Inequality of income

PETER J. NICHOLSON

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Statistics Canada reported recently that the earned income of the “average” Canadian — the so-called median income — was the same in 2004 as in 1982. After we subtract inflation to keep the purchasing power of a dollar roughly constant, it turns out that median income, before taxes, did not rise at all over those 22 years. Yet during that same time the Canadian economy grew, in real per capita terms, by more than half. But only the very well-paid – those above the 90th percentile of the income distribution – saw any significant increase in earned income; and the higher up the earnings ladder, the greater the growth. What has been going on?

Canada’s experience is not unique. We are following the same pattern as the United States – as usual, a bit more mutedly and a few steps behind. In the 30 years after the Second World War, the U.S. income distribution did not vary much, as the average American worker’s earnings grew in tandem with a robustly expanding economy.
 
Things changed abruptly starting about 1973; productivity growth collapsed, and the economy lapsed into a long inflationary stagnation. Eventually, North America recovered, but the fruits of growth no longer flowed in the same proportion to the average worker. Between 1975 and 2005, median family income in the U.S. increased by only 28% (with most of that coming in 1993-2000) while the economy overall grew by 86% in per capita terms. Between 2000 and 2005, median U.S. family income actually fell slightly.

Meanwhile, those at the top of the heap have been doing better than ever. The average earnings of the highest 1 per cent of the U.S. income pyramid rose a very healthy 160% between 1975 and 2005, while the income of the rarefied top 10th of 1 per cent soared 350%, in real terms, from $800,000 (U.S.) in 1975 to some $3.6-million by 2005.
These figures challenge the central faith that has guided economic policy in the U.S., Canada and other market economies for more than half a century: the assumption that economic growth can be harnessed for the benefit of all citizens, not just the rich.
 
The U.S. picture – in pattern, if not quite in degree – is mirrored in Canada. While Canadians have experienced some real growth at the low end of the income spectrum since the early 1980s – and incomes of families have generally increased a bit more than those of individuals – essentially all of the action has been at the very top. (The income measure is before taxes and government transfer payments. Those offsets mitigate inequalities in market-derived income – more so here than in the U.S. – but my focus here is on the outcomes being generated in the market economy.)

THE GREAT U-TURN

A fascinating study by Professors Michael Veall of McMaster University and Emmanuel Saez of the University of California used income tax statistics to trace the proportion of total income going to top earners from 1920 through 2000 in Canada and the U.S., as the accompanying graph shows. The shares of the top 1 per cent have taken remarkably similar U-shaped paths in the two countries. Those at the top, as compared to everyone else, are pretty much back to where they were in the Roaring Twenties.

The share of the merely very well-paid – say, those between the 90th and 95th percentiles of income – waned sharply in the 1930s and ’40s, but, unlike the top 1 per cent, their share of the pie has increased only very little in the U.S. and not at all in Canada.

These facts raise a lot of questions. What happened in the late 1970s to cause the top incomes to start increasing so strongly? And why, after three decades of healthy growth in the incomes of most North Americans from 1945 through 1975, have the earnings of the great majority in both the U.S. and Canada stopped growing in pace with the overall expansion of the economy?

There are no definitive answers, but plenty of theories. What is clear is that the income share of the ultra-rich nosedived in the Second World War, as earnings from capital (primarily interest and dividends) withered. The imposition of highly progressive income taxes during wartime and in the aftermath – the top marginal tax rate in 1944 in Canada was 95% – as well as a more egalitarian social consensus, combined to limit the reconcentration of wealth in the U.S., Britain, Canada and other industrial countries. Although the share of the top earners has now essentially recovered to pre-war levels in the U.S., with Canada and Britain not far behind, in Japan and most of the continental European countries, top income shares have increased little since their steep fall more than a half-century ago.
 
The trends suggest that the neo-conservative movement that gained strength in the U.S. after the stagflation of the 1970s, and amid growing concern over the excesses of the welfare state, may have created a social and political environment more tolerant of winner-take-all behaviour. This was captured by the words of Gordon Gekko in Oliver Stone’s 1987 film, Wall Street: “Greed is good.” And it has been spectacularly illustrated by the remarkable rise in senior executive compensation, especially in the U.S. In the 1960s and ’70s, CEO compensation at the top 50 American companies averaged about 40 times the average worker’s pay. By 2003, it was more than 350 times.

SUPERSTAR CEOs

The possible reasons for this spectacular disconnect from historical norms are much debated in U.S. academic and political circles. Some argue that the increase of top executive pay simply mirrors the growth in the size and market value of firms in an expanding global economy.

As recently as the 1970s, most executives in large corporations were regarded as bureaucratic managers and paid accordingly. But in the 1980s, the rise of the leveraged buy-out made executive jobs less secure and placed a high premium on entrepreneurial “turnaround skills.” These factors tied reward to risk and made the market for CEO talent much more competitive.

Ironically, rules that require the publication of top executive compensation may also be contributing to the remarkable growth of pay packages. This is because the new transparency has put pressure on boards to match or exceed the pay of executives in competitor companies, thus causing a self-reinforcing upward spiral. Whatever the reasons, the media have also helped to create the “celebrity CEO,” a type not unlike top athletes and entertainers. The individual comes to personify the team and is rewarded commensurately, in an “economics of superstars.”

Professors Veall and Saez argue that the dramatic rise of the top income shares in Canada has likely been driven by the increase in the U.S., which began a little earlier. The market for top executive talent straddles the border, so the competition from skyrocketing compensation in the United States – or simply the demonstration effect of what was happening in the U.S. – has translated to comparable inducements here. As evidence, they note that the top income shares of francophone Quebeckers have not increased to nearly the same extent as the top shares in other provinces, or of anglophones in Quebec. If competition from the U.S. is indeed the driving factor, this would be expected, considering the lower job mobility of francophones.

IMMINENT OUTCRY

The phenomenon of extreme concentration of income among the “superstars” and their like – does not fully explain the stagnation, over the past 30 years, of the real incomes of the vast majority of workers. It is not true that the income of a Bill Gates comes largely at the expense of the rest of us. So what has happened?
Again, informed opinion is divided, and again, despite broadly similar experience in Canada, the issues are much more debated in the U.S. than here. There are three principal, related explanations: (1) the decline of unionization in the U.S., as competitive pressure reduced labour’s bargaining power, particularly in manufacturing; (2) trade liberalization and the globalization of labour supply, in some combination of cheap imports, outsourcing (notably to India and China) and immigration; and (3) a sharp increase in demand for the skills needed to handle new technologies, particularly related to computers – so-called “skill-biased technical change.”

These factors, taken together, have reduced the demand for less skilled people (and thus put downward pressure on their wages) while increasing the premium for a high level of technical skill. All of this has skewed the U.S. income distribution toward the top, but, apart from examples like Bill Gates and Steve Jobs, it has little to do with the remarkable growth of the ultra-rich.

The puzzle remains as to why income stagnation for the great majority of Americans, despite robust growth for the economy as a whole and spectacular gains for those at the very top, has not produced more of an outcry.
One obvious reason is that, by definition, there are so few at the very top. We simply don’t rub shoulders with them, except vicariously in the celebrity media, where the ultra-rich provide mass entertainment value.
More fundamentally, inequality of “consumption” counts for more than the abstract inequality of income.

Thanks to falling prices of things like cellphones, flat-screen TVs and air travel and designer knock-offs of all kinds, consumer inequalities between the rich and everyone else may appear actually to have narrowed.
Meanwhile, buoyant employment and debt-augmented consumption (fuelled by home equity loans and steadily declining personal savings rates) have combined to create a further impression of mass prosperity, despite the income statistics.

But the rosy appearances are finally starting to fade as the U.S. economy softens, the real estate bubble deflates and the presidential campaign gets into full swing.

So expect to hear a lot more about divvying up the income pie south of the border. Canadians – who are experiencing the same trends but just a step behind – should definitely start paying attention.

Peter J. Nicholson is President of the Council of Canadian Academies. The opinions expressed are the author’s own.

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