Economics
There's rich, and then there's rich
Sep 22nd 2010, 17:00 by R.A. | WASHINGTON
AT THIS point, there is a fairly healthy literature documenting recent growth in American income inequality. Some of it points to changes within the broad middle of the income distribution, captured principally by growth in the college wage premium, which is rooted in shifts in the supply of and demand for skills. But as many progressives point out, these dynamics can't really explain the stunning growth in incomes at the very top of the spectrum.
Pay dynamics there are usually chalked up to growth in "CEO pay", but as new research out of the Chicago School of Business indicates, CEO salaries are peanuts compared to the change being earned in finance:
We also ?nd that hedge fund investors and other "Wall Street" type individuals comprise a larger fraction of the very highest end of the AGI distribution (the top 0.0001%) than CEOs and top executives. In 2004, nine times as many Wall Street investors earned in excess of $100 million as public company CEOs. In fact, the top twenty-?ve hedge fund managers combined appear to have earned more than all ?ve hundred S&P 500 CEOs combined (both realized and ex ante). This trend accelerated after 2004. In 2007, it is likely that the top ?ve hedge fund managers earned more than all ?ve hundred S&P 500 CEOs combined.
The bolding is mine. I wish there were something more than bolding I could do; an emoticon with its jaw on the floor might work well. The authors of the paper, Steven Kaplan and Jushua Rauh, have an interesting take on this:
We argue that the evidence is more consistent with theories of skill-biased technological change, superstars, greater scale, and their interaction than with the other theories. With the large improvements in information technology and the substantial increase in value of the securities markets over the last twenty-?ve years, asset managers, investment bankers, lawyers, and top executives now apply their talent to much larger pools of assets.
Of course, the nice thing about being a hedge fund manager is that you pay the capital gains tax rate on your income. It's interesting to think about the appropriate way to tax income like this. Without getting too deep into the discussion, it's worth considering the incentive effects of ridiculous income levels on talent allocation. In a superstar world where earnings are particularly outlandish for people like hedge fund managers, young people may be encouraged to pursue such careers even if the odds of success are relatively low (just as young people may devote themselves to dreams of celebrity or athletic stardom despite low odds of success). From a societal perspective, it may be a bad idea for talent to overallocate itself toward these ends, rather than toward occupations in which a good but not stratospheric income is more likely. Just a thought.
(Hat tip: Tyler Cowen)
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Letting the financial industry risk takers melt down in 2008 might have had the silver lining of blowing up the hedge fund model as well.
As of yet nobody has explained to me why we could not recover somewhat quickly (inside of 5 years is my guess, which is a fraction of how long the malaise will continue thank to the bailouts) from a general meltdown/writedown of bad debts. Banks might disappear, currencies might crash, chain reaction defaults would likely occur. But life would go on and systems that serve a valuable purpose would be reconstructed anew.
What did the top technology startup founders earn compared to the CEOs? (I'm thinking the founders of Google, Yahoo, and Microsoft, not the people who are starting startups this year.)
It's not just the hedge fund guys who are earning huge money. And, arguably, the startup founders actually are earning it, in that they are creating a company that's worth a huge amount of money. (Even after the dot-com crash, some of those companies were still worth a mint.)
Is it a problem if the founder of a company, who takes it from zero to billions of dollars, makes a huge amount of money in the process? If so, why? (And why do you think people do this? It's not just because they think it will look good on their resume for their next job application.)
If you try to reward this behavior less, you probably get fewer companies that grow from zero to billions of dollars. Is that really where you want to go?
"Never confuse genius with a bull market."
Of course their incomes are obscene, and the tax rate is an insult to every American who works for a living. And the most comical thing is that you can be paid these absurd sums on the way up, and not have to refund them when you lose a bundle. If the idea of working for "nothing" as you recover is too painful, all you have to do is say "So sorry", send your customers their share of what's left, and close up shop.
This nonsense exists only because the allegedly "smart money" wants to believe in magic. If individuals want to pay handsomely for fairy dust, that's their business. But we need to put the chains back on trustees so that they can't play this way with other peoples' money.
I'm sure the fact that placing money into securities has been the only reasonable manner to save for retirement for the past few decades has quite a bit to do with it. I'm sure the micro-traders can probably make a few cents on millions of shares per day knowing that on the 1st and 15th huge sums of money will enter the market blindly, buying up popular 401k manager funds, the purchases of which can be determined in the prospectus.
Hedge fund owners get a 2% of assets fee for managing the investments plus 20% of the profits. Investors (mostly institutions) gladly pay the fee. No one holds a gun to their heads and forces them to invest with hedge funds, unlike the guv who forces everyone to pay taxes at the point of his gun. Why anyone thinks a mutually agreed upon exchange is immoral I can't understand. The Church determined them to be moral over 500 years ago. The desire people feel to take that money away is known as envy, which the Church has always maintained is evil.
That said, the high earnings of people in the financial services industry is empirical proof of the Austrian theory of money. Keynesians don't have a respectable monetary theory at all; monetarists believe that new money created by the Fed reaches everyone in the country at the same time. Only Austrians understand that new money enters the economy at specific places and times. For the past two decades new money has entered the economy through financial service firms, like hedge funds. Those who receive the new money first make huge profits from being able to purchase assets before prices rise. The losers are the last chumps to get the new money after prices have risen, usually the poor working slob.
There is something evil in the scenario, but it's the Fed's manipulation of the money supply.
In this blog, our correspondents consider the fluctuations in the world economy and the policies intended to produce more booms than busts.
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