Losing Argument

James K. Glassman from the February 1996 issue

The Winner-Take-All Society , by Robert H. Frank and Philip J. Cook, New York: Free Press, 272 pp., $25.00

Except for a shallow recession four years ago, the U.S. economy has been humming along very nicely since Ronald Reagan was elected president. But we have to worry about something, don't we? So lately economists, sociologists, and politicians have been worrying about the disparity between the richest Americans and everyone else.

Since 1978, for example, the top 5 percent of households have increased their share of the national income from 17 percent to 21 percent. In real dollars, the average income of the top 20 percent of Americans has grown by about one-third while the average income of those in the middle 20 percent has been flat.

While no one really knows why this divergence has occurred, many economists think, as Robert H. Frank and Philip J. Cook put it in The Winner-Take-All Society, that "the best performers have somehow gotten `better' relative to their colleagues." This conclusion--to which Frank and Cook, by the way, do not subscribe--is a natural outgrowth of what's called "human capital theory," which is the idea that a person's wages are determined by his own store of income-producing assets, such as education, intelligence, and drive.

Adam Smith described the concept more than 200 years ago in The Wealth of Nations: "The contrast between the intelligence, the activity, and, above all, the economy [that is, thrift] of some and the indolence, inaction and dissipation of others, was a fourth principle of inequality and the most powerful of all."

Human capital is analogous to financial capital. "Thus," write Frank and Cook, "a worker with twice as much human capital as another will earn twice the wage, just as someone with $10,000 in the bank will earn twice as much interest as someone with only $5,000."

Economists who adhere to this sensible theory believe that the computer revolution and increased access to information have vastly increased the stock of human capital for some Americans when compared to others who are less brainy, educated, or diligent. This is Labor Secretary Robert Reich's constant refrain, and the solution, he says, is to increase chances for education and training.

But even economists who subscribe to the human capital theory admit that it isn't completely satisfying. Writing in November in The Washington Post, my colleague Steven Pearlstein cited Frank Levy, an economist at the Massachusetts Institute of Technology who has been "reviewing all of the wage inequality literature of the past decade." Levy was forced to conclude that "economists can explain only about half of the increase in inequality over the last 20 years." For one thing, incomes in the United States have diverged more than those in Japan and Europe, where the same technological forces are present.

Frank, who teaches economics, ethics, and public policy at Cornell, and Cook, who teaches public policy at Duke, think they can explain the other half of the increase in inequality--and perhaps more than that. The provocative thesis of their book is that it is the nature of more and more job markets to give top performers huge rewards and everyone else crumbs. Thus, Michael Eisner makes $200 million in a single year as CEO of Disney; novelist Danielle Steel gets $12 million per book; boxer Evander Holyfield is paid $28 million for a year of prizefights. Meanwhile, median incomes stagnate, most writers can't even get their books published, and the average boxer is lucky to earn a few hundred dollars a fight.

Frank and Cook admit that "the widening gap between winners and losers is apparently not new," and they quote the British economist Alfred Marshall, writing in 1890: "There never was a time at which moderately good oil paintings sold more cheaply than now, and there never was a time at which first-rate paintings sold so dearly." Markets have always rewarded the best with a premium. "What is new," say Frank and Cook, "is that the phenomenon has spread so widely and that so many of the top prizes have become so spectacular."

Most markets, of course, do not reward a single winner, but a select group--a handful of best-selling novelists, pro basketball players, or movie stars. But, in some markets, the phrase "winner-take-all" is close to the literal truth, the gap between the number-one and number-two performer is that wide. "For many years," the authors write, "the face of Mary Lou Retton, the 1984 gold medalist in gymnastics, peered out at millions of Americans each morning from the front of their Wheaties boxes. Her endorsement contracts have earned her several million dollars in the years since her medal. But although Retton's victory over the 1984 silver medalist came by only a slim margin, today almost no one can even remember the runner-up's name."

Why do Frank and Cook think that winner-take-all markets are emerging now, all of a sudden? One reason is technology. But unlike adherents to human capital theory, Frank and Cook have a specific force in mind--the ability to broadcast rather than narrowcast. The best opera singer 100 years ago may have earned the equivalent of $1 million a year. Her income was sharply limited by physical constraints--the number of seats in the theaters she could tour in a single season. Today, however, Michael Jackson can make $50 million a year since he can reach hundreds of millions of fans in just one night by satellite and sell them his mass-produced CDs the next morning.

A second reason for the rise of winner-take-all markets is something the authors call "decision leverage." As corporations have grown larger, write Frank and Cook, "a small difference in the quality of even a single decision can translate into an enormous difference in the value of final output. Consider a chief executive officer who must decide which of two new products will be produced by his Fortune 100 firm....Making the right choice could easily mean several million dollars of added profit."

At this point, you may be nodding your head in agreement. What an interesting idea! But before you get carried away--and before we learn the rest of the authors' argument (the economic and social consequences of winner-take-all systems, and the remedies), let's take a breather and ask an important question: What evidence, other than juicy anecdotes about movie stars and athletes, do Frank and Cook provide to back up their thesis?

As far I can see, none. Intuitively, we can understand that, in the glamour professions (entertainment, sports), the top performers reap huge rewards, almost certainly larger in relative terms than in the past. But those changes may simply be the result of the decline of cartels like the studio system--which kept stars from receiving earnings that properly reflected their store of human capital--or the tyranny and collusion of professional sports-team owners before players' unions.