Pethokoukis, Economics, U.S. Economy

Is rising income inequality actually a good sign for the economy?

Image Credit: Robert Gordon

Image Credit: Robert Gordon

Economist Robert Gordon paints a gloomy picture of America’s economic future with his provocative paper “Is U.S. economic growth over?” In addition to sniffing at the recent pace and quality of innovation today vs. America’s golden age — they produced the internal combustion engine, we produced Twitter — Gordon points to several other headwinds, including income inequality, that will prevent a fast rise in American living standards. (This is the counterargument to “The robots will take all our jobs.”)

As Gordon explained in a WSJ op-ed:

And inequality in America will continue to grow, driven by poor educational outcomes at the bottom and the rewards of globalization at the top, as American CEOs reap the benefits of multinational sales to emerging markets. From 1993 to 2008, income growth among the bottom 99% of earners was 0.5 points slower than the economy’s overall growth rate. If future output grows, as I expect, at a rate of just 1% a year, that means the overwhelming majority of Americans will see their incomes grow just 0.5% annually.

Others have argued that Gordon is seriously misunderstanding and underestimating an IT revolution still in its infancy. In fact, the rise in income inequality may provide some proof of that fact. David Altig, research director at the Atlanta Fed, points to a 15-year-old paper by economists Jeremy Greenwood and Mehmet Yorukoglu:

Greenwood and Yorukoglu go on to assess, in detail, how durable-goods prices, inequality, and productivity actually behaved in the first and second industrial revolutions. They conclude that game-changing technologies have, in history, been initially associated with falling capital prices, rising inequality, and falling productivity. …

Greenwood and Yorukoglu conclude their study with this pointed question: “Plunging prices for new technologies, a surge in wage inequality, and a slump in the advance of labor productivity – could all this be the hallmark of the dawn of an industrial revolution? Just as the steam engine shook 18th-century England, and electricity rattled 19th-century America, are information technologies now rocking the 20th-century economy?”

I don’t know (and nobody knows) if the dark-before-the-dawn possibility described by Greenwood and Yorukoglu is the apt analogy for where the U.S. (and global) economy sits today. But I will bet you there was some commentator writing in 1870 who sounded an awful lot like Professor Gordon.

Here is a bit more from Greenwood and Yorukoglu:

A simple story is told here that connects the rate of technological progress to the level of income inequality and productivity growth. The idea is this. Imagine that a leap in the state of technology occurs and that this jump is incarnated in new machines, such as information technologies. Suppose that the adoption of new technologies involves a significant cost in terms of learning and that skilled labor has an advantage at learning. Then the advance in technology will be associated with an increase in the demand for skill needed to implement it. Hence the skill premium will rise and income inequality will widen. In the early phases the new technologies may not be operated efficiently due to a dearth of experience. Productivity growth may appear to stall as the economy undertakes the (unmeasured) investment in knowledge needed to get the new technologies running closer to their full potential. The coincidence of rapid technological change, widening inequality, and a slowdown in productivity growth is not without precedence in economic history.

Of course, one difference between then and now could be our inability to raise the level of human capital needed to catch up with “game changing” innovation. But the rise in income inequality could help make the case that we have been experiencing rapid technological change and not suffering through a “great stagnation.”

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