Market Commentary
by Byron Wien
 
04/02/2014

The Inequality Issue

President Obama has said that rising income inequality and a lack of economic mobility is “the defining challenge of our time.”  He is advocating raising the minimum wage, extending unemployment benefits and making sure workers get paid for overtime.  Those measures may provide some relief, but in my view they do not come close to dealing with the fundamental problem.  Enhancing the Earned Income Tax Credit may be a better approach.

There is no question that conditions have changed in the last three decades.  A study by The International Monetary Fund showed that the share of national income earned by the richest 10% of the United States population increased from 30% in 1980 to 48% in 2012.  The top 0.1% increased its share from 2.6% to 10.4%.  University of California professor Emmanuel Saez estimates that 95% of all the gains made in the current recovery have gone to the top 1%.  Another academic study shows that the share of income going to the top 1% is higher in America than in other developed countries.

Inequality is likely to become a more important political issue.  A Pew Research poll in January showed that 65% of the respondents believe the gap between rich and poor has increased in the last decade.  A February poll by CNN revealed that almost 70% of Americans believe the government should do more to narrow the gap, and 60% believe taxes paid by wealthy people should be raised to reduce poverty.  More than half of the people polled think that the rich had special advantages not available to the general population and about half thought a person is poor because of conditions beyond his or her control.  Former New York Mayor Mike Bloomberg thinks poverty is an important issue, but points out that the disadvantaged in the United States mostly live in dwellings with flush toilets, color television and refrigerators.  They also have cell phones.  These conditions are much better than in many other countries.  Much of this data was reported in a New York Times op-ed by Charles Blow.

Almost everyone in politics has a plan for dealing with inequality.  G. W. Bush had “No Child Left Behind.”  New York’s new mayor Bill de Blasio wants to expand pre-kindergarten education in the public schools and expressed regrets about earlier comments on charter schools.  Many believe charter schools like KIPP Academy are effective and should be encouraged.  Programs like the Harlem Children’s Zone, which address the problem holistically from pre-natal care through the educational process and involve the whole family, have proven to be workable models for others.  Teach For America has enriched the quality of education in public schools across the country.

Almost everyone agrees that getting a good education is an important key to success.  Every three years the Organisation for Economic Co-operation and Development (OECD) conducts a study of 510,000 15-year-olds in 65 participating countries.  The last survey was in 2012; 5,000 U.S. students were tested.  The United States ranked 17th in reading, 21st in science and 26th in mathematics out of the 34 OECD member countries.  Reading the Programme for International Student Assessment (PISA) commentary on the results may provide some useful insights.  “Students in the United States have particular weaknesses in performing mathematics tasks with higher cognitive demands, such as taking real-world situations, translating them into mathematical terms, and interpreting mathematical aspects in real-world problems.”

Socio-economic background has a significant impact on student performance in the United States, with some 15% of the variation in student performance explained by this factor, similar to the OECD average.  Although this variation has diminished over time, disadvantaged students continually show less engagement, drive, motivation and self-beliefs.  Students in the U.S. do not report strong motivation towards learning mathematics.  Only 50% agreed that they are interested in learning math, slightly below the OECD average of 53%.  Since we live in an increasingly quantitative society, math weakness can be a career disadvantage.  There are four million vacant jobs in the United States.  Some are for welding and patient care, but many of them are in areas that require quantitative skills like computer programming, which has a median compensation level of $74,000, according to the Bureau of Labor Statistics.  “Just over one-quarter of 15-year-olds do not reach the PISA baseline Level 2 of mathematics proficiency, the level at which students begin to demonstrate the skills that will enable them to participate effectively and productively in life.  This percentage is higher than the OECD average of 23% and has remained unchanged since 2003.  In Hong Kong, China, Korea, and Singapore only 10% or fewer are poor performers in mathematics.”  Some argue that our average performance may be unimpressive, but our top performers do well.  The data do not show this.  “Only 2% of the students in the United States reach the highest level (6) of performance in mathematics compared with the OECD average of 3%.  31% of the students in Shanghai reach that level.  Top performers in reading and mathematics are near the OECD average.”

The Center for American Progress has done a study which shows that for the first time in history, the current generation will be less well-educated that its parents.  These results are particularly disturbing when you consider how much the United States spends on education.  We rank third after Luxembourg and Switzerland in per capita GDP.  Only Austria, Luxembourg, Norway and Switzerland spend more per student.  The Slovak Republic, which spends less than half of what we spend per student, performs at about the same level.  Korea, the highest-performing OECD country in mathematics, spends below the OECD average (although many Asian families spend considerable amounts on tutoring and after-school education).  Other factors do not explain the underperformance of the U.S.  Parents in America are better educated than in most other countries, ranking sixth.  The share of students from disadvantaged backgrounds is about the OECD average.  We do have a higher percentage of immigrants (our rank is sixth), but so does Canada which performs above the OECD average.  The study shows that students with pre-primary education tend to perform better at the age of 15 than those without it.

The data on inequality show a major change since 1980.  I believe it is unproductive to attack the rich continuously as though they deliberately exploited others as they built their net worth.  Most people in the top 10% worked hard in school, got a good education, put in their 10,000 hours developing a skill and benefited from the growth that took place in America after the 1980-82 recession.  Good luck also played a role in every one of their lives.  Capitalism has always rewarded risk-taking, entrepreneurship and innovation.  This process creates growth and jobs, and the initiators of successful projects often benefit handsomely just as the unsuccessful suffer.  America’s economic leadership is rooted in creativity, and financial incentives are a major motivating force.  It is true that profit margins are at an all-time high and median family income has been flat during this recovery, but I believe that is more a function of globalization and technology than other factors. 

The real problem is that we have to improve prosperity for those in the lower part of the income stream.  When Russia, China and India entered the global economy, having abandoned many of the commercial aspects of Communism (Russia, China) and becoming less insular (India), the world got three billion new customers as Tom Friedman has observed, but it also got three billion new competitors, some of whom could produce quality products at a low cost.  This has kept inflation low, but it has eliminated jobs in high labor cost countries like the United States.  Technology has also had an impact on the size and quality of the workforce as companies have spent money on capital equipment to get the goods and services out the door with fewer workers.  The impact of these factors has been heavy on middle-class manufacturing and service workers.  I believe this is a structural change in the economy that is not likely to be reversed.

As you might expect, levels of inequality vary across the country.  The Brookings Institution has done a study of various cities using the 95/20 ratio.  “This figure represents the income at which a household earns more than 95% of all other households, divided by the income at which a household earns only 20% of all other households.  Over the past 35 years members of the top group have generally experienced rising incomes while the bottom group has seen their incomes stagnate.  The ratio for the whole United States is 9.1, with the 95th percentile at $191,000 and the 20th at $21,000.”  Cities like Atlanta, San Francisco, Boston and Miami had ratios of 15, while Fort Worth, Raleigh, Wichita and Omaha (Warren Buffett notwithstanding) had ratios of around 8.  San Francisco had the highest 95th percentile income at $354,000; Silicon Valley has made its mark.  The real question is what is the quality of life for a family living in a city at the 20th percentile level of $21,000?

There has been another change since 1980 that may have had an even greater impact on inequality.  According to census data the percentage of births to unmarried women has risen from 18% in 1980 to 41% in 2012.  That is a remarkable increase.  If you assume that a two-parent family is more likely to provide a better environment for a child to grow up and become educated, then this change may have an important bearing on the inequality issue.  If you agree that inequality results not so much from the top 10% doing well as it does from the bottom 20% not doing better, this is borne out by the fact that the likelihood of a child raised by a single parent not finishing high school is higher than that for a child of two-parent families.  In America today, if you don’t finish high school the chances of your being unemployed or not being able to earn an income that will enable you to live a middle class life are high.

Many believe that teen-age pregnancies are primarily responsible for this change, but teenagers only account for 17 percentage points of the 41% of births to unmarried women.  A single parent trying to hold a job, maintain a household and raise one or more children faces many challenges.  Having family close by can help, but finding the time to guide and motivate the kids can be daunting.  I spent my teenage years as an orphan and I have some feeling about what it’s like to go through that period without parental guidance.

I do not know what can be done to encourage the occurrence of births in families where two parents are present.  This requires a societal change and politicians and the clergy have been moralizing about it for decades.  Arthur Brooks of the American Enterprise Institute has written a thoughtful essay in Commentary that explores many aspects of the inequality issue.  He also sees it as a societal problem and recommends that we try to reestablish the fundamental values of faith, family, community and work.  I support his prescription, but I think it is hard to implement.

A growing economy which would produce a greater number of better-paying jobs would also help.  More vocational training in high school would also prepare people for good jobs.  I think that government programs like job-creating infrastructure improvement and job retraining would be positive, and we can afford them now that we have reduced the deficit to 3% of GDP.  Any important shift in inequality is likely to be uneven, experience setbacks and take a long time to produce visible change.  Hopefully the fact that there is so much focus on the issue may mean that steps will be taken to bring on a shift in the balance.

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