Let’s review some basic facts. A good place to start is median income—the income of the person at the fiftieth percentile of the total distribution. The year 1999 was the peak year for the real (inflation-adjusted) income of the median American household. It reached $54,932 that year, but then started falling. By 2011, it had fallen nearly 10 percent to $50,054, even as overall GDP hit a record high. In particular, wages of unskilled workers in the United States and other advanced countries have trended downward.
Meanwhile, for the first time since before the Great Depression, over half the total income in the United States went to the top 10 percent of Americans in 2012. The top 1 percent earned over 22 percent of income, more than doubling their share since the early 1980s. The share of income going to the top hundredth of one percent of Americans, a few thousand people with annual incomes over $11 million, is now at 5.5 percent, after increasing more between 2011 and 2012 than any year since 1927–28.
Several other metrics have also been increasingly unequal. For instance, while overall life expectancy continues to rise, life expectancies for some groups have started to fall. According to a study by S. Jay Olshansky and his colleagues published in Health Affairs, the average American white woman without a high school diploma had a life expectancy of 73.5 years in 2008, compared to 78.5 years in 1990. Life expectancy for white men without a high school education fell by three years during this period.
It’s no wonder that protests broke out across America even as it was beginning to recover from the Great Recession. The Tea Party movement on the right and the Occupy movement on the left each channeled the anger of the millions of Americans who felt the economy was not working for them. One group emphasized government mismanagement and the other abuses in the financial services sector.
While undoubtedly both of these problems are important, the more fundamental challenge is deep and structural, and is the result of the diffusion to the second machine age technologies that increasingly drive the economy.
Recently we overheard a businessman speaking loudly (and cheerfully) into his mobile phone: “No way. I don’t use an H&R Block tax preparer anymore. I’ve switched to TurboTax software. It’s only $49, and it’s much quicker and more accurate. I love it!” The businessman was better off. He had a better service at a lower price. Multiplied by millions of customers, TurboTax has created a great deal of value for its users, not all of which even shows up in the GDP statistics. The creators of TurboTax are also better off—one is a billionaire. But tens of thousands of tax preparers now find their jobs and incomes threatened.
The businessman’s experience holds a mirror to the broader changes in the economy. Consumers are better off and enormous wealth is created, but a relatively small group of people often earns most of the income from the new products or services. Like the chemists who used silver halide to create camera film in the 1990s, human tax preparers have a hard time competing with machines. They can be made worse off by advances in technology, not just relative to the winners, but also relative to their income when they were working with the older technologies.
The crucial reality from the standpoint of economics is that it takes only a relatively small number of designers and engineers to create and update a program like TurboTax. Once the algorithms are digitized they can be replicated and delivered to millions of users at almost zero cost. As software moves to the core of every industry, this type of production process and this type of company increasingly populates the economy.
Between 1983 and 2009, Americans became vastly wealthier overall as the total value of their assets increased. However, as noted by economists Ed Wolff and Sylvia Allegretto, the bottom 80 percent of the income distribution actually saw a net decrease in their wealth.Taken as a group, the top 20 percent got not 100 percent of the increase, but more than 100 percent. Their gains included not only the trillions of dollars of wealth newly created in the economy but also some additional wealth that was shifted in their direction from the bottom 80 percent. The distribution was also highly skewed even among relatively wealthy people. The top 5 percent got 80 percent of the nation’s wealth increase; the top 1 percent got over half of that, and so on for ever-finer subdivisions of the wealth distribution. In an oft-cited example, by 2010 the six heirs of Sam Walton’s fortune, earned when he created Walmart, had more net wealth than the bottom 40 percent of the income distribution in America. In part, this reflects the fact that thirteen million families had a negative net worth.
Along with wealth, the income distribution has also shifted. The top 1 percent increased their earnings by 278 percent between 1979 and 2007, compared to an increase of just 35 percent for those in the middle of the income distribution. The top 1 percent earned over 65 percent of income in the United States between 2002 and 2007. According to Forbes, the collective net worth of the wealthiest four hundred Americans reached a record two trillion dollars in 2013, more than doubling since 2003.
In short, median income has increased very little since 1979, and it has actually fallen since 1999. But that’s not because growth of overall income or productivity in America has stagnated; GDP and productivity have been on impressive trajectories. Instead, the trend reflects a significant reallocation of who is capturing the benefits of this growth, and who isn’t.
This is perhaps easiest to see if one compares average income with median income. Normally, changes in the average income (total income divided by the total number of people) are not very different from changes in median income (income of the person exactly in the middle of the income distribution—half earn more and half earn less). However, in recent years, the trends have diverged significantly.
How is this possible? Consider a simple example. Ten bank tellers are drinking beers at a bar. Each of them makes $30,000 a year, so both the mean and median income of this group is $30,000. In walks the CEO and orders a beer. Now the average income of the group has skyrocketed, but the median hasn’t changed at all. In general, the more skewed the incomes, the more the mean tends to diverge from the median. This is what has happened not only in our hypothetical bar but also in America as a whole.
Overall, between 1973 and 2011, the median hourly wage barely changed, growing by just 0.1 percent per year. In contrast, productivity grew at an average of 1.56 percent per year during this period, accelerating a bit to 1.88 percent per year from 2000 to 2011. Most of the growth in productivity directly translated into comparable growth in average income. The reason why median income growth was so much lower was primarily because of increases in inequality.
Adapted from the book The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies by Erik Brynjolfsson and Andrew McAfee. Excerpted by arrangement from W. W. Norton & Company. Copyright 2014.
Erik Brynjolfsson is the director of the MIT Center for Digital Business and one of the most cited scholars in information systems and economics. Andrew McAfee is a principal research scientist at the MIT Center for Digital Business and the author of Enterprise 2.0.
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