The Wealth of Humans, Part VII: Solutions?

<Part I, Part II, Part III, Part IV, Part V, Part VI>

To recap: the Digital Revolution has reduced the bargaining power of the average worker through two channels. The first is by creating an abundance of labor through automation, enhanced productivity, and globalization. The labor supply has outstripped labor demand, forcing workers to accept low wages or no work. The second is by changing the nature of the most productive activities. Serving as a cog in an industrial process was once a high value activity with clear and measurable aspects: how many units did you produce? Are they up to standard? But now the highest value activities occur within firms acting primarily as information processing organisms, and the success of these firms relies on social capital. This social capital is hard to measure, and by its nature cannot be taken or easily replicated. So despite being crucial to the success of their firms, workers don’t have the bargaining power to fully capture their share of gains versus the owners of capital.

This has led to a stagnation of wages and an employment trilemma that suggests that the only sources of mass employment in the future will be low productivity, low wage work. Is there anything we can do?

Avent runs through a few proposals to get the average person more money that I’d like to explore. I think it’s important to keep some questions in mind as we consider each.

  • Is our goal to reduce inequality or simply raise the floor for the bottom end of the income distribution?
  • Is there a trade off between inequality/redistribution and economic growth?
  • What types of redistribution do we want to engage in?

It should be said that the assumption here, and one that has underlain the entire book, is that today’s inequality is chiefly due to skills biased technical change. There are other potential causes, such as growth in economic rent seeking, that should be kept in mind, though I won’t deal with them here.

Income Redistribution

The first is to pay workers more. Simple, no? If we simply mandate that businesses have to pay their workers more, we can wipe our hands clean and call it a day. In this current election cycle this has been the message of the Fight for $15, a call for a nationwide $15/hr minimum wage which has been accepted into the Democratic Party’s platform (pdf) this year. While the evidence on the employment impact of the minimum wage is equivocal (though a number of cities and states recently raising their minimum wages may provide some good future evidence), economic theory suggests this isn’t the best way to raise incomes.

Substantially raising the minimum wage would almost certainly incentivize greater automation and lead to some amount of disemployment. We can quibble about the magnitudes of these effects, and depending on the elasticities involved it could be the case that a modestly higher minimum wage would pass a cost benefit test.  Still, I’m generally uneasy with raising the minimum wage, especially at the federal level, because it’s such a blunt instrument that only helps some fraction of those already employed.  

It’s not often brought up in minimum wage debates, but it is a form of redistribution, just not explicitly so: the money comes either from higher prices passed on the consumers or a redistribution of work itself to the more productive; it’s far less likely the money is coming out of the CEO’s pocket, which is what I imagine many people assume happens.

But there are tools beyond the minimum wage. Various forms of wage subsidies have been proposed or implemented across the world. These come in different flavors, but they all involve the government paying workers the difference between the market rate and the desired income level. For example, the Earned Income Tax Credit in the US is a refundable tax credit (if the value is higher than your tax burden, you still get paid in full) with benefits that phase in with work and out at higher levels of income.  The advantage of wage subsidies is that the burden falls on the government rather than the employer, leaving less distortion in the labor market. For a great overview of wage subsidies vs the minimum wage, read this interview with economist (and Nobel laureate) Edmund Phelps, who is a big proponent of wage subsidies.

The most extreme forms of wage subsidy are the Universal Basic Income (UBI) or a Guaranteed Minimum Income (GMI), which have been in the press quite a lot lately. In a UBI system, every citizen gets some predetermined income, often quoted around $10,000/year, regardless of work status or wealth. GMIs work differently: they are means tested in the sense that you only receive support if you’re below the income threshold. So if you made $8000/year, you’d receive $2000. If you’re not in the labor force, you’d get the full $10,000, and anything above would get nothing.

The two have slightly different sets of incentives; the work incentive problem is probably worse with an MGI, though it is potentially far less expensive than a UBI. Both are able to deal with people not in the labor force, whom the minimum wage and wage subsidies ignore. And of course, these programs require that the most productive workers continue to be so, since they will be financing such programs through heavy taxation. I don’t think it’s unreasonable to worry about incentives to work less from such heavy redistribution, though that may also aid in lessening the problem of labor abundance.

What I find most attractive about these programs is that they provide an alternative to market labor, which I think would be far more effective than any rules or regulations at making market work more fair, respectful, and enjoyable. At the dawn of the Industrial Revolution, people had the option to live off the land if they didn’t want to participate; in the developed world today, there is no similar option. When employers at the lower end of the labor market know that people have no alternative, whether consciously or not they make those jobs worse.

Equalize Growth

Another proposal is to make workers at the lower end more productive. If the productivity growth at the bottom of the income distribution were to increase, inequality could be reduced without active redistribution (and the worries that come with it).

However, Avent laments that the ways to make workers more productive in rich societies seem limited. As noted previously, the societal returns to education (the clearest path to such productivity gains) seem to have run out of steam in the US and other developed countries.

Avent makes the additional point that if education does not lead to higher rates of economic growth, then increasing it only functions as a tool of redistribution among individuals.

For example, increasing the number of people going to medical school will probably not lead to a higher rate of growth in the economy, but it will increase the supply of doctors, reducing the pay of current doctors and increasing the pay of the new ones relative to their wages prior.  This is not necessarily bad; this type of redistribution is more passive than wage subsidies and more subject to market signals. Still, these types of gains will not solve the fundamental problem of labor abundance; they may even exacerbate it after a point.

It also bears mentioning that the logic of raising productivity to raise wages may be questionable, as there has been a well documented decoupling of wages and productivity since the 70s.

Ungate the Cities

Finally, and what I think is the most promising solution, is to allow more proximity to higher productivity workers. Wages in dense, urban areas are higher at all levels than in low density  (and low productivity) areas. The fundamental reason is opportunity cost. When the highest productivity workers in an area need a service, such as a haircut, the opportunity cost for one of them to engage in that activity is high, so they have a higher willingness to pay. So a hair stylist with the same skill can earn a higher wage simply by moving from the suburbs to the city.

What this requires to work well, however, is for housing supply to keep up with housing demand. Otherwise, lower wage workers either get priced out of cities or have to spend a disproportionately high fraction of income on housing (negating the higher wage).

Silicon Valley and the Bay Area are the Ur-example of how not to implement proximity. These areas, despite the ever growing demand for highly skilled workers, have steadfastly refused to expand their housing supply, leading housing prices and rents to increase to such a level that even those same highly skilled workers can barely afford themOn the other side, Tokyo has performed admirably in increasing its housing supply to meet demand.

As I’ve mentioned before, Avent has written about this before in The Gated City, which again is absolutely worth reading (and doesn’t take much time!).

This one thing, allowing housing supply to match demand, is likely the best near term solution to the problems in The Wealth of Humans. It’s something that is feasible right now and doesn’t require the creation of new government programs. The problem is that housing is locally controlled, so any effort to relax regulations at the local level across several municipalities would require a determined and coordinated effort to defeat rampant NIMBYism.

I’ll just close with a small personal story along these lines. A few years ago, near where I live in Washington, DC (a city that has also seen a considerable increase in housing demand), construction work began on a lot that had apparently lain fallow for close to 20 years: a new apartment building was going up. This lot is on a major road that has dozens of apartment buildings on either side in both directions. And yet, the neighborhood, which largely consists of homes around the million dollar mark, felt that this construction was a sign of ‘disrespect’. In fact, they distributed flyers and lawn signs asking for us to ‘Respect Chevy Chase’ (the neighborhood, not the actor!). They demanded large changes to the project, and through the local government structure, the Advisory Neighborhood Council, tried to halt construction until the developers acceded to their demands.  Luckily, they were not successful, but just imagine this scenario playing out hundreds, if not thousands, of times a year across the country. People who are already sitting pretty are using the government to prevent anyone else from sharing in their neighborhoods. Beyond the issues of income and wealth inequality, I think this type of behavior is a major source of a lot of social ills in the country, and I hope to expand on it at a future date.

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