A blogoff on inequality

What I find interesting is that US income distribution before government redistribution is in some cases more equal (on Gini terms) than several European OECD countries (but not all).

Of course, after government redistribution, the U.S. lags almost all OECD countries in Gini terms.

However if inequality actually reduced economic growth, somoene would have to explain why the U.S. is growing faster nad has a lower unemployment rate than most other OECD countries that are more "income equal".

I've just re-read some of the blog off and came across this from Heather:

"Consumption comprises the overwhelming share of economic demand. If the vast middle doesn't see income gains, they can't purchase the goods and services that keep our economy moving."

This strikes me as a very uninformed comment, for two reasons. One, it wrongly assumes they next dollar that goes to the rich is somehow taken out of the economy. Two, it indicates Heather believes that money's velocity drives the economy, i.e. we feel better off when people around us are spending their money. This is a mistake over anything but the short run, an illusion created by focusing on measures of macroeconomic performance rather than intrinsic things like an economy's production of innovation and its division of labor.

Half sigma,

I'm not sure I agree that the cost of capital can ever be "too low" or "too high". The problem with bad investments is not the cost of capital but the quality of decision-making.

Even brilliant minds sometimes make poor decisions. My former employer, Fedex CEO and founder Fred Smith, once decided to invest $600 million in a combination fax-ground delivery product we named Zapmail. IMO, it was a poor investment decision. But Fred Smith has made hundreds of right decisions the past 30 years, and both his stockholders and employees love him fot it.

Zapmail would have failed at any cost of capital. Pets.com might have attracted venture capital when its cost was twice as high. Likewise, most of Fred Smith's decisions and many investment decisions in the 90's would not have depended on a low cost of capital.

Greg,

Where did you take that Econ 1 class?

I was trying to say more than just "the numbers don't mean anything." I was trying to show why they don't mean anything. I think if people thought more carefully about how the numbers are collected and how they are interpreted, they would be more skeptical of the claims that the average person is falling behind.

You make an excellent point about mobility. There have been studies of how much people move around—-I referred to the one by Danziger and Gottschalk. You can find it here:

http://fmwww.bc.edu/ec-p/wp398.pdf

Read the sections on relative and absolute mobility and look at Tables 4 and 6.

Prof. Roberts: I thought you probably should have spent more time taking apart the data presented by Boushey. All I read was "these numbers don't mean anything, let's move on." I agree, but you probably could have offered the WSJ readers a little more meat. As for anecdotes, I looked up the Census numbers for these magic quintiles. I'm only one data point, but I've managed to move back and forth between all 5 in the past 15 years. Back when I took Econ 1 from a certain Prof. Roberts, my roomies & I had a household income somewhere just above zero. (1st quintile) My first job out of school was teaching Jr. High. (2nd quintile) Getting an engineering job and marrying another engineer moved me through the 3rd & 4th quintiles. Then my wife quit work and we had a kid. Back to the 3rd. I fenagled a raise and my wife went back to work part time, and what do you know? 5th quintile. And my plan is to retire someday, hopefully into a comforable 3rd/4th quintile senesence. Among my peers, and among most of the my parent's peers, this sort of movement seems pretty normative. How do we design a survey that captures that?

I believe, probably like most folks hovering around this site, that people can choose their quintile, given enough time and persisitence. It's just that high paying jobs suck more than low paying jobs. I'd like to be a snowboard instructor. Is it unfair that snowboard instructors can't make what an aerospace engineer does? My brother is finishing his B.A. in Jazz Performance, knowing that he'll probably never break out of the 2nd quintile. I don't know which of us is the happier for our decisions.

Brandon,

Your link isn't working. ")." is prepended, making the URL invalid. Just so you know. Good article, though.

Excuse me, I mean that you say we are investing *too* much, while most say (if anything) not enough.

>One could argue that the cost of capital has been TOO low, resulting in dumb investment in stuff like "pets.com," the result being an inefficient allocation of resources.

Because of an internet bubble in the 1990s, you are going to dismiss the entire argument? You just sound foolish, you should have kept your mouth shut. Yes, people have made bad mistakes, no that doesn't mean that resources are not efficiently aloocated - would government have done better? Not unless you think we should follow the example of the Soviet Union. Risk and reward are what make up all investment- we have to learn and make mistakes - many internet companies failed, that doesn't mean the experiment was a waste.

Furthermore, you act as if we aren't investing enough, yet most people would say that we as a country, aren't investing enough (eg we buy things from overseas instead of cosuming and investing in America). You argument is so full of holes that you should use it as a sponge.

>Rich people also give money to dumb charities. For example, some rich guy gave $115 million to the University of Arizona College of Law. Does the U.S. really need a $115 million law mecca located in Tucson Arizona? I think not.

? WOw. You are really grasping at straws and name calling now. Rich people give to dumb charities. Therefor governmen should spend our money for us - invest and spend for us. How is supporting a private law school dumb, anyway? It makes it cheaper for poor kids who want to study law, but this is a bad thing because you don't like Arizona? You are showing your lack of a coherant aregument and your bigotry, now.

johngaltline: "If you look more closely at the rich man's wealth, you'll see that most of it goes unconsumed, creating jobs for the rest of us."

One could argue that the cost of capital has been TOO low, resulting in dumb investment in stuff like "pets.com," the result being an inefficient allocation of resources.

Rich people also give money to dumb charities. For example, some rich guy gave $115 million to the University of Arizona College of Law. Does the U.S. really need a $115 million law mecca located in Tucson Arizona? I think not.

Bravo! You've made some dynamite points:

The rich are not lounging on caviar, lighting their cigars from flaming hundred-dollar-bills. Even the guy who supposedly makes hundreds of times as much as the mail clerk is actually living a pretty conventional life.

If you look more closely at the rich man's wealth, you'll see that most of it goes unconsumed, creating jobs for the rest of us. We need those people to have that money, because they're the only ones in our society who will leave it invested instead of hocking it for new TVs.

In a country where so few are saving, the rich are actually performing a valuable service.

When the proletarian mob arrives, complete with pitchforks and torches, to redistribute the wealth of the bourgoisie, they're going to be disappointed to find that the rich aren't hoarding all the bread, meat, medicines and baby formula. Instead, the rich man's strongbox holds the title to the factory where the entire town works Yeah, the rich are real evil...

Meanwhile, any worker can be a millionaire by simply contributing to their IRA in their twenties.

It's the same as every collectivist argument: always "how do we redistribute," never "how do we get the poor to become more wealthy." Well, the rich are rich because they don't consume everything. Our poor should look to them as an example, not as villains.

>Another issue is whether people feel they have a reasonable chance of rising in status, and if there is a huge gap separating regular people from the rich, then the answer is no they don't. Then that means the "American Dream" is dead.

Not that you will bother to read or consider the arguments, but this post directly addresses your concern: http://www.myarsefrommyelbow.net/index.cgi?page...>

(The URl has been intermittantly down for a few days, sorry to all about that.)

"There has been very little work on the question of absolute mobility."

I don't get it.

Can't the IRS just track a given SSN's increase in income over time?

Adjust it for inflation, and things like filing jointly after marriage, and you have a hard measure of absolute mobility.

Of course, this won't count those whose tax returns misrepresent their lot in life. It would probably be skewed towards making the rich look less so.

One of the interesting arguments I found put forth by Bushey was her claim that debt levels and debt servicing levels being at all time highs have anything to do with inequality.

"This indicates that families are having trouble financing the lifestyle they want on their income alone."

Why do people like Bushey feel that anyone is entitled to a lifestyle that satisifies their WANTS and not their NEEDS. How could any government policy change this sense of entitlement?

Brian:

spencer's claims are misleading, at best.

Average annualized GDP growth per capita from:

1940-1950 4.1%

1950-1960 1.6%


1960-1970 2.8%


1970-1980 2.1%


1980-1990 2.3%


1990-2000 2.0%


2000-2004 1.3%

http://eh.net/hmit/gdp/gdp_answer.php?CHKrealGDP_percap=on&year1=1940&year2=2004

You can use the data at the link to construct average rates of growth in GDP per capita for any window. You'll find (surprise!) that there is such a thing as a business cycle. You'll also find (since spencer brought politics into it) that the 8-year trailing growth rate was higher in 1990 (under Reagan and Bush the Elder) than it was at any point in Clinton's term. FWIW.

You'll also find an apparent trend toward less volatility in the trailing growth rates, but no detectable trend toward lower rates overall.

Spencer,

"From WW II to about 1980 real per capita income growth average about 3%. But since 1980 that growth rate has slowed sharply -- it was below 2% from 1981 to 1992 , rebounded to almost 3% under Clinton but has been under 1% under Bush."

Could you provide a link to these statistics?

Half Sigma,

"what people care about his how they are doing compared to their contemporaries."

If that is all people care about (which I don't think it is) then what is the point of even discussing this since it is a mathimatical impossibility for everyone to be doing well compared to everyone else.

Of course, that wouldn't keep people from proposing government solutions to "fix the problem"

Half sigma,

I think the U.S. is still the land of opportunity. Stanley and Danko revealed in "The Millionaire Next Door" that 80% of current millionaires are first-generation rich. Many of the wealthiest Americans of recent years - Larry Ellison, Paul Allen, Warren Buffett, Sam Walton - did not arise from a privileged class. I've personally known a dozen or so high-income corporate officers who grew up in modest neighborhoods.

Prof. Roberts,

I went the discussion board for that debate. And according to Ken Jarboe, the only reason that you work for George Mason is because you were born smart.

I have a young son, who seems to have also been born smart. Could you please tell me how you avoided studying in high school to get into college, how you were able to not forego immediate earning after high school and not graduate university, and then again forego immediate earning after undergrad and not get admitted to grad program, not complete the work required to complete an advanced degree, and then after not completely any of that how do you remain at your job with no effort, results or work.

You truly are an amazing smart man to achieve you position without having to add the least amount of effort, delay gratification, or personal sacrifice. And more the point, it is amazing that you were born with such an innate understanding economics, writing skills, and knowledge of information and studyings that wasn't even known before you were born.

Kudos, Senor.

Your WSJ post is strictly focused on absolute measures of wealth relative to a baseline in the past, but as I've pointed out a zillion times in the comments here, what people care about his how they are doing compared to their contemporaries.

Another issue is whether people feel they have a reasonable chance of rising in status, and if there is a huge gap separating regular people from the rich, then the answer is no they don't. Then that means the "American Dream" is dead.

"Nobody wants to be in the lowest quintile"

Timothyb, I agree with most of your arguments, but not this one. I've met many people who totally lack ambition, and others who intentionally channel their ambition into non-lucrative endeavors. For many in the bottom quintile, government transfers such as Medicare or subsidized housing allow them to lead comfortable lives on "poverty-level" incomes.

Hi Russ,

For income equality stats, "Economic Freedom of the World" annual reports by James Gwartney and Erik Gartzke provide the stats you needed for your debate with Ms. Boushey. Once it is established that economic freedom is better for all (including the middle class and poor)the inequality debate becomes pretty meaningless.

Russell,

It is interesting that your agruement has turnd into a denial of income and wealth inequalities. I think that if we step back from the debate we would agree on something surprising: we want inequality.

Now, nobody wants to be in the lowest quintile, or to be absolutely poor, but that is the point, the free market provides strong incentives to work hard to get rich. Can everyone get rich, no, but that is where your main point comes in. The system provides a good life for everyone in it. Do the rich live better lives, sure, but that is why we are all trying to get rich.

The key is mobility, and if 10, 20, or whatever percent of the bottom quintile make it to the top quintile, that is pretty good, after all if initial wealth and talent was randomly distributed you would expect only 20% to reach the top, while you would expect 20% to stay put, 20% in the second quintile, etc.

Neither talent nor a culture that encourages hard work and education is not randomly distributed, so you would expect less than 20% of the bottom quintile to reach the top quintile.

May I ask a real simple question that cuts the heart of the matter? If income inequality is increasing then what should be done about it? Will the proposed remedies be of net benifit to society? And isnt the whole question of income inequality an extreme waste of time? The ethical thing to worry about is the distribution of living standards accross this country. The U.S may have the most income inequality of all of the world's rich nations but it also probably has the highest rate of consumption for its poor. Therefore, what I am saying is that if the United States offers a better deal to the poor than the whole of Europe, outside of Norway, then what are we complaining about?

Also, isnt the income inequality debate a question of ends and not means? That is what is so terribly disconcerning to me. I get the feeling from listening to the left that they only use the inequality issue to pine for more government involvement. However, when it comes to improving the lives of the poor by ways of reducing government created artificial scarcity(zoning laws, regulation, licenced practitioners) and school vouchers they become surprisingly silent. This makes me think that they are only concerned with enacting their plans and are on the whole not too worried about improving the lives of the poor.

interesting, ben. But Socialism was in large part an attempt to reduce inequality, and eg Sweden still has almost no inequality compared to the US (and UK and others, but the US has by far the most inequality of the highly developed free market nations). The trade-off is prosperity - they have a top quintile equal to our third quintile. Other nations with slightly different approaches are more prosperous but have higher unemployment.

Inequality may have grown in Sweden, but it is still much lower than in the US - because, though they have made reforms and reduced their public sector, they are still much more heavy on the socialistic programs/approach than we are.

I brought it up to make the case that in order to address the "problem" of inequality, we would have t flaten all of incomes down to where our poorer citizens are and then reduced growth would keep us there for decades.

If anyone is thinking "Well, thats not so bad, middle class is good and we would all be there together..." remember this:

1. Had we done that in the 1970s, we would all be where our bottom quintile is today.

2. Most people in the lower quintiles are young - by the time people reach middle age, most of them are in the top quintile of society. Dragging everyone down would mean that nobody can reach the standard of living that most people reach before they retire.

3. This "terrible inequality" is mostly the horribly unfair inequality between people just starting out and people who have worked their whole lives and are ready to retire.

-- its like a teenager saying to his dad "its not fair, you have more money than me" -- turn that into policy and you have Sweden; turn it into more radical revolution and you have Russia circa 1917.

Liberty

"Whichever of those she might choose is being attempted in Europe right now - and they have succeded in reduce inequality"

The main concern from Heather is the increase in US inequality. But inequality has increased in most Western countries in the last 25 years, including in Europe where government redistribution is greater.

The problem with a rant against higher inequality is that it is also a rant against the causes of that inequality, which is fine if those causes are political corruption that Heather seems to believe. But if inequality is caused by higher returns to education or the liberation of women then what is the problem? I'd take personal freedom any day if the only expense were a larger statistical difference between my quartile the next.

For a possible explanation of why mobility seems to have fallen over the past few decades, see my essay "Peak Mobility" at Catallarchy (http://catallarchy.net/blog/archives/2005/10/27...>

The basic idea is that as economic opportunity increases, we see an initial burst of class movement due to advancement of those previously held down by lack of opportunity, but that this falls off once the population is better sorted according to natural ability.

You made some great points, but she was able to complain that you were using anecdotes too much at the start - and you could have rattled off some impressive counter-stats to her mobility data earlier. Along with Gottschalk/Danziger you could have included the US Treasury study and Cox and Alm (1996)--

http://www.urban.org/url.cfm?ID=406722&rend...>
-- that compare individuals against the society's quintiles - instead of against quintiles made up of the original study group as your opponents studies did - and found 95% mobility after 15 years including 29% who moved from the bottom quintile to the top.

Just as you argue, people improve income over their lifetime, its only wehn you compare them against others who also improved their income, that it looks like stagnation.

In addition, when you ask "what do you suggest that we do to fix this problem, if one exists" , you can propose an answer - a more redistributive tax system, more welfare and social security benefits, a minimum wage etc. Whichever of those she might choose is being attempted in Europe right now - and they have succeded in reduce inequality, but at what price? When you compare mobility across countries, you find that they move relative to their study-peers but passing those peers is easy, none of them move much in real terms; we move much farther but since we all move its hard to see when compared realtive to each other.

She like equality of income, we like "equality of movement" - the fact that all people may improve their lives in America.

For more of my own analysis - please read this:

http://www.myarsefrommyelbow.net/index.cgi?page...>

Maybe I would pay a little more attention to your claim that the CPI massively overstates inflation if you understood enought about it to even know that they do actually adjust the data for quality improvements in new cars.

I'm afraid that you are extremely guilty of ignoring the point that since roughly about 1980 there has been a sharp slow down in the rate of growth of the well being of most of the population. You do a great job of making comparisons over the last 40 years without acknowledging that there was a massive break in the gains at about the midpoint of the period you are talking about. From WW II to about 1980 real per capita income growth average about 3%. But since 1980 that growth rate has slowed sharply -- it was below 2% from 1981 to 1992 , rebounded to almost 3% under Clinton but has been under 1% under Bush. I'm not trying to make this a political point, but the clear fact is that the rate of progress in the well being of the population has slowed sharply over the last quarter century. You may be right that it is due to government interference in the economy, but you are incorrect in denying that it has happened.

John Dewey -- while you are correct that the number of people owning stocks has increased sharply, the distribution of wealth from stock ownership has not changed significantly over that period. The share of stocks owned by the top 1% of the income distribution has remained very stable at about 67%.

I'd also suggest adding a reference to the David Schmidtz Cato Unbound essay on "When Inequality Matters".

http://www.cato-unbound.org/2006/03/06/david-schmidtz/when-equality-matters/

I'm not sure how Heather gets the title 'economist' when she advances an argument so devoid of economics. Her thesis seems to be that inequality is a political phenomenon, and therefore can be purchased by the rich to their advantage.

I presume Heather would agree that inequality matters to the extent that it affects opportunity. Her mistake, I think, is to look at cross-sectional outcomes and equate those with opportunity for individuals. As Russell noted, this is a serious mistake, although one that is close to ubiquitous in the literature protesting inequality. I liked Russell's point about inequality being an emergent property in an economy, rather than something tangible.

Which leads to an important element missing from Heather's analysis: what can be done about it? Even if inequality is a problem worth fixing, what rules would one prescribe to reduce it? As an economist, Heather would presumably recognize the problems with solutions like higher minimum wage and minimum conditions and higher top tax rates. So what does she recommend?

Heather also failed to establish inequality as something that matters. The best she did was to cite correlations of inequality with health. But correlation isn't causation and I would say in this case it is obvious that the relationship isn't causal (I don't believe people get sick because they are surrounded by wealthier people). So why raise it in a discussion about inequality?

In my view a slam dunk to Russell in response to a quite incoherent argument. Heather, try putting on your economist's hat, it might be a better fit.

Russell,

Your discussion with Heather focused on income levels. I was bothered by her assertion that WEALTH is being concentrated in the hands of a small elite group.

I remember reading that participation in equity ownership is at an all time high in the U.S., if we include all the funds in 401K's and IRA's. I think also the increase in housing values since 1990 has far exceeded that of prior years. An analysis of wealth should also include the implied wealth from expected social security and pension payments.

Scott Burns wrote this in 2003:

'In 1997, economists Arthur B. Kennickell and Annika E. Sunden examined the impact of this implied wealth on the distribution of conventional wealth. "Overall," they found, "the results indicate that Social Security and pensions constitute a substantial fraction of household wealth, comprising 82 percent of total net worth."'

As this implied wealth mainly accrues to those not in the top 10% of wealth or income, government statistics that report only financial assets overstate the degree of wealth inequality.

Prof. Roberts, I would say you won handily (but take that with a grain of salt, since your side was consistent with my priors). Particularly notable for me was Boushey's failure to respond in any way to your discussion of the Gottschalk/Danziger study, which dealt more directly with the issue than any of the data she offered.

One minor addition I wish I could make: In your last entry, you write, "In America, the level of inequality is the result of differences in skills . . . and a thousand other factors caused by each of us going about our lives as workers, managers, family members and consumers." I would add "and investors" to that list.

If social unrest increases with relative inequality as she alledges, then how has the crime rate fallen with every burst of recent economic growth?

Do people steal bread when their relative economic status declines?