Photographer: Price Chambers/Bloomberg

Mountain ranges like the Grand Tetons took millennia to grow to their present size. Wall Street bonuses? More like 25 years.

New York State yesterday released its annual report on Wall Street pay, reporting that the average New York City securities industry bonus went up eight percent last year, to $121,890. Surprised? Didn’t think so. That Wall Street bonuses went up is roughly as unexpected as an airplane getting delayed at O’Hare: it doesn’t happen every time, but you can usually bet on it.

That climb has made Wall Street bonuses the focus of the current debate about inequality. The $121,890 average includes bonuses for everyone from secretaries to traders and senior executives. For those last categories alone, the numbers would be much, much higher. I’ve taken the New York State Comptroller’s report, which lists bonuses all the way back to 1985, and adjusted the numbers to 2012 dollars, to account for inflation.

The result: Since 1985 the average securities industry bonus in the city has risen about four-fold. There’s a big jump from 1990 to 1991, when bonuses went from about $27,000 in real-dollar terms to $52,000, and a series of further increases from there. Bankers and traders in a bad year now earn much more than they did in a good one. You can see the chart to the right.

So what accounts for the rise in Wall Street pay? Defenders of the compensation status quo tend to point to increased productivity. Foes ask, reasonably, what the heck folks on Wall Street do that makes them worth so much more. There’s some data in the report that goes a long way toward explaining the increase — though probably not nearly as far in justifying it.

The next chart uses the numbers from the state report and the Securities Industry and Financial Markets Association to compare the total inflation-adjusted bonus pool for New York City to the number of industry workers in New York. You’ll see right away that the second part just doesn’t change much. In 1985, the industry had about 130,000 employees in New York. Last year, that number was 169,200 (fewer than in 1997, and barely more than the 163,000 workers in 1987).

Meanwhile, the bonus pool has risen in real-dollar terms from $4.1 billion to $20.1 billion. The industry and its profits have grown with the economy, which has roughly doubled in size since 1987 (and financial services has grown more). The number of highly-paid New York-based employees has not.

The economists Robert H. Frank and Philip J. Cook anticipated this kind of trend in their book “The Winner Take All Society.” For a long time, I resisted the idea that the economy had changed in ways that brought the big rewards to the top of the pyramid. For one thing, I thought, every superstar, whether in banking or movies, creates work for many other folks. In addition, I assumed that if fewer highly skilled employees were needed to do the same job, then supply and demand should dictate that those employees would earn less.

The New York City data, though, are compelling. University of Chicago economists Steven N. Kaplan and Joshua Rauh have theorized that the main reason for the rise in Wall Street pay is that “asset managers, investment bankers, lawyers, and top executives now apply their talent to much larger pools of assets.” The bonus charts support that explanation.

You can argue about whether there’s something special about those folks, or whether they’ve just gotten lucky. You can’t argue with the math, which shows unequivocally that income at the top is growing because essentially the same number of people are splitting greater profits.

Next week I expect I’ll take a more careful look at this, moving beyond New York City. There are other factors to consider, like the drop in the city’s share of industry employment from about 30 percent in 1992 to 21 percent now. Nonetheless, I suspect the general principle that the jobs at the top of the economic ladder are becoming ever more lucrative as their industries scale up without adding staff will hold up. If so, that reveals some truths uncomfortable for both sides in the debate over incomes at the top. For the harshest critics of Wall Street. the fewer employees/more profits explanation isn’t exactly the cloak-and-dagger conspiracy they might wish for.

On the other hand, for those who think that all is just hunky-dory on the inequality front, this isn’t exactly a pleasing result either. Fewer people sharing more profits means Wall Street employees may be more “productive” — but not in any way that non-economists understand that word. It’s not that they work harder or have somehow gotten vastly smarter. It’s just that it doesn’t take many more people to do a $300 million deal than a $50 million. That basic fact does a lot to explain why incomes on Wall Street have grown. It doesn’t do anything to make it seem fair.

Photograph by Christian Heeb/laif/Redux

The San Remo apartment building, on New York’s Upper West Side.

The most expensive apartment in the twin towered Art Deco masterpiece looking out over Central Park, the San Remo, rented for $900 a month. The tenant was a stockbroker named Meno Henschel who, according to what he told the Census Bureau, lived in his apartment together with his wife, a cook and two maids. Henschel had one of only two apartments that rented for more than $600. Another, with room for a family of five, plus the requisite cook, butler and maid, rented for $540.

The year was 1940, and that $540 is what would now generally be referred to as about $8,850 in today’s dollars. Except it’s  almost impossible to find an apartment like that to rent today. Like most  of the great prewar luxury Manhattan buildings, the San Remo has long since been converted into a co-op, owned by the residents.

Very rarely an apartment there will come up for a short-term rental. There is one listed now. The asking price is $29,750 a month.

At first glance, this may strike you as the kind of problem that rich people file under “even richer people’s problems.” So the price of Central Park views has gone up? Feh, probably you can find yourself another park to look at. You might assume that the price of living in one of New York’s most expensive buildings tells us nothing of value to most Americans, who (a) don’t live in New York, (b) don’t live in rentals, and (c) couldn’t come close to affording that kind of price.

In fact, it tells us a lot. Extraordinary as a rent of $29,750 a month may seem, the rise in the price of a rental at the San Remo is not exceptional. You can find similar or even bigger increases at every level of the market, down to the most ordinary middle-class apartments. Looking closely at rents at the San Remo and other places in New York opens up questions about whether we’re measuring inflation accurately. And those questions, in turn, have big implications for how we understand the cost of living and quality of life—not only of those who live in the San Remo, but of the middle class.

Nationally, according to U.S. inflation data, since 1940 rents have risen 1,014 percent, so they have gone up about 11-fold. For the New York area alone, the increase is a little higher, 1,250 percent. Though those are big numbers, they’re actually lower than the overall 1,536 percent rise in prices reported by the Bureau of Labor Statistics, the agency that gauges inflation.

Most New Yorkers, however, would guess that the price of housing has risen much faster. Diving deep into old records bears that out. The 1940 census found the median rent in New York City to be $38.10. In 2011, that was $1,100. That’s an increase of 2,787 percent—close to twice the rate of inflation. And when you start comparing specific apartments, delving into the newly released 1940 census forms in which I found how much Meno Henschel paid for his apartment, the differences are even starker.

At the San Remo the price increase is greater than 50 times. It’s a good example, because the San Remo is one of very few buildings not to have changed in character over 70 years. It was, as Dennis Hughes, the real estate agent handling the listing puts it, an “iconic” building then, and it remains so now. It’s a time capsule of luxury living. But that kind of increase hasn’t happened just at the top. You can see the same pattern in much more modest places.

One is the one-bedroom apartment I lived in from 2004 through 2009 in Williamsburg, Brooklyn. Back in 1940, as I found from the handwritten (and recently digitized) census forms, most of the tenants were Italian. Several were truck drivers; it’s not hard to imagine that one settled there and his friends followed. The rent was $18 to $24 a month. The upper end of that is $369 in current dollars. When I moved in late in 2004, the real estate broker cautioned me that it “wasn’t a luxury building.” Indeed, it wasn’t, as the broken front door lock suggested and the heat inspectors could confirm, but the rent was $1,500 a month, and later it rose to $1,615.

So what’s happening here? Most conventional stories of inflation hold that the consumer price index tends to overestimate how much prices rise. For a long time, the index, the government’s main inflation yardstick, didn’t adjust for changes in quality, and many economists believe that it still doesn’t do it enough.

With rent, it’s a different story. Rent is a particularly important piece of the consumer price index. The government uses data on rents not only to estimate inflation for those who actually rent their homes, but also to separate out the investment value of homes and derive a measure of how much homeowners pay to keep a roof over their heads. Together, “rent” and “owner’s equivalent rent” make up about 30 percent of the inflation measure.

Changes in rent, though, are not easy to measure. Rents tend to rise slowly over time, and a lot of what makes a home desirable changes, too—think “location, location, location.” Those difficuties have led to some awkward results. Mike Shedlock, a well-regarded blogger who looks at economic trends, has tracked how the rents the government measured barely budged during the housing boom and rose afterwards even as real estate agents wrung their hands over falling prices.

Perceptive recent work on rent comes from three economists who worked together at the Philadelphia Federal Reserve, Theodore Crone, Leonard Nakamura, and Richard Voith (Nakamura is a vice president of the Philadelphia Fed). Their research makes a good starting point for figuring out the rent puzzle.

The most important insight in their work is that for decades the inflation measures skipped over the cases in which a tenant moves out. Think about that for a second: A landlord avoids raising the rent for a decade for a good tenant, then when the tenant moves, ups the rent to a market rate. Or, as is common in New York, rent regulations keep rent from rising until a tenant moves out. Those are precisely the units in which the rent is most likely to rise, and for some four decades they weren’t counted in inflation.

Crone, Nakamura and Voith estimate that this and other problems bring down the government’s measure of rent increases by about 1.4 percent a year for the whole period that runs from 1942 to 1985. Nakamura outlines these findings in a very readable paper published by the Philadelphia Fed. Over such a long period, 1.4 percent into a really big number. Add that in, and instead of falling 20 percent in real-dollar terms over six decades, rents rise 50 percent.

Think about what that means for the middle class. Since 1970, the average hourly earnings of American workers (excluding managers) have stayed almost exactly flat by the official inflation measure. If, however, the cost of housing has risen faster than those measures say, then that means that many folks are actually worse off than they were then. You can see how that matters, and not just to the people in the San Remo with Central Park views.

Source: Google Street View

The building in Brooklyn I lived in from 2004 to 2009. Not exactly a model of luxury.

The reason I started with the San Remo wasn’t just to get you to marvel at how much a fancy apartment in New York costs these days. OK, that was part of it; it’s not an accident that Robin Leach’s show wasn’t called “Lifestyles of the Average to Upper Middle Class.” The other reason for focusing on the San Remo, though, is that in most buildings and neighborhoods, so much changes that it’s hard to compare prices over extremely long periods of time.

Often when you read stories about the economy they’ll translate a price from decades ago into “today’s dollars.” By that measure, the $540 that a San Remo apartment rented for in 1940 is $8,856 in today’s dollars. Except that it’s clearly not: If you’re talking about rent, it’s $29,750 in today’s dollars. We know that because that’s what a San Remo apartment rents for today.

If we work off that $540 price for a San Remo apartment (one of the more expensive ones then; many rented for less than $400), that’s an increase of 5,409 percent.

Notably, that number is a lot higher the calculations of Leonard Nakamura and his collaborators. By their measure, rents from 1940 to 2000 increased about 15-fold. That would make the increase in rent higher than the overall inflation rate—but still well below the change in median New York City rents. Even with this effort to fix the data, we still don’t get close to the kind of inflation you see for many New York apartments, those long turquoise and magenta lines at the bottom of the chart.

So what else is at play here? We just don’t know. It’s tempting to explain the San Remo by looking at the rise in income at the top. That’s the market for four bedroom apartments with park views. Strangely, however, the change in the price of a fancy Manhattan apartment is actually lower than the 67-fold increase in the price of the underheated Brooklyn walkup I lived in for five years.

It’s difficult to judge the degree to which that Brooklyn apartment—unlike the four-bedroom in the San Remo—is “the same” as it  was in 1940. The heat may have worked more reliably then, and the building had not yet been blessed with its current asbestos-shingled facade. On the other hand, it wasn’t within throwing distance of about half a million trendy restaurants, as it is now. How do you calculate the value of those kinds of changes and plug them into the inflation model?

“The main thing we cannot take into account [in measuring inflation],” says Leonard Nakamura, “is how a city changes over time.” That’s certainly part of the rent puzzle. In the post-war years there has been a major national transition from renting to home ownership. In New York, as in many parts of the country, many of the most desirable properties in most desirable neighborhoods can no longer be rented at all. This is essentially the case with the San Remo. As the San Remo and buildings like it turned owner-occupied, they’ve dropped out of the inflation measure.

That may have pushed down measured rent in New York and many other places as well. As the upper and middle class have moved to home ownership over the last decades, it’s possible that the the homes and neighborhoods that have stayed rentals are the ones that have been less desirable in hard-to-measure ways. That might help explain the enormous divergence between New York rents and the inflation yardstick, but it’s hard to test without a much deeper dive into real estate records.

1940 census forms from tenants at the San Remo. You can see Meno Henschel’s $900 rent at the left, the highest at the time.

Complaining about inflation can seem like an old person’s diversion; yes, at some point a steak dinner did cost three bucks and penny candy was a penny. So what?

With rent, however, the intuition that prices have risen faster than the inflation data appears very robust not only to laypeople, but to professional economists as well. Robert Gordon is an economist known for his pioneering work on how we’ve overstated inflation in durable goods, such as cars, which have improved over time. He suspects that housing may be different. As Gordon writes in an e-mail, ”the low prices my parents paid in the 1950s for a lot, a house, my Harvard education … seem unbelievably cheap by today’s standards.”

If rent has indeed risen more than the usual inflation measures indicate, it would help explain why many families have the sense that they are working ever harder to afford to live in what they think of as a nice neighborhood. More generally, understanding what’s happened to the price of shelter is key to the current debate on inequality and how we answer the question that gets asked (rightly) in every election year: “Are we better off?”

The other takeway from New York rents is that when you think about inflation, you may consider asking “inflation in what?” and “inflation for whom?” We are so used to talking about the headline inflation number that comes out each month that we tend to forget it includes changes in literally thousands of prices. The increase in rent at the San Remo is not the same as the increase at a new college grad’s shared apartment across the river in Brooklyn, or at a public housing complex in the Rockaways—or in a different city. Nor is it the same as the change in the price of steak or childrens’ clothes.

And because inflation isn’t the same for different items in the consumer basket, it’s not the same for different people, either. It may, for instance, be higher for the wealthy, who are competing for the same few ultraluxury properties. It may be lower for older people, who don’t worry about moving. And it may be higher for those who have to move often. Measuring inflation accurately is a hard problem, and over the years economists both inside and outside the government have made great efforts (and strides) to get it right. The evidence of New York is that we’re not there yet.

Already the national discussion has turned from talking about inflation in general to focusing on specifics, like the costs of education and health care. It may be time to start cutting up the data in even more granular ways to get more specific answer to those questions of “inflation in what?” and “for whom?” That may pose some questions for government policies. In return, it’s likely to offer up some answers to why we live the way we do up and down the economic ladder.