Hal Varian's uncertainty problem

Many Theories on Income Inequality, but One Answer Lies in Just a Few Places

by Hal Varian


It is widely recognized that income inequality increased in the 1990’s, but nobody knows quite why. Despite the lack of hard evidence, there are plenty of theories.

One says the culprit was declining unionization. Another ties it to immigration and outsourcing. A third theory is that the demand for high-level cognitive skills has increased, while other explanations range from changes in executive compensation to the lack of policy initiatives directed toward the working poor.

All these factors may have contributed..., but there is little solid evidence about their relative importance. Two University of Texas researchers, James K. Galbraith and Travis Hale, added an interesting twist to this debate in a paper, “Income Distribution and the Information Technology Bubble.”

According to Mr. Galbraith and Mr. Hale, much of the increase in income inequality in the late 1990’s resulted from large income changes in just a handful of locations around the country — precisely those areas that were heavily involved in the information technology boom.

Their study used data on average income and population by county available from the Bureau of Economic Analysis... The authors compute a measure of inequality known as the Theil index... They present their results in two ways. The most visually arresting is an animated map ..., which shows how per capita income by county has changed over time. The other depiction is a simple plot of the Theil index from 1990 to 2000. ...

A big advantage of looking at county data is that it is possible to identify counties that contributed the most to the increase in income inequality from 1994 to 2000. It turns out that the five biggest winners in this period were New York; King County, Wash. (with both Seattle and Redmond); and Santa Clara, San Mateo and San Francisco, Calif., the counties that make up Silicon Valley. The five biggest losers were Los Angeles; Queens; Honolulu; Broward, Fla.; and Cuyahoga, Ohio.

What do the counties in the first list have in common? Their economies were all heavily driven by information technology in the late 90’s. ... The implication is that the income gains of the 1990’s associated with the technology bubble not only accrued to a relatively small number of people but also occurred in a relatively small number of geographic areas.

To drive this point home, the authors asked what would have happened to the index if just 4 of the 3,100 counties in the United States exhibited average income growth in the technology boom years. The four are Santa Clara, San Mateo, San Francisco (all associated with Silicon Valley) and King County, Wash. (home of Microsoft).

Note the remarkable difference... If the per capita income in just these four counties had grown at the same rate as the average in the United States, income inequality across counties would have changed little in the late 1990’s. In other words, only four counties drove most of the change across the 3,100 counties.

The findings by Mr. Galbraith and Mr. Hale offer something to all sides in the debate. Perhaps options grants and initial public stock offerings had a lot to do with income inequality. Changing compensation patterns for technology-related skills could also be significant.

But the biggest point that I take away is a simple one: there’s no substitute for being in the right place at the right time.