Steve Israel And The Gatsby Curve-- If The Music Industry Is A Microcosm Of What's Happening In The U.S. Economy, Move To Another Country... Fast

Last weekend, when I started drawing the connection between Steve Israel and his constituents, The Princesses: Long Island, a number of people suggested I should have taken a more highbrow approach and drawn the comparison to another, somewhat less culturally repulsive fictional figure, The Great Gatsby. West Egg, a fictional North Shore town invented by F. Scott Fitzgerald, is certainly part of Israel's district, albeit in a pre-Israel era. Fitzgerald's novel, set in the 1920s, explores themes like resistance to social change on the one hand and social upheaval on the other-- not to mention decadence, the position of women in society, and socio-economic excess.

Somehow I don't think anyone at the White House had Steve Israel in mind when outgoing Council of Economic Advisers chairman Alan Krueger released the "Great Gatsby Curve" chart Wednesday evening at a lecture of the Rock and Roll Hall of Fame Museum, Land of Hope and Dreams: Rock and Roll, Economics and Rebuilding the Middle Class. From Krueger's prepared remarks:

The music industry is a microcosm of what is happening in the U.S. economy at large. We are increasingly becoming a “winner-take-all economy,” a phenomenon that the music industry has long experienced. Over recent decades, technological change, globalization and an erosion of the institutions and practices that support shared prosperity in the U.S. have put the middle class under increasing stress. The lucky and the talented – and it is often hard to tell the difference-- have been doing better and better, while the vast majority has struggled to keep up.

These same forces are affecting the music industry. Indeed, the music industry is an extreme example of a “super star economy,” in which a small number of artists take home the lion’s share of income.

The music industry has undergone a profound shift over the last 30 years. The price of the average concert ticket increased by nearly 400% from 1981 to 2012, much faster than the 150% rise in overall consumer price inflation.

And prices for the best seats for the best performers have increased even faster.

At the same time, the share of concert revenue taken home by the top 1% of performers has more than doubled, rising from 26 percent in 1982 to 56 percent in 2003.

The top 5 percent take home almost 90 percent of all concert revenues.

This is an extreme version of what has happened to the U.S. income distribution as a whole. The top 1% of families doubled their share of income from 1979 to 2011.

In 1979, the top 1% took home 10 percent of national income, and in 2011 they took home 20%. By this measure, incomes in the entire U.S. economy today are almost as skewed as they were in the rock ‘n roll industry when Bruce Springsteen cut “Born in the U.S.A.”

In my talk, I will focus on why these dramatic changes are taking place and explore their consequences. I will also describe President Obama’s vision for providing more opportunities for middle class families and those struggling to get into the middle class.

I should be clear about my overall theme: while the U.S. economy is recovering from the worst financial and economic crisis since the Great Depression, we must also take steps to strengthen the middle class and provide more opportunities for those born to less fortunate circumstances. If we don’t, we will fail to live up to our promise as a Nation and be susceptible to the kinds of forces that created economic instability in the past. To rebuild the economy from the middle out, the private sector will have to step up and reinvigorate the norms and institutions that have supported inclusive growth in the past. The government has an important role to play as well, but with severe budget constraints and limited political will, the government can only set the conditions for the private sector to grow, and provide more jobs and opportunities for middle class families. It is, to a considerable extent, up to private sector businesses, organizations and communities to ensure that economic growth leads to widely shared prosperity and a decent living for the vast majority of our people.

Let me start with the economics of the music industry, and then turn to the economy at large.

I want to highlight four factors that are important in generating a superstar economy. These are technology, scale, luck and an erosion of social norms that compress prices and incomes. All of these factors are affecting the music industry.

The idea of a “super star economy” is very old. It goes back to Alfred Marshall, the father of modern microeconomics. In the late 1800s, Marshall was trying to explain why some exceptional businessmen amassed great fortunes while the incomes of ordinary artisans and others fell. He concluded that changes in communications technology allowed “a man exceptionally favored by genius and good luck” to command “undertakings vaster, and extending over a wider area, than ever before.”

Ironically, his example of a profession where the best performers were unable to achieve such super star status was music. Marshall wrote, “so long as the number of persons who can be reached by a human voice is strictly limited, it is not very likely that any singer will make an advance on the £10,000 said to have been earned in a season by Mrs. Billington at the beginning of the last century, nearly as great [an increase] as that which the business leaders of the present generation have made on those of the last.”

Elizabeth Billington reputedly was a great soprano with a strong voice, but she did not have access to a microphone or amplifier in 1798, let alone to MTV, CDs, iTunes, and Pandora. She could only reach a small audience. This limited her ability to dominate the market.

Modern economists have elaborated on Alfred Marshall’s insights. The economist Sherwin Rosen developed a theoretical model in which super star effects are driven by “imperfect substitution” and “scale” in production. Simply put, imperfect substitution means that you would rather listen to one song by your favorite singer than a song and a half by someone else. Or, in another context, it means that if you need to have heart surgery, you would rather have the best surgeon in Cleveland perform it rather than the second and third best together.

Scale means that one performer can reach a large audience.

Technological changes through the centuries have long made the music industry a super star industry. Advances over time including amplification, radio, records, 8-tracks, music videos, CDs, iPods, etc., have made it possible for the best performers to reach an ever wider audience with high fidelity.

And the increasing globalization of the world economy has vastly increased the reach and notoriety of the most popular performers. They literally can be heard on a worldwide stage.

But advances in technology have also had an unexpected effect. Recorded music has become cheap to replicate and distribute, and it is difficult to police unauthorized reproductions. This has cut into the revenue stream of the best performers, and caused them to raise their prices for live performances.

My research suggests that this is the primary reason why concert prices have risen so much since the late 1990s. In this spirit, David Bowie once predicted that “music itself is going to become like running water or electricity,” and, that as a result, artists should “be prepared for doing a lot of touring because that’s really the only unique situation that’s going to be left.” While concerts used to be a loss leader to sell albums, today concerts are a profit center.

But there are limits to how much artists can charge their fans for concert tickets because of social pressures. Most people do not want to think of their favorite singer as greedy. There are a lot of great singers to choose from. Would you rather listen to a singer who is committed to social causes you identify with, or one who is only in it for the money? Part of what you are buying when you buy a recording or concert ticket is the image of the performers. The image and the music are intrinsically linked.

Some of our greatest artists have also been great champions of important social and economic causes, including George Harrison, Joan Baez and Bono.

If artists charge too much for their tickets, they risk losing their appeal. In this sense, the market for rock ‘n roll music is different from the market for commodities, or stocks and bonds. Considerations of fair treatment exert pressure on how much musicians can charge, even superstars.

Along these lines, one of my favorite performers, Tom Petty, once said, “I don’t see how carving out the best seats and charging a lot more for them has anything to do with rock & roll.”

And artists like Garth Brooks and, more recently, Kid Rock have made a point of charging a low price for all of the seats in the house when they perform.

In fact, the best seats for the hottest concerts have historically been underpriced. This is a major reason why there is a market for scalped tickets.

But many artists have been reluctant to raise prices to what the market will bear for fear of garnering a reputation of gouging their fans.

They also protest when tickets sell for a higher price on the secondary market, and often try to prevent the secondary market entirely. And it is considered scandalous when performers sell tickets on the secondary market themselves.

This behavior can only be explained in light of fairness considerations. Singers want to be viewed as treating their fans fairly, rather than charging them what supply and demand dictate. Indeed, you can think of market demand as depending on the perception of fairness.

In many respects, concerts could be thought of as a giant block party instead of a traditional market. While it is socially appropriate to charge neighbors some fee for coming to a block party to pay for the provisions, it is inappropriate to charge them enough to make a hefty profit. There is a compact that fans come and bring their enthusiasm and support for the band, and the band charges a reasonable price and puts on a good show.

Now, as inequality has increased in society in general, norms of fairness have been under pressure and have evolved.

Prices have risen for the best seats at the hottest shows-- and made it possible for the best artists to make over $100 million for one tour-- but this has come with a backlash from many fans who feel that rock ‘n roll is straying from its roots. And this is a risk to the entire industry.

Let me next turn to the role of luck. I said “best artists,” but I also could have added luckiest artists. Luck plays a major role in the rock ‘n roll industry. Success is hard to judge ahead of time, and definitely not guaranteed, even for the best performers. Tastes are fickle, and herd behavior often takes over.

Even the experts, with much at stake, have difficulty picking winners. Columbia Records turned down Elvis Presley in 1955 and the Beatles in 1963. They turned down Bob Dylan in 1963, and almost rejected “Like a Rolling Stone” in 1965, which was later named the greatest rock ‘n roll song ever by Rolling Stone magazine.

Or consider Sixto Rodriguez, the subject of the documentary movie Searching for Sugar Man. Rodriguez recorded two-and-a-half albums from 1970 to 1975, which were commercial flops. But he was a huge success in South Africa, and his music became the battle hymn of the anti-Apartheid movement. And-- amazingly-- he was unaware of his fame and influence.

Both good and bad luck play a huge role in the rock ‘n roll industry. And the impact of luck is amplified in a superstar economy.

...Let me next turn to the economy more generally. The same forces of technology, scale, luck and the erosion of social pressures for fairness that are making rock ‘n roll more of a superstar industry also are causing the U.S. economy to become more of a winner-take-all affair.

The effects of technological change and globalization on inequality have been well documented in the past.

It is abundantly clear that computer and information technology has revolutionized the way work is done in the U.S. In 1984, less than a quarter of workers directly used a computer on their job. Today, nearly two thirds of workers directly touch a keyboard at work, and millions of others have had their jobs altered by embedded computers and information technology. Computer and information technology has reduced the demand for jobs that can be routinized, and increased the demand for highly educated workers who can use the technology to increase their productivity.

The U.S. economy has also become much more integrated with the world economy in recent decades. While exports and imports made up only 11 percent of GDP in 1970, they made up 31 percent last year. You see signs of globalization everywhere: for example, American bands tour much more internationally today than they used to. A more globally connected economy increases the reach of successful entrepreneurs and artists, but also brings many more low-wage workers into competition with our workforce.

These developments have contributed to some of the momentous changes we have seen in the U.S. economy. This chart shows the share of total income going to the top 1% of families starting in 1920.

During the Roaring ‘20s inequality was very high, with the top 1% taking in nearly 20% of total income. This remained the case until World War II. Price and wage controls and the patriotic spirit that “we’re all in it together” during World War II caused inequality to fall. Interestingly, the compression in income gaps brought about by World War II persisted through the 1950s, 1960s and 1970s. Beginning in the 1980s, however, inequality rose significantly in the U.S., with the share of income accruing to the top 1% rising to heights last seen in the Roaring ‘20s.

After World War II, a social compact ensured that workers received a fair share of the gains of economic growth. This was enforced by labor unions, progressive taxation, a minimum wage that increased in value, anti-discrimination legislation and expanding educational opportunities.

This social compact was good for business and good for the economy. But the social compact began to fray in the 1980s. You can see from the following chart that wages of production and nonsupervisory workers moved pretty much in lockstep with productivity until the late 1970s.

Since the 1980s, however, labor compensation has failed to keep pace with productivity growth, and this has put stress on middle class workers.

...An astonishing 84 percent of total income growth from 1979 to 2011 went to the top 1 percent of families, and more than 100 percent of it from 2000 to 2007 went to the top 1 percent.

These trends are driven by a pulling apart of wages, with much faster wage growth for the highest income earners over the last three decades, and wages barely keeping pace with inflation or falling behind for everyone else.

...Next, let me consider the role that fairness plays in the economy. We already saw that social pressures for fairness affect the concert industry.

Workers, like music fans, expect to be treated fairly, and if they perceive they are paid unfairly their morale and productivity suffer.

To examine the role of fairness at the workplace, in a recent experiment Ernst Fehr and coauthors randomly varied the pay of members of pairs of workers who were hired to sell membership cards to discotheques in Germany. Obviously, it is not fair if, by luck of the draw, your pay is lower than that of your co-worker who was hired to do the exact same job. They found that increasing the disparity in pay between pairs of workers decreased the productivity of the two workers combined. Their findings suggest that a more equal distribution of wages would be good for business because it would raise morale and productivity.

This conclusion is reinforced by fascinating new research by Alex Edmans of Wharton. Edmans finds that when a company makes the list of the “100 Best Companies to Work for in America” its stock market value subsequently rises by 2 to 4 percent per year. Because employee morale suggests that treating workers fairly is in shareholders’ interests. Unfortunately, too many executives have strayed from this ethic, to the detriment of their shareholders and the economy.

The notion that profitable companies should share some of their success with their workforce used to be ingrained in U.S. companies. Earlier studies have found that companies and industries that are profitable tend to pay all of their workers relatively well, the managers as well as the janitors. In economics we call this “rent sharing.” While this is still the case, the practice has been eroded.

...It is not hard to find reasons why the institutions and practices that long enforced norms of fairness in the labor market have been eroded. At a time when market forces were pushing an increasing share of before-tax income toward the wealthiest Americans, the previous administration cut taxes disproportionately for the well off.

Even earlier, in the 1980s when inequality was starting to take off, the nominal value of the minimum wage was left unchanged from 1981 to 1989, causing it to decline in the value by 27 percent after accounting for inflation. The minimum wage serves as an important anchor for other wages, and the whole wage scale was brought down by the decline in the minimum wage.

A lower minimum wage and regressive tax changes sent a clear signal that maintaining fairness was not a priority.

And policies and tactics that undermined the ability of workers’ to join unions and exercise their right to collectively bargain weakened a critical institution that has long fought for fairness in the labor market, and served to strengthen the middle class, both for union members and nonmembers.

While we rightly celebrate the achievements of those who have been able to scale new heights of success in our economy, the shift toward becoming more of a winner-take-all economy has also had a number of adverse consequences for the U.S. economy that merit great concern.

I’ll highlight three.

First, the three-decades’ long stagnation in real income for the bottom half of families threatens our long cherished goal of equality of opportunity. In a winner-take-all society, children born to disadvantaged circumstances have much longer odds of climbing the economic ladder of success. Indeed, research has found that countries that have a high degree of inequality also tend to have less economic mobility across generations.

This is shown in the next chart, which displays a plot of the degree of income mobility across generations in a country on the Y-axis (the intergenerational income elasticity) against a measure of the extent of inequality in that country in the mid-1980s (the Gini coefficient for after-tax income) on the X-axis.

A little over a year ago, I called this relationship “the Great Gatsby curve,” because F. Scott Fitzgerald’s novel highlighted the inequality of the Roaring ‘20s and class distinctions-- I had no idea they would remake the movie as a result!

Each point in the graph represents a country. Higher values along the X-axis reflect greater inequality in family resources roughly around the time that the children were growing up. Higher values on the Y-axis indicate a lower degree of economic mobility across generations. The points cluster around an upward sloping line, indicating that countries that had more inequality across households also had more persistence in income from one generation to the next. Note that the U.S. is on the upper right of the line, indicating that we have both high inequality and low mobility.

The rise in inequality since the 1980s is likely to move us further out on the Great Gatsby Curve.

Quantitatively, the persistence in the advantages and disadvantages of income passed from parents to children is predicted to rise by about one quarter for the next generation as a result of the rise in inequality that the U.S. has experienced over the last 25 years.

We are already seeing a growing gap in the enrichment activities provided to children born to higher and lower income families.

[S]ince the 1970s expenditures on educated-related activities-- including music and art lessons, books and tutoring-- have been growing for children in families in the top 20 percent of income earners, but stagnant for children in the bottom 20 percent.

...Children of wealthy parents already have much more access to opportunities to succeed than do children of poor parents, and this is likely to be increasingly the case in the future unless we ensure that all children have access to quality education, health care, a safe environment and other opportunities that are necessary to have a fair shot at economic success.

There is a significant cost to the economy and society if children from low-income families do not have anything close to the opportunities to develop and apply their talents as their more fortunate counterparts from better-off families, who can attend better schools, receive college prep tutoring, and draw on a network of family connections in the job market.

Diverse observers from Raghuram Rajan of the University of Chicago to Robert Reich of Berkeley have suggested a second way in which rising inequality and slow income growth for the vast middle class have harmed the U.S. economy – namely, by encouraging families to borrow to try to maintain consumption, a practice which cannot go on forever, and by reducing aggregate consumption. As a result of the rise in inequality, the amount of income going to the top 1 percent of American families has increased by about $1 trillion on an annual basis. Because the middle class has a higher propensity to spend their income than the top 1 percent, this curbs consumption. An increasingly top-heavy distribution of income is a drag on aggregate demand and economic growth, and a contributing factor to credit bubbles.

President Obama made this point very clearly in a speech in Osawatomie, Kansas: “When middle class families can no longer afford to buy the goods and services that businesses are selling, it drags down the entire economy, from top to bottom.”

Third, an active line of research examines the connection between inequality and longer term economic growth. In a seminal study, Torsten Persson and Guido Tabellini found that in a society where income inequality is greater, political decisions are likely to result in policies that lead to less growth.

...In this year’s State of the Union Address, President Obama said, “We can either settle for a country where a shrinking number of people do really well, while a growing number of Americans barely get by, or we can restore an economy where everyone gets a fair shot, and everyone does their fair share, and everyone plays by the same set of rules.”

He went on to outline a robust set of proposals to grow the economy from the middle out, by creating more middle class jobs and opportunities for those who are struggling to make it to the middle class.

...One of my predecessors as Chairman of the Council of Economic Advisers, Arthur Okun, wrote an influential book called, Equality and Efficiency: The Big Tradeoff. Okun argued that policies that increase equality often reduce efficiency.

But given the dramatic rise in inequality in the U.S. over the past three decades, we have reached the point where inequality is hurting the economy. Today, a reduction in inequality would be good for efficiency, economic growth and stability.

Growing the economy from the middle out is not only an economic necessity; it is also a national imperative. Our system of government as well as our economy work better when we have a rising, thriving middle class, with broad common interests.

The expanding middle class in the post-war period was a defining experience for our country. Just like music, this shared growth and prosperity helped bring the nation together.

President Obama captured the changes sweeping our economy well when he said, “The world is faster and the playing field is larger and the challenges are more complex. But what hasn’t changed-- what can never change-- are the values that got us this far. We still have a stake in each other’s success. We still believe that this should be a place where you can make it if you try. And we still believe, in the words of … [Theodore Roosevelt that] ‘The fundamental rule of our national life, the rule which underlies all others-- is that, on the whole, and in the long run, we shall go up or down together.’” And I agree with the President that America is still on the way up.

Thursday morning, President Obama was in Miami singing the praises of corrupt members of his own party, self-serving careerists like DNC Chair Debbie Wasserman Schultz. F. Scott Fitzgerlad could have set Gatsby along Collins Avenue in Miami Beach in Wasserman Schultz's district instead of on the North Shore of Long Island in Steve Israel's. Neither of these putative "Democrats," each a high-ranking leader inside the party establishment has the slightest connection to the problems of the struggling working class Americans Krueger talked about in his lecture. As we saw last week, in fact, Israel was bragging how he had the access to Obama needed to persuade him to keep the Bush tax cuts in place for his wealthy North Shore constituents and campaign donors. Similarly, Wasserman Schultz has made a career for herself by kissing up to the wealthy interests-- like the crooked Fanjul brothers who run the American sugar business-- while faking solidarity with working families. I spent much of my life in the music business and I ran into plenty of shady, greedy untrustworthy characters like Steve Israel and Debbie Wasserman Schultz. It has a lot to do with why the industry is in the toilet today-- just like the American economy. Believe me... it's not all the Republicans' fault.