Scott Sumner Reviews Krugman Reviewing Reich On Inequality

See Paul Krugman on inequality.

"Paul Krugman reviews Robert Reich's new book in the New York Review of Books:

Something else began happening after 2000: labor in general began losing ground relative to capital. After decades of stability, the share of national income going to employee compensation began dropping fairly fast.

I'd call that a bit misleading. In fact, the share of national income going to labor has risen slightly in the past 50 years, from 68.0% in 1965:2 (the golden age of unions) to 68.1% in 2015:2. The only reason I say a bit misleading, rather than completely false, is that the share has indeed fallen since 2000. 

In a comment section to this post, Matt Rognlie points to many flaws in the labor share data, which suggests the recent decline in labor's share is overstated. One issue is the problem of how to impute labor income to the self-employed entrepreneur. (He has several comments, read them all.) Both Rognlie and Kevin Erdmann have pointed to the fact that much of the recent strength in capital income is due to a rise in implicit rents in owner-occupied homes, not explicit "income" as most people think of the term. 

All you have to do is look at the enormous decline in real interest rates on 10 year bonds, from nearly 7% in the early 1980s to less than 0.7% today, to realize that capital isn't doing all that well either.

Krugman continues:

Other evidence points indirectly to a strong role of market power. At this point, for example, there is an extensive empirical literature on the effects of changes in the minimum wage. Conventional supply-and-demand analysis says that raising the minimum wage should reduce employment, but as Reich notes, we now have a number of what amount to controlled experiments, in which employment in counties whose states have hiked the minimum wage can be compared with employment in neighboring counties across the state line. And there is no hint in the data of the supposed negative employment effect. 

Why not? One leading hypothesis is that firms employing low-wage workers--such as fast-food chains--have significant monopsony power in the labor market; that is, they are the principal purchasers of low-wage labor in a particular job market. And a monopsonist facing a price floor doesn't necessarily buy less, just as a monopolist facing a price ceiling doesn't necessarily sell less and may sell more.

This is cherry picking the empirical results. First of all, studies of the minimum wage reach mixed results on the employment impact. But the more important problem is that the studies generally show higher minimum wages being passed on to consumers in the form of higher prices. (Again, I'm indebted to Matt Rognlie for pointing this out.) If firms really did have monopsony power, and as a result employment did not fall, then there should be no pass through of higher wages in the form of higher prices.

Krugman continues:

Once upon a time, around a third of workers in both the US and Canada were union members; today, US unionization is down to 11 percent, while it's still 27 percent north of the border. The difference was politics: US policy turned hostile toward unions in the 1980s, while Canadian policy didn't follow suit.

I'm tempted to ask what kind of story begins, "Once upon a time"? Union membership was nearly 35% of wage and salary workers in 1954. By the time Reagan took office it was down to 21%. Thus most of the decline in unionization occurred before Reagan took office. Indeed the share of union workers has been declining for 60 years. That's not to say Reagan's policies played no role, but they certainly were not the primary factor.

Despite these objections, I have some sympathy for Krugman's argument that rising inequality (especially at the top) is due to increases in market power. In my view that's partly due to the US economy shifting from a commodity and basic manufacturing economy, to a high tech economy where intellectual property rights form a barrier to competition. At the low end I think that immigration for Latin America has depressed the wage levels of less well educated American born workers, especially men.

My preference would be to address the inequality issue in four ways:

1. Have a lower proportion of low skilled immigrants and a higher percentage of high skilled immigrants---there are plenty in India and China who wish to come here, but also more than you might expect from Africa, the Middle East and Latin America.
2. Weaken intellectual property rights. I don't favor eliminating them, but I'd prefer to keep them only for entirely new inventions, not improvements of existing products. Copyrights need to be made much shorter.
3. Change zoning laws to encourage more building. This will be really hard to do; indeed I think things are likely to get worse, not better.
4. Replace income taxes with progressive consumption taxes and low wage subsidies. Eliminate cigarette taxes. Legalize drugs.

Thus I oppose the progressive agenda of high marginal tax rates on personal income, taxing corporate income, inheritance taxes, higher minimum wage rates, pro-union legislation and tighter regulation of business. Indeed I think less regulation of business, especially eliminating occupational licensing laws, would be beneficial. Our current regulatory regime is simply too complex for the less educated to deal with. Heck, it's too complex for me; I can barely do my taxes."