THE GREAT REVERSAL

In the 1980s, while growth remained sluggish, inequality exploded. Thanks to the outstanding and painstaking work of Thomas Piketty and Emmanuel Saez, the world now knows what happened: 1980 is the year Reagan was elected.

The story for the UK is very similar. The turning point, like in the US, is somewhere very close to 1979, the year Mrs. Thatcher took over. Before 1979, the top income share falls steadily from 1920. After 1979, there is a similar rise, interrupted briefly by the global financial crisis of 2009. Unlike in the United States, inequality has not yet reached the 1920s levels, but it does not have that far to go.³⁰

In continental Europe the pattern is strikingly different. Before 1920, the top income share in France or Germany, Switzerland or Sweden, the Netherlands or Denmark was not too different from that in the US or UK. But sometime after 1920, inequality crashed in all of these countries, like in the United States, and stayed down, unlike in the United States. There are small ups and downs, and Sweden actually has a significant upswing starting somewhere in the 1980s, but the levels remain very low by US standards.³¹

These data are about pre-tax income, before the rich paid taxes and the poor received transfers.

At the same time, around 1980, wages stopped increasing, at least for the least educated. The average hourly wage adjusted for inflation for US workers who were not managers rose through the 1960s and 1970s, reached its peak in the mid- to late-1970s, and then drifted down through the Reagan-Bush years, before slowly turning around. As a result, the average real wage in 2014 was no higher than in 1979. Over the same period (from 1979 to today), the real wages of the least educated workers actually fell. Among high school dropouts, high school graduates, and those with some college, real weekly earnings among full-time male workers in 2018 were 10 to 20 percent below their real levels in 1980.³³ If there had been any trickle-down effect of lower taxes, as its advocates claimed, one would expect wage growth to have accelerated in the Reagan-Bush years. But the opposite happened. The labor share (the share of revenues used to pay wages) has continuously declined since the 1980s. In manufacturing, almost 50 percent of sales were used to pay workers in 1982; it had fallen to about 10 percent in 2012.³⁴

The fact that this great reversal takes place during the Reagan and Thatcher years is probably not coincidental, but there is no reason to assume Reagan and Thatcher were the reason it happened. Their election was also a symptom of the politics of the time, dominated by anxiety about the end of growth.

More importantly, it is not a priori obvious that Reagan-Thatcher policies were the main reason why inequality went up. The diagnosis of what actually happened in this period, with its obvious implications for policy, has been and continues to be an active area of debate within economics, with some, like Thomas Piketty, squarely blaming changes in policies, while most economists emphasize that the structural transformation of the economy, and particular changes in technologies, also had a lot to do with it.³⁵

The reason why this is not an easy question is that this was also a period of momentous changes in the world economy. Starting in 1979, China launched market reforms. In 1984, India started taking baby steps toward liberalization. These countries would eventually become two of the largest markets in the world. Partly as a result, world trade expanded relative to world GDP by about 50 percent over this period,³⁶ with the consequences we discussed in chapter 3.

The advent of computing was the other characteristic feature of the era. Microsoft was founded in 1975; in 1976, the Apple I was released, followed by the much more widely sold Apple II in 1977; IBM released its first personal computer in 1981. Also, in 1979, NTT launched the first widely distributed handheld cell phone system in Japan. Mostly on the strength of selling cell phones, Apple became the first trillion-dollar company in August 2018.

To what extent do technological change and globalization explain the pattern of increase in inequality in the US and the UK? To what extent did policy, tax policy in particular, play a role?

With computerization came other technological change. This may not have been a revolution in the sense that the steam engine brought in a revolution, as Robert Gordon argued, but like the steam engine and its love child, the internal combustion engine, it killed a lot of jobs.

This skill-biased technological change clearly explains the increase in the return to college education.³⁷ But it cannot explain what happened at the very top of the income distribution, unless we think skills were suddenly transmogrified just for the very richest. We usually think of skills increasing relatively continuously with education and wage levels. So, if the explosion of top income inequality was just due to technological progress, the widening of the distribution of wages should have been not just for the ultra-rich but also for the merely rich. But, in fact, those making, say, between $100,000 and $200,000 a year have seen their pay increase only slightly more rapidly than the average, while those who are making more than $500,000 have seen their incomes explode.³⁸

This suggests that plausible changes in technology are unlikely to explain the stratospheric increase in incomes at the very top. Nor, for that matter, can they explain the difference between United States and continental Europe; technological change has been similar in all rich countries.