Rising inequality a political threat to free trade deals

Greg Ip of the Wall Street Journal reports on new data from the U.S. Internal Revenue Service showing that the richest Americans’ share of the national income is at a high not seen since the roaring ’20s:

The wealthiest 1% of Americans earned 21.2% of all income in 2005, according to new data from the Internal Revenue Service. That is up sharply from 19% in 2004, and surpasses the previous high of 20.8% set in 2000, at the peak of the previous bull market in stocks.

Even President Bush, worried about trade deals with Colombia, Panama, Peru, and South Korea failing to make it through Congress, has had to admit things are out of whack:

In yesterday’s interview, Mr. Bush said that some executive compensation is excessive, and that some corporate boards fail to ensure that shareholders know how company funds are being spent. Those practices, he said, can give rise to feelings the economy isn’t working fairly for all Americans.

But it’s not CEOs, but Wall Street players who are raking it in the most, according to an interesting paper by Steven Kaplan and Joshua Rauh of the University of Chicago. Consider these numbers:

In 2004, nine times as many Wall Street investors earned in excess of $100 million as public company CEOs. In fact, the top 25 hedge fund managers combined appear to have earned more than all 500 S&P500 CEOs combined (both realized and estimated). [My emphasis.]

That’s staggering, and it’s sure to give Senate Majority Leader Harry Reid, who just announced that he doesn’t expect to pass a bill raising taxes on private-equity and hedge-fund managers, an ulcer or two. If the Democrats in Congress fail to change that equation, unfortunately, they are likely to seek redress in protectionist measures that would probably do more harm than good.

Kaplan and Rauh doubt there’s a link between widening inequality and trade. “It seems unlikely,” Kaplan and Rauh write, “that trade theories can account for the massive observed increase in inequality at the highest levels of the income distribution, especially given the breadth of this phenomenon and the fact that it does not affect only the groups for which the products and services are heavily and increasingly exported or bid for by tradable sectors.” Instead, Kaplan and Rauh believe, “With the huge improvements in information technology and the substantial increase in value of the securities markets over the last twenty-five years, asset managers, investment bankers, lawyers, and top executives can now apply their talent to much larger pools of money.”

That’s true, but what about the global angle? I’m not sure what Kaplan and Rauh consider “trade,” but I think it’s odd that they don’t address the globalization of capital markets and, in particular, the role of Asia’s explosive economic growth in pouring massive amounts of liquidity into the United States, keeping U.S. interest rates low by buying dollars, and so on. Surely that has a lot to do with why U.S. hedge-fund managers are doing so well, no? I invite econ types reading Passport to weigh in via email at passportblog [at] ceip.org.