I’m Gettin’ Money
Throughout the financial crisis, I’ve been dimly trying to remember something I read on Tyler Cowen’s blog a long time ago. Today, Paul Krugman shows off his Nobel Prize skillz by finding the post in question:
I also found myself thinking about the Kaplan-Rauh paper finding that Wall Street was largely responsible for the surge in very high incomes, which was widely taken as evidence that the new rich were really earning their money (though to be fair Tyler Cowen didn’t say that.)
Time for some reevaluation, don’t you think?
Here’s a link to the paper itself. The abstract:
We consider how much of the top end of the income distribution can be attributed to four sectors — top executives of non-financial firms (Main Street); financial service sector employees from investment banks, hedge funds, private equity funds, and mutual funds (Wall Street); corporate lawyers; and professional athletes and celebrities. Non-financial public company CEOs and top executives do not represent more than 6.5% of any of the top AGI brackets (the top 0.1%, 0.01%, 0.001%, and 0.0001%). Individuals in the Wall Street category comprise at least as high a percentage of the top AGI brackets as non-financial executives of public companies. While the representation of top executives in the top AGI brackets has increased from 1994 to 2004, the representation of Wall Street has likely increased even more. While the groups we study represent a substantial portion of the top income groups, they miss a large number of high-earning individuals. We conclude by considering how our results inform different explanations for the increased skewness at the top end of the distribution. We argue the evidence is most consistent with theories of superstars, skill biased technological change, greater scale and their interaction.
In retrospect, it seems that the “Wall Street” proportion of this wasn’t much more than people taking a general upward trajectory in the market and adding lots of leverage to generate extraordinary returns. And the Wall Street portion is extremely large relative to the Main Street portion.
18 Responses to “I’m Gettin’ Money”
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November 23rd, 2008 at 12:29 pm
In retrospect, it seems that the “Wall Street” proportion of this wasn’t much more than people taking a general upward trajectory in the market and adding lots of leverage to generate extraordinary returns. And the Wall Street portion is extremely large relative to the Main Street portion.
Having closely read both Matt’s post and Krugman’s post, I still can’t figure out whether Matt agrees with Krugman or not, or exactly why Krugman thinks Kaplan-Rauh should be reevaluated, or whether either Matt or Krugman actually disputes K-R’s findings. Perhaps I’m just dumb. Please advise.
November 23rd, 2008 at 12:37 pm
I don’t necessarily see why inequality caused by skill based technological change is seen as harmful. If instead of having thousands of investment bankers we only need a few better paid ones doing the same job this is good. It means our economy is more specialized and more productive. Those former investment bankers, for all I know, could become doctors or lawyers. Inequality, to some extent, is probably necessary for these improvements in productivity to occur. It would be hard to imagine a rock star or athlete who used to service a small town now service the whole world for the same wage. These superstars are working harder (just look at their hours worked per week) and are responsive to their wage. What would be unfortunate is if progressives’ idealistic hatred for inequality actually made everyone worse-off even if it raises the relative income for a few. Progressives’ goal shouldn’t be to arbitrarily reduce inequality, it should me to maximize the income of the poor and middle class. So, why not make your case for that instead of vilifying something that has to a certain extent made us all better off?
November 23rd, 2008 at 12:52 pm
“…While the representation of top executives in the top AGI brackets has increased from 1994 to 2004, the representation of Wall Street has likely increased even more…”
Not surprising, as Wall Street’s commercial/investment banks were, in effect, the gatekeepers of the tidal wave of easy credit that’s been at the heart of FRB policy under Greenspan/Bernanke.
November 23rd, 2008 at 1:29 pm
James Gary
Krugman wants to reevaluate the claim that that Wall Street execs’ high salaries were the by-product of tremendous value added to the economy.
Yglesias agrees, saying that Wall Street’s proportion (of those earning high incomes) wasn’t due to much more than irresponsible leveraging on unrealistic market assumptions.
Agreement aplenty.
November 23rd, 2008 at 1:35 pm
gordon gekko apparently missed the whole “sub-prime market and assorted leverage shitpile has rocked the economy, and not in a good way” news that has brought the DJIA down from 13,000 to 8,000 over the course of a single year. Otherwise he wouldn’t be idiotically opining about “vilifying something that has to a certain extent made us all better off”.
Further, there is no evidence that the maldistribution of wealth makes us better off. It makes those who get it better off and, as we’ve seen, makes them immune to real effects from their bad choices.
November 23rd, 2008 at 1:46 pm
Yes I agree with Krugman and Yglesias. It’s complicated so Gordon Gekko is also right that superstars “add value” and “earn what they make”.
Gekko: “These superstars are working harder (just look at their hours worked per week) and are responsive to their wage.”
You compare them with athletes and rock stars but what they were often doing is playing shell games with heavy leveraged bets.
But what was the “added value”? Allocating resources effectivey and efficiently in the economy? They just made the accounting more and more opaque so that no one trusted each other. Granted a lot of this was due to competition among these superstars, a sort of mutually assured destruction: you have to do it because your competitor is.
The moment that made me laugh was when the two remaining superstar investment banks voluntarily retreated and became regular old banks, thereby submitting to many more regulations, so that big government would provide a safety net and restore confidence.
November 23rd, 2008 at 1:59 pm
I’ve said it before, but I think income spikes in the financial sector are early indicators of where the next bubble will form. We don’t need to limit executive compensation; we just need to be aware of it and put a lot of scrutiny on the financial products that bring in really big bonuses. Those are the products that will attract a lot of irrational behavior down the road.
November 23rd, 2008 at 2:42 pm
Evil Twin,
It is possible that a more ambitious and specialized financial industry increased volatility and led to this crash. Fine, increase regulation and reduce the financial industry’s size and scope. But you are ignoring the root cause of inequality found in this report. What they are saying is technological change has allowed the industry to do more with less. You could say they tried to do too much with too little but to argue the financial industry hasn’t fundamentally changed thanks to technology is disingenuous.
All I am saying is we shouldn’t destroy these productivity gains just because inequality seems morally unfair or because voters hate Wall Street. We also shouldn’t automatically assume (as Matt tends to do) that inequality is a problem by itself.
November 23rd, 2008 at 3:27 pm
What’s productive about the financial industry? All they’re doing right now is destroying wealth.
November 23rd, 2008 at 3:34 pm
An important corection is due here. Very few employees of Wall Street got rich. It was mainly the upper echelon of the corporate officers who were rolling in the dough. The peons were often decently paid, but certainly not at CEO or star athlete levels.
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