Riding the High Income Wave
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Economics Finance & Accounting Aug 1, 2011

Rid­ing the High Income Wave

High earn­ers ride high­er, but rougher, eco­nom­ic waves

When the recent reces­sion sud­den­ly reared its head, it bit deeply into near­ly everyone’s pock­et­books. It even­tu­al­ly gnawed across gen­der lines, indus­tries, and socioe­co­nom­ic sta­tus­es. Though econ­o­mists say the reces­sion has end­ed, and that we have been in a recov­ery for two years, many peo­ple are still recov­er­ing from the recession’s sharp teeth. But who was bit the deepest?

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It may be hereti­cal to sug­gest it, but those who expe­ri­enced the great­est shock to their incomes were like­ly the top 1 per­cent of earn­ers. That’s right, America’s high­est incomes may have been hit hard­est in terms of the scale of the con­trac­tion, accord­ing to research by a pair of econ­o­mists at the Kel­logg School of Man­age­ment. In fact, incomes of the super­earn­ers are vast­ly more sen­si­tive to eco­nom­ic cycles of booms and bust than pre­vi­ous­ly real­ized, con­clude Annette Viss­ing-Jør­gensen and Jonathan A. Park­er, both pro­fes­sors of finance at the Kel­logg School of Management.

Pre­vi­ous stud­ies hold that the poor typ­i­cal­ly bear the worst of reces­sions. But the past three decades have bucked this trend of past years, Viss­ing-Jor­gensen and Park­er found in a recent study pub­lished by the Brook­ings Insti­tu­tion in its Papers on Eco­nom­ic Activ­i­ty. They say that mul­ti­ple lines of evi­dence reveal that since the ear­ly 1980s, the incomes of the top 1 per­cent of earn­ers in our nation have become 2.4 times more sen­si­tive to eco­nom­ic expan­sions and con­trac­tions than those of aver­age earn­ers. This cycli­cal­i­ty, they say, is close­ly cou­pled to a well-stud­ied phe­nom­e­non where these top earn­ers are also tak­ing home an increas­ing­ly greater share of the nation’s income. Fur­ther buck­ing con­ven­tion­al wis­dom, the researchers found that incomes of the top earn­ers were even more volatile — ris­ing more in booms and falling more in reces­sions — than those of folks at the very low end of the income distribution.

To reach these con­clu­sions, Park­er and Viss­ing-Jor­gensen used sev­er­al datasets based on tax returns and pop­u­la­tion sur­veys to scru­ti­nize the dis­tri­b­u­tion of annu­al incomes in each year and track the top 1 per­cent of earn­ers, or the top 1 per­centers. The top 1 per­centers are not nec­es­sar­i­ly the same indi­vid­u­als each year, just those earn­ers who land at the frothy top. They have increased their share of the nation’s aggre­gate income from 8 per­cent in the ear­ly 1980s to 18 per­cent in 2008. The top 0.01 per­cent increased their share of aggre­gate income from 0.7 per­cent to 3.3 per­cent for the same time peri­od. As a whole, the top 1 per­centers more than dou­bled their income share between 1982 and 2008, while the top 0.01 per­cent more than quadru­pled theirs.

To put a num­ber on what this means, con­sid­er that in 2008 the top 1 per­cent of earn­ers had, on aver­age, an income 14 times the size of an aver­age person’s. This equates to an aver­age income of $906,000 for the top 1 per­cent as a whole and $17.1 mil­lion for the top 0.01 per­cent. In oth­er words, the super­earn­ers are gob­bling an ever-larg­er slice of the nation’s income pie, but, like an acquired aller­gy, that big­ger slice is mak­ing them ever more sen­si­tive to eco­nom­ic dips and peaks.

What we found is that the rich ride the waves of the econ­o­my much high­er and much low­er than the aver­age earn­er,” Park­er says. We’re becom­ing a win­ner-take-all soci­ety, where the top earn­ers win big and lose big.”

The ques­tion is, why?

Rise of Cycli­cal Incomes

Viss­ing-Jor­gensen and Park­er say that before the 1980s, the cycli­cal­i­ty of top earn­ers was slight­ly less than aver­age. Between 1947 and 1982, their incomes rose on aver­age 1.2 per­cent­age points per year less in each boom and fell by 1.1 per­cent­age points per year less in each reces­sion” com­pared to aver­age house­holds, the pair report. But after 1982, the top 1 per­centers’ incomes rose on aver­age 5 per­cent more per year dur­ing booms and fell 3.7 per­cent more per year dur­ing reces­sions. The incomes of the top 1 per­centers were, on aver­age, 2.4 times more cycli­cal than those of aver­age earners.

Park­er says they were care­ful to exclude fluc­tu­a­tions in earn­ings from cap­i­tal gains or stock options, which would be close­ly tied to the peaks and val­leys of the stock mar­ket. Sim­i­lar find­ings held for just wage and salary earn­ings. This is not hap­pen­ing due to just stock options,” Park­er says. The cycli­cal­i­ty holds true in a more gen­er­al sense. But we can’t rule out the idea that the increased use of per­for­mance-based com­pen­sa­tion is part of the causal mechanism.”

The team also found that the high­er some­one land­ed in the income dis­tri­b­u­tion, the more cycli­cal their income tend­ed to be. In the most recent eco­nom­ic expan­sion, from 2003 – 2007, the top 1 per­centers’ incomes increased annu­al­ly by an aver­age 7.8 per­cent. But a dif­fer­ent sto­ry unfold­ed when Viss­ing-Jor­gensen and Park­er fur­ther strat­i­fied the top 1 per­cent. They found the 99.0th to 99.9th per­centile of earn­ers expand­ed their incomes each year by 5.6 per­cent, the 99.9th to 99.99th per­centile expand­ed theirs by 8.7 per­cent, and the incomes of the top 0.01 per­cent shot up a whop­ping 13.9 per­cent. In an almost mir­ror pat­tern, earn­ers in these same brack­ets watched their incomes shrink annu­al­ly dur­ing the ear­ly part (2007 – 2008) of the recent reces­sion by 6.7, 8.9, and 12.7 per­cent, respectively.

When the pair com­pared the earn­ings cycli­cal­i­ty across the nation’s income dis­tri­b­u­tion, they noticed a skewed U-shape: the mid­dle income brack­ets were com­par­a­tive­ly unex­posed to eco­nom­ic fluc­tu­a­tions, the low­est quin­tiles were high­ly exposed, and the top 1 per­cent were extreme­ly exposed.

Income inequal­i­ty and cycli­cal­i­ty of the top earn­ers held true across indus­tries and were not dri­ven by any one sec­tor, Park­er says. These facts also held true across recent decades and dif­fer­ent coun­tries. When Park­er and Viss­ing-Jor­gensen ana­lyzed ten coun­tries that have had sim­i­lar sharp increas­es in wage inequal­i­ty, they found that the same coun­tries that had big ris­es in the income share of top earn­ers also had big increas­es in the expo­sure of top incomes to eco­nom­ic fluc­tu­a­tions. This sug­gests that the phe­nom­e­na may oper­ate inde­pen­dent of social norms, tax and fis­cal poli­cies, and gov­ern­men­tal regimes. How­ev­er, it does not hold true across all coun­tries, Park­er says.

The find­ings that incomes of the top 1 per­cent have become more cycli­cal since 1982, and that the incomes of the top earn­ers with­in the top 1 per­cent are even more sen­si­tive, poke holes in the pre­vi­ous­ly-held belief that the top earn­ers can ride out down­turns with few dis­rup­tions. The fact that these find­ings hold true in some coun­tries with dif­fer­ent tax, social, gov­ern­men­tal, and finan­cial norms adds to their valid­i­ty. But at the same time, the find­ings raise big ques­tions: Why are the super-rich earn­ing so much more, and why has their income grown more sen­si­tive since 1982?

Enter the Super­star” Work­er

In the ear­ly 1970s, the income gap between the haves and the have-nots began to grow. Econ­o­mists explained the phe­nom­e­non in terms of tech­no­log­i­cal improve­ments that favored those with high skills and edu­ca­tion. The idea was that com­put­ers, for exam­ple, raised the pro­duc­tiv­i­ty of those with high lev­els of edu­ca­tion rel­a­tive to those with low­er lev­els. But in the ear­ly 1980s, the income share of the top 1 per­cent sud­den­ly accel­er­at­ed. This hap­pened at exact­ly the same time that their earn­ings became more exposed to nation­al income changes. (Won­der­ing why that 1982 bench­mark keeps pop­ping up? It’s not that a switch was flipped in 1982; it’s just that this trend start­ed then,” Park­er says. In oth­er words, the date emerged from the data and is not due to changes in tax or fis­cal policies.)

Viss­ing-Jor­gensen and Park­er posit that skill and edu­ca­tion lev­els may not be dri­ving volatil­i­ty, but that the super­star” work­er effect is like­ly more respon­si­ble. Such work­ers can har­ness infor­ma­tion com­mu­ni­ca­tions tech­nol­o­gy to, well, sim­ply do more. Viss­ing-Jor­gensen and Park­er first float­ed this expla­na­tion in a pre­vi­ous­ly pub­lished paper, but expand upon it in their recent one.

The most plau­si­ble expla­na­tion of our find­ing is that infor­ma­tion and com­mu­ni­ca­tion tech­nolo­gies have changed and increased the extent to which there is a win­ner-take-all soci­ety.” — Parker

Think of it this way,” Park­er offers. A sports stars 30 years ago might be on TV only occa­sion­al­ly on a nation­al­ly tele­vised game. But for the most part, the enter­tain­ment they pro­vid­ed was to the peo­ple who actu­al­ly attend­ed the games. Now, near­ly every sin­gle pro­fes­sion­al sports game is tele­vised, some­times across the world. So the abil­i­ty of one indi­vid­ual to enter­tain every­body has gone way up.” In this new world, the best enter­tain­ers pro­vide a huge amount of prized enter­tain­ment for every­body, and so they get more of the income, he says. Wage inequal­i­ty across pro­fes­sion­al sports play­ers increas­es, and the best are paid more while the rest are paid less.

Or you might think of it in terms of an online retail­er who hawks their wares at a slight­ly reduced price. Any­one, with a few clicks of a but­ton, can com­pare prices in cyber­space, and so these sell­ers soon out­com­pete the oth­ers and take a larg­er share of the income.

In oth­er words, the abil­i­ty of these super­stars to scale up their pro­duc­tiv­i­ty allows them to pro­vide a low markup to a vast mar­ket, dri­ving up their earn­ing poten­tial. But when fluc­tu­a­tions or rip­ples squeeze those small markups, the super­stars’ incomes take a huge hit.

What we offer in our paper is evi­dence of a new fact, that the cycli­cal­i­ty of the top earn­ers’ income is linked some­how to the increased share of aggre­gate income that they earn,” Park­er says. We think the infor­ma­tion com­mu­ni­ca­tions tech­nol­o­gy nar­ra­tive does the best job of fit­ting the exist­ing facts in con­junc­tion with this new one.”

Park­er says the paper does not make any pro­nounce­ments about whether the widen­ing income gap is good or bad for our soci­ety. Instead, he says it is focused on doc­u­ment­ing the chang­ing nature of our labor mar­kets, prov­ing the exis­tence of this new fact, and rul­ing out some can­di­date expla­na­tions for this new fact.”

The most plau­si­ble expla­na­tion of our find­ing is that infor­ma­tion and com­mu­ni­ca­tion tech­nolo­gies have changed and increased the extent to which there is a win­ner-take-all soci­ety,” Park­er says. Such a change can increase the extent to which super­stars earn the bulk of the income, and there­fore bear the bulk of the fluctuations.” 

Relat­ed read­ing on Kel­logg Insight

Today’s Ris­ing One-per­centers: The grow­ing gap between the very rich and everyone

About the Writer

T. DeLene Beeland is a science writer based in Asheville, NC.

About the Research

Parker, Jonathan and Annette Vissing-Jorgensen. 2010. “The Increase in Income Cyclicality of High-Income Households and Its Relation to the Rise in Top Income Shares.” Brookings Papers on Economic Activity. Fall: 1-55.

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