Friday, October 12, 2007

The Rich Get Richer - for now

News out today about growth in income inequality tells us that through 2005, the wealthiest among us got even wealthier. The rich got richer, the poor poorer, the middle closer to the bottom. Actually, that’s not really what the data show. The true message is that a higher percentage of the total of all incomes went to the top 1% of the earners. Whether they kept any of that income is not in the data, so they may or may not be “wealthy.” If you want the details, you can find them all over the wires, including on this blog: .

The income data explain why the middle class is uneasy about the economic outlook while others feel everything is just fine. The share of the national profits that went to high earners grew (for them, everything is fine), which means the share that went to everyone else fell (things are not so good). Some argue this is because those with high-level skills can gain scale economies from these skills through the globalization of the economy (the argument from the right). Maybe. Or maybe the political machine has been used to benefit high earners more than low earners (the argument from the left). I think some of both, plus some other factors that someone should research (and I am sure someone will).

As I began analyzing this news, my mind went off in so many different directions that I have a scratchpad of notes that could provide blog fodder for a week. Issues include tax policy, executive compensation, national competitiveness, social fairness, immigration, and so on. I decided that I should focus on one discrete issue at a time, and picked the economies of scale argument as a starting point. (Maybe I’ll come back to some of the others in another post.) Here goes.

Truth be told, I kind of like the economies of scale argument. It makes some intuitive sense to me and relates to other issues I have written about lately. If your skills are suddenly in demand from many more customers (the world is flat!) and nobody else has learned to do what you do (or has the required resources at their command), according to the laws of supply and demand your skills should be worth more. If this is the reason for the higher share of income going to the wealthy, then the top earners better watch out! You know what happens in a global free market? Price (the high price of your skills) signals profitable demand and, as a result, people allocate resources to learning to do what you do. Supply goes up, price (the value of your skills) goes down. Right now you may be very valuable, but as those millions of students in China and India learn to do what you do, you may become less valuable.

It seems to me that this trend is already evident. Skills that take less time to learn, such as manufacturing and programming, have already moved to other markets. Just ask the UAW about this. I believe the same trend is happening in some areas of the high-earner industries, although many are in denial. It may just be that it has taken longer for global competition in high earner industries to develop due to lags in education or financial infrastructure.

Lets take Wall Street as an example, where high earners abound. There is concern on Wall Street that the United States is becoming less competitive in the business of underwriting. Our market share is in decline. What could be wrong? Well, Wall Street rallied the politicians who commissioned studies to determine why we are losing market share. They concluded that there are lots of reasons why, but THE FACT THAT WALL STREET CHARGES ABOUT TWICE THE FEES AS CHARGED IN OTHER MARKETS has nothing to do with it (they are in denial). I have written on this before, and if you would like the full commentary you can find it here: I suspect someone who writes full time will fully research this issue at some point, and I look forward to the result.

Wall Street is used to charging high fees because for decades they have had the only game in Globaltown. The global market for financial resources has, however, begun to mature and Wall Street is no longer the bouncer at the only club in town. If you don’t like the cover charge you can go down the street (or across the pond). As capital accumulates in other markets, financial talent follows it. These markets will naturally compete with our markets, and more competition leads to lower prices. Supply and demand - remember that’s why Wall Street salaries are high to begin with. So why is Wall Street losing market share? Because Wall Street charges too much given its loss of the monopoly it has had for so long. Does this sound like Xerox? Yup.

To stay competitive Wall Street will likely need to lower its price and this means less money for the high earners on Wall Street. So it appears to me that Wall Street may just be a few years behind Main Street. For other professionals such as corporate executives who reap huge benefits from running concentrations of shareholder investment, it will probably take longer to suffer any competitive impact. They are, to some extent, insulated from competition for their positions because they have some control over the process (that argument from the other side). Likewise, attorneys (another high earner group) still have barriers to entry as against global competitors because attorneys must be admitted to practice in the United States. But if Wall Street lowers prices, they may put pressure on their lawyers to follow suit. I am beginning to feel some pain.

Since Wall Street makes up a large portion of those top earners, the latest trend in earnings may soon reverse course. The reported data is from 2005, and I wonder what it will look like for 2008.

Back to the scratchpad. Maybe I’ll wait and try to decipher some of the (other) inevitable babble that will follow this news.
(c) Mark Palermo, 2007

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Anonymous said...

Wall Street meets globalazation,it's gonna hurt :)

As a manufactuer (33 years) of stuff that hurts when it hits your foot, I can only say welcome to the club ;)

Anonymous said...

It’s a simple matter of mathematics, there’s only one planet and so only a finite amount of resources and so wealth. As some regions come up others have to come down. What a fine time to think about starting a family.