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Wage Gaps, Inequality, and Government

Tags Free MarketsOther Schools of ThoughtPolitical Theory

10/12/2006William L. Anderson

Perhaps it is human nature for people to decry whatever their situation might be. All of us wish to be better off than we are at the present time, not matter how good the state of our current circumstances.

While that might be so, the supposed "inequality crisis" decried by some economists (and, of course, members of the political classes) does not stem necessarily from human discontent with the nature of scarcity, but rather from the propensity of some to play with aggregate numbers — and call it "economics."

Although the typical American consumer today has more affordable goods from which to choose than any time in this nation's history, that has not stopped some prominent voices from declaring that "unfettered" capitalism is undermining prosperity.

The most prominent voice on this current "inequality crisis" has been Paul Krugman, who from his New York Times editorial page perch has declared that "economic inequality is rising in America." Moreover, Krugman squarely places the "blame" for this state of affairs upon the dominant ideological climate:

I've been studying the long-term history of inequality in the United States. And it's hard to avoid the sense that it matters a lot which political party, or more accurately, which political ideology rules Washington.1

Certainly an issue like "inequality" in the United States will touch a nerve, given that this is a country founded upon a "Declaration of Independence" which declared that "all men are created equal." Yet, people throughout history have understood that all earning power is not equal, and that no matter what a government does, short of killing everyone in the country, that there is going to be some inequality somewhere.

Anyone with even minimal training in economics understands marginal productivity and its effect upon the income one receives for services rendered, and it is a fact of life that some people are going to have skills that will be compensated higher than others.

(If Krugman really were to believe in his own doctrines of "income equality," perhaps he might be willing to accept less pay at Princeton University in order to have other colleagues receive more. If he is not willing to do so, he has no right to demand that others be forced into having their incomes confiscated in the name of equality.)

Adherents of Keynesian theory — and Krugman is one — believe that income inequality ultimately leads to large-scale "underconsumption," which ultimately pulls an economy into a state of low production and high unemployment. The reasoning is as follows:

  • High-income individuals are less likely to spend all or most of their income for consumables, unlike low-income people, and thus have a higher "marginal propensity to save";
  • In the Keynesian system, net savings will always be greater than net investment, which means that some income will "leak" out of the economy;
  • As more income leaks from the economy, overall spending is not high enough for consumers to "buy back" the products they have made. Therefore, inventories pile up as underconsumption takes its toll;
  • Underconsumption then leads to unemployment, and unemployment leads to more unemployment until the economy implodes on its own and settles at a harsh "equilibrium" of low production and high unemployment.

Keynesians believe that because a free market economy is inherently unstable and leads to underconsumption, government must intervene via spending and taxation in order to bring the economy to a state of "full employment."

One strategy, they hold, is for government to impose high marginal income tax rates in order to siphon money from higher-income earners and either transfer that money to lower-income people, or just have government engage in spending either for "massive public works" or some other scheme that will help the economy avoid the pitfalls of underconsumption.

Therefore the "equalization" of incomes through spending and taxation is not, they contend, simply a "feel-good" scheme by which the political classes can claim that they have created "income equality": such policies also serve to keep an economy operating at a higher level than one left to the devices of free markets.

In the Keynesian state of the world, there is no difference between a government and private enterprise when it comes to efficiency and output. In fact, as Krugman notes, in areas such as medical care, government is going to be a lower-cost, higher-output entity than private medicine, since governments do not have to make "profits," which in Krugman's view unnecessarily pull money from the spending stream to go into the pockets of wealthy people, who then save their money and drive an economy into the throes of underconsumption.

It is clear, according to Krugman, that the golden age of income equality in the United States was long ago and can be revived only with policies that favor high, confiscatory tax rates and enforced unionization, as well as other methods of coercion. He writes:

Since the 1920s there have been four eras of American inequality:

The Great Compression, 1929-1947: The birth of middle-class America. The real wages of production workers in manufacturing rose 67 percent, while the real income of the richest 1 percent of Americans actually fell 17 percent.

The Postwar Boom, 1947-1973: An era of widely shared growth. Real wages rose 81 percent, and the income of the richest 1 percent rose 38 percent.

Stagflation, 1973-1980: Everyone lost ground. Real wages fell 3 percent, and the income of the richest 1 percent fell 4 percent.

The New Gilded Age, 1980-?: Big gains at the very top, stagnation below. Between 1980 and 2004, real wages in manufacturing fell 1 percent, while the real income of the richest 1 percent — people with incomes of more than $277,000 in 2004 — rose 135 percent.

What's noticeable is that except during stagflation, when virtually all Americans were hurt by a tenfold increase in oil prices, what happened in each era was what the dominant political tendency of that era wanted to happen.

Franklin Roosevelt favored the interests of workers while declaring of plutocrats who considered him a class traitor, "I welcome their hatred." Sure enough, under the New Deal wages surged while the rich lost ground.

What followed was an era of bipartisanship and political moderation; Dwight Eisenhower said of those who wanted to roll back the New Deal, "Their number is negligible, and they are stupid." Sure enough, it was also an era of equable growth.

Finally, since 1980 the U.S. political scene has been dominated by a conservative movement firmly committed to the view that what's good for the rich is good for America. Sure enough, the rich have seen their incomes soar, while working Americans have seen few if any gains.2

We have another term for what Krugman calls the "Great Compression": It is called the Great Depression — and World War II. In other words, Krugman claims that the Great Depression, a time when the nation's unemployment rates were in double-digits, was a good time for the American "middle class" because, statistically speaking, incomes for wealthy people fell. (Robert Higgs gives us another pictureof the Great Depression and the New Deal that is not as rosy as Krugman's.)

Likewise, we are supposed to believe — if Krugman is an authority — that World War II was a good time for Americans because of "income compression." Again, Higgs presents another pictureof so-called war prosperity:

Many aspects of economic well-being deteriorated during the war. Military preemption of public transportation interfered with intercity travel by civilians, and rationing of tires and gasoline made commuting to work very difficult for many workers. More workers had to work at night. The rate of industrial accidents increased substantially as novices replaced experienced workers and labor turnover increased. The government forbade nearly all nonmilitary construction, and housing became extremely scarce and badly maintained in many places, especially where war production had been expanded the most. Price controls and rationing meant that consumers had to spend much time standing in lines or searching for sellers willing to sell goods at the controlled prices. The quality of many goods deteriorated, as sellers forbidden to raise prices adjusted to increased demands by selling lower quality goods at the controlled prices.

One problem here is that Krugman depends upon "apples and oranges" statistics. One can use things like the Consumer Price Index to "prove" that Americans are worse off today, economically speaking, than they were in 1973, yet if we were to time-travel to that era, most of us would be shocked to discover just how much worse off we were back then compared to today. The US economy has seen great advances in computer technology, which in turn has driven gains elsewhere.

For example, would one today facing major surgery really want to be transported back to the health care of 1973? Perhaps one might want to visit a typical 1973 grocery store and compare the choices people had then to what is available today. (I remember talking long distance that year to a girl I was dating who lived in another city. We talked for two hours on a Sunday evening, and the call cost me $28, or close to $100 in today's dollars. The same call today would have a marginal cost of zero, since I am on a plan for which all local and long-distance calls cost me $30 a month.)

Curiously, Krugman often condemns Wal-Mart in his columns, yet Wal-Mart has provided low-income people with consumer choices that simply would not have been possible in the former "golden ages" of income equality. After all, if the obvious end of production is consumption, then the real measure of economic progress is the number of opportunities that people have to consume and what is available to them.

If Krugman really wishes us to believe that the 1930s was a brighter era, economically speaking, than 2006, he can try to convince us. However, he has been quite inconsistent. In one piece, he writes:

Is the typical American family better off than it was a generation ago? That's the subject of an intense debate these days, as commentators try to understand the sour mood of the American public.

But it's the wrong debate. For one thing, there probably isn't a right answer. Most Americans are better off in some ways, worse off in others, than they were in the early 1970s. It's a subjective judgment whether the good outweighs the bad. And as I'll explain, that ambiguity is actually the real message.

Here's what the numbers say. From the end of World War II until 1973, when the first oil crisis brought an end to the postwar boom, the U.S. economy delivered a huge, broad-based rise in living standards: family income adjusted for inflation roughly doubled for the poor, the middle class, and the elite alike. Nobody debated whether families were better off than they had been a generation ago; it was obvious that they were, by any measure.3

In another article, he says:

Finally, since 1980 the U.S. political scene has been dominated by a conservative movement firmly committed to the view that what's good for the rich is good for America. Sure enough, the rich have seen their incomes soar, while working Americans have seen few if any gains.4

Thus, he seems to believe that people today either are worse off or no better off than they were 30 years ago, and any gains in productivity only accrued to wealthy people. He goes on to say:

The stagnation of real wages — wages adjusted for inflation — actually goes back more than 30 years. The real wage of nonsupervisory workers reached a peak in the early 1970's, at the end of the postwar boom. Since then workers have sometimes gained ground, sometimes lost it, but they have never earned as much per hour as they did in 1973.5

What is the cause of this human misery? According to Krugman, it is so-called conservative ideology. In one place, he writes:

Why have workers done so badly in a rich nation that keeps getting richer? That's a matter of dispute, although I believe there's a large political component: what we see today is the result of a quarter-century of policies that have systematically reduced workers' bargaining power.6

Elsewhere, he declares:

…it seems likely that government policies have played a big role in America's growing economic polarization — not just easily measured policies like tax rates for the rich and the level of the minimum wage, but things like the shift in Labor Department policy from protection of worker rights to tacit support for union-busting.

And if that's true, it matters a lot which party is in power — and more important, which ideology. For the last few decades, even Democrats have been afraid to make an issue out of inequality, fearing that they would be accused of practicing class warfare and lose the support of wealthy campaign contributors.

That may be changing. Inequality seems to be an issue whose time has finally come, and if the growing movement to pressure Wal-Mart to treat its workers better is any indication, economic populism is making a comeback.7

In other words: Prosperity is the creation of the political classes. Should the government levy high taxes on the so-called wealthy, bring back labor union power to the levels that existed in the private sector in the 1940s through the 1960s, and engage in other coercive tactics, we can bring back a "golden age" in economics.

He writes:

That's why the debate over whether the middle class is a bit better off or a bit worse off now than a generation ago misses the point. What we should be debating is why technological and economic progress has done so little for most Americans, and what changes in government policies would spread the benefits of progress more widely. An effort to shore up middle-class health insurance, paid for by a rollback of recent tax cuts for the wealthiest Americans — something like the plan proposed by John Kerry two years ago, but more ambitious — would be a good place to start.8

Indeed, I believe we should be debating why these technological advances have not had even more influence in wiping out poverty, but I would approach it from a different point of view. For the past century, we have seen the advance of the state, and all its coercion. Krugman argues that the way to advance an economy is to give the state nearly unlimited powers.

However, there is another way to put it: Since 1973, we have seen government grab powers, increase taxes, and regulate wealth out of existence. However, despite the growth of government and the continued debasement of the once-proud dollar by the Federal Reserve System, entrepreneurs and producers have still managed to make breathtaking achievements and to provide opportunities for others.

Now, Krugman actually seems to believe that the way to prosperity is to destroy wealth, regulate firms like Wal-Mart out of existence, and make it more difficult and costly to produce goods. (He seems to labor under the delusion that higher factor costs mean that more wealth is being created.) Yet, that argument is nonsense, and it is nonsense on its face.

Income equality and prosperity are not the same things. It is theoretically possible for the state to make all incomes equal; Lenin and his cohorts tried to do that in Russia from 1917-1921, and we know the horrific results of that experiment. Yet, if Krugman is to be believed, we would have to assume that 1917-1921 was a golden age for the Russians, rather than a time of war, famine, and death.

  • 1. Krugman, Paul. "Wages, Wealth and Politics," New York Times, August 18, 2006, A17.
  • 2. Ibid.
  • 3. Krugman, Paul. "Progress or Regress?" New York Times, September 15, 2006, A25.
  • 4. Ibid., August 18, 2006.
  • 5. Krugman, Paul. "The Big Disconnect," New York Times, September 1, 2006, A17.
  • 6. Ibid.
  • 7. Ibid., August 18, 2006.
  • 8. Ibid., September 15, 2006.

Contact William L. Anderson

William L. Anderson is Senior Editor at the Mises Institute and professor emeritus of economics at Frostburg State University in Frostburg, Maryland.