Friday, August 27, 2010

Only The Talented Tenth Have The Skills To Pay The Bills?

Raghuram Rajan has one of the more interesting theories of the financial crisis: he thinks inequality happened; that politicians addressed inequality by expanding the lower- and middle-class’s exposure to debt; that that debt blew the system up. It’s a neat, attractive theory in many ways, and it leads him to focus on education as a panacea.

While I’m not against education by any means, or improving education, I do think that Rajan’s take is a false trail. Here’s his point on inequality:
Since 1968, income inequality has been steadily increasing in the United States. I am not referring to the Croesus-like income of a John Paulsen, the hedge fund manager who in 2008 netted over $3 billion, about 75,000 times the average household income. I refer to a more worrying everyday phenomenon that confronts most Americans, the disparity in income growth rates between a manager at the local supermarket and the typical factory worker or office assistant. Since the 1970s, the wages of the former, typically workers at the 90th percentile of the wage distribution in the United States, have grown much faster than the wages of the latter, the typical median worker. Or consider the table below, which shows that the wages of occupation groups that are paid more than the national average in 2002 have grown much faster since then than the wages of occupation groups below the average…
And let’s reproduce the graph he uses here:

See that graph? I think it undermines his entire point. Is the top 10th percentile really that much more talented than the 10th-25th percentile? You’d have to believe that for Rajan’s theory to make sense—after all, his graph that his entire argument rests upon has the upper tenth making 2.4% more in wage gains from 2002-8 than the fifteen percent just below that. Does it have that many more skills? I’m very skeptical of that account. (Also, since I’ve never really seen the data presented in this way—you could make the case that the upper tenth didn’t get that great a deal from the inequality years either. 1.7% gain in 6 years…is not very good. I’ll have to look at the data elsewhere, but I suspect that comparatively it doesn’t stack up well, when you compare it either to the past or to peer countries.) And of course what Rajan’s graph obscures is that the top 1% made out better than the 9% just below them. Again, I think you’d be hard pressed to argue that the difference between those two groups in talent is really that large, and (of the ones who are that much more talented) this isn’t really reproducible.

So while I agree that inequality is one of the root causes of the crisis, I can’t agree with the prescription: I’d argue the prescription happens to be…health care and stiff financial reform. (Education reform, while a great idea to do well, is not strictly relevant to this exact argument.)

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