Monday, November 5, 2007

Income Inequality in Oregon

The Oregon Center for Public Policy recently released a report on rising income inequality in Oregon. I am taking their data on face value, but the Oregon data they present broadly mirror the national trend: income inequality has increased dramatically in the last few decades. There is a raging debate among economists over two main related questions: One, is the rising inequality simply a matter of ever increasing returns to education, especially at the higher levels? Two, is this rising inequality then a matter of simple natural economic forces, or is it being driven by policy?

Let me try and describe both very briefly. As the US economy evolves into a more service and IT driven economy, the returns to higher education compared to a high school diploma, say, are becoming more and more divergent. Since jobs in high tech areas tend to be very high productivity and ever increasingly so, while jobs that require a high school diploma tend to not be very productive and that productivity has not increased much in the last 30 years (think waiters, mechanics, sales people, etc). Thus the returns to these jobs are also diverging as they are related to the productivity of the workers themselves. Few economists dispute these basics, but the debate rages over whether this is enough to explain such a high divergence in incomes. The million dollar question is if this is a result of the natural maturation of the economy or a bi-product of long-standing government policies toward free trade, labor unions, education, corporate taxes and regulation, etc. (I will assert that I agree with many economists who point out that income inequality is also severe before taxes as it is after taxes, so current tax policy is not a good or complete explanation

These debates are mostly centered around national policy because most of this is a national, economy-wide, story. But the answers to these questions are critical because the 'natural evolution of the economy' story suggests that it is not a problem in the sense that government should get involved directly, while the policy story suggests that government is already involved directly and should figure out what policies are creating this divergence and try to change them. I believe that regardless of the true causal link, there is one thing that is clear in the modern economy: to an every increasing degree the path to prosperity is through education and the government is failing badly in this arena. In fact I believe that in my lifetime, without serious refocusing on both K-12 and college education, the U.S. will loose its place as the world's leader in new technological innovations, new markets and new industries. What is not as clear is how active the government should be in income redistribution. There is always a trade off between reducing incentives and lowering investment versus the drag on the economy that a large population of impoverished individuals imposes. But there is also a bigger question about whether increasing inequality threatens our democracy over the long run. I fear that we are already seeing signs of both the economic drag and the political polarization I would expect in the face of increasing income inequality. I don't think we can afford to ignore it any more.

(NB: I will present an economic theory that suggests one partial explanation for the huge increase of incomes at the top of the distribution later this week).

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