Thomas Piketty has an entire graduate course on this question - the political economy of inequality (see the syllabus at Paris School of Economics at http://jourdan.ens.fr/piketty/fichiers/enseig/ecoineg/Syll2007-2008.htm in French). You can find the major articles in the debate referenced there.

Some of the big questions are whether the change is technologically driven - has the productivity of good CEOs or high education increased in recent decades? Is it political - the decline of unions, COLAs, employment laws and other aspects that push up middle class wages? Is it due to changes in tax policy - effective taxation on the rich is much less than in the past and so giving them a greater share can make more sense?

Looking at the various Piketty and Saez time series work, the most likely hypothesis is probably the impact of tax policy.

One would think that since the rich can only spend so much, the rest will be invested and create capital pooling.

One might think that, but apparently after many years of supply-side dominance, it hasn't happened. So one might also think that you're wrong.

I see the top 1%, the middle 60% and bottom 20%... what about the other top 19%?...

re: where is spending going to come from... we live in a global economy... there are billions of people living in poverty who would LOVE to have a middle class income of $50,000 and the comforts that come with it... perhaps if we focused more on making their lives better we'd do a lot more for humanity (and the US economy) than worrying about giving the middle class in the United States enough to buy that second flat-screen television.

Too bad that the whole union thing never really made it big in America. Strong unions and collective agreements like we have here in Scandinavia would probably have been helpful in countering this development.

i should have your labor-liberal badge for this post.

Since the problem coincides extremely well with the decline in union density, it would seem that increasing unionization is the obvious policy response. While companies have become increasingly concentrated, workers have been less so, with a resulting imbalance in bargaining power.

That balance needs to be restored, and fiddling with tax policy isn't going to do it.

So one might also think that you're wrong.

Always willing to learn. So, if the money is not invested and it's not spent....where does it go?

Also, it just occurred to me that Ezra is conflating Wages with other forms of income.

They are not equivalent.

One involves trading labor for money and the other involves varying amounts of risked capital. Much of the return may be for the risk.

Quick response (not having read the other comments yet): in my world, wages were stagnant (literally not changing) because our bosses spent more money on us by spending it on health care. Our benefits cost more and more, and any money they wanted to send our way was swallowed up paying for health care increases.

In case it matters, I'm not at some large or small company, I work for a state university. And we are a unionized faculty.

To me, this issue of stagnant wages and increased health care costs (i.e. getting benefits rather than losing them) seems an awful lot like a system-driven version of the 50s era, when fixed wages received the "benefits" of health care. So, much like segregation in the south was once law and then became geographical reality (urban flight, new suburbs, etc.), we have jobs with health care and without.

Meaning: you can't answer questions about wages without looking at benefits, meaning pension and health care. What happened to the sum of all three in the past few years? That's what I want to know.

Power.

We've had four decades of a conservative propaganda project explicitly aimed at convincing people that greed by the wealthy is good, and that decent pay for ordinary work is bad.

Tax policy is one of the symptoms of this movement's success (especially the tax policy that now taxes all earnings that result from owning things less than it does earnings from doing things), but that, too, is symptomatic.

Ultimately those power relations and beliefs have to change for the US economy to prosper. In some countries that's been done by legislation and regulation, in others by social disapproval of extravagant greed, in others by hanging people from lamp posts.

But this notion that the government shouldn't interfere in wage-setting is just specious. Perhaps the government shouldn't micro-manage private sector pay directly, but it already interferes in wage-setting in innumerable ways, from minimum wage decrees and Davis-Bacon to FICA tax cutoffs and "part-time" and "independent contractor" rules, to tax consequences for excess CEO pay. The question is what regulations would best aid companies in achieving more sensible wage structures. Perhaps a nice tax surcharge for greater-than-productivity increases in above-median wages, and credits for increases below the median. (Quite possibly something else, but it's obvious that if one set the gini coefficient as an explicit goal the same way one does the inflation or unemployment rate there are tools to address it. The problem is that rich-people propaganda has made the goal of lessening inequality difficult even to assert in polite company.)

Always willing to learn. So, if the money is not invested and it's not spent....where does it go?

I'm not saying it wasn't invested, I'm saying that investment does not lead to general income growth. "Trickle down" is a farce. Investment simply leads to more income for those able to invest. This is why we have an economy filled with -- indeed, practically predicated on at this point -- jobs that do nothing but receive remuneration for shifting money around. By freeing up the rich to invest more capital, the "supply side" people created the credit-driven economy: more money to loan. This is a fine idea until enough people figure out that the returns on investment are made out of air -- they don't physically exist and are backed by a promise from people whose debt has climbed while their earnings have remained the same.

Jeez, El V, this ain't rocket science. A telephone answering monkey could tell you that's a bad scheme.

How about start talking about making the Employee Free Choice Act an integral part of any stimulus package. I mean unions workers make on average 30% more than their nonunion counterparts.

The National Labor Relations Act was largely spun the same way back during the last massive economic distress.

The best thing to do quickly would be a national single-payer, healthcare system that would take the burden off businesses and workers. Wages would have to rise to keep all the people suddenly freed up to search for better jobs, without worrying that they'll lose their healthcare.

First I think that we can assume that the graph represents before tax income. Second I understand that Europe has seen the same growing before tax inequality.

I like an hourly wage subsidy but it would surely create anti-immigrant sentiment.

I'm no expert on corporate governance, but it would seem to me that corporate governance reform is part of the equation here. There seems to be a systemic problem with corporate board oversight; ideally, boards would represent shareholder interest and negotiate lower pay packages for executives. But in reality, there are cultural and structural reasons why these negotiations result in wildly overcompensated executives.

I'm not saying that such reform would solve the problem, but I think that it would address part of the distributive injustice in wages directly, and might also indirectly change a gilded age mentality that allows for the level of inequality we're seeing. It's a sort of broken-corporate-windows / defining-inequality-down theory...

There's an interesting discussion of this taking place over at TPM Cafe between Krugman, Reich, De Long, and Baker, in a discussion of Krugman's new book.

http://tpmcafe.talkingpointsmemo.com/tpmcafe-book-club/2008/12/14-week/

Basically, once we're out of this current mess, what will our economy look like if it is to have sustainable growth? Do we revert to our credit-financed spending of the 1990s? Do we work less hours because we have decreased demand? How does the rest of the world (especially China) respond if US demand never recovers to pre-bubble levels?

Infirm CEO pay is a problem but fortune 500 CEOs are few (only 500 you know). As a computer programmer I know that I can replace quite a few clerks. Am I a part of teh problem?

I'm not saying it wasn't invested, I'm saying that investment does not lead to general income growth.

Well, you're a fuckin' MORON because if you review, I didn't mention income growth. I said POOLING OF CAPITAL.

And that's why you're Billy Elliot (dumbass)

How about start talking about making the Employee Free Choice Act an integral part of any stimulus package.

am,

This wouldn't be very stimulating. It could signal higher costs in a global market.

BTW Gasoline, housing and food is quite a bit cheaper than it was a few months ago so everybody got a good raise except for those who lost jobs and investors (mostly rich and upper middleclass).

El V:

The point that he was trying to make is that excess capital pooling is in fact bad for the economy, because you get a situation of too much capital chasing too few productive investment opportunities, and a potential for a falling rate of profit. This tends to lead to the creation of less productive investment vehicles that are more risky and more profitable, but that generally rely upon an ever-expanding economy to keep paying off.

Now here's where wages comes into it - without enough consumption, the investment goes to waste. Whether it's investment in machinery and factory plant or IT or other investments aimed at productivity, you still need someone to buy the goods you've just made more efficiently; if it's financial investments, like securities or derivatives and the like, you need at the bottom somewhere for enough of an income stream to bubble up from corporate profits or mortgage payments or increasing property values and the like to pay things off. Thus, when you have a stagnant wage structure, you create a hollowing-out effect; the economy can expand and grow on credit for a while, but the underlying problem remains - not enough people can afford to buy the goods that are being produced and the real estate that's on the market.

El V:

As regards to why EFCA is not a bad thing. Keep in mind that one man's labor costs is another man's consumer receipts. Since any individual employer has to pay a much smaller proportion of the increased wage bill than they receive in the way of increased consumer spending, wage increases can be very good for employers - in the context of a demand-deficient economy. Thus, the costs and benefits more than balance themselves out, and corporations can start to plug increased revenue into expanding their business (thereby increasing volume) or into making their business more efficient (lowering costs through newer plant, management systems, IT, etc.)

Further good reading on this topic of long term wage trends and long term economic trends is this piece that Rutgers historian James Livingston wrote two months ago in two parts.

http://hnn.us/articles/55614.html

He looks at parallels between the 1920s and 1930s and today. He writes:

"[T]he Great Depression was the consequence of a massive shift of income shares to profits, away from wages and thus consumption, at the very moment—the 1920s—that expanded production of consumer durables became the crucial condition of economic growth as such. This shift produced a tidal wave of surplus capital that, in the absence of any need for increased investment in productive capacity (net investment declined steadily through the 1920s even as industrial productivity and output increased spectacularly), flowed inevitably into speculative channels, particularly the stock market bubble of the late 20s; when the bubble burst—that is, when non-financial firms pulled out of the call loan market in October—demand for securities listed on the stock exchange evaporated, and the banks were left holding billions of dollars in “distressed assets.” The credit freeze and the extraordinary deflation of the 1930s followed."

Like Krugman and Reich, he sees a similar situation today, where an economy dependent on consumer demand fueled by wages but no longer able to increase demand due to stagnating median wages and reduced access to credit becomes unsustainable.

The fact that we have the time to discuss these issues in the middle of the work day for little other reason than our own entertainment while hundreds of millions of people in other parts of the world are walking several miles a day to just get drinking water instead of making goods or providing services that we can all benefit from should give us an answer to how to grow the global economy.

Come on folks, this isn't that hard.

Subsidies on low income are not a lasting solution, and Clinton's EITC was a patchjob.

When you can't live on a minimum wage job, then the minimum wage is non-viable. If the minimum wage was indexed to some combo of productivity and inflation, we would not be in the situation where the consumer below the 90th %ile had to run up big debts to finance consumption.

All the benefits of productivity have flowed to the corporations and their executives. Inflation has slowly run away from the minimum wage.

A single person should be able to live above poverty with the income from one 40/hr week job, and a 3 person household should be able to live from 1 or 1.5 or 2 incomes without borrowing or substandard housing and nutrition.

We may need to curb somehow the incomes of executives to some reasonable multiple over entry salaries, and healthcare needs a national solution that is universal and not employer based.

For those who argue that a higher min. wage would be uncompetitie in world markets, then we need to level that field with agreements that prevent US companies from offshoring on labor costs that often amount to a small percentage of total product costs, and that reward other countries from begger-thy-neighbor labor policies.

From the link on why health care costs supposedly can't be at the root of this:

"As a practical matter, however, health insurance costs cannot explain the recent decline in wages for the lowest-paid workers because so few of them are covered by health insurance."

But when the wages of those who do (i.e the middle class, unionized workers, etc) goes down -- because they're being eaten by benefits -- doesn't that have a depressing effect on wages all around, including the poor?

Nothing redistributes income like a good stock market crash. The bursting of the internet bubble took a big bite out of the incomes of the top 1%. They should do even worse in the latest crash. Unfortunately crashes don't raise wages for everyone else, unless they lead to big policy changes.

Just looking at the graph, inequality seems to be bubble-driven, not technology driven.

Everyone keeps missing the real cause of income inequality. The rise of managed funds and the subsequent rise in overpaid fund managers and corporate executives.

If you look at the very high income earners - fund managers, corporate executives, they are people who get very rich on managed funds - other people's money. It is the lazy management of this money that allows them to grant themselves large payrises and big fees.

Until people start controlling their savings funds more directly - and start telling their pension funds to vote against executive pay and against large fees for financial agents who dont really do anything, the earnings in this sector will rise and rise.

But policy experts are rather less surefooted on how to raise wages.

Uh, unions? They do that. Incredibly effectively. There is literally no other institution that does this. They are serving a vital social function no one else can.

The obvious policy move here is to pass laws that give unions a better playing field. Like, oh, I dunno....EFCA!!!

And Jesus Christ, there IS such a thing as too much money for investment. There are only so many good investments out there--and even fewer when you have an economy with a consumer base totally destabilized by stagnant wages.

If you've got too much investment money, it competes for these good investments, their returns go to shit.

And when jackasses start inventing ridiculous things to invest in (whose ridiculously high levels of risk provide only middling returns because, as above, capital is arbitraging), you invest in them because the glut of capital creates its own momentum. For christ's sake, even Ponzi schemes were good investments for a decade.

There are two hypotheses for excessive CEO/top management pay scales that sound good to me. The more obvious one is that the people who get to decide compensation for top management are typically the board of directors, who are generally top management for other enterprises, and vote in their own benefit.

There's another theory that I've seen, but not often. It looks back at the Reagan era tax cuts and rollback of regulation that ushered in the merger and acquisition circus of the '80s. Corporate enterprises under that regime that wanted to survive had to take steps to make themselves unattractive as takeover targets, and one aspect of that was adjusting their balance sheets to lower cash reserves and take on more debt. (Companies with assets anywhere near their market capitalization could be, and were, bought out by speculators who then raided their corporate bank accounts to pay off the loans that financed the takeovers.)

So corporate managers had to figure out where to allocate money to make it unavailable to raiders. It didn't take an Einstein to figure out that they could give it to themselves as compensation.

Ummm.....Trade anyone?

That billions you see in our trade deficit used to be dollars invested in this country and distributed to workers in this country.

I think JimPortland expresses the wants and desires of the left best. He wants government to get in the business of telling industry what to pay workers and also what to pay the executives.

Perhaps he would like to tell industry what to produce and when to produce it.

(Pssssst...it's called 'central planning and it hasn't worked very well elsewhere)

Others name unions, or culture, or politics, or deny the trend altogether.
I assume by "name unions" you mean "name the lack of unions", since (a) the prevalence of unions is in fact falling and (b) there's no clear way stronger unions could lead to more income inequality anyway.

Weaker unions, on the other hand, could obviously lead to more income inequality, since it is exactly what they were formed to reduce.

You could also pass an explicit pay-ratio limit - nobody can make more than X times what the lowest-paid worker at the same employer makes - which means a CEO who wanted to give himself a raise would have to also give raises to the lowest-paid workers at his company. If he can't do that and stay competitive, maybe he doesn't deserve that raise for himself either...