Saturday, November 17, 2007

Rising Inequality: Natural Outcome of Competition

The top graph above (click to enlarge) shows the rising income share of the top-earning 25% of U.S. taxpayers from 1986-2005 according to IRS data. In 1986, the top 25% earned 59.04% of total income, and by 2005 the income share of the top 25% increased to 67.5%, indicating rising income inequality over time.

Interestingly, the same pattern of rising income inequality over time also can be found in professional baseball. Using a sample of 5 MLB teams from the USA Today Salaries Database for professional sports (NBA, NFL, MLB and NHL), the bottom chart above shows an increasing share of total payroll going to the top 25% highest-earning players on each team from 1988 to 2007.

Consider that in 1988, for the 5 teams listed above, an average of 59% of total payroll went to pay the highest-earning 25% of the team roster (slighly lower than the 62.4% share for the general population), and by 2007 that payroll increased to 70% on average for these teams (slightly higher than the 67.5% for the general population).

What are we to make of this pattern of rising income inequality in both MLB and the general population?

Here's what US Court of Appeals Judge Richard Posner wrote on his blog last year:

As society becomes more competitive and more meritocratic, income inequality is likely to rise simply as a consequence of the underlying inequality--which is very great--between people that is due to differences in IQ, energy, health, social skills, character, ambition, physical attractiveness, talent, and luck. Public policies designed to reduce income inequality, such as highly progressive income taxation and middle-class subsidies, are likely to reduce the aggregate wealth of society, and therefore should not be adopted unless rising income inequality is a social problem.

Here's another way to think about it: If your talents, abilities, and intelligence place you 2-3 standard deviations above the mean, would you rather be selling your labor services in 1807, 1907, 1957, or 2007? Probably 2007. Given Babe Ruth's talent, he would have obviously been much better off playing today instead of the 1920s. The super-talented baseball players of today are facing higher rewards than their peers of 20 years ago, and they are able to command greater shares of team payrolls.

And as talented as Tiger Woods, Oprah, and Bill Gates are, I don't think they would trade today's opportunities for marketing their "superstar" talents with the opportunities of the 1950s. And if your engineering talents place you 3 standard deviations above average and you're living in India or China, I don't think there's any question that you're much better off today than in the 1980s.

Bottom Line: Competition breeds competence, and above-average competence commands higher monetary rewards in an increasingly competitive, increasingly globalized world economy. Rising income inequality over time is a natural outcome of competition and globalization.


At 11/17/2007 12:14 PM, Blogger spencer said...

But major league sports are not a free market. They are a monopoly and all you are demonstrating is that some of the monopolistic economic rent has been shifted from the owners to the players.

At 11/17/2007 9:08 PM, Anonymous Anonymous said...

If one compares the talent and athleticism of athletes in different sports, for example football compared to ballet, what in fact drives the salaries is the customer who values football ahead of ballet regardless of the skill, talent, or physical effort required to deliver a performance.

What drives salaries? Is it a sports monopoly, competition, the ability of one person to successfully promote their work (ie. Picasso) or customer demand that places more value on one form of work than another or is it a combination of these factors?

I doubt that there is a simple answer. What does appear to be clear is that income inequality has a tendency to increase as a society becomes more economically prosperous. One can either see this as a social evil worthy of redistributive correction or a natural tendency.

At 11/17/2007 10:25 PM, Blogger Soul Searcher said...

That's a strange comment coming from you, spencer. How did these economically coerced players manage to force such a transfer, especially considering most of them come from poor backgrounds Isn't the reason we need unions in "monopolistic markets"?


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