Inequality Is a Drag – by Paul Krugman

Liberals have generally viewed this as a trade-off worth making, arguing that it’s worth accepting some price in the form of lower G.D.P. to help fellow citizens in need. Conservatives, on the other hand, have advocated trickle-down economics, insisting that the best policy is to cut taxes on the rich, slash aid to the poor and count on a rising tide to raise all boats.

But there’s now growing evidence for a new view — namely, that the whole premise of this debate is wrong, that there isn’t actually any trade-off between equity and inefficiency. Why? It’s true that market economies need a certain amount of inequality to function. But American inequality has become so extreme that it’s inflicting a lot of economic damage. And this, in turn, implies that redistribution — that is, taxing the rich and helping the poor — may well raise, not lower, the economy’s growth rate.

You might be tempted to dismiss this notion as wishful thinking, a sort of liberal equivalent of the right-wing fantasy that cutting taxes on the rich actually increases revenue. In fact, however, there is solid evidence, coming from places like the International Monetary Fund, that high inequality is a drag on growth, and that redistribution can be good for the economy.

Earlier this week, the new view about inequality and growth got a boost from Standard & Poor’s, the rating agency, which put out a report supporting the view that high inequality is a drag on growth. The agency was summarizing other people’s work, not doing research of its own, and you don’t need to take its judgment as gospel (remember its ludicrous downgrade of United States debt). What S.& P.’s imprimatur shows, however, is just how mainstream the new view of inequality has become. There is, at this point, no reason to believe that comforting the comfortable and afflicting the afflicted is good for growth, and good reason to believe the opposite.

Specifically, if you look systematically at the international evidence on inequality, redistribution, and growth — which is what researchers at the I.M.F. did — you find that lower levels of inequality are associated with faster, not slower, growth. Furthermore, income redistribution at the levels typical of advanced countries (with the United States doing much less than average) is “robustly associated with higher and more durable growth.” That is, there’s no evidence that making the rich richer enriches the nation as a whole, but there’s strong evidence of benefits from making the poor less poor.

But how is that possible? Doesn’t taxing the rich and helping the poor reduce the incentive to make money? Well, yes, but incentives aren’t the only thing that matters for economic growth. Opportunity is also crucial. And extreme inequality deprives many people of the opportunity to fulfill their potential.

Think about it. Do talented children in low-income American families have the same chance to make use of their talent — to get the right education, to pursue the right career path — as those born higher up the ladder? Of course not. Moreover, this isn’t just unfair, it’s expensive. Extreme inequality means a waste of human resources.

Consider, for example, what we know about food stamps, perennially targeted by conservatives who claim that they reduce the incentive to work. The historical evidence does indeed suggest that making food stamps available somewhat reduces work effort, especially by single mothers. But it also suggests that Americans who had access to food stamps when they were children grew up to be healthier and more productive than those who didn’t,which means that they made a bigger economic contribution. The purpose of the food stamp program was to reduce misery, but it’s a good guess that the program was also good for American economic growth.

The same thing, I’d argue, will end up being true of Obamacare. Subsidized insurance will induce some people to reduce the number of hours they work, but it will also mean higher productivity from Americans who are finally getting the health care they need, not to mention making better use of their skills because they can change jobs without the fear of losing coverage. Over all, health reform will probably make us richer as well as more secure.

Will the new view of inequality change our political debate? It should. Being nice to the wealthy and cruel to the poor is not, it turns out, the key to economic growth. On the contrary, making our economy fairer would also make it richer. Goodbye, trickle-down; hello, trickle-up.

When Public Outperforms Private in Services – By Eduardo Porter

The remnants of a BP refinery in Texas City after a 2005  explosion. BP had a string of accidents following its privatization.  William Philpott/Agence France Presse — Getty Images

Few corporate sagas capture the virtues and vices of state-owned companies and private enterprise better than the drama of BP’s roller-coaster ride between failure and success.

Ten years ago, BP was the darling of the energy world — the unprofitable duckling transformed by privatization under the government of Margaret Thatcher into a highly profitable swan.

The London civil servants of the 1960s and ’70s who all but ignored profitability as they issued directives across British Petroleum’s bloated corporate network were replaced by highly motivated managers who were rewarded for cutting costs, reducing risk and making money. The company’s more incongruous businesses — food production and uranium mines, for instance — were sold. Payroll was cut by more than half. Oil reserves jumped. The time it took to drill a deepwater well plummeted. Profits soared.

But then, in 2005, a BP refinery in Texas City blew up, killing 15 and injuring around 170. In 2006, a leak in a BP pipeline spilled hundreds of thousands of gallons of oil in Prudhoe Bay, Alaska. And in 2010, an explosion on the Deepwater Horizon oil rig killed 11 and resulted in the biggest offshore oil spill in the history of the United States. These days, BP’s stock trades about 25 percent below where it was before the disaster off the coast of Louisiana, about the same place it was a decade ago.

BP’s bumpy ride is recorded in “The Org: The Underlying Logic of the Office,” a compelling new book by Ray Fisman, a professor at Columbia Business School, and Tim Sullivan, the editorial director of Harvard Business Review Press. “The Org” aims to explain why organizations — be they private companies or government agencies — work the way they do.

The book offers telling insight on a topic that has ebbed and flowed across the world over the last 30 years, as governments of all stripes have set out to privatize state-owned enterprises and outsource services — what does the private sector do better than government, and what does it do worse? Long dormant in the United States, the debate has acquired new urgency as governments from Washington to statehouses and city hallsaround the country consider privatizing everything from Medicare to the management of state parks as a possible solution to their budget woes. One of the authors’ chief insights is that every organization faces trade-offs — inherent conflicts between competing objectives. The challenge is to manage them. This is way more difficult than it sounds.

While in government hands, British Petroleum paid too little attention to profitability, constrained by its need to please elected officials who often cared more about keeping energy cheap and employment high. But in private hands, it may have cared about profits far too much, at the expense of other objectives. “BP veered from being a company that made sure nothing blew up to one focusing on cost-cutting at all costs,” Professor Fisman said.

The success or failure of an organization often depends on whether it can clearly identify its goals and align the interests of managers and employees to serve them. Yet whatever reward structure an organization picks can skew incentives in an undesirable way.

“The Org” tells us of the sociologist Peter Moskos, who joined the Baltimore police force to study police behavior. The police hierarchy demanded arrests, so police officers arrested people: 20,000 in one year in the Eastern District alone, out of a local population of 45,000. One officer set a record by locking up people for violating bicycle regulations. Unsurprisingly, perhaps, Baltimore’s murder rate continued to climb.

“The more we reward those things that we can measure, and not reward the things we care about but don’t measure, the more we will distort behavior,” observed Burton Weisbrod, a professor of economics at Northwestern University who was a pioneer in research on the comparative behavior of nonprofit institutions, corporations and government organizations. As Professor Fisman and Mr. Sullivan put it: “If what gets measured is what gets managed, then what gets managed is what gets done.”

Rewarding teachers for how well their students perform on standard math and reading tests will encourage lots of teaching of reading and math, at the expense of other things an education might provide. Private prison operators who bid for government contracts by offering the lowest cost per inmate will most likely focus on cutting costs rather than tightening security. Unsupervised apple pickers who are paid by the apple will probably pick them off the ground.

This insight is important to the debate over the competence of public and private organizations because it underscores a significant difference in how they meet their goals. Profit is one of the most potent incentives known to man — a powerful tool to align managers’ interests with corporate goals. But it also has drawbacks. With earnings as the overriding, nonnegotiable priority, private enterprise often has little wiggle room to handle the tension between conflicting objectives.

There are instances in which privatization can help achieve broad social goals. After Argentina privatized many of its municipal water supply systems in the 1990s, investment soared, the network expanded into previously underserved poor areas and the number of children dying of infectious and parasitic diseases tumbled. (Most water companies were nonetheless renationalized by a later government.)

Still, our recent memory of mortgage banks blindly offering risky mortgages to shaky borrowers and bundling them into complex bonds to sell to unwary investors should dispel the notion that the profit motive inevitably aligns incentives in a socially desirable way.

The pursuit of financial rewards, by private companies or even nonprofit organizations, can directly undermine public policy goals.

A recent study found that private universities and colleges collect higher fees from poor students who receive Pell Grants, absorbing over half the value of federal aid. Public colleges, by contrast, do not discriminate against those who get aid.

This suggests a good rule of thumb to determine when a private company will outperform the public sector: if the task is clear-cut and it’s possible to define concrete goals and reward those who meet them, the private sector will probably do better. “If I can write a perfect contract in which I pay for a concrete observable outcome, can rule out cream-skimming and can ensure the measure is not gamed, there is no reason that the private sector can’t do it better,” Professor Fisman said.

But if the objectives are complex and diffuse — making it difficult to align profit with goals without undermining some other desirable outcome — the profit motive could well make conflicts more difficult to manage. In these cases, privatization is probably not the best solution. In their rush to save money by outsourcing services, governments might forget that.


Twitter: @portereduardo

All Economics Is Local – By Michael Reich and Ken Jacobs

In the face of congressional inaction, the debate on raising the minimum wage is moving to the local level. As more cities and counties consider setting their own wage standards, they can learn from the policy experiments already underway.

Since the mid-1980s, states in every region of the country have raised the local minimum wage, often numerous times. Twenty-one states (and Washington, D.C.) currently have wage floors above the federal level ($7.25), and 11 of these raise them every year to account for inflation. Washington State currently has the highest, at $9.32; California’s is set to increase to $10 on July 1, 2016.

More than 120 cities and counties have adopted living wage laws that set pay standards, many of them in the $12 to $15 range. These higher standards usually apply only to employees of city service contractors, like security guards, landscapers and janitors. In some cities, living wage laws cover workers at publicly owned airports or stadiums, as well as at shopping malls subsidized by local development funds. While the impact on the individual workers covered under these laws is often quite significant, their reach is rarely broad enough to affect the local low-wage labor market as a whole.

For this reason, cities and counties are now enacting higher local minimum wage policies that cover all work performed in the area. Cities as varied as Albuquerque, San Francisco, San Jose, Calif., Santa Fe, N.M., and Washington, D.C., have minimum wages ranging from $8.60 in Albuquerque to $10.74 in San Francisco. The District of Columbia, which is raising its minimum wage to $11.50 in 2016, wisely joined with two neighboring Maryland counties to create a regional standard.

Many more cities are getting ready to follow suit. Richmond, Calif., Oakland and Seattle are seriously considering setting their own minimum wage. The Richmond City Council just voted an increase that will go to $12.30 by 2017. Advocates in Oakland are aiming for $12.25. Seattle is discussing $15. Prodded by its new mayor, New York City is seeking the right to set its own minimum wage rate, instead of using New York State’s.

A Seattle group held a march last Saturday calling for raising the minimum wage to $15 per hour.
Stuart Isett for The New York Times
A Seattle group held a march last Saturday calling for raising the minimum wage to $15 per hour.

With the national debate stuck in the same old rut, states and cities have again become laboratories of democracy. Are they on the right path? For the last 15 years we have been doing research on just this question.

One city we have studied in detail, San Francisco, has passed a dozen labor standards laws since the late 1990s. After adding the effects of other local laws mandating employers to pay for sick leave and health spending, the minimum compensation standard at larger firms in San Francisco reaches $13. Our studies show that the impact of these laws on workers’ wages (and access to health care) is strong and positive and that none of the dire predictions of employment loss have come to pass. Research at the University of New Mexico on Santa Fe’s floor (now $10.66) found similar results.

These are not isolated cases. Research on the effects of differing minimum wage rates across state borders confirms the results of the city studies. But how can minimum wage increases not have negative effects on employment? After all, according to basic economic theory, an increase in the price of labor should reduce employer demand for labor.

That’s not the whole story, though. A full analysis must include the variety of other ways labor costs might be absorbed, including savings from reduced worker turnover and improved efficiency, as well as higher prices and lower profits. Modern economics therefore regards the employment effect of a minimum-wage increase as a question that is not decided by theory, but by empirical testing.

Our research and that of other scholars illuminates how businesses actually absorb minimum wages at low-wage industries. Higher standards have an immediate effect in reducing employee turnover, leading to significant cost savings. Minimum wage increases do lead to small price increases, mainly in restaurants, which are intensive users of low-paid workers. How much? A 10 percent minimum wage increase adds 0.7 cents on the dollar to restaurant prices. Price increases in most other sectors, like retail, are too small to be visible, partly because retail pays more than restaurants.

Even if Congress finally acts to raise the federal minimum wage, higher standards at the state and local level still make sense. It will surprise no one that living costs are generally higher in cities than in rural areas. They often vary among cities in the same state. The New York City metro area is 26 percent more expensive than upstate Utica; costs in the San Jose metro area are 30 percent higher than in El Centro, in southeastern California. Policy makers need to take these variations into account. This is not just a theoretical idea. It has long been policy in Japan. Minimum wages in Tokyo and Osaka are as much as 30 percent higher than they are in regions with the lowest cost of living.

Here’s another way to think about it. One measure of employers’ latitude to absorb higher wages compares the minimum wage to the median wage. From the 1960s into the 1970s, the minimum-median ratio in the United States varied between 41 and 55 percent. Since the mid-1980s, it has been much lower, varying between 33 and 39 percent. A minimum wage increase to $10.10 by 2016, as President Obama proposed earlier this year, would restore the national ratio to 50 percent. By comparison, San Francisco’s $10.74 minimum wage is 40 percent of the city’s median wage. In other words, although some of the proposed rates may seem high by national standards, they look more reasonable when measured against local wage levels.

Local minimum wages also represent a response to growing inequality within cities, in too many of which a growing army of low-paid workers — maids, gardeners, janitors, restaurant and security workers — provide personal services to an increasingly well-heeled minority.

The record is clear. Employers can afford to pay higher wages that raise families out of poverty and bear a closer relation to local living costs. And there’s a moral value, too. An increase in the local minimum wage restores, on a very personal level, some of our notion of fairness.

Michael Reich is a professor of economics at the University of California, Berkeley, and the director of the Institute for Research on Labor and Employment; Ken Jacobs is the chairman of the Center for Labor Research and Education at Berkeley; together with Miranda Dietz, they are the authors of “When Mandates Work: Raising Living Standards at the Local Level.”