What Does Income Inequality Mean for the Economy?

November 15, 2012

When Henry Ford started the Ford Motor Company one of the things he did was implement a $5 a day workday. This was revolutionary because he paid a wage that was double the current market rate and also reduced worker hours. His goal in taking these measures was to reduce worker attrition. To my parent’s generation this probably does not seem like an unusual move. For the past fifty or so years people expected to join a single firm and move up in the ranks and be rewarded for their loyalty. Employees and firms were intensely loyal to each other.

In recent years this model has changed. Companies have moved from a model where they hired high school or college graduates and trained them to be productive employees into firms that poach job candidates that are ready to hit the ground and ignore the unemployed. This shift in mentality is apparent in the following 60 Minutes segment:

In the segment it seems to me that the owners of the companies have decided to shift the cost of training from their firms and onto the taxpayers. We also see that the wages for these precision manufacturing jobs are not high paying. At $12-$15 an hour they are making around $25,000 to $31,200 if they work 40 hours every single week of the year. This is below the state median income in Connecticut and also around 125% of the poverty line for a family of four. In Connecticut these workers would probably be in the poorest 20% of wage earners. Unless these firms move their wages in line with union shops (that according to the segment pay around $29/hour) we are using taxpayer money to get people jobs that do not bring them into the middle-class.

The is the kind of thing that is scary because typically you would expect unskilled jobs to pay little since there is an excess supply of unskilled labor and then skilled jobs to pay more because there is less supply of skilled labor. Instead it seems the global economy is also driving down the price of skilled labor as well. As labor costs fall at the bottom and then the CEOs reap the surplus we get the following result (via Center on Budget and Policy Priorities):

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Income inequality is not in and of itself a terrible thing. However too much of it causes problems. The associated paper from the Center on Budget and Policy Priorities points out:

There is also evidence that income inequality causes more direct harm to people in poverty. For example, a number of papers prepared for a conference on income inequality sponsored by the Federal Reserve Bank of New York found a link between higher levels of inequality and poor schools, substandard housing, and higher levels of crime.
It is not a big leap to recognize that if the private sector is not properly caring for its workers than the public sector safety net will have to pick up the slack (or alternatively we have to be willing to let people in poverty suffer, a position favored by some Republicans). So ultimately it costs all taxpayers money. Additionally the fact that workers do not make much money means that they do not have the ability to consume many of the products that entrepreneurs might peddle to them. This is why I do not think anyone argues too much income inequality is a good thing. As far as solutions to the problem, I will leave that for discussion in the comments section. Personally, as a free market person, I tend to believe that strengthening unions and collective bargaining rights is the best approach. However I am interested in hearing your thoughts below.

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This work by Matt Zagaja is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 Unported License.