up cues – from clothes, accent, grade, school, suburb, race, religion, whatever whether the person they’re thinking of hiring is going to be a lot worse than useless."

    Good point — and if you’re right there are policy implications. There is an asymmetrical information problem here (although it’s not exactly parallel to the used car example).

    In a 1985 paper Gary Burtless reported on an experiment with targeted wage subsides that seemed to show that the subsidies reduced the job seeker’s chances of being hired. He wrote:

    Although the vouchered worker was offered at steep discount, employers appeared to interpret the voucher as implying "damaged goods." Given this interpretation, job applicants using the voucher were placed at a disadvantage in comparison to identical job applicants who refrained from identifying themselves as welfare recipients.

    As Burtless notes, other government programs could produce the same effect. If participation in a training or job search program is a reliable signal that the government has classified a job seeker as long term unemployed or disadvantaged then employers may be less likely to hire them.

    Employers use signals because they aren’t able to observe a job seeker’s productivity directly and can’t rely on the job seeker to tell them. So,as you say, they use a variety of signals they believe are statistically associated with suitability for the job (sometimes the process might be unconscious). Amateur tattoos or gaps in a CV might signal a spell in prison which in turn acts as a signal of ‘poor character’. Slovenly dress might signal a lack of interest in the job or a lack of awareness about what employers and customers expect and so on.

    Too often economists assume information problems away.

  8. Craig Malam says:

    Nicholas, I think the push for tax cuts for the rich becomes stronger when the chips are falling their way because it is at that precise time most people feel the chips are falling their way also (albeit in disproportionate measure). Better time for the drum-beaters to give themselves a pay rise. It sounds somewhat cynical, but actually I’m being quite optimistic about human nature here – we don’t begrudge superstars who make silly money, as long as we have enough in the ‘real world.’ I think there’s a link with the obsession of celebrity also, those people exist somewhere in tv land, so we don’t get too worked up by the surrealness of their place in the world.

    On the o-ring theory, I’m just not sure that the increase in sophistication of the workplace is broadly based enough to explain the kind of shifts Krugman is pointing out. For sure there could be a disproportionate effect among workers in any production process towards the low skilled (because of the information problem), but there always would have been. Have there really been that many ‘o-rings’ added to the economy? As Jason points out, we’ve also added alot of new areas where the potential exists for those who are selected aginst in some areas, to be selected for in others.

    One person’s introvert signifies lost sales, while for another it signifies insightful economic analysis….. Maybe I should grow a beard and go out less..

  9. meika says:

    just met someone who is out of the big house after some armed robbery, now got a full time job… but not through any application process… (pool hall attendant)

    He is a personable extravert.

    Jason, I didn’t say they hated their work or that exraverts do badly in the new economy, but in Tasmania?? Details Jason, details….

  10. Craig,

    Krugman is talking about the big winners. I was taking exception to the list of causes for those at the bottom set out by the authors of the study. That wasn’t really their topic either, so they were just writing stuff down, and their list of causes seemed to me to be complacent.

    The ‘O-ring’ theory doesn’t require a space shuttle to blow up. Just a car to be built wrong, a financial settlement to be missed – a concrete pour to go wrong because the right people didn’t turn up at the right time. These things are commonplace. I think our culture has been very slack about them. But it’s tightening up because of competition. That’s mostly a good thing. But it leaves a huge hole for those who don’t go for that kind of thing.

  11. Don,

    “Amateur tattoos or gaps in a CV might signal a spell in prison which in turn acts as a signal of “‘poor character'”.

    Why the scare quotes around “poor character”. Do you think a spell in prison tends to suggest

    1) poor character or
    2) ‘poor character’ ?

  12. Craig Malam says:

    I agree that their list was a little shoddy, but I was saying the o-ring explanation probably has its problems too, unless we can point to a relevant factor that has changed (like greater competition). Still, you would expect that even when competiton isn’t too feirce, most firms would have practiced this screening – they stand to save dollars by excluding the ‘lemons’. Even when profits are great, its better when they’re great + some more. So when profits come under the squeeze there really should be too much more to gain from greater screening…

  13. Don Arthur says:

    "Why the scare quotes around ‘poor character’"?

    Nicholas – Thanks for asking about that. I did it almost automatically because I’m cautious about the explanatory value of character traits (as opposed to other individual level variables like intelligence or skill). There’s a large body of evidence from social psychology which shows that people tend to overestimate the importance of personality traits and underestimate the importance of situational variables. Some psychologists call this the ‘fundamental attribution error.’

    For policy makers it’s an important kind of explanatory bias because it can lead to wasteful and ineffective responses to problems like crime, unemployment and welfare dependency. The idea that violent crime or terrorism can be abolished by identifying people with criminal or terrorist personalities and either killing or incarcerating them is a good example. Whenever a politicians tells you the root cause of a problem is bad character it’s time to hold on tight to your wallet.

    That said, it is rational for employers to be cautious about hiring people with criminal records. It’s unlikely that a few years in prison have had a major effect on the variables which influence criminal offending. I’d think very carefully before hiring an accountant with a history of embezzlement.

  14. Kim says:

    I’m not sure deunionisation belongs there

  15. Tiny Tyrant says:

    “The question: Why is it that the push for tax cuts to the rich seems to strengthen as the chips in the marketplace are falling ever more heavily in their favour?”

    My suggested answer: With more money, comes more power, both of which increase the ability to push their agenda.

    At the same time, the stressed out po’ folk are more susceptible to the mendacious scare campaigns which assist the passing of this agenda.

    At this rate, we should have enough ‘pain’ to see a revolution occur in 50 years, or so.

  16. Kim,

    Pretty obviously unions that are successful increase wages for their members. That’s the benefit. The costs? They’re paid by the general community including by those on lower wages, and those (for instance those wishing to work in unionised industries – like cars in Detroit) that would like to work for less, but are not able to.

  17. Kim says:

    Nicholas, those who would like to work at all in vehicle manufacturing in Detroit don’t have much of a chance of doing so anymore. Most vehicle manufacturing is now non-union in the South.

    But I don’t know what you mean in practice by the first statement. Do you mean that prices are higher because of unionisation? Unfortunately if you’re on minimum wage, you don’t get to consume much at all beyond the basics of food, shelter and clothing (if indeed you can afford these), so I imagine you must be referring to “the general community” as those with higher purchasing power?

  18. Kim, I fear I am misunderstanding you, because I can’t believe you are serious but you seem to be saying that those on lower incomes are so stretched that they can’t be hurt by price rises. That sure beats me.

  19. Kim says:

    No, no, Nicholas. What I’m saying is that if we’re talking about deunionisation in the area of manufacturing, price rises in cars or whatever won’t affect those who can’t afford cars. There might be another question about the degree to which price inflation in sectors which are unionised translates across the economy, but I don’t know that this can be asserted without being demonstrated empirically.

    My point really is that you seem to be relying on a theoretical impact of unionisation, and I’m suggesting that deunionisation affects different (and far fewer) people in the US than in Australia, and I wonder if you looked at the empirical literature on its effects before disagreeing with Krugman. That’s all.

  20. Kim,

    Unionisation has destroyed Detroit which I’m saying is bad for people who live in Detroit and especially bad for those who want to work in the fast departing car industry – but you want me to check out the empirical literature, on the grounds that the poor don’t drive cars.

    Let me propose a hypothesis. Where what looks like facts don’t look like you want them to, you call for closer attention to the evidence. Where they do – well I don’t know.

    But we’re dealing with a dearth of evidence about what the real facts are our whole lives and I’m quite happy with the generalisations I’ve made.

    Higher wages drive up prices (I assume this is fairly general unless otherwise demonstrated). Certainly work in Australia on protection in the 1970s showed that areas where we were trying to drive up wages (with protection – particularly in clothing and cars) hurt the working class’s purchasing power disproportionately.

  21. Kim says:

    I’m not trying to be pedantic, Nicholas. What I’m pointing to is that the coverage of unions outside manufacturing, transport and mining in the US was always so patchy that I don’t think you can reasonably infer the same level of effect on prices generally. Nor, given the size of the American economy can the same influence of protection on consumer prices be extrapolated. I’m also presuming that Krugman has some basis for his statement, which you seem to reject a priori.

  22. derrida derider says:

    The trouble with the “unions have always hurt the poor” line is twofold:

    1) high unionisation in unskilled work has historically been associated with relatively low poverty in the surrounding society. Sure correlation doen’t imply causality, but this at least rules out high levels of unionisation having a *strong* pro-poverty effect.
    2) its always been the working classes that are keen on unions. Do you seriously think such large numbers of people over such a long time have systematically mistaken their self-interest?

    And its a bit rich, BTW, to blame the unions for all of Detroit’s troubles. Those health and pension plans were freely offered by management as a substitute for wage rises and as a means of providing “golden handcuffs” to reduce turnover costs (BTW, its strange how the Japanese carmakers, with a much older workforce and even more generous pension plans, don’t have to blame unions much). And it ain’t unions that insisted on making poorly engineered SUVs and V8s at a time when it was obvious cheap oil couldn’t last and American consumers were rich enough to prefer better engineering.

  23. Ken Parish says:

    DD

    Unions by definition represent their members, who in turn are the people employed in a paticular industry or workplace/s. Unions don’t represent the unemployed or “the working class” generally. The fact (if correct) that it’s mainly the working class who have been keen on unionism doesn’t undermine Nicholas’s argument or say anything at all about whether they have “mistaken their self-interest”. The members of the working class not employed in a particular industry are NOT members of the union, and those who are clearly have a self-interest in taking collective action to enhance their terms and conditions. Equally clearly, by doing so successfully they increase the cost of labour and potentially price out of the market some of the marginal unemployed who might conceivably have got jobs had the labour price been a bit lower.

    Whether one regards that as a sufficient argument for deregulation of the labour market, given labour economists who suggest that the net employment-enhancing effect of such deregulation is likely to be very modest, is much more arguable. Clearly such deregulation is significantly inegalitarian, in that the wages and conditions of significant numbers of existing working people (in occupations lacking strong marketplace bargaining positions) will fall over time, while this increasing inequality will only be counterbalanced by a rather lesser number of new employees entering the labour market at the lower entry-level wages.

    Personally, I could have supported some aspects of the Howard government’s recent changes if they had simultaneously enhanced the social security safety net and boosted spending on genuine retraining programs (as opposed to bullshit makework schemes like Work for the Dole). But even then, they should have retained a reasonably rigorous “no disdvantage” test as applied when AWA’s were first introduced. I fear that the new regime is already promoting a “race to the bottom” in some industry sectors, potentially producing a nasty US-style dog eat dog society for little real net economic benefit.

    BTW I question the assertion that the working class are the main group who have shown a commitment to unionism. In fact, I suspect that at least for the last 30 years or so public sector white collar unions (including nurses and teachers) have been considerably more successful in retaining higher levels of unionism than blue collar occupations. But i may be wrong; it’s only a subjective impression and I certainly haven’t checked the figures.

  24. Kim says:

    I think it’s not as simple as that, Ken – it depends on whether you have a union movement with a strategy that seeks to lift all boats (ie – the Swedish model, or the Accord era ACTU which in many ways acted against its member unions’ immediate interests) or whether unions are more economistic.

    And I agree with dd. I still think this discussion ignores the very different historical pattern and influence of unionisation in America as opposed to Australia.

  25. Andrew Leigh says:

    Tony Atkinson and I have a paper (PDF) out today showing similar trends for top incomes in Australia.

Leave a Reply

Your email address will not be published. Required fields are marked *

Notify me of followup comments via e-mail. You can also subscribe without commenting.