Tuesday, May 02, 2006

What Really Matters

While reviewing readings for my upcoming macroeconomics final, I stumbled onto a paper by Ian Dew-Becker and Robert J. Gordon called "Where Did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income." They agrued that between 1966 and 2001, only the top 10% of income earners experienced income growth equal to that of productivity growth. This reality runs counter to general macro theory where productivity growth is the direct cause of the growth of real income per capita. So what happened?

Dew-Becker and Gordon cite downward pressures on wages--deunionization, immigration, free trade--to justify the discrepency. This seems awfully lacking. If free trade decreases net exports, it must increase investments (BP=0). Fewer unions might decrease wages, but they also decrease demand for workers, which increases wages. Immigration might decrease demand, but it saves companies money which increases demand for labor in other areas. Money doesn't disappear.

At the heart of the problem is believing having less money means you become poorer. This is false. Suppose I give everyone in the US $2,500. Has everyone become richer? Nope; inflation rises to compensate (this analysis gets a little strange when you consider trade so let's make a simplifying assumption of a closed economy). Now let's suppose I give everyone in the US a $2500 fridge. Has everyone become richer? You bet they have (expect for that small minority that has absolutely no use for another fridge and despises it taking up so much space). How can this be? Aren't they the same thing?

Not at all. Money is a means to an end. Think of all the things the average American has access to now that they didn't in the 1960s. That fridge is well and beyond this one from the 50s, which features automatic defrosting and balanced humidity as some of its main selling points. We also have computers, cell phones, more colors for paint, iPods, longer lasting durables, etc, etc. In other words, just because the real income is not has high as it "should be" doesn't mean that lower 90% is getting shafted.

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