Inequality: the Chantelle theory

Paul Krugman reports on increasing inequality at the top end of the US income distribution:

There was hardly any rise in the share of income going to people between the 90th and 95th percentiles [between 1979 and 2003]: almost all the gain went to the top 5 percent. And most of the gain went to a very small elite. The income share of the top 1 percent went from 9.6 to 17.5, percent accounting for more than 70 percent of the top decile's gain. The income share of the top 0.25 percent went from 4.9 to 10.5, accounting for a bit more than half the total gain.

(via Brad DeLong. See also this paper (pdf) by Emmanuel Saez and Thomas Piketty)

Leave aside – though we shouldn’t – the question of justice. Why has this happened?

The most popular theory is Sherwin Rosen’s economics of superstars. Tiny differences in talent, he said, can lead to enormous inequalities in income; there are sharply increasing returns to ability. This is why, say, Beyonce, earns millions more than singers who are only slightly less talented or beautiful than her.

Maybe this is happening at the top end of the labour market. Superstar economics – say in the market for chief executives – is becoming more pronounced. What have always been increasing returns to talent are actually increasing further.

That’s the theory. Here is a brilliant paper (pdf) which casts doubt on it.

Olivier Gergaud and Vincenzo Verardi studied the prices of Pokemon trading cards.

Now, the thing about these is that the characteristics of the cards are easily observed, so there’s no disputing what talent is. They then estimated hedonic prices for the various cards, and compared these to actual prices.

They found that there is an element of Rosen’s superstar phenomenon; the highest quality cards command a price even higher than their qualities warrant, suggesting there are increasing returns to talent.

However, this is only part of the story. There’s also some overpricing of even modestly talented cards. Superstars, then, needn’t be more talented than others. They say:

It is possible to be untalented and successful; anybody may become one day a superstar, whatever his talent level.

This, they say, happens because consumers need some common culture, and their desire for idols leads them to converge sometimes upon people/cards of modest ability; think Chantelle.

Which raises the question. Are top-earning chief executives Beyonces or Chantelles?

You can guess my Bayesian prior. The question is: what evidence can shake it?

Comments

[jf]

You consistently raise interesting topics of discussion. A parrallel phenomenon seems to be taking place in the near monopoly of Microsoft. It has a virtual lock on the PC operating system, but there are alternative personal computer operating systems out there (Apple and Linux to name two). Is Microsoft's marketshare relative to it's superiority? If it is just a little bit better than the others, shouldn't it have just a little bit better marketshare? As American big business goes, so goes the hierarchy within individual businesses.

[Jeremy]

the major reason driving pay at the top end is the result of many features, most of the social. But, and Jack Welch realises this, the investment bankers, and there extraordinary salaries, are driving CEO's to seek higher compensation (remember the Chris Gent, Goldman Sachs deal bonue row: Gent got a deal bonus, thension funds complained, Gent said he wanted to be paid as much as the bankers).

Bear Stearns returned record results today, as did Lehman. The pay at these places is extraordinary and is affecting the wider economy. Remember that financial services proportions of the s&p 500 are currently at record highs.

[Tom]

What jf said about your topics being interesting. Keep up the good work.

It does make sense that increasing returns is rarely present without a little (or a lot) of uncertainty. Who can tell who'll be a good CEO or manager of the Canadian hockey team or the English football team until you give them a go?

It also makes sense that the more history is important the more the starting point (or smartness of the winner) need not be remarkable in any way.

Which is to say that this all seems very depressingly believable.

[Robert Schwartz]

Krugman is a political hack who works for the NYTimes. Why is opinion interesting.

[Tom]

Apart from "political hack" and "works for the NYTimes", you've really nailed him.

[Maynard Handley]

I continue to be amazed that this issue of CEO pay is treated as some aspect of pure economics, with power in all its forms something completely irrelevant to the issue.
What's next? An analysis of how Stalin came to rule the Soviet Union because the market determined that he represented the best value for money?

[Robert Schwartz]

OK he is a third rate political hack.