I came across this superb lecture (Thanks to Rodrik for the pointer) by Frank Levy (MIT prof) on income inequality in US and the role of institutions. The lecture is basically a short-version of the paperhe coauthored with Peter Temin.
The main idea is:
I want to talk tonight about the role of institutions in achieving a fair distribution of the gains from economic growth. In labor economics today, institutions do not receive much attention. Most attention is reserved for market forces like the impacts of technology and international trade. The work I will discuss tonight does not deny the importance of market forces. But I will argue that institutions – unions, the minimum wage, the tax system, accounting conventions and ultimately the tone set by the government – have the power to either moderate or reinforce the underlying market. I will describe how U.S. institutions abandoned a moderating role sometime after 1975, when market forces were already tending toward greater inequality. In my story, the inequality we see today reflects continued market pressures unhampered by institutional restraint.
He goes on to show how inequality has widened in US. He has an interesting take on the education inequality:
Finally, many people argue that today’s earnings problem is really an education problem – that the labor market is changing and we don’t have enough well educated workers. That is clearly a part of the story – in these figures, you can see the growing gap between college and high school graduates. But you also can see the problem goes deeper since, for example, the compensation of the average 40-year-old man with a bachelor’s degree is not growing in line with productivity. In other words, we can’t seriously talk about an education problem whose solution requires making everyone an MBA, a lawyer or a PhD.
We can see similar things happening in India with incomes accruing mostly to those with fancy degrees. The media generally reports one side of the story that the son/daughter gets more salaries than his/her father who has much more experience. This is usually celebrated. The other side of the story is – rising inequality.
Levy looks at what led to this rising inequality in US and he says it is mainly because of lack of institutions. The abstract of the main paper says:
… the income distribution in each period was strongly shaped by a set of economic institutions. The early postwar years were dominated by unions, a negotiating framework set in the Treaty of Detroit, progressive taxes, and a high minimum wage – all parts of a general government effort to broadly distribute the gains from growth. More recent years have been characterized by reversals in all these dimensions in an institutional pattern known as the Washington Consensus.
What should be done to reduce inequality in US? The answer is a no-brainer- get the institutions back. Though there is no clarity w.r.t to type of institutions. All the paper says is:
Only a reorientation of government policy can restore the general prosperity of the postwar boom, can recreate a more equitable distribution of productivity gains where a rising tidelifts all boats. The precise form of this reorientation is not yet clear.
The authors also have pointed out an interesting thing: most of the gains have actually accrued to the financial sector.
When we say that the top one percent of tax filers now receive something over 17 percent of all taxable income, it will not surprise you that a significant fraction of that top 1 percent comes from the financial sector.
This reminded me of what John Bogle keeps saying in his speeches – the excesses in the financial sector. So many things are linked in economics. It also partly looks at the compensation issues in the financial sector which Raghu Rajan has pointed.
In India, also we need to do similar type of studies. What is driving the inequality in then country. Unlike US, the % of have-nots are expected to be much larger in India. So, if we want to address inclusive growth we may need to take a relook at our labor market institutions.
Mostly Economics 