Three Misconceptions About Inequality
Concern about inequality in the U.S. is getting well-deserved attention. Unfortunately, though, discussions of the problem too often rest on three misconceptions: that capital is rising as a share of the economy, that most of the rise in wage inequality is explained by growing gaps within companies between higher and lower paid workers, and that workers are increasingly moving from one job to another.
All three of these notions are wrong, to varying degrees: Capital outside of housing and land has not increased in the U.S. relative to the economy. Most of the increase in wage inequality has occurred between companies, not within them. And people are less, not more, likely to switch jobs today than they were in the past.
The piece of this that might hold the most potential to explain all the misunderstanding is that companies have diverged in their productivity and profit rates. And that in turn could signal the rise of “economic rents” -- for example, profits at some companies well in excess of what's necessary to keep them in the market. Such windfall gains to some firms (and workers) may underlie the whole three-part puzzle.
During roughly the same period, the return on invested capital -- that is, how much profit is generated for each dollar of investment -- also grew more unequal between companies. While the typical return was roughly constant, at about 10 percent, returns became more dispersed over time.
In particular, from 1965 to 1967, only 1 percent of non-financial firms earned returns of 50 percent or more, but from 2005 to 2007, 14 percent did. In other words, 50 years ago, one out of 100 firms earned 50 percent returns. More recently, one out of seven did.
These data suggest three things: First, the typical return to capital hasn't changed much, which is what you would expect, given that the capital-output ratio excluding land and housing has been stable.
Second, from company to company, that return has become much more unequal, as has productivity. Some of this inequality between companies in returns and productivity tends to spill over into wages. And this is precisely what we've seen. It explains more of the rise in overall earnings inequality than does the increased gaps between the pay of higher earners and rank-and-file workers within a given company.
Finally, workers at the high-paying, high-return, high-productivity companies are not motivated to leave, so entry into jobs at those companies may be limited. This reduces aggregate job turnover.
This alternative narrative may have a few holes -- as it is cobbled together from different pieces of information -- but it at least deserves more attention. (Note that even if it can help to explain inequality, it can’t explain wage stagnation, which is often conflated with inequality.)
The most troubling aspect of this narrative, by the way, is that much of what the increasingly profitable companies are earning may exceed what’s necessary for them to continue producing their goods or services.
The McKinsey & Co. team that documented the rise in super-high returns noted, “In many cases, this improvement has occurred in industries with strong barriers to entry, such as patents or brands where gains that companies have made from decreased raw-material prices and increased productivity have not been transferred to other stakeholders.” The rise in housing and land values, which explains the entire rise in the ratio of capital to output, may represent yet another form of windfall gains.
Thus, as Joseph Stiglitz has said, our understanding of growing inequality “requires a greater understanding of rents, what gives rise to them, and how they evolve over time.”
For all the concern that has been focused on the problem of inequality, this understanding of the role played by windfalls and company-to-company inequality has received shockingly little attention.
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
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