Generally, I restrict this weblog solely to discussions of new economics research, with a bias toward theory; there is no shortage of good economics writing on the internet about policy, or the “economics of everyday life”, or economic statistics.
That said, I understand that theory is often esoteric. How, you may wonder, do some of these results apply to “real” economics, or to the “real” world? An editorial by a top-notch empirical economist, Ken Rogoff, is making the rounds on the internet today, and I think this is a great example to show the value of theory.
Essentially, Rogoff argues that growing inequality will in some sense self-correct. This is because “simply put, the greater the premium for highly skilled workers, the greater the incentive to find ways to economize on employing their talents.” Rogoff is considered quite liberal, and supports efforts to expand educational opportunity, but “it would be foolish, if not dangerous, to infer rising inequality in relative incomes in the coming decades by extrapolating from recent trends.”
Unfortunately, theory suggests this argument is not totally correct. As discussed on this blog earlier this year, Samuelson pointed out decades ago that there is, from the perspective of a firm in general equilibrium, no such thing as cheap or expensive factors of production. This is true even if the firm is a monopolist; all we require is free entry in factor markets. The argument is simple: every factor of production is paid their marginal products. A firm has no greater need to economize on high-skilled labor than they do on low-skilled labor or on capital: at the margin, lowering costs is lowering costs.
Constructively, what does this mean for inequality trends? It means that to decrease inequality, either marginal products of different workers need to equalize (perhaps implying more equality of educational opportunity), or factor markets without free entry need to loosen. The second argument strikes me as the important one. Intellectual property, occupation licensing requirements such as those in medicine, skilled immigration restrictions that are biased across sectors of the economy, and high-paying patronage jobs are a few among many distortions on the factor side. Theory tells us that the market will not self-correct these distortions, and therefore contra Rogoff, we should be worried about long-run growth in inequality.