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I’ve been thinking a bit about why wealth inequality really doesn’t matter – but I think the argument is a little more nuanced than I presented. In particular, what I wrote yesterday is concerned largely with the positive, but in reality this debate is intimately connected with normative action. In the wake of Piketty’s book (which I have not finished) a number of people are talking about taxes on global capital.

I don’t have a very strong opinion on that (other than a negative gut reaction). But there are things we can do closer to home – appealing to both conservatives and liberals – that would be more feasible and possibly more effective. In this debate we are faced with a slurry of terms that are sometimes used to describe the same underlying phenomenon but are each different: wealth, capital, returns on capital, and capital share of income.

While I am unconvinced that just the inequality of net worth (“wealth”) really does much harm to a nation’s socioeconomic fiber – indeed I think concentrated wealth is probably a necessary consequence of capitalism – it is clear that skill-biased technological change, and what that portend’s for labor’s share, is probably an important concern (if nothing else in the discussion of income inequality itself).

And here’s the problem. Government programs, the way they are currently structured, are largely to blame for gaping disparities like this:

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(Before I go on, it is worthwhile noting this picture, yet again, confirms my previous point that wealth inequality per se isn’t increasing and was never a problem).

What we see isn’t surprising. The bottom 90% of Americans are basically excluded from the stock market – the most important source of long-run returns for pretty much everyone else. What’s striking here is that this inequality is far worse than inequality of wealth itself. So not only do the rich own more capital, they own the best capital.

To some extent this is unavoidable. Rich, well-connected elite have far better access to the best investment opportunities like secondary private markets and hedge funds that provide alpha. (Chances are if a hedge fund is doing well accounting for management fees, they don’t want you as a client). But the people that benefit from this are the extremely wealthy percent of a percent not even demarcated above, not simply affluent Americans who are still extremely well-represented in stock markets as a whole.

And the reason for this? Perhaps poor government policy.

The real wealth of most Americans is their claim on social security in the future. Social security has been an incredible source of, well, security for many citizens and pretty much the reason many are not in poverty today. But the Social Security Trust, which actually handles all of this money, is basically forcing you to invest in low-return government debt.

This becomes a source of inequality as social security as a portion of total implied wealth (here defined as your claim on future GDP) is far higher for the bottom 95% of Americans, who can barely save, than anybody else. On the other hand, for people that actually manage to save (even if just a little bit) the stock market is a source of real, long-term prosperity.

Furthermore, misguided government programs encouraging homeownership – something many economists have come to agree isn’t a good thing for poorer people – once again distorts private investment choices to relatively low-return stores of wealth like residential real estate. When the productivity growth is coming from financial, informational, and social capital, what value is owning a home in Podunk, Missouri?

Again, mortgages are the primary – and possibly only – source of explicit wealth for middle-class Americans.

Many conservative economists have reached the conclusion that we should probably privatize social security. As a purely financial matter, I am inclined to agree – the justification for our current program is fully predicated on the dangerous assumption that government bonds are the best long-term investment when, in fact, Vanguard Target Retirement 2045 is the way to go.

In fact, what we need is something akin to a Sovereign Wealth Fund that allocates payroll tax receipts in a more productive way. This should have great appeal to conservatives as well as liberals. For conservatives, it frees an immense source of domestic equity away from relatively inefficient projects furnished by the national government to more entrepreneurial and productive ventures in private markets. Indeed the cost of capital (in normal times) would probably fall. For liberals, it is the most logical extension of the welfare state, designed in a way complementary, not opposed, to modern capitalism.

This would solve what I see is the heart of the problem Ezra Klein and others are getting to when they worry about wealth inequality. It isn’t the disparity of wealth itself (which is background noise), but the changing structure of the returns. It is a tragedy that over the past thirty years, the stock distribution was so much more skewed than wealth distribution.

The government is ultimately a bank that can print its own money. What it should be doing is guaranteeing a minimum return in future receipts, as it does today, as well as investing in the option for more explosive growth. If the stock market performs so poorly as to not provide the returns necessary for to meet the obligation (and there’s a very low chance this would happen over the long run) the government can always finance the difference with a deficit. In fact, since returns would be far higher, chances are in a financially-driven recession, the increase in deficits would be lower.

This is probably not enough, but does more to solve inequality than a meaninglessly small increase in capital gains taxes would accomplish. More importantly, it achieves this without further harming private interests, and yet greatly increases capital redistribution. It would also unleash an incredible amount of capital for the investment the private sector desperately needs.

Here’s the short and sweet argument for privatized, but guaranteed, security. Rich people should give poor people equity in their companies rather than taxes to the government to solve issues of capital return disparity. The only role government should play is effectively guaranteeing a minimum return, in other words purchasing a barrier put on the S&P in the event valuations fall below what is promised. That is cheaper, more efficient, and the principle we ought to work on.

Paul Krugman notes that persistent unemployment hurts the employed as well by decreasing their bargaining power, citing the low (voluntary) quit rate as evidence. This is an interesting claim with compelling evidence – wages grow a lot faster for everyone when unemployment is low.   But there’s something peculiar about the the recent recovery – it’s relatively powerless. Let me explain. Both the early and late 2000s recessions have been followed by so called “jobless recoveries” where output rises a lot quicker than employment. One would expect that this would be correlated with slower increase in bargaining power (using quit rate as a proxy) though there is no way to be sure, the JOLTS dataset we use to measure these things only goes as far back as the turn of the century.

But one would at least guess that a recovery in power would be in line with a recovery of the labor market. Using quits and unemployment as the relevant proxies, this would be incorrect:

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The above is a simple graph of unemployment and quit level since 2000. Economic theory predicts that sharp falls in output and employment should be followed by proportionally rapid recoveries (the so-called “v-shaped” recession). It is a well-known fact that the late 2000s recession hardly followed this pattern. But the way quits and unemployment differ in their respective dynamics is interesting. Even though the decline in unemployment after 2007 was hardly proportional to the crash, at least it was quicker – that is a higher absolute slope – than the early 2000s. Conversely, not only did quits fall much faster in 2007, they also recovered – in absolute and relative terms – much more slowly!

If you crunch the numbers you’ll see that after 2001 unemployment fell 30% as quickly as it picked up. The same figure for 2007 is 20%. So it’s slower, but at least comparable. On the other hand, in 2001 quits recovered 64% as quickly as they fell whereas for 2007 that figure stands at an anemic 28%. Quits after 2001 picked up at 0.61 points (indexed to 2007) every month, but only 0.43 points in 2007, despite the much sharper crash.

Some of this is not surprising. While a deeper recession would normally be followed by a deeper recovery, there are limitations on the extent to which this relationship can hold, especially noting second order effects of hysteresis and market inflexibility. But some of this is definitely surprising. Using the figures above, unemployment recovered almost 70% as quickly in 2007 as it did in 2001. Without some important structural changes, that figure would be in the same ballpark for relative quit recovery, which only stands around 40%.

Qualitatively this means the willingness of workers to quit their jobs is far less than the unemployment rate would indicate, even using the standards of the 2000s, which weren’t by any measure amazing years for labor. If JOLTS went as far back as the Clinton years we would probably see an even stronger relationship between quits and unemployment, something that’s falling apart.

So now I should answer the proverbial “what does this mean”. There are a number of candidate explanations. Loyal readers know that I’m not hostile to a partially structural read, but even that can’t explain everything, because structural arguments generally accept that unemployment rate (as opposed to employment level or participation rate) is a broadly accurate read of the economy, and that much of labor force exit is due to an aging population (or technology, or whatever). I haven’t looked at the numbers, but if we looked at the above data using employment-population ratio instead of unemployment, the late and early 2000s may not look so different.

Ultimately if we are to believe that the structural power relationship in the labor market has not changed noticeably since 2000, unemployment rate grossly overstates the pace of labor market recovery, and the Fed should not even be thinking about tightening of any type. On the other hand, to the extent that unemployment rate is a good gauge of overall labor market health, workers have seen a pretty substantial fall in their bargaining power since 2000 (and remember this is independent of employment levels, unless there are some severe nonlinearities in the data).

Another explanation comes to mind, though given the magnitude it is unlikely. Tyler Cowen notes that future inequality will likely be tolerated without Occupy-esque discontent as an aging country likes stability and calm. It may similarly be the case that older workers are less likely to quit their job as that implies an abrupt shift and uncertainty. Job changes may also require intrastate relocations, something else that has declined over the last few decades (though there’s a bit of chicken and egg, here).

All are pretty harrowing tales for American workers, though in the long-run the former is preferable. The growing unwillingness of workers to quit places strong disinflationary headwinds in the economy as the ability to hit a wage-price spiral becomes much more difficult. Edward Lazear and James Spletzer also estimated that low churn (of which quits are a big component) cost the US economy $208 billion dollars this recovery. More generally – and in this arena I have no expertise; I turn to leftists like Matt Bruenig – this has social consequences by placing a subservience of labor to capital. I’m generally wary of such distinctions, and it’s unclear that any of the proposed solutions like higher minimum wages and stronger unions would make much of a difference – but the possibility exists and it is important.

The powerless recovery is freaky. We are possibly seeing a greater dependence on employment when tight labor markets are a thing of the past.

Ezra Klein’s remarks on inequality led to a pretty rich discussion, for the most part, disagreeing with his proposition that inequality isn’t the defining challenge of our time. His response today is great, making a clear – and agreeable – case that full employment is the most urgent problem facing policymakers today. The problem, I think, is that this still conflates importance with urgency and that which implies the former most certainly does not so the latter. Most of his recent post is correct. Unemployment is depressing median wages and absolutely nothing is more important right now than job creation.

But I want to focus on another, somewhat tangential, part of his post. Ezra writes:

Within the general rubric of “inequality,” income inequality gets a whole lot more attention than wealth inequality. But wealth inequality is much more concentrated and, in various ways, much more dangerous for the social structure. In particular, it’s wealth inequality that really ossifies social mobility.

The children of the top one percent only occasionally manage to match their parent’s incomes. But they often receive massive inheritances that grow over time, installing them atop the economic ladder and giving them a political reason to fight like hell against progressive tax policies (the Walton family is a good example here). And this kind of inequality doesn’t have any of the salutary benefits of income inequality: Massive inheritances don’t make people work harder. They give them a reason to never work very hard at all, and to try to influence public policy so they never have to work hard in the future, either.

I’ve written something along the same lines before, but have revised my belief that wealth inequality is an important signal. I’ll first detail why I think wealth is not too important before noting some reasons why it might be in the future. For one, wealth inequality has almost always been bad and – unlike income inequality – is not showing significant deterioration. In fact, the richest one percent actually saw a decline in their power over the Clinton boom:

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Of course, the wealth Gini is at any given moment in time “worse” than the income Gini, but that’s like comparing apples and oranges. To consider why think about how wealth and inequality thereof accrues: savings and investment. At any arbitrary level of income inequality, wealth inequality will increase, with a higher propensity to save among the rich as the first order effect (and capital gains as an important feedback). 

It’s pretty shocking how static wealth distribution has been, then, given the increasing income inequality. It’s difficult to argue then that wealth inequality – which is hardly a changing feature, unlike income – actually matters for political process in the way Ezra suggests. As disgusting as the Walton family’s politics might be, they have if anything only ossified the existing wealth inequality, without any first order effect on income (as Ezra points out, why should useless trust fund babies care about income taxes when they aren’t actually doing anything productive enough to earn seriously). Arguing that it is important that wealth inequality ought to be more important by arguing that wealth inequality engenders policies to protect wealth inequality is begging the question.

A focus on wealth also obscures monetary policymaking. Quantitative easing almost certainly increases wealth inequality, though there are good reasons to believe it improves income inequality (which over the long run would decrease wealth inequality… as you can see the interplay and economic dynamics are complicated to say the least) through a tighter labor market. In fact, one reason why monetary policy over the past decade did not increase wealth inequality as much as it could have is America’s expensive, pro home ownership programs like interest deductions and guaranteed loans.

In a freer real estate market – one that many economists agree would be more efficient and fraught with less moral hazard – it is likely that homes ownership would be more concentrated, with much of the middle class renting from the rich. The easy money policies of the early and late 2000s, then, would have increased wealth inequality that much more. But that would not mean anything, and should not be the basis for any policy action.

On the other hand, some important things are changing and wealth inequality may be more important in the future. As Piketty and Zucman document in a must-read paper, the wealth-to-income ratio in rich countries has increased substantially over the Great Moderation challenging conventional economic wisdom that this ratio is constant over time and reflecting lower population and productivity growth coupled with higher savings.

However, their data is a lot less remarkable for the United States, where population growth is relatively robust, and savings low – the ratio has increased though not markedly so. Still, in an age of automation and increasing capital shares, the increasing ratio could become an important economic issue.

Ultimately, though, capital income is still income. The return of wealth is not as much a reason to worry about wealth inequality but for capital tax parity with income – something progressives worried about income inequality have long advocated.

The importance of wealth inequality boils down to this. It is difficult to argue, as I think Ezra does, that this matters in and of itself because wealth inequality has historically been around as high as it is, and few would have suggested this is a problem a few decades ago. Suggesting that high wealth inequality begets more wealth inequality is not just assuming the conclusion (that this is bad) but also is not empirically guaranteed (though I am less convinced of this, data show that the 1%/median wealth ratio has increased substantially).

The arguments that wealth inequality matter for other reasons go back to some form of income inequality, usually distribution of capital gains. These are central to debates about inequality of all stripes. Wealth is not at all irrelevant, though. Flows matter more than stocks but when we as a society realize that deeper safety nets and education for the poor are important, we’ll tax the flow of inheritance every year instead of income which is scarce relative to the flow of wealth.

Ezra Klein argues that inequality should not be shaping political discourse to the extent that it is. That’s probably true. But this article misses a few important points and, I think, doesn’t do the best job of characterizing the progressive argument. Or maybe we’re in agreement, and I’ve misunderstood – it’s hard to tell (though, given that I’m commenting on a Wonkblog post, more likely than not).

A quick preface. Arguing that “unemployment and growth, not inequality, will be the defining problem” of our age is dissonant beyond the mutual causality (which is not very well founded) Ezra acknowledges simply because inequality is only a problem when growth is a problem. I don’t remember much about the 90s – intellectually, my generation really was born of financial crisis and political gridlock – but it’s hard for many Americans to think of the Clinton era, despite rising inequality, as a bad time due to high rates of job creation and growth. Polls suggest that perception of inequality and class warfare are worse than usual – vindicated by both the Occupy and Tea Party movements.

As long as your income is growing – even if not nearly as quickly as financiers on Wall Street – it’s not hard to foolishly convince yourself that you have a same shot at those riches as the millionaire next door (Americans ubiquitously believe that equality of opportunity is a worthwhile goal). But when the music stops the story changes. Inequality is a problem, politically and economically, precisely because of secular stagnation.

That, by itself at least, does not mean inequality is the defining problem of our age. It’s worthwhile dividing problems into two categories: those that are urgent, and those that are important. It is also worthwhile noting that usually one does not imply the other. Let me be absolutely clear: the most urgent problem facing America today is unemployment. This is almost incontrovertible. Both progressives arguing that inequality is and conservatives arguing that deficits are urgent do discourse a disservice.

But candidates for the most important problem are more diverse still. Existentially, there is little more daunting than the tail risks from climate change. If the United States, China, and India do not legislate strict carbon taxes into law within the next two decades many other debates will become moot.

Less apocalyptic, but important over the long run still, are rising inequality and secular stagnation. But it is difficult to argue that growth is a uniquely more challenging problem than inequality. It is easy – and right – to rail against the stale debate that we ought to tax the one percent five percent more (as if that will solve anything), but (contra Dylan) most solutions to unemployment will actually increase both opportunity and equality. The Wonkblog post suggests most of the connection between inequality and growth come from a persistent demand shortfall resulting from income earned by those with a higher marginal propensity to save.

And while this has dominated some progressives corners of the blogosphere over the past week, it’s hardly the most important link between the two. Curing unemployment results in a tighter labor force which eventually results in what economists call a wage-price spiral as workers expect inflation to rise, and demand higher wages, forcing inflation to rise. As the unit cost of labor rises quicker than that of capital, we would hopefully see a return of labor share and general prosperity.

The best way to increase wages, employment, and equality would be for the government to contract labor supply by hiring all unemployed workers who want a job in menial, labor-intensive positions. This would increase inflation, reduce the primary balance, and force unskilled wages to increase more rapidly than cost of capital (human or physical).

Most things we do to reduce inequality would also increase growth, at least in the economic model (thematically, not rigorously) employed by proponents of secular stagnation like Paul Krugman or Larry Summers. The best way to deal with inequality would be to increase some form of handout, financed by a deficit, which would aid inequality and growth at the same time. In fact, other than the second-best solution of the minimum wage, it’s not easy to think of something that – within the Keynesian model many people in this conversation favor – would reduce inequality without improving growth.

Neither inequality nor growth are the “defining problem of our time”, but they are born of the same ill, low aggregate demand. In times when demand is high, society will tolerate much more inequality and growth will be limited by supply-side factors. In fact, that’s the reason growth per se is not a problem of our time. If we were experiencing inflation despite low growth rates, it is difficult for the wonks of the world to do anything about it. That is the realm of science and engineering.

But we’re not there yet and, as far as I can see, the most convincing arguments suggest that both inequality and growth are first cousins. You would really need a Republican to find a way to better one without bettering the other (and, arguably, the farm bill is a perfect example to this effect).

The latter half of the 20th century was a great time for American liberalism. Our big, but more or less market oriented, government – for the first time – used public policy as a means of substantially curbing inequality across the country. The story of postwar America was of the middle-class autoworker living a good life.

There are economic reasons to doubt that we’re reaching a crescendo in the era of increased polarization: skill-biased technological change being key among them. But the more pressing issue is social, political and, unfortunately, broadly unmentioned. Perhaps the ferment in economic structure due to automotive and other technology played an important role in creating the new middle-class.

However, it is indisputable that Roosevelt, Truman, and Eisenhower era policies of very high taxes and public spending played an even more important role. Most Americans today cannot comprehend the extent to which the Federal Government was involved with economic life just two generations ago.

In a democratic society, this implied incredible political will to create progressive institutions. I have little doubt that if we wanted to, policy could cure inequality with a broad enough mandate – like that given to Roosevelt.

But this obscures something important. The Great Recession might have been the worst economic event in American history since the Great Depression. But it wasn’t the Great Depression. Living standards for the median and poor in America might be at their relative minimum since the Great Depression. But not their absolute minimum.

To understand the difference between then and now, citing GDP per capita is just not enough, because the mean blurs tail skews. In 1933, the average income for the bottom 90% was less than $7,000 dollars. In other words the average Chinese (who is very poor, by the way) lives much better today than most Americans did then.

The political will in a democratic society to vote to eat, be clothed, and provide for your children is very strong.

The equivalent figure today is over $30,000. Sure the rich today are unimaginably wealthier – but that doesn’t change the evaporation of fundamental want.

This is to say that we may never again see the political will from the country as a whole necessary to employ policy to curb inequality. This is to say that the Kuznets Curve for inequality in democracies might well be bimodal.

Last week I wrote about the puzzling discrepancy between an increasing wage share for the top 1% on the backdrop of a falling wage share for the country as a whole. The first important takeaway is that labor share isn’t as relevant to stagnating wages or emerging inequality as many believe.

There is, I realize, a deeper connection between this fact and the broader debate of of the 1% and their “fair share”. We know that in America, like many other rich countries, capital’s share of income has increased substantially since 1970. (This is also around the year the GINI uptick begins which, I think, is an accident). We also know that capital is disproportionately owned by the rich: in 2009 the top 1% of Americans owned over 35% of all stock.

We would extrapolate from these stylized facts that non-wage income would play a disproportionately important role in the incomes of the wealthy. And we would be wrong:

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(I’d should also include income from interest and land rent in the latter group but this, in general, followed the same trend and was relatively insignificant.)

This surprised me. Not only do we fail to see what would be an expected trend, but we see broadly the opposite: wages play an increasingly important role for America’s elite. To believe that every bit of the elite income advantage derives from productivity differences, as Greg Mankiw clearly does, would be to believe in not just a rapid divergence of human capital, but one so rapid as to make up for the emerging importance of capital gains.
I wanted to find out more about the distribution of wages over time but my site of choice, “The World Top Incomes Database”, doesn’t have such granular data. No less, given the 1% share of total income, labor share of GDP, and the wage share of the 1%, this isn’t hard to estimate with basic probability. As:

p(1% | wage) = p(1%) * p(wage | 1%) / p(wage).

The probability a random dollar is “in the 1%”, so to speak, given it’s from earned income is obviously the wage share of GDP. The probability that you are in the 1% is, well… 1%. The income database from which my above graphs were created gives us the chance a random dollar allocated to the 1% comes from earned income. I estimated p(wage), using the FRED series (WASCUR/GDP), clearly labor’s share of income.

This gives me a time series the wage distribution, and I found the most curious thing:
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The y-axis is the difference between the share of total income captured by the 1% and the share of total wages captured by the 1%. It remained above zero till the late ’70s, implying capital gains, land rents, and other unearned income were disproportionately allocated to the wealthy relative to the country. That’s what you would expect. But increasingly since the ’80s, the capital discrepancy seems to be falling in favor of a wage discrepancy (both cannot increase at once, as they must all average out to the 1%’s share of total income).

And here’s why this is the case:

Wage income includes wages, bonuses, exercised stock options and bonuses

Ay, there’s the rub! If you look at the first two graphs, you’ll see that the top 5% and 1% move very proximately with the .05%. This is, of course, because most income going to the “affluent plus” category really goes to the super-rich. Members of the top .05% earn, on average, almost 2 million dollars annually most of which are bonuses. This lends support, I believe, to new evidence, from Josh Bivens and Lawrence Mishel, suggesting that the supply-side tax cuts of the ’90s and noughties simply increased the chance and extent to which top executives negotiated for a higher salary.

If you define labor rent as the income over and above that which is required to keep an employee in his current position, nothing comes closer than negotiating higher just because the tax rate is lower. (I have other issues with the paper, for example, might this not indirectly support the claim that lower tax rates creates a desire for higher income, whether realized through rentiership or productivity).

Corporate governance is hard to measure. I do think, however, that the growing blur between the chief executive and chairman creates a severe principal-agency dilemma insofar as the allocation of unnecessary rents towards top CEOs. By this I don’t mean celebrity CEOs who number in less than one handful, but the unnamed mass that run public corporations.

Are we to believe that this CEO, just through genetic assortment (as Mankiw believes) and disproportionate access to opportunity (only 40% of Harvard is on financial aid, for example, that means over 60% of kids come from families that can afford to pay $60,000 a year) has not only increased his wages thusly, but to the extent that his increased wage dominates his increased income from capital? This means if wages really tracked productivity, the rich are at singularity. And probably beyond.

That is the question, I believe, so-called “defenders of the 1%” must answer. And other liberals, who love a good ol’ battle between labor and capital, should probably accept a falling labor share – for good – and try to promote a system that most equitably distributes opportunities given this constraint.

P.S. I’m in the process of crunching the same numbers for European countries. I’ve found  the increased wages for the French elite to be far more muted. Indeed, the French elite have seen an increase in the share of their income from dividends. Overall, the wage-capital discrepancy (accounting for changes in labor share, etc.) seem to be tamer. That said, the countries I’d most like to compare with America are Germany and the United Kingdom, neither of which has the granularity of data (through the Top Incomes Database) from less relevant countries like Italy and Spain.

Peter Orszag here considers the interesting and recent phenomenon of taxi drivers with college degrees. Tyler Cowen adds comment here. Let’s consider a few stylized facts about the emerging labor market:

  • There will be stark inequality.
  • College grads tend to be underemployed or unemployed unlike ever before.
  • Without good luck, you can expect to graduate with not insignificant debt.
  • There’s something about this “knowledge economy” thing. It’s probably good if you can take a derivative functions, and such.

There are two ways to have this conversation. We either talk about the “new economy” where paying the big bucks for an English degree isn’t worth it, but also where you can get a full computer science degree from a top school for less than $8,000. Or you talk about the “old economy” where people still care about the vanilla Bachelors. For signaling if nothing else.

I think Orszag, and too many others, speak in a hybrid construct; a mongrel between the old education and new labor market. That’s very understandable, because this is where we are today. Still, it’s broadly not a very useful discussion. The point of this post isn’t to pontificate about the future, but give some concrete predictions on college education vis-a-vis the labor market.

Here’s the money word: bundling. College, the experience, is contrary to popular belief mostly a consumption good. We’ve successfully disguised it as investment because the relatively small portion of it that was yielded huge dividends between 1950 and 1980. Bundling worked in this context, because the experience aggregated many different goods (English 101, Econ 102, etc.) into one. The consumption value of college exists today, but the economic fundamentals behind bundling do not. Here are features of a successful bundle (like pre-Netflix TV):

  1. Relative economies of scale and scope.
  2. Opportunity cost of bundling is low.
  3. Very high barriers to entry.
  4. There’s value from the bundling itself.
  5. And, most importantly, heterogenous demand. Technically, this means that for two agents, demand for components within the bundle are inversely correlated (you like Math relative to Physics, and me vice-versa).

(1), (3), and to an extent (4) probably will still exist in some form. But the opportunity cost of bundling will no longer be low. Bundling means a university has to congregate PhDs for about a 100 different fields within a physical locale, provide them with good salary, a good number of them with tenure, and all of them with good research activities. For teaching schools it means somehow convincing a PhD to get off the “publish or perish” mindset. For research schools it means ensuring strong research opportunities exist, for all disciplines.

Then you have to add agglomeration effects, which work deeply in favor of Harvard and MIT over a random university. If I’m a hotshot with a PhD in Math from Princeton, where do you think I want to go? (Hint: not Utah). All of this makes the non-established university, meant for the non-established students, an incredibly expensive operation. It’s been worth it, until a decade ago.

But things are worse today. Young whippersnappers today don’t want to learn from a third-rate professor in a lecture hall of 500. They can learn from, quite literally, the ustads of a field from online ventures. Yes, there’s a lot of skepticism about that today. But to the extent the new, “knowledge economy” is everything people fear, online education in its best form will exist. In the next ten years, highly versatile technologies will exist allowing students to interface across the globe in ways we can’t imagine.

How can a current bundler, with its non top tier professors, compete with the best future version of edX? Khan? Minerva? The bundlers will begin their slow descent into glorified credentialing services, and then test centers with Gothic halls.

With education debundled, students will no longer undergo a whole four years of education, but present disaggregated credentials for various courses. Tyler Cowen sees the future in, I don’t think, a dissimilar way:

The more likely scenario is that the variance of the return to having a college education has gone up, and indeed that is what you would expect from a world of rising income inequality.  Many people get the degree, yet without learning the skills they need for the modern workplace.  In other words, the world of work is changing faster than the world of what we teach (surprise, surprise).  The lesser trained students end up driving cabs, if they can work a GPS that is.  The lack of skill of those students also raises wage returns for those individuals who a) have the degree, b) are self-taught about the modern workplace, and c) show the personality skills that employers now know to look for.  All of a sudden those individuals face less competition and so their wages rise.  The high returns stem from blending formal education with their intangibles.

Except it’s not the variance that’s important. I see it this way. Every college student’s future earning potential, after controlling for background and genetics, is normally distributed. The uncertainty arises from intangibles (call this the Charles Murray factor) but also dumb luck. As Cowen has it, we would agree that it is the variance of means that increases when, in fact, it is the variance of variances. There’s no way to forecast this, or even form a Bayesian prior on what one’s normal distribution is. But we can assert that it exists, and that it will change.

It’s a little tricky to explain why I think this. An increase in variance, other things equal, means there’s a higher chance that someone with a lower mean (because they came from a poor family and such) will end up in the top decile. That’s clearly not the case. So we can take the inequality of prior means to be a background condition, the symptom of an unequal country. Within this context, the debundling of education will increase the variance by allowing students to more accurately target their strengths. There’s also much more room for falling below the curve without the guidance of an environment. The variance of variances increases because certain people, poor and not, will choose to take a “safer” path, that doesn’t lend itself to mobility.

Net net, you will see that more surprisingly poor kids make it “out” in the debundled world, than the counterfactual of our current education system. And you’ll see more people do even worse. So Cowen is right, in a sense, that the variance of the aggregate normal distribution will increase. However this is predicated on a background trend (inequality) that almost guarantees that result.

Variance across the aggregate normal is bad if it emerges from variance in individual means, and concentration of uncertainty among the bottom quintile. But variance on the individual, to the extent it is equally distributed, is a great thing. Variance kills despondence of the poor. It kills complacence of the rich. Indeed, we should do everything in our hands to make the prior normal distribution of a one year-old, just about as uncertain as possible.

That is the goal of a competitive society. It’s a well-known story that soon after the American Revolution, productivity stateside skyrocketed versus Britain. The absence of a state-protected aristocracy gave the American farmhand huge incentive to work hard, and get rich. His variance was high.

The “Great Unwinding” is better understood as not just a divergence of mean but also a contraction of variance. My certainty that I’ll never be “on the dole” – as an eerily high number of Americans, at one time or another, are – is a sign of societal ill. And the debundling of education can fix that.

A certain group will be exempt. Indeed, I expect that Harvard and Yale will last longer than America itself. The intense agglomeration economies within Ivy League and such schools, and the incredibly different population that attends, is removed from the scope of this observation. But take comfort that the top 25 schools graduate less than 1% of the population. Indeed, once the variance of variances of the population increases, competition to attend the Ivy League will follow suit, and next time around rich kids may not have the upper hand they do today.

Alas I am not predicting an end of inequality. But I do see in the Internet’s evolution a huge potential for more equal opportunity. I fear that too many will still be slave to genetics. Whether of looks, brains, or charm. What’s my most absurd belief? I will die in a Rawlsian society. At age 18, I will also say it is my most optimistic belief.