Economic Inequality in the United States – San Francisco Fed

The Performance of the U.S. Economy and Income Distribution

This Economic Letter is adapted from the 2006-2007 Economics of Governance Lecture delivered by Janet L. Yellen, president and CEO of the Federal Reserve Bank of San Francisco, at the Center for the Study of Democracy, University of California, Irvine, on November 6, 2006.

Introduction

My topic today is the performance of the U.S. economy, with a focus on how trends for the economy as a whole have been playing out for our nation’s individuals and families. One area I’d like to examine in particular is how the income that has been generated by our economy over the past three decades or so has been distributed among the various income groups, from the top to the bottom.

Questions of income inequality, of course, are not part of the Federal Reserve’s dual mandate from Congress, which is to foster price stability and to promote maximum sustainable employment. Nonetheless, this has been an interest of mine for a long time, and not only as an academic. In addition to my years as an economics professor at U.C. Berkeley, I’ve also had several stints as a macro policymaker, first on the Federal Reserve Board in Washington, D.C., then on President Clinton’s Council of Economic Advisers, and now at the Federal Reserve Bank of San Francisco. Much of my interest in macro policy has been founded on the belief that it can and should improve the lives of the broad range of our nation’s people. I think of this as happening through two channels. First, policies that reduce the frequency and size of the fluctuations in business cycles can spare people the painful disruptions that occur during recessions, or, in the worst cases, tragic events like the Great Depression of the 1930s. Second, policies that succeed in enhancing the long-run growth of productivity should help lift the average standard of living over time.

The Great Moderation and Productivity Trends

By many measures, these two channels have been operating extremely well in our economy for some time. In terms of the business cycle, for almost two decades we have been enjoying an era that many economists call the “Great Moderation”; in other words, recessions have been less frequent, and the swings have been less severe, while, at the same time, inflation has come down to quite moderate levels and itself has been less volatile. Productivity trends also have been very favorable, probably in no small part because of the impact of technological advancements. Growth in labor productivity has been quite rapid for over ten years now, following more than a quarter century of stagnation that began in the early 1970s.

Given these two developments—more macro stability and more rapid labor productivity growth—it is tempting to conclude that most Americans are feeling “better off.” But a glance at the newspapers suggests that this is not necessarily the case. Indeed, poll after poll shows that many Americans feel dissatisfied with the long-term direction of the economy and are worried about the future. Recent polls by the Pew Charitable Trust, the New York Times and CBS News, and various labor organizations indicate that growing shares of respondents feel that they and their children will experience a diminished quality of life in coming years, and that, even today, working conditions are marked by more insecurity and stress than they were a generation ago (see, e.g., Greenhouse 2006).

Income Inequality and Wage Trends

Productivity and Real Wages

A natural place to begin is by looking at average real compensation, that is, average wages plus benefits for an hour of work adjusted for inflation. In the U.S., the growth in average real compensation has roughly tracked growth in labor productivity, which measures the value of output per hour of work adjusted for inflation. When U.S. labor productivity growth slowed sharply and unexpectedly in the early 1970s and then stayed sluggish for the next 25 years, growth in average real compensation also was sluggish. Then, in the mid-1990s, labor productivity growth surprised us again, only this time, thankfully, on the upside: it suddenly took a big jump up—to over 3% at an annual rate—and it has stayed in that vicinity ever since. As I mentioned, this development probably stemmed mainly from technological innovations and the huge investments businesses made to harness them for production. How has this affected average real compensation growth? It has jumped, too, also hitting a 3% rate.

From this perspective, then, it would seem that things are looking pretty good. However, the public mood does not seem consistent with this view. To see why, we need to dig a little deeper. When we look at data on the distribution of real wages, which constitute the bulk of compensation, we find striking evidence of increasing inequality. For example, economists Dew-Becker and Gordon (2005) report that, from 1997 to 2001, nearly 50% of productivity gains went to the top 10% of the distribution. Importantly, they find roughly the same pattern going back more than 30 years.

Wage Inequality

As Figure 1 shows, from 1973 to 2005, real hourly wages of those in the 90th percentile—where most people have college or advanced degrees—rose by 30% or more. As I will discuss later, among this top 10%, the growth was heavily concentrated at the very tip of the top, that is, the top 1% (Piketty and Saez 2006). This includes the people who earn the very highest salaries in the U.S. economy, like sports and entertainment stars, investment bankers and venture capitalists, corporate attorneys, and CEOs. In contrast, at the 50th percentile and below—where many people have at most a high school diploma—real wages rose by only 5% to 10%.

What I’ve described so far is the big picture for wage inequality—the major change over three decades. However, an interesting twist on the story has occurred during the last decade, when rapid productivity growth raised the real wages of workers throughout the distribution for the first time since the 1960s. During this period, real wages of the lowest earners—the

SDGs, Targets, and Indicators

1. Which SDGs are addressed or connected to the issues highlighted in the article?

• SDG 1: No Poverty
• SDG 4: Quality Education
• SDG 8: Decent Work and Economic Growth
• SDG 10: Reduced Inequalities

2. What specific targets under those SDGs can be identified based on the article’s content?

• Target 1.1: By 2030, eradicate extreme poverty for all people everywhere.
• Target 4.1: By 2030, ensure that all girls and boys complete free, equitable, and quality primary and secondary education leading to relevant and effective learning outcomes.
• Target 8.5: By 2030, achieve full and productive employment and decent work for all women and men, including for young people and persons with disabilities, and equal pay for work of equal value.
• Target 10.4: Adopt policies, especially fiscal, wage, and social protection policies, and progressively achieve greater equality.

3. Are there any indicators mentioned or implied in the article that can be used to measure progress towards the identified targets?

Yes, there are indicators mentioned or implied in the article that can be used to measure progress towards the identified targets. These include:

• Income distribution among various income groups
• Growth in average real compensation
• Wage inequality among different education levels
• Job displacement rates
• Income volatility and fluctuations

SDGs, Targets, and Indicators Table

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Source: frbsf.org

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