The Kuznets Curve and Inequality over the last 100 Years

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel first started being given in 1969, the backlog of worthy economists who were deserving of the prize was very large. Thus, it was a considerable compliment when the third Nobel prize given in economics went to Simon Kuznets in 1971. Among other major contributions, Kuznets was one of the primary contributors to thinking through the issues of constructing national income accounts and GDP. But my focus here is on a theory which grew out of his Presidential Address on \”Economic Growth and Income,\” delicvered to the American Economic Association in 1954 and published in the March 1955 issue of the American Economic Review. This lecture led economists to speak of a \”Kuznets curve.\”

Here\’s a short explanation of the logic behind the Kuznets curve from Branko Milanovic in the September 2011 issue of Finance and Development has several articles with perspectives on inequality. \”The Kuznets curve, formulated by Simon Kuznets in the mid-1950s, argues that in preindustrial societies, almost everybody is equally poor so inequality is low. Inequality then rises as people move from low-productivity agriculture to the more productive industrial sector, where average income is higher and wages are less uniform. But as a society matures and becomes richer, the urban-rural gap is reduced and old-age pensions, unemployment benefits, and other social transfers lower inequality. So the Kuznets curve resembles an upside-down `U.\’\”

In 2011, of course, the notion that inequality always declines as an economy grows no longer seems plausible. Later in the same issue, Facundo Alvaredo offers some nice figures of trends in inequality around the world since about 1900, where inequality is measured by the share of total income going to the top 1% of the income distribution. There are four figures, each with a group of countries. \”In Western English-speaking countries, inequality declined until about 1980 and then began to grow again. Continental European countries and Japan had a decline until about 1950; since then income distribution has leveled. For Nordic and Southern European countries, the drop in inequality in the
early part of the century was much more pronounced than the rebound in the late part of the period. Developing countries show initial declines in inequality followed by a leveling off in some cases and an increase in inequality in others.\”

For a series of posts in July on the extent and causes of U.S. income inequality, see:

How high is U.S. income inequality?

Causes of Inequality: Supply and Demand for Skilled Workers

How the U.S. Has Come Back to the Pack in Higher Education

An Inequality Parade

Prenatal Inequality

Douglas Almond and Janet Currie discuss \”Killing Me Softly: The Fetal Origins Hypothesis,\” in the Summer 2011 issue of my own Journal of Economic Perspectives. They begin (parenthetical citations deleted throughout):

In the late 1950s, epidemiologists believed that a fetus was a “perfect parasite” that was “afforded protection from nutritional damage that might be inflicted on the mother.” The placenta was regarded as a “perfect filter, protecting the fetus from harmful substances in the mother’s body and letting through helpful ones.” Nonchalance existed with regard to prenatal nutrition. During the 1950s and 1960s, women were strongly advised against gaining too much weight during pregnancy. During the baby boom, “pregnant women were told it was fine to light up a cigarette and knock back a few drinks.” Roughly half of U.S. mothers reported smoking in pregnancy in 1960.

But what if the nine months in utero are one of the most critical periods in a person’s life, shaping future abilities and health trajectories—and thereby the likely path of earnings? This paper reviews the growing literature on the so-called “fetal origins” hypothesis. The most famous proponent of this hypothesis is David J. Barker, a British physician and epidemiologist, who has argued that the intrauterine environment—and nutrition in particular—“programs” the fetus to have particular metabolic characteristics, which can lead to future disease.\”  

Almond and Currie offer a thoughtful overview of the evidence that a wide array of environmental factors may have long-run effects not only on health, but also on economic outcomes like wages. These environmental factors that can affect fetal development include both extreme situations like famine, but also milder environmental factors like infectious diseases, exposure to pollution, maternal diet, and even severe weather during a pregnancy. Thinking through what constitutes cause-and-effect evidence for these issues often involves a search for a natural experiment. Two of the points they make about the implications of their argument as a whole, several points struck me with particular force:

1) There\’s a long-standing argument in the social sciences about nature vs. nurture, but arguments over genetic influence are getting a lot more complex these days than what I learned back in grade-school about Gregor Mendel and his pea plants. The current subject of epigenetics explores how the same genes can lead to different characteristics. As Almond and Currie write in this context about fetal effects: \”[T]he hypothesized effects reflfl ect a specific biological mechanism, fetal “programming,” possibly through effects of the environment on the epigenome, which are just beginning to be understood. The epigenome can be conceived of as a series of switches that cause various parts of the genome to be expressed—or not. The period in utero may be particularly important for setting these switches.\”

2) While this literature is still young and growing, it could turn out to be true that one of the most important ways to help children is to help their pregnant mothers. Almond and Currie write: \”[O]ne of the most radical implications of the fetal origins hypothesis may be that one can best help children (throughout their life course) by helping their mothers. That is, we should be focusing on pregnant women or perhaps even women of child-bearing age if the key period turns out to be so early in pregnancy that many women are unaware of the pregnancy. Such pre-emptive targeting would constitute a radical departure from current policies that steer nearly all healthcare resources to the sick, i.e., the “pound of cure” approach. That said, the existing evidence is not sufficient to allow us to rank the cost-effectiveness of interventions targeted at women against more traditional interventions targeted at children, adolescents, or adults.\”

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The "American Dream"

The pollster John Zogby writes on the Forbes blog about some of his recent results on what Americans are thinking about their ability to achieve the \”American dream.\” 

Zogby writes: \”In an interactive poll taken immediately after Obama’s 2008 election, 68% of adults said it is possible for them and their families to achieve the American Dream, and 18% said it did not exist. Almost as many (62%) agreed most middle class families could achieve it. Our poll taken a week ago showed 49.7% believing the dream was achievable for their families, 30% saying it did not exist and 44% agreeing it is achievable for most middle class families. … There was little change over three years in how people defined the American Dream. In 2008, 38% defined it as material goods and 43% said it was spiritual happiness. Now, 40% choose the material and 37% spiritual. Above I suggested our loss of national confidence is about more than just economic well-being. The reason is our finding that those who define the American Dream as material are only slightly more likely to say it doesn’t exist than are those who define it as spiritual happiness. It seems we have both an economic and psychological recession.\”
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But just what is the \”American Dream\”?  The phrase “the American Dream” was coined by a Pulitzer prize-winning historian named James Truslow Adams in his 1931 book The Epic of America. Truslow described the American Dream in this way (pp. 415-416) :

\”But there has been also the American dream, that dream of a land in  which life should be better and richer and fuller for every man, with opportunity for each according to his ability or achievement. It is a difficult dream for the European upper classes to interpret adequately, and too many of us ourselves have grown weary and mistrustful of it. It is not a dream of motor cars and high wages merely, but a dream of social order in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position. I once had an intelligent young Frenchman as a guest in New York, and after a few days I asked him what struck him most among his new impressions. Without hesitation he replied, \”The way that everyone of every sort looks you right in the eye, without a thought if inequality.  Some time ago a foreigner who used to do some work for me, and who had picked up a very fair education, occasionally sat and chatted with me in my study after I had finished my work. One day he said that such a relationship was the great difference between America and his homeland. There, he said, \”I would do my work and might get a pleasant word, but I could never sit and talk like this. There is a difference there between social grades which cannot be got over. I would not talk to you there as man to man, but as my employer.\”\”

\”No, the American dream that has lured tens of millions of all nations to our shores in the past century has not been a dream of merely material plenty, though that has doubtless counted heavily. It has been much more than that. It has been a dream of being able to grow to fullest development as man and woman, unhampered by the barriers which had slowly been erected by older civilizations, unrepressed by social orders which had developed for the benefit of classes rather than just for the simple human being of any and every class. And that dream has been realized more fully in actual life here than anywhere else, though very imperfectly even among ourselves.\”

Adams puts this idea of the \”American dream\” at the center of his description of telling the American narrative and describing what it means to be an American (p. 174):

\”If Americanism in the above sense has been a dream, it has also been one of the great realities of American life. It has been a moving force as truly as wheat or gold. It is all that has distinguished American from a mere quantitative comparison in wealth or art or letters or power with the nations of old Europe. It is Americanism, and its shrine has been in the heart of the common man. He may not have done much for American culture in its narrower sense, but in its wider meaning it is he who almost alone has fought to hold fast to the American dream. This is what has made the common man a great figure in the American drama. This is the dominant motif in the American epic.\”

The Zogby poll tells us that more people are feeling discouraged in July 2011 than in November 2008, which isn\’t an enormous shock given the Great Recession and the Long Slump that has followed. I\’m dubious that the survey tells us much about the \”American dream\” in the broader sense of James Truslow Adams, which includes material well-being and personal happiness, but also includes some broader issues: opportunity to shape one\’s destiny;  when social order means less and individuals mean more; when social equality is a common presumption in a way that reaches beyond equal treatment before the law; and when the successes and failures of the country are judged by how they affect everyday people.

An Inequality Parade

I\’ve posted recently on How high is U.S. income inequality?  I followed up with posts on about Causes of Inequality: Supply and Demand for Skilled Workers and How the U.S. Has Come Back to the Pack in Higher Education. Here\’s one more metaphor on the subject. Back in its January 20, 2011 issue, the Economist magazine had one of its wonderfully readable surveys that touched on many issues of inequality, called \”A special report on global leaders: The rise and rise of the cognitive elite.\” The entire article is worth reading, but here is a striking way to visualize U.S. income inequality.

\”Jan Pen, a Dutch economist who died last year, came up with a striking way to picture inequality. Imagine people’s height being proportional to their income, so that someone with an average income is of average height. Now imagine that the entire adult population of America is walking past you in a single hour, in ascending order of income.\”

\”The first passers-by, the owners of loss-making businesses, are invisible: their heads are below ground. Then come the jobless and the working poor, who are midgets. After half an hour the strollers are still only waist-high, since America’s median income is only half the mean. It takes nearly 45 minutes before normal-sized people appear. But then, in the final minutes, giants thunder by. With six minutes to go they are 12 feet tall. When the 400 highest earners walk by, right at the end, each is more than two miles tall.\”

Causes of Inequality: Supply and Demand for Skilled Workers

Last week I posted on how measures of U.S. income inequality have evolved over time. There, I ducked the question of why this has happened. In \”The Undereducated American,\” a report that came out last month from the Georgetown University Center on Education and the Workforce, Anthony P. Carnevale and Stephen Rose offer a nice synopsis of the answer economists give most often.

They write: \”The relative wages of college-educated workers have been rising much faster than the wages of
people with a high school diploma. The laws of supply and demand are the best single indicator of whether the United States is producing enough, too few, or too many college graduates. If the relative earnings of college-educated workers rise faster than the earnings of their counterparts, it means the demand is growing faster than supply. The data, therefore, are unequivocal—Americans are undereducated.\”

To illustrate this theme, they present a couple of useful figures from the 2008 book by Claudia Goldin and Larry Katz: The Race Between Education and Technology. The first figure shows how supply and demand of college-educated workers has evolved over time, compared to the 1970 levels. The general pattern is that demand for these skilled workers was ahead of supply in the 1920s, supply then went ahead of demand most of the time up until about 1980, and since then demand for skilled labor has outstripped supply.

The next figure shows the \”wage premium\”–that is, how much more is skilled labor paid over unskilled labor. In this figure, “skilled labor” is defined as all holders of four-year college degrees and graduate degrees, plus one-half of those with some postsecondary education, while \”unskilled labor” those who did not complete high school, those with only a high school degree, and the other half of those with some postsecondary education.

When demand for skilled labor outstrips supply, then the wage premium for skilled labor is high. When supply outstrips demand, the wage premium for skilled labor drops. This is a powerful explanation for why inequality of incomes has changed over time.

But while I\’m sure this argument is a lot of the explanation for rising inequality, maybe most of the explanation, other issues play a role as well. For example, the demand for skilled and unskilled labor is also affected by factors like the great advances in information and communications technology in recent decades, and by the  ability of firms to outsource some kinds of production to other countries. In addition, the evidence on income inequality from my post last week suggests that a lot of the rise in inequality is because of gains going to the very top of the income distribution--not necessarily broadly distributed to all of those with a higher level of education. So puzzles about the causes of inequality remain. 

How high is U.S. income inequality?

When looking for statistics on U.S. income inequality, my standard starting point is the data from the U.S. Department of the Census, which shows the share of income received by each quintile (that is, each fifth) of the income distribution, as well as the share received by the top 5% of the income distribution.
(Specifically, see Table F-2 at this link.)

The basic story is that the income distribution didn\’t move too much from the mid-1950s up to about the mid-1970s; indeed, when I was learning economics in college in the late 1970s and early 1980s, a rule of thumb was that the U.S. income distribution was essentially stable. But since then, the share of income going to the top fifth has risen substantially, from 40.7% of all income in 1975 to 48.2% of all income in 2009. That increase of 7.5 percentage points is almost all traceable to the top 5%, which saw its share of total income rise by 5.8 percentage points over this time–that is, from 14.9% of total income in 1975 to 20.7% of income in 2009. Over this time, the \”fourth fifth\” of the income got a slightly smaller share, and the bottom three-fifths all saw a substantial decline in their share of total income.

In an essay in the March 2011 issue of the Journal of Economic Literature, Anthony Atkinson, Thomas Piketty, and  Emmanuel Saez write about \”Top Incomes in the Long-Run of History.\” (An ungated version of the paper is available at Saez\’s website here.) They use tax data to construct estimates of income inequality in the U.S. and other countries going back to early in the 20th century. The tax data isn\’t directly comparable to the Census data just mentioned, but it\’s the only reliable source of data on the very top of the income distribution going back this far in time. The paper is long and chock-full of insights, but here are a few of their basic facts on U.S. income equality over time.

First look at the share of income going to the top decile–that is, the top tenth–of the income distribution. This follows a U-shaped pattern: after rising in the 1920s, the share of income going to the top tenth drops in the Depression, stays relatively fixed from the 1940s up through the 1970s, and rises since then.

Now, break down that top tenth into three parts: the top 1%–the solid triangles in the graph; the next 4%– that is, from the 95th up to the 99th percentile–which is the hollow triangles in the graph; and the next 5% after that–that is, from the 90th to the 95th percentile–which is the hollow diamonds in the graph. It turns out that most of the increase in the share of income received by the top 10% is actually a rise in the share being received by the top 1%.

Finally, look not at the top 1%, but at the share of income received by the top one-tenth of 1%. Remarkably, it turns out that a large share of the growth in inequality is because of growth in the share of income received by this tiny sliver of the income distribution.

How bothersome is the level of inequality we have reached in the United States, and the concentration of that inequality in the extreme upper part of the income distribution? There is of course great controversy on this point. After all, these figures are annual snapshots, and don\’t show mobility across income levels between years. Probably the top 0.1% of the income distribution varies considerably from year to year, depending on which executives are cashing in a lifetime\’s worth of stock options in a single year. At the bottom end of the income distribution, income statistics don\’t take into account the value of \”in-kind\” transfers like Medicaid, Food Stamps, or vouchers for low-income housing. There are questions about how well tax data captures the overall income distribution at different historical points in time. There are a variety of arguments over why this trend toward great inequality has happened, many of them emphasizing how changes in information and communications technology have allowed those with high skills to increase their earnings.

For now, I\’ll duck these issues and controversies , and just let the fact that I think these data are worth presenting speak for itself. We can debate what the facts mean, but it IS a fact that in historical terms, U.S. income inequality is currently very high, about as high as it has been in the last century. It is also a fact that most of that change in inequality is because of a larger share of income going to the very top of the income distribution. 

Not What You Know or Who You Know, But Where You Work

Since the 2009 World Development Report on \”Reshaping Economic Geography\” was published, I\’ve had the opening paragraphs up on the bulletin board outside my office door, as food for thought for those passing by. 

\”Place is the most important correlate of a person’s welfare. In the next few decades, a person born in the United States will earn a hundred times more than a Zambian, and live three decades longer. Behind these national averages are numbers even more unsettling. Unless things change radically, a child born in a village far from Zambia’s capital, Lusaka, will live less than half as long as a child born in New York City—and during that short life, will earn just $0.01 for every $2 the New Yorker earns. The New Yorker will enjoy a
lifetime income of about $4.5 million, the rural Zambian less than $10,000. A Bolivian man with nine years of
schooling earns an average of about $460 per month, in dollars that reflect purchasing power at U.S. prices. But the same person would earn about three times as much in the United States. A Nigerian with nine years of education would earn eight times as much in the United States than in Nigeria. This “place premium” is large throughout the developing world. The best predictor of income in the world today is not what or whom you know, but where you work.\”

I think I work hard. Lots of Americans think they work hard. But when you compare the economic situation of modern America with the rest of the world, or with long-ago history, then (in a phrase commonly attributed to the old football coach Barry Switzer) we\’re all born standing on third base, congratulating ourselves for hitting a triple.