Tuesday, September 7, 2010

Who Gets the Surplus?

The post below, on price effects and the case for public provision, left out one of the articles that got me thinking about these questions in the first place: Robert Gordon's Has the Rise in American Inequality Been Exaggerated? The piece makes a number of provocative claims about inequality, some convincing, some less so. But the interesting bit, in terms of the price effects argument, is on college wage premium and geographic variations in the cost of living:
A stunning new data set [on geographic price-level differences] undermines our previous conclusion (2008) that real income per capita has increased significantly in superstar bi‐coastal metropolitan areas. ... Without adjustment for price level differences, per capita incomes in Massachusetts and New York are respectively 26.1 percent and 20.0 percent above the national average. With correction for regional price disparities, these percentages drop to 10.7 and ‐0.2 percent respectively.

In an important and related piece of research, Moretti (2008) notes that college graduates disproportionately cluster in metropolitan areas that have a high cost of housing. He finds that fully two‐thirds of the previously documented increase in the return to college between 1980 and 2000 vanishes when he corrects for differences in the cost of living across metropolitan areas. His cross‐area price measures are comprehensive and ingenious and take account of differences in housing costs, housing quality ... and price differences of non‐housing goods... Moretti then asks why college graduates sort into expensive cities. He carries out an empirical analysis that distinguishes between supply and demand factors and concludes that college graduates move to expensive cities because jobs for college graduates are increasingly located in those cities, not because they particularly like living in those cities. [my emphasis]
Gordon goes on to suggest some reasonable caveats to these findings, but whether the exact figure is two-thirds or something lower, the point remains that the supposed education premium can often only be fully realized in cities, where a large part of it is claimed by urban landowners rather than the person with the education.

And this is the fundamental point: We always have to ask, where is the market power? Who gets the rents? Wherever the surplus originates, where it ends up depends on who has the monopoly -- who controls something in inelastic supply.

This is an important question for policy, as in the post below. But it's also something you'll find union and community activists thinking about. If you're trying to put pressure on the boss, you better make sure it's the boss with power; and that means the one who controls the relevant scarce resource. A couple decades ago, that was often a manufacturer, while the retailers downstream were dispersed in a competitive market. Now it's often the other way round.


  1. So, there are two or three understandings of inequality which always get elided in these discussions. To keep things clear, I like to call type 1 a 'utilitarian' based notion of inequality, and type 2 a 'freedom' based notion. Economists like Gordon and the guys at Chicago who are arguing that inequality has not increased because of the different price vectors facing the rich and the poor are implicitly using the former. Our intuitions however, often reflect the latter. Example: the poor can substitute between yucky spinach and catfood. the rich can substitute between arugula and catfood. If spinach becomes cheaper and arugula becomes more expensive then the utility of the rich is lower for the same level of income than earlier while the utility of the poor is higher. Ergo, in this analysis, inequality has decreased. But the poor are no more able to buy arugula and the rich no less able to buy spinach. Indeed, in as much as arugula is something to be desired, the poor suffer as much or more from not being able to buy it. Ergo, in this 'freedom' based concept, inequality is the same or has increased. I think that it is important to keep these two different ideas in mind.

  2. Josh, just discovered your blog from a tip by Sawicky; have broadcast your post with that awesome video with the guy who wrote "Financial In/stability in Iceland" far and wide. Hope all is well is your world.

  3. Arjun,

    That's a really important point.

    What you're calling type 1 inequality is based on the assumption is that income only matters for the consumption basket it buys, whereas in reality, the individual carries his social power, as well as his bond with society, in his pocket, whatever it's spent on. So you are absolutely right that we can't simply use the different price deflators for the typical consumption baskets of the rich and the poor to compute "real" inequality, as Gordon does. That far I agree with your critique (and the Gordon piece is quite problematic.)

    But, do you think that completely negates the narrower point about the concentration of college graduates in urban areas with high-cost housing? I'm inclined to think there's still something there, especially if the Moretti article (which I haven't looked at) is right that the college wage premium is much smaller for people who don't live in those areas. But I could be convinced otherwise.


    Hi! Apparently the video is from a new documentary, Inside Job by Charles Ferguson.