The asset bubble theory of income inequality

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There’s been a debate going on for a few years about whether the big rise in income inequality in the U.S. over the past three decades has been at least partly a political phenomenon or purely an economic one. The first camp, whose members include political scientist Larry Bartels and economists Thomas Piketty and Emmanuel Saez (pdf), argues that decisions about taxing and government spending made since the early 1980s have increased the disparity of incomes. The second, which consists of the vast majority of economists who study such things (although more have been drifting toward the Bartels-Piketty-Saez camp in recent years), contends that globalization and technological advance have increased the rewards to the most skilled and reduced pay for those whose work can be done by machines or lower-paid workers overseas. Since globalization and technological advance are good things, the increase in inequality thus isn’t really something we’d want to stop.

Well now, after looking at the data about the country’s 400 highest earners and reading the comments by pneogy and shepherdwong, I am ready to offer an important new theory (well, not entirely new): The rise in income inequality over the past 30 years has to a significant extent been the product of a series of asset-price bubbles. Whenever the market (be it the market in stocks, junk bonds, real estate, whatever) booms, the share of income going to those at the very top increases. When the boom goes bust, that share drops somewhat, but then it comes roaring back even higher with the next asset bubble. It’s not the same people raking it in every time—there’s lots of turnover in the top 400—but skimming the top off of asset bubbles appears to have become the leading way to get rich in these United States in the past three decades.

These asset bubbles weren’t pure bubbles. Prices always began rising for some real economic reason, then got out of hand. So in this accounting, the rise in income inequality would be partly based on economic fundamentals, partly on financial market excess. Which brings to mind UCLA finance professor Richard Roll’s famous (among the cognoscenti, which you will join if you read The Myth of the Rational Market, which goes on sale June 9) 1987 presidential address to the American Finance Association (pdf). Roll looked at stock market movements from 1982 to 1987 and tried to account for them using economic data, industry data and company-specific news. Those factors explained less than 40% of the movements, leading Roll to surmise that either there was lots of private data out there moving markets that he hadn’t been able to get his hands on, or many stock market fluctuations were irrational. “It would be nice,” he wrote, “to have a method for detecting the difference.”