Robert Solow earned his Nobel Prize for showing that economic growth does not come from people working harder but rather from working smarter. That means using new technologies and new techniques of production to create more value without increasing the labor, capital, and other resources used.
Even a few percentage points of faster productivity growth per year can lead to large differences in wealth over time. If labor productivity grows at 1%, as it did for much of the 1800s, then it takes about 70 years for living standards to double. However, if it grows at 4% per year, as it did in 2010, then living standards are 16 times higher after 70 years. While 4% growth is exceptional, the good news is that the past decade was a pretty good one for labor productivity growth—the best since the 1960s. The average of over 2.5% growth per year is far better than the 1970s and 1980s, and even edges out the 1990s (see Figure 3.1). What’s more, there’s now a near consensus among economists about the source of the productivity surge since the mid-1990s: IT.
Something like this has been happening to incomes in the U.S. economy. There have been trillions of dollars of wealth created in recent decades, but most of it went to a relatively small share of the population. In fact, economist Ed Wolff found that over 100% of all the wealth increase in America between 1983 and 2009 accrued to the top 20% of households. The other four-fifths of the population saw a net decrease in wealth over nearly 30 years. In turn, the top 5% accounted for over 80% of the net increase in wealth and the top 1% for over 40%. With almost a fractal-like quality, each successively finer slice at the top of the distribution accounted for a disproportionately large share of the total wealth gains. We have certainly not increased our GDP in the way that Franklin D. Roosevelt hoped for when he said during his second inaugural address in 1937, “The test of our progress is not whether we add more to the
There was always a wage at which all these horses could have remained employed. But that wage was so low that it did not pay for their feed.
To be sure, technology is not the only factor that affects incomes. Political factors, globalization, changes in asset prices, and, in the case of CEOs and financial executives, corporate governance also plays a role. In particular, the financial services sector has grown dramatically as a share of GDP and even more as a share of profits and compensation, especially at the top of the income distribution. While efficient finance is essential to a modern economy, it appears that a significant share of returns to large human and technological investments in the past decade, such as those in sophisticated computerized program trading, were from rent redistribution rather than genuine wealth creation.
Other countries, with different institutions and also slower adoption of IT, have seen less extreme changes in inequality. But the overall changes in the United States have been substantial. According to economist Emmanuel Saez, the top 1% of U.S. households got 65% of all the growth in the economy since 2002. In fact, Saez reports that the top 0.01% of households in the United States—that is, the 14,588 families with income above $11,477,000—saw their share of national income double from 3% to 6% between 1995 and 2007.
Inequality Can Affect the Overall Size of the Economy
Technology changes the shares of income for the skilled vs. unskilled, for superstars vs. the rest, and for capital vs. labor. Is this simply a zero-sum game where the losses of some are exactly offset by gains to others? Not necessarily. On the positive side of the ledger, inequality can provide beneficial incentives for skill acquisition, efforts toward superstardom, or capital accumulation. However, there are also several ways it can hurt economic well-being.
First, one of the most basic regularities of economics is the declining marginal utility of income. A $1,000 windfall is likely to increase your happiness, or utility, less if you already have $10 million than if you only have $10,000. Second, equality of opportunity is important to the efficiency and fairness of a society, even if unequal outcomes are tolerated or even celebrated. Equality of opportunity, however, can be harder to achieve if children of poverty get inadequate health care, nutrition, or education, or people at the bottom are otherwise unable to compete on a level-playing field. Third, inequality inevitably affects politics, and this can be damaging and destabilizing. As economist Daron Acemoglu puts it:
Economic power tends to beget political power even in democratic and pluralistic societies. In the United States, this tends to work through campaign contributions and access to politicians that wealth and money tend to buy. This political channel implies another, potentially more powerful and distortionary link between inequality and a non-level playing field.
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