Sunday, December 9, 2012

Paul Krugman Has Changed His Mind About An Important Problem

As labor gets more expensive in developing countries, some firms are shifting production back to developed countries.  This will only have a small impact, however, on job growth because a lot of the intermediate products that are assembled into final products are made with robots.  This caused Krugman to rethink some of his assumptions about the causes on income inequality.  Economists have assumed that those with more education and better skills are awarded a skill based premium in the labor market, and that is responsible for income inequality. We should address income inequality by expanding educational opportunity.  He then looks at a graph that shows that wage compensation has been a shrinking share of income for the last several years.  More of the income has been going to owners of capital. That implies that the ownership of capital may be a determinant of income inequality.  That will limit economic opportunity because capital is passed on from one generation to another.  Reducing or eliminating  estate taxes has amplified that problem. This is new territory for economists who explain income inequality on differences in educational attainment.

I posted an article yesterday on the differences in income between hedge fund managers and full professors at Harvard.  Five hedge fund managers employed by the Harvard endowment, earn almost as much as the total income of 450 full professors at Harvard.  It is hard to explain that kind of income difference by appeals to the lack of education or skills among Harvard's illustrious faculty.  Hedge fund managers have a unique set of skills.  They know how to make money by betting on changes in asset prices, and by leveraging those bets with borrowed money.  We reward those skills more than we do the skills of those who create knowledge, and pass on knowledge to future generations.  We also reward those who are skilled at forming a business based upon the inventions of scientists or engineers who created the knowledge that was essential for the development of products and services provided by the business.  The founders of the business end up owning a valuable asset.  The scientists and engineers may get a small share of the equity and a good salary. Betting on asset price changes, or the ownership of appreciating assets, is the path to high incomes and wealth.

It is also easier to get rich by purchasing assets at low prices than it is by building a business through one's labor.  That is how the oligarchs in Russia got rich, and that is how many got rich through the ownership of natural resources that they acquire from governments at below market prices.

This discussion about income, and the acquisition of wealth, raises serious questions about the assumption in economics that income growth is closely related to growth in social welfare.

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