Sunday, October 17, 2010

The Causes of Rising Income Inequality

Why have the rich have gotten so much richer?

In a 2005 study, Robert J. Gordon and Ian Dew-Becker found that the top 10 percent of earners saw their share of overall income rise from 27 percent in 1966 to 45 percent in 2001. But that study also documented that fully half of that increase came from the relative gains made at the very top of that spectrum - those at the 95th percentile and above.

That study also distinguished between "superstars," whose incomes were market-driven, and CEOs, whose incomes were "chosen by their peers." In their new survey, the authors carve out a third group - high-income professionals, especially lawyers and investment bankers, whose pay is market-driven but who don't enjoy the benefits of "audience magnification," whereby the superstars can fill entire arenas or sell recordings to millions of people.

Their point: income inequality is growing even among the top 10 percent of earners as the superstars and CEOs increase their pay faster than lawyers and investment bankers. But at least the pay of the superstars, lawyers, and investment bankers is market-driven. The pay of CEOs is not.

[Note: However, the study does not recognize the extent to which the markets for superstars, lawyers and investment bankers may impose externalities, and thus even these classes of upper income earners cannot be considered entirely justified. If external costs were factored into, say, investment bankers' and CEOs' compensation (e.g., impacts on public debt, unemployment levels, and reduced output / consumption arising from incompetently structured, speculative, engineered financial products of minimal social utility that contribute to asset bubbles & financial instability) then such compensation would almost certainly be significantly lower. If, in turn, the lowered compensation was redistributed to lower income groups via the tax and transfers systems, or utilized to fund a form of social insurance that benefits middle-class job creation, income inequality would be reduced.]

"CEOs, through compensation committees and inbreeding of boards of directors, have a unique ability to control their own compensation," the authors write. "Furthermore, if a director approves a higher compensation package, that may subsequently lead her to receive more compensation at her own firm."

They cite one study of 1,500 firms that found that the compensation earned by the top five corporate officers in 1993-5 equaled 5 percent of their firms' total profits during that period; by 2000-2, that ratio had more than doubled to 12.8 percent. The trend was caused in equal parts by arbitrary pay decisions by corporate boards and by the showering of stock options on CEOs, they conclude.

Furthermore, the survey cites a study showing "ample evidence that firms work to disguise the magnitude of CEO pay," such as lifetime healthcare, below-market-rate loans, and above-market-rate loans when CEOs defer their compensation, to lessen shareholder outrage.

Such research "is important because it tells shareholders what to expect and where their outrage constraint should be set," the authors write. [Thus my relatively higher hopes for even greater shareholders' rights reforms.]

Controversies about the Rise of American Inequality: A Survey (NBER Working Paper No. 13982) "- Sent using Google Toolbar"

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