Ed Conard recently joined Harvard’s Harvey Mansfield to discuss his Oxford University Press chapter, “The Economics of Inequality in High-Wage Economies,” at Harvard University’s Program on Constitutional Government. The video, audio, and text of his speech and the Q&A session are available below.
Thank you for taking time out of your precious day to listen to my point of view. I appreciate it.
I’m here to summarize my view on the Economics Underlying Inequality in High-Wage Economies and what we might do to increase the prosperity of America’s middle- and working- classes.
Let me start with my view of American economic history since World War Two, and the radical change it has undergone.
The post-World War Two transition from agriculture to manufacturing opened an enormous window of unharvested investment opportunities. America’s talent rushed to design and market new products produced by domestic blue-collar workers. Innovations created for the war, but not yet commercialized, accelerated their success.
Growth was unencumbered by government spending and regulation. Taxes were low. Marginal tax rates were high, but no one paid them.
Returning soldiers transitioned easily from farms to factory jobs when they found young women working there and in the surrounding areas. The military instilled the workforce with discipline and respect for authority. And the war damaged offshore competition.
At the same time, America saturated its population with education and found talented but uneducated people who grew far more productive with formal education.
Productivity growth boomed. The economy grew rapidly from a low standard of living. And blue- and white-collar workers shared similarly in America’s success.
Alfred Sloan’s landmark 1963 book, My Years with General Motors, typifies the times. It contains chapters like, “The Concept of the Organization,” “Co-ordination by Committee” and “The Development of Financial Controls.” In a world where satisfying growing demand was the hurdle to success, the specter of competition was barely on his radar.
By 1996, Intel CEO Andy Grove, in his top-selling business book, Only the Paranoid Survive, writes “…I believe in the value of paranoia,” and, “the more successful you are the more people want a chunk of your business … until there is nothing left.” He warns of “strategic inflection points” that alter “the way business in conducted.” Grove focuses exclusively on competition and exhibits none of Sloan’s confidence.
For starters, international trade gradually exposed U.S. manufacturers to $3-an-hour offshore labor. This put enormous pressure on domestic manufacturers to increase productivity or fail. Manufacturing productivity grew faster than the demand for domestically made goods, which hollowed out manufacturing employment.
An unexpected slowdown in the growth of the population after women entered the workforce put financial pressure on defined benefits retirement programs, which made legacy companies less attractive places to work.
While science grew more complex and progress gradually slowed down, information technology nevertheless opened a new window of unharvested opportunities, opportunities that required less capital and blue-collar labor than manufacturing. It also increased the demand for high-skilled workers.
Information also increased the effectiveness of talented decision-makers. High-scoring domestic students increasingly left the sciences for quantitative MBAs.
In jobs where performance can vary, the most productive workers are three-times more productive than the least productive workers. Information magnifies the differences and makes it easier to measure and reward high performers—as opposed to tasks performed as teams in large collective enterprises. With incumbent companies languishing, the most productive workers migrated to high-skilled services that could measure and differentiate their pay.
As the talented engineers retired, they were gradually replaced by computer programmers and MBAs who migrated to knowledge-oriented companies like McKinsey, Goldman Sachs, Google, and Microsoft, without many blue-collar workers. These companies supply information to high-skilled decisionmakers. In effect, high-skilled workers increasingly went to work for each other.
At the same time, lower-skilled workers were left behind to fend for themselves.
Traditional economics assumes entrepreneurs will employ displaced workers and that competition between employers will drive up productivity and wages. But when properly trained talent has moved to Silicon Valley and outsourced their blue-collar work to China, high-skilled entrepreneurs may never arrive. Research finds manufacturing towns that have lost factories haven’t recovered lost wages.
With the loss of manufacturing jobs, lower-skilled workers migrated to manual service with less high-skilled supervision and engineering than manufacturing. This slowed low-skilled productivity growth.
Exacerbating the problem, services have historically had inherently slower productivity growth. When an engineer designs a machine, the machine structures its use. Structured use reduces the need for supervision. By their nature, services are less structured physically. Productivity growth in low-skilled services requires day-to-day supervision and discipline akin to exercise. Greater entropy-related losses slow the productivity growth of low-skilled services.
The migration of talent to large coastal cities further exacerbated the divide between blue- and white-collar workers. Exorbitantly high real estate prices, high taxes, immigrant populations willing to accept low after-rent wages, and public schools filled with low-scoring students preclude domestic blue-collar workers from following white-collar workers to faster growing coastal cities.
These forces divided high- and low-skilled workers by companies and geography. We see books like Coming Apart and Bowling Alone that recognize the growing division without fully understanding the underlying economics causing it.
These divisions made it harder for blue-collar workers to provide services to the most talented and valuable customers. Instead, those services were increasing supplied by low-skilled immigrants willing to accept low after-rent wages.
The divide has been especially powerful in America for two reasons.
First, America has far more low-skilled people to care for, and far less talent to care for them. Unbeknownst to most people, America has half the number of high-academic-scorers as a percent of the population, and twice as many low-scorers as Northern Europe. That leaves Scandinavia with 4-times as many high-scorers per low-scorer as America—an enormous difference.
When talent constrains growth, the economy will devote more resources to increasing the productivity of talent. And when talent is constrained, the more talent America devotes to producing innovation, the less talent it can devote to increasing the wages of lesser-skilled Americans.
Given America’s shortage of talent, America must squeeze more value out of its talent for the benefit of others than Europe and Japan, for our low-scorers to achieve the same standard of living,
Fortunately, we do. America’s talent is far more productive than their counterparts in other high-wage economies. Today’s information-based technological frontier—which includes not only creating information technology, but also using the technology to gather information, and using the information to make more effective decisions—has proved to be a gold mine. Mining gold has made America’s talent more productive than their counterparts in other high-wage economies.
As the high-wage world has transitioned from manufacturing to information, a positive feedback loop has taken hold in America, unlike elsewhere in the world. Whether from economies of scale, good fortune, or entrepreneurial risk-taking, successful American risk-takers have gradually created cutting-edge companies, like Google and Microsoft, capable of mining the technological frontier. In turn, mining the frontier spins off valuable knowledge that increases the expected payoffs for the successful risk-taking. It’s much easier to identify and solve problems worth solving if you are solving related problems. The more likely you are to succeed at solving a problem, the more likely you are to take the risks needed to solve it.
Fortunately, today’s innovations have also produced competitive advantages that earn excess returns over and above the cost of capital. Were there no excess returns to risk-taking, competitors would simply wait for others to innovate and copy them.
Americans have responded to these higher expected payoffs by getting better training, working longer hours, and taking more risks than their counterparts in other high-wage economies. In turn, their success has gradually expanded the institutional capabilities America needs to mine the technological frontier. Over decades, risk-taking, innovativeness, and the productivity of America’s talent has gradually pulled away from the rest of the high-wage world.
America has produced 5-times as many $1 billion startups as Europe. 5-times is an astonishing difference. Apple alone is worth more than the 30 largest German companies combined. Europe and Japan’s talent simply aren’t pulling their weight.
Because of the higher expected payoff for success, the behavior of talented Americans relative to their counterparts in other high-wage economies, and America’s resulting outsized success, I don’t find arguments that minimize the importance of incentives for the risk-takers very persuasive.
While taxes bear directly on payoffs and, therefore, risk-taking, their effects are gradual and compounding. Low taxes can’t make bad ideas profitable. To generate good ideas, you have to build companies capable of mining the technological frontier. That takes decades of successful risk-taking, not years. We can’t measure the long-term impact of taxes other than to compare America's outsized success to the anemic contributions from all other high-wage economies. Even that's hard to do because we don’t know how much America’s outsized success has raised the rest of the world, although clearly it's a lot.
But underneath the success of America’s positive feedback loop, talent is increasingly working to grow its own productivity and less and less to grow the productivity of blue-collar workers.
Exacerbating matters, low-skilled immigration and trade with low-wage economies—which buys low-skilled labor from the rest of the world and sells high-skilled American labor—spreads America’s talent thinner. Managing talent from abroad via Skype saps management’s attention further.
While it’s difficult to measure the productivity of white-collar and blue-collar workers, productivity measures by sectors indicate large differences in productivity growth by skill level. The information-oriented sectors have invested substantially more in IT and grown productivity 4-times faster than the physical-product-oriented sectors over the last 20 years—2.8% per year growth vs 0.7%. That may not sound like a lot, but over 20 years that equates to a 50% increase in the output of knowledge workers relative to physical workers. These differences surely reflect differences in the productivity growth of high- and low-skilled workers more broadly.
Within the physical sector, manufacturing, retail distribution, and wholesale distribution, have grown productivity much faster, but they are shedding workers. So the productivity growth of sectors adding blue-collar workers is near-zero.
In effect, productivity growth is pushing blue-collar workers into sectors suffering from what economists call Baumol’s cost disease—sectors whose wage growth depends on the productivity growth of other sectors, in America, chiefly the faster productivity growth of our highest-skilled workers.
Because of the faster productivity growth of America’s most productive workers, America’s middle class now enjoys incomes (after subtracting taxes and adding back government services) that are 30% higher than Northern Europe on average—up from 20% higher in the mid-1990s. America’s incomes are 70% higher than Southern Europe, with test-score demographics similar to America.
European incomes would be even lower if they weren’t free riding on America’s disproportionate contribution of innovation, military spending, and healthcare profits. …and lower still if it didn’t have far more talent than America to supervise their low-skilled workers. European sclerosis is far worse than people admit.
With Baumol’s cost disease, faster growing high-skilled productivity drives up demand for workers in the rest of the economy. With a restricted supply of middle-class workers, growth has driven up their wages. With a less restricted supply of lower-skilled workers—from automation, offshoring, and low-skilled immigration—growth has increased employment rather than wages.
Under these constraints, high-skilled workers, immigrants, and offshore workers have been the biggest beneficiaries of America’s success, not lesser-skilled Americans. Today, 40 million foreign-born adults and their 20 million native-born adult children—35 million of which are largely low-skilled Hispanic adults—now call America home. Is it any surprise domestic blue-collar workers elected a brass knuckled bully to fight for them?
Given America’s success relative to other high-wage economics, what can we do to make things better?
I am not a libertarian. My dispute is not over whether to help others, but how best to do it.
I believe liberals and conservatives share the same objective: extracting as much value from America’s talent for others as we can. We just differ in our beliefs about how to achieve that objective.
Even liberal economists agree that investors must create $5 of value for others—for their customers, employees, and suppliers—to put a dollar in their own pocket. We can either motivate our talented risk-takers to create another $5 or take more of the dollar they keep by raising taxes further. I see more leverage in increasing the $5.
Given the higher payoffs for risk-taking, the subsequent behavior of America’s talent, and our resulting outsized success, I find it hard to believe that higher taxes that reduce the expected payoffs for successful risk-taking won’t gradually slow America’s growth. With the rising cost of retiring baby boomers and growing deficits threatening growth-crushing tax increases that leave America vulnerable to a growing Chinese military threat, we can’t afford to slow America’s growth. Nor do I see compelling arguments to take risks that may slow growth.
With government spending already consuming 36% of GDP in America (before the Biden Administration) and projected to rise rapidly as baby boomers retire, I support reallocating government spending to help others rather than increasing the share of GDP consumed by government. Unfortunately, the two are often conflated for political purposes.
In part, I arrive at my conclusion because I believe government spending—other than giving people money—has been woefully ineffective. New York, California, and Illinois all have higher taxes. Have they increased test scores, improved mobility, reduced poverty, or otherwise affected significant change? Does upstate New York, isolated from the extremes of NYC, achieve better outcomes? No.
Similarly, America spends more on education per student than Western and Northern Europe and equilibrates spending across incomes with state and federal subsidies.
From the OECD, the test scores of European-Americas are the same as the weight-average test scores of Europeans. Asian-Americans score the same as Asians. The scores of children from low socio-economic families (as measured by the number of books in their home) are the same as Western Europe. The scores of first-generation Americans are higher. Scandinavian-Americans score higher than Americans and earn more, substantially more than their Scandinavian counterparts—the darlings of liberal comparisons. Given how much we spend at all income levels is hardly surprising the rest of the world has no secret sauce America failed to try.
Massachusetts students score higher than other states, but they score higher when they enter schools and don’t improve relative to the rest of the country after attending school.
The only schools that show significant effects after adjusting for some, but not all, selection bias are “no excuses” charter schools. Their benefits are limited to the poor. Their effect on scores are largely gone by the 12th grade, although they do seem to improve citizenship. Nevertheless, the NAACP and Democrats oppose them.
Studies of identical twins separated at birth indicate variation in test scores are 50% to 80% genetic and that only half of the rest—1/6th if we use the 65% center point —is attributed to the shared environment, at least as the shared environment is current administered. If we could improve the shared environment 20%, it would yield a 3% improvement (= 20% x ½ x 1/3).
Aside from the (worldwide) Flynn effect (which probably comes from better nutrition), no one has produced much improvements in education/test scores beyond the one-time improvements the world has achieved by saturating their uneducated populations with education and by improving neglected school districts.
Bill Gates didn’t believe the data. He spent hundreds of millions of dollars of his own money running a variety of experiments guided by the best experts. He achieved no improvement according to Rand Corporation. Gates has said publicly, it’s harder to increase test scores than it is to cure Malaria. He has also said: the problem isn’t unmotivated teachers; it’s unmotivated students.
As an experienced businessman, who sees nothing but miraculous cures for cancer, I see nothing but failure, exaggerated claims, and a lot of wishful thinking. I believe organic growth fast enough to avoid growth-crushing tax increases and to mitigate the threat of a growing and worrisome China is a pipedream regardless of how well we fine-tune policy. That’s not to say we shouldn’t try to improve education, but that rather that we shouldn’t stake America’s future on it.
Alternatively, we can just give lesser-skilled families money, although this taxes investment and successful risk-taking—the very things that accelerate economic growth, employment, and wages.
How much America reallocates to poor family is surprisingly hard to come by. The Census Bureau, for example, does not count nearly half of our spending in its widely publicized poverty measures—it doesn’t count all noncash spending such as healthcare, rent subsidies, and tax credits for example.
Prior to the Biden Administration, and not counting the $1.5 trillion per year America transferred to retirees over the age of 65, or money spent helping everyone, such as public-school education, we transferred about $1.3 trillion to people under the age of 65. That’s about $22,500 per person under the age of 65 in the bottom 20%, or $90,000 per family of 4, although a large share of that money is not transferred to the poor. Estimates that comport with my own work indicate America gives poor families that earn $14,000 a year on average about $33,000 of additional benefits in 2015 for a total of $47,000 of income. For perspective, the median household income at that time was $55,000.
At those levels of expenditures, surely it’s prudent to ask: Why isn’t $47,000 enough? How much more to we have to give before “more” is no longer a priority? My take is that we are close to an optimal spending amount, which is not to say we can’t improve the way we spend the money.
With tax policy allowing median income families to consume about as much government services as they pay in taxes, and education unable to produce enough high-earning workers to generate the necessary tax revenues, high-skilled immigration is the only viable solution for growing faster, spending more and avoiding growth-crushing tax increases.
America issues a million green cards-a-year. With six million full-time workers with top-5% talent and 7 billion non-Americans, we could potentially recruit another 6 million ultra-high-skilled immigrants, which may double America’s growth rate. That would go a long way toward solving our problems.
Educators also need to persuade America’s talented students that they have a moral obligation to get the tedious training, perform the arduous task of serving customers, and take the risks that increase the productivity of other people, especially lesser-skilled Americans. Let’s not kid ourselves, despite our good intentions, we overwhelmingly serve each other as customers.
These are my conclusions and the reasoning behind them. I would love to hear and debate yours.
Q&A PART 1
Q&A PART 2
14 Questions for Ed Conard
Tom Palmer (Snr. Fellow, Cato Institute): Do we have the ability to recruit high-skilled labor from around the world? Can we identify and restrict immigration only to them? What happens to the rest of the world if the U.S. recruits their best and brightest?
Jeff Bristol (Snr. Partner, Parrish Associates): Is a return to a 1960s economy a viable alternative to your proposed policies i.e. close the borders, build a wall, and reindustrialize our low-skilled workers? Would reindustrializing low-skilled labor allow them to eventually become high-skilled labor?
David Epstein: What about the demand-side view of productivity growth and income/wealth inequality? Does income/wealth inequality slow growth because there isn’t enough consumption to demand goods and services?
Bernhardt Trout (Prof. Chemical Engineering, MIT): Your proposal could lead to further working-class decline. How would you help the working class? Secondarily, how does your proposal for recruiting high-skilled labor consider U.S. security, political impact, and cultural systems since many immigrants won’t necessarily share our values?
Harvey Mansfield (Prof. Government, Harvard University): What is the driving force that your argument relies on? Isn’t it culture, as opposed to purely economics?
Peter Hansen: What are the synergies between MBAs and engineers? What do the MBAs bring to productivity that engineers and entrepreneurs can’t?
Eileen McDonagh (Prof. Political Science, Northeastern University): America’s founding myth is rebellion and mistrust of centralized government. Does that impede society and government cooperation to solve our biggest challenges?
Avi Nelson (Entrepreneur + fmr. Radio Host): Do you see resentment of wealth and income inequality as the driver of Trump or was it political correctness and the denigration of America by the left? Is economic resentment really the issue?
Andy Zwick (Exec. Director of Harvard’s Program on Constitutional Gov’t): How does technology affect lower-skill workers, i.e. worker training vs software that allows lower-skilled workers to serve functions with less formal training? Is there an opportunity for software to improve lower-skill workers’ productivity?
Anna Schmidt: Should there be government incentives to encourage people to study computer engineering and software development? Is the future very big companies occupying multiple niches, like Amazon? What is your view of universal basic income (UBI)?
Avi Nelson (Entrepreneur + fmr. Radio Host): Is there any country that utilizes its talented workers as well as U.S.? If not, why has the U.S. been so uniquely successful? Is there a formula others could follow to replicate U.S. success?
David Epstein: Who benefits most from a high-skill worker optimizing the productivity of a low-skill worker? Does increased low-skilled productivity translate into higher low-skilled wages?
Jeff Bristol (Snr. Partner, Parrish Associates): Is another answer to inequality and redistribution something akin to workers guilds?
Paul Peterson (Prof. of Government, Harvard Kennedy School): What impact has the COVID-19 pandemic had on the economy? It looks to me like the largest upward redistribution of wealth in history.