Causes of income inequality in the US

Question

I read an article in BusinessWeek that talked about income inequality in the US.

The article attributed the difference to the Intel chip that came in 1971. Since that time big hi-tech companies have grown in US, which caused income growth among wealthy people and also didn't lead to a relatively large growth in jobs because a lot of work was outsourced to places like China.

To what extent is this explanation valid in the US... or is it insignificant in accounting for the income differences between the rich and the poor?

Answer 1

The reason you bring forward belongs to technological directed change, which is regarded one of the main explanations for wage growth differentials. Keep in mind it's not exactly the way you're phrasing it: The growth in tech companies rewards people who are skilled well for their kind of jobs (as opposed to "wealthy people").

Card and DiNardo have a nice summary article on the issue:

The recent rise in wage inequality is usually attributed to skill-biased technical change (SBTC), associated with new computer technologies. We review the evidence for this hypothesis, focusing on the implica- tions of SBTC for overall wage inequality and for changes in wage differentials between groups. A key problem for the SBTC hypothesis is that wage inequality stabilized in the 1990s despite continuing ad- vances in computer technology; SBTC also fails to explain the evo- lution of other dimensions of wage inequality, including the gender and racial wage gaps and the age gradient in the return to education.

Answer 2

One of the very fast explanation would be made by canonical growth model of Robert Solow.

In this model, the countries with different levels of saving converge to their own steady state (convergence clubs), which means that countries with different savings rate would have different steady states. (so the capital level $K$ and income level $Y$ would be different.) In this case, with capital accumulation, there would be an income inequality. This can be a basic theoretical explanation.

Also, there exists some growth models with technological progress. For example, the South-North economic model. Basically, north is supposed to create the technology by investing in high-tech and there exists some spillovers from North countries to South countries. (You can easily find the formal mathematical model in literature.) By this simple model, there exists a divergence of economies in terms of their steady state levels of capital and income.

Also, there exists another recent findings of Thomas Piketty which states the famous equality $r>g$ which says that interest rates have been higher than the growth rates of economies, which basically states that people having money have earned more money.

Edit : All points mentionned above is about the inequality between countries but at some point, the inequality between countries could also explain the inequality within country. As between countries, inequality rises, probably, inequality rises in a one country (US or other).

Because the inequality in my explanation stems from capital accumulation. So, it is straightforward to say that, people in a given country, having more savings make investment, accumulate capital and this could probably increase income inequality between capital holders (who have savings) and workers (who have not sufficient savings for investment in technology, machines etc.)

Also, there will be some cycles. People having interest rate from their capital will invest these interests in other investments again from which they could increase more their wealth (I mean capital from wealth.) This also will create more income inequality within a country and I think this explanation is valid not only for US but also for other countries.

Answer 3

The biggest factor is capital accumulation. As Einstein put it "The most powerful force in the universe is compound interest."

Income inequality has been growing ever since the start of the Industrial Revolution. Technological advance has allowed for the resent exponential economic growth. The advance in the cost of computing is also exponential (Moore's law), but a lot steeper, so there must be some saturation and diminishing return.

People who live form paycheck to paycheck are not able to accumulate much capital and never enter the exponential game. There is some correlation between deferral of gratification at young age and wealth later on in life, amongst other things:

A gradient of childhood self-control predicts health, wealth, and public safety (2010) (There is a pdf link on the page)

Three more interesting charts:

U.S. income shares of the top 1% and top 0.1% of households 1913-2013, including capital gains.

A Look At The Huge Gap Between The Nominal And Inflation Adjusted Dow

S&P 500: Total and Inflation-Adjusted Historical Returns

I don't have a correlation number to present, but let the most powerful visual pattern processor know to man do its job.

Obvious correlation between share of income of the wealthy and stock market performance. The period deserving attention is between 1950 and the early 80s. Despite that there was a strong bull market between 1950 and 1965, income inequity did not rise. That is a period of sustained high taxes for the rich. The federal income tax for the highest income bracket was 90% in that period. Then it was really slashed between 1963 and 1988, form 91% to 28%. And that is partly why we saw a rise in income inequality during a bear market.

The world slowly become more global after the Second World War** and then really globalization kicked in after the fall of the Soviet Bloc and the free market reforms in China, India, Africa. This made it safe for American capital to be invested there. Usually any nation is a tax haven for foreign capital and capital gains taxes are low to absent. As an unintended consequence, the capital of the rich Americans lifted out of poverty millions around the world, especially in Asia. They chose to invest their savings to create capital, that would make the labour of workers in other countries more productive, not in the US.

** Before the Great War, in many parts of the the Western World and Eastern Europe freedom of trade was widely adopted and property rights enforced and the world was very global. In the 19th century a person could travel across Europe without a passport, with the exception of the Russian and Ottoman Empires.