Cafe Hayek

Wrong

Over at Freakonomics (HT: Planet Money), Justin Wolfers cites this graph as proof that the rich have gotten most of the income gains in the last 35 years:

 

This alas, is a meaningless chart. It tells you nothing about who got the gains of the last 35 years. Why? Because they're not the same people in the quintiles. Starting in 1973, and it's not a coincidence, the divorce rate in the United States began to rise. The number of families increased dramatically simply because of divorce. There was also an increase in the number of families headed by single women with children. The quintile breaks-points changed, not because the economy was growing or shrinking but simply because of changes in the types of families.

The chart is highly misleading. It implies that poor people have done poorly while rich people have thrived. Rich people have thrived. But so have poor people. If you look at longitudinal studies of the same people (the Michigan PSID for example) you get a totally different picture than this one. And that's because this one is designed to fulfill a political agenda. It's a beautiful example of how facts by themselves are not meaningful. There is nothing dishonest about the chart, just its interpretation.

I invite my students from last semester to remember what else we came up with when talking about a graph just like this one.

In the comments to Wolfers post, nosybear writes:

Shows what we know - some time in the last three decades we as a nation decided the rich should get richer, the poor, well, not so much. Education alone doesn’t account for it. Taxation does. We’ve apparently decided generational wealth is a good thing and oligarchies should run the country.

But this isn't true. There is no "we." This isn't explained by taxation. How would that work? The left is angry about measured inequality but they can't point to the mechanism that leads to all the poor people being held down. Especially when we know that educational attainment is growing in America and education does lead to higher income.

I'm suggesting that there is no explanation because there is nothing to be explained. the phenomenon that the rich "have gotten almost all of the gains" is a statistical artifact.

There have been changes in the distribution of income, the amount of inequality, and the returns to education since 1973. This chart distorts what really happened.

Why Greater Differences in Incomes?

Brink Lindsey's explanation for rising differences in incomes is very different from Paul Krugman's explanation.  (I rank this Lindsey essay as a must-read.)

Can You Spot the Billionaire?

Nora ______ e-mailed me earlier today; she was terse: "How do you sleep at night justifying policys [sic] that make incomes more unequal???"

My first response is to say "grow up."  As long as Mr. Smith earns his income rather than steals it, Mr. Jones ought not care.  Envy is an ugly sentiment, and becomes ghastly and dangerous whenever it is manifested in government policies.

But my more measured response is here.

On Inequality

I applaud these two letters-to-the-editor appearing in today's Wall Street Journal:

In regard to the appearance of French economists Thomas Piketty and Emmanuel Saez in President Barack Obama's budget ("The Obama Rosetta Stone," by Daniel Henninger, Wonder Land, March 12): In their use of statistics of the top 1% of income earners, Messrs. Piketty and Saez make the same false assumptions that the Internal Revenue Service does. In 1980 income disparity began to take off in the U.S. leaving the top 1% of income earners with a greater share of the income pie. Like the IRS, these French economists use "household" income as their measure.

But consider that 1980 was about the time when large percentages of college-educated women began to enter the workforce. Many of these professional women would go on to marry other professionals. This in effect created a doubling of "household" income for many families.

At the same time out-of-wedlock birth rates and divorce began to skyrocket creating large percentages of single-parent households. It should be no surprise that a two income household has a much higher income than a single-income household even if all workers make exactly the same income.

Surgeons will always make more than janitors, as anyone who has ever gone "under the knife" will agree with, and their income should not be distorted because they are married to a fellow surgeon.

My working wife and I often find ourselves in this 1% bracket, but if we were to divorce we would never come close. It's ironic that the left decries the income disparity between men and women, but in the instance when women earn equal pay it is used to inflame class warfare.

Steve Walde
Easton, Conn.

President Obama's new era of responsibility budget makes it clear that 5% of the population (the rich) must assume more financial responsibility for the other 95%. Fair enough, but is there some new responsibility that the other 95% also must assume? If not, that seems somewhat irresponsible.

Efforts to countermand the laws of nature to create a completely fair society mean forcing equality of outcomes, an end result that isn't fair, healthy or sustainable. History tells us that this type of class warfare never has a happy ending.

R.D. Shipley
Stamford, Conn.

Real wage inequality

About half of the return to a college education over and above that of a high school education, is eaten up by higher costs of living—college grads tend to live in high wage but high cost urban areas. So says this working paper by Enrico Moretti (HT: Peter St. Onge). He recognizes that the higher costs of living are partly because of higher amenities in urban areas. Clever insight. Might be important.

Who Pitches In?

Here's a letter that I sent recently to the Washington Post:

Dear Editor:

Supporting Pres. Obama's efforts to "redistribute" incomes, E.J. Dionne quotes an administration official: "'Over the past two or three decades, the top 1 percent of Americans have experienced a dramatic increase from 10 percent to more than 20 percent in the share of national income that's accruing to them,' said Peter Orszag, Obama's budget director.  Now, he said, was their time 'to pitch in a bit more'" ("The Re-Redistributor," March 2).

This "Progressive" mindset poisons sound thinking.

First, in market economies incomes aren't "distributed"; they're produced and earned.  Second, persons whose earnings rise disproportionately more than those of other persons generally achieve this outcome by increasing their production disproportionately more than other persons increase theirs; the fact that someone's income rises means that he or she already is pitching in more.  Third, the share of federal individual income-tax revenues paid by America's top one-percent of income earners has recently been on the rise.  In 2006 (the latest year for which data are available) this tiny group of Americans paid a whopping - and all-time high - 39.9 percent of such taxes.

Sincerely,
Donald J. Boudreaux

Pietro Poggi-Corradini on Inequality

My and Russ's friend Pietro Poggi-Corradini, a mathematician with a deep appreciation of Hayek, sent the following e-mail to us a few weeks ago:

Research on inequality usually keeps track of percentiles. So let's look at the following simple example. A society at the beginning consists of 10 individuals, 9 of which make 1 dollar and 1 who makes 10 dollars. Social scientists decide to keep track of the top 20%. So the top 20% makes an average of 5.5 dollars while the bottom 80% makes an average of 1 dollar. Now suppose that after 1 year there are now 8 people making 1 dollar and 2 people making 10 dollars. The top 20% now makes an average of 10 dollars. Dividing 4.5 by 5.5 this represents an 82% increase for the top quintile. The bottom 80%  on the other hand sees a 0% increase in income. One would like to conclude that "inequality has risen".  But  if you were given a choice to live in a society like the earlier one with 9 people making the same income of 1 dollar and one very rich person making 10 dollars, or live in the latter society where less people make 1 dollar and more people make 10 dollar, what would you choose? A simple calculus of probability tells me that the latter society might be more appealing to most people.

My Argument for Redistribution

Here's a letter that I recently sent to the Boston Globe:

William Joseph Leach is correct: arguments for income "redistribution" typically rest on nothing more firm than highly subjective assessments by Jones of what Smith "needs" or "doesn't need" (Letters, October 5).

If such assessments truly justify "redistribution," why start with monetary wealth?  Far better first to redistribute political power. Such power - unlike wealth in market economies - is extracted from voters who have little incentive or ability to wisely assess what they receive in return for their votes.  I believe that neither John McCain nor Barack Obama needs the power that one of them will soon acquire. The same is true of Members of Congress, high-level bureaucrats, and governors: they neither need nor deserve the power they possess.

Let's redistribute this power widely and more equally, to the masses, so that America is rid of unconscionable and socially destabilizing concentrations of power.

Sincerely,
Donald J. Boudreaux

Bernstein on inequality

The latest episode of EconTalk is a conversation with William Bernstein on inequality. It's more of a debate than a conversation. Hope you like it. And check out the links. They include some of the sources Bernstein references as well as some responses to those sources.

The Concentration of Economic Power

The world is full of people who worry about the "concentration of wealth" allegedly caused by free markets.  Some of this worry is simply envy masked as a more socially acceptable sentiment.  Mature and economically literate people do not envy the success of others; instead, they applaud it and understand that a successful producer's wealth is created rather than being extracted from the hides of the less-financially successful.

Some of this worry, though, is genuine and sincere -- if still, in my judgment, unwarranted.

Regardless of one's reasons for wringing one's hands about the 'inequality' of wealth, it's important to keep in mind that financial wealth is not the only source or form of 'inequality.'  Each Member of Congress arguably has more financial influence than does Bill Gates or other tycoons acting in the market.

This wonderful post, over at Division of Labour, by Bob Lawson explains.  Here's a teaser:

Let's explore this point a bit by comparing the concentration of financial power in the hands of the 535 members of the United States Congress with the concentration of financial power of the 535 richest people in the United States.

According to Forbes, the 400 richest people had a combined net worth of $1.57 trillion. Let's simply assume the next 135 richest people had the same net worth, though they surely didn't, as the 400th person--$1.3 billion each. That brings our estimate of the combined net wealth of the richest 535 Americans to $1.75 trillion.

But wait, this is net worth, which is a stock, not income, which is a flow. So let's figure the annual income flow from the ownership of $1.75 trillion to be 10% of that amount. (I don't know if this number is high or low. On the one hand really rich folks probably are good at making high rates of return. On the other hand much of that $1.75 in net worth is likely to be speculative, consumptive, and/or illiquid assets like real estate, yachts, artwork, etc where the return is difficult to determine without selling the item. It turns out, you could double or triple this estimated return and still make the point I'm going to make.) Our estimate therefore is that the richest 535 Americans have about $175 billion (10% of $1.75 trillion) to spend on an annual basis.

Ok, let's compare this group with the 535 members of the US Congress.  According to the latest Economic Report of the President, the annual outlays of the federal government amounted to $2.73 trillion in fiscal year 2007.

So I estimate that the 535 members of the US Congress enjoy over 15 times the financial power of the 535 richest Americans.

Measuring inequality (with contest results)

In this earlier post, I challenged readers to challenge this chart:

I asked you to:

Write ONE sentence explaining ONE thing that is wrong with concluding that these numbers are evidence that the US economy has become more tilted toward the rich at the expense of the poor.

There were 206 responses before I cut off the comments.

It's a pretty stark and dramatic picture. On the surface, it seems to indicate that the only people who got ahead in America over the last 30 years are the richest of the rich, the top 1%. The bottom 90% saw essentially no improvement. And this was mostly  during a time when the economy was  booming. The goal, I believe, of the people who draw such charts, is to destroy the argument that a rising tide lifts all boats. And the chart seems to show that.

So what is wrong with concluding from the chart that the economy is broken or at least hopelessly tilted toward the rich?

The most important argument made was that there are compositional changes that might account for the depressingly small improvement for the bulk of the population:

IRONMAN said it very simply: The composition of U.S. households has changed from 1946 through 1976 and through 2006.

A number of you speculated on what the changes might have been. ROSS wrote: There is inconsistency in the data because these numbers are for households and not individuals and will be affected by changes in the marriage and divorce rate.

ESOX LUCIOUS wrote: Immigration heavily skews the data for the poor to become poorer because quite a few of the immigrants arrive in a state of poverty.

MESA ECONOGUY was definitely on the right track: The comparison of household income is fake, because the number of households has increased at a much faster rate than the number of people (due mostly to divorce), creating artificially plummeting incomes per household, but nearly constant income per person.

These points are correct. Of course, they don't refute the implicit claim of the chart. But they do make you wonder.

In support of the importance of the argument, between 1976 and 2006, the population in the US rose from 218 million to 300 million, an increase of 38%. But in the Piketty and Saez data, the data used to create the chart, the number of taxpaying units, which is actually their estimate of the number of households, rose 63%. So there has been an enormous increase in smaller households. The main factor, presumably, is an increase in the divorce rate over the period.

Even if single women earned the same amount as their husbands (and my guess is that they did not), an increase in the divorce rate would depress any growth in average household income.

Here's a simple illustration of this distorting effect, taken from page 20 of my visual essay, Half Full,:

Every individual's income doubles, but at the same time, half of the households divorce. Even though everyone's income has doubled, the growth in household income is only 33%, rather than 100%. Median household income is unchanged, even though the median individual has seen 100% growth in income.

In creating this example, I was interested in the distortions caused by  looking at quintiles rather than the top 1% or bottom 90%. But let's look at what has happened to the bottom 80% in this example. The average income of the bottom 80% of households in the first situation is 100%. After divorce and a doubling of everyone's income, the average income of the bottom 80%  has increased by only 17%. (There are 12 households in the bottom 80% and their total income is $1400. So average is $117.)

How important is this effect? I don't know. But as I point out in Half Full, there is evidence that most Americans are doing much better than they were in the 1970s.

There were many other good points made in the comments that are relevant. I liked PATRICK's observation: The chart shows that the incomes of the top 1% have increased at a higher rate than those of the bottom 90% of households, any argument as to the "cause" of this discrepancy can not be inferred from the numbers alone and must be considered speculation or guess-work.

Sensible points about the fishiness of the choice of starting date and breakpoint of 1976 were made by UNIT, LOWCOUNTRYJOE, BRET, and KIRZNER FERVOR.

Thanks to everyone who participated in the contest.

What's Fair?

I'm struggling to get the best comments from the recent contest up in a new post. Shooting for Monday. Sorry for the delay. Meanwhile, check out this very interesting set of pictures from Macroblog that our contest inspired.

Government Brings Out the (Undisciplined) Kid in Us

Here's a letter that I sent today to the Boston Globe:

Derrick Jackson wants government to reduce income differences among Americans ("Politely declining to touch the income gap," August 19).  Forget that even poor Americans today generally have greater access to goods and services than did middle-income Americans of a generation ago.  Instead ask: what kind of philosophy demands that government adopt and act on values that all decent parents teach their children to reject?

Who among us sends our children to school or to the playground with admonitions to begrudge classmates or playmates possessing nicer clothing or fancier toys?  Who among us counsels our youngsters to form schoolyard coalitions for forcibly confiscating expensive sneakers and video games from 'rich' kids for "redistribution" to poorer kids?  Who among us would not scold our children for such envy, and punish them severely if they participated in such thievery?

Children should avoid envy and learn to thrive by producing rather than by taking.  The same is true for adults.

Sincerely,
Donald J. Boudreaux

China, Wal-Mart, and Inequality

Here's a letter that I sent recently to the Washington Post.

E.J. Dionne uncritically quotes Rep. Barney Frank's assertion that freer trade makes incomes more unequal: "Free trade has increased wealth, but it's been monopolized by a very small number of people" ("Capitalism's Reality Check," July 11).  Rep. Frank and Mr. Dionne ought to study recent research by the University of Chicago's Christian Broda and John Romalis.  These scholars find that official measures of income distribution - which do show increasing inequality in recent years - greatly overstate inequality because they fail to account for the differential impacts of trade and big-box retailing on the purchasing power of the poor relative to that of the rich.

Data from 1994 through 2005 show that trade with China along with the retailing efficiencies of Wal-Mart have lowered the prices of the goods that poor people buy much more than they've lowered the prices of the goods that rich people buy.  The result is that, as Prof. Broda reports on his blog, "real inequality in America, if you measure it correctly, has been roughly unchanged."

Sincerely,
Donald J. Boudreaux

A link to this paper by Broda and Romalis can be found here.

Redistributing Grades

My and Russ's friend, the mathematician Pietro Poggi-Corradini, has this sensible proposal for "redistributing" students' grades -- sensible, that is, for people who believe that incomes earned in markets should be "redistributed" by the state.

Egalitarian?

Dew-Becker and Gordon write (HT: Arnold Kling):

Only the top 10% of US earners have seen their incomes grow faster than productivity since 1966. Part of the top-earner income growth is driven by market forces (superstar economics); the only feasible pro-equality policy here is more progressive taxation.

Two questions:

1. What does "the" top 10% mean over a forty year period when there are huge changes in family structure and immigration? I will try and read the paper but "the" top 10% is an awfully slippery concept. The statement certainly doesn't mean what it sounds like.

2. Why would more progressive taxation lead to more equality? Increasing the progressivity of the tax code would increase pre-tax measured inequality. Does anyone have a model or an estimate of the impact on post-tax and post-transfer inequality. My guess is that it would be modest at best.

The only decent (and I mean that in more than one sense) policy to reduce inequality is a policy that improves the school experience of the least-skilled children. 

Families and percentiles

As I have written here before, looking at slices of the population over time is a very misleading indicator of what happens to particular families over time, particularly when family composition is changing. Arnold Kling makes the same point and does it superbly:

In his new book Unequal Democracy, Larry Bartels writes (p.7),

families at the 20th percentile experienced declining real incomes in 20 of the 58 years...by comparison, families at the 95th percentile have experienced only one decline of 3% or more in their real incomes since 1951.

I have a nit to pick, which is that Census department percentiles are not families. 

Suppose that we start out with 20 families, and the 4th-lowest family (the 20th percentile) has an income of $10,000, while the 3rd family has an income of $9500. Next year, suppose that everyone's family income rises by 2 percent, but we add a new family at the bottom of the income distribution, with an income of $6000. As a result, the new 20th percentile is now somewhere between the income of the original 3rd family (now the 4th family out of 21) and the original 4th family (now the 5th family). The income of the 20th percentile goes down, even though the income of every family has gone up.

Next, consider what happens when you have millions of families, and you add lots of new families each year. Because new families (immigrants and young families) tend to join the income escalator at the bottom, it should be no surprise that the bottom percentile shows declines more frequently than the top percentile.

I do not want to succumb to disconfirmation bias, which is the tendency to find one thing wrong with something you disagree with and then dismiss the whole idea. But I have a hard time buying into stories about income inequality that look at the behavior of census percentiles over time. At the very least, the author ought to be clear that movements in census percentiles are not the same as movements in families. Bartels is the opposite of clear on that point.

Another issue that people raise with Census data is that the basic unit is the household. If a household breaks into two households, due to divorce, average household income plunges by 50 percent, even though nobody's income has changed. Trends in household income tend to look worse than trends in income per person.

Arnold has it exactly right. To get an idea of the magnitudes, here are some numbers:

Here's what has happened to the number of households in the US:

2000   105 million
1990   93 million
1980   81 million
1970   63 million
1960   53 million

So between 1960 and 2000, the number of households has doubled. What happened to population over that same period?  Again from the Census:

2000   282 million
1990   250 million
1980   228 million
1970   205 million
1960   181 million

The average American household has gotten a lot smaller:

2000   2.7
1990   2.7
1980   2.8
1970   3.2
1960   3.4

Why did this happen?  The obvious answer is that people are having fewer children.  That would lower average household size.  But that is not much of the story.  The real story is a change in the composition of families due to an explosion in divorce in the 60s and 70s.  Here's a breakdown of the proportion of total families headed by women:

Year     Single Mothers   Single Woman w/o kids      Total

2000      12.1%                     17.2%                            29.3%
1990      11.7%                     16.8%                            28.5%
1980      10.8%                     15.4%                            26.2%
1970        8.7%                     12.4%                            21.1%
1960        8.4%                       9.8%                            18.2%

So over the last half-century, the number of households has increased at a much faster rate than the number of people, mainly because of divorce. That totally contaminates the comparison of percentiles over time and makes it appear that people are falling behind or standing still when in, fact, particular families are seeing their standard of living rise. Arnold calls a nitpick. I call it a massive structural flaw.

American Consumption

Mike Cox and Richard Alm have an excellent op-ed in today's New York Times.  It exposes as (at best) facile the view -- expressed just yesterday by the Gray Lady's columnist Bob Herbert -- that "[t]he middle class is hardly flourishing" -- that America's middle-class is disappearing and needs to be "resuscitated."

Here are some key paragraphs:

Income statistics, however, don’t tell the whole story of Americans’ living standards. Looking at a far more direct measure of American families’ economic status — household consumption — indicates that the gap between rich and poor is far less than most assume, and that the abstract, income-based way in which we measure the so-called poverty rate no longer applies to our society.

The top fifth of American households earned an average of $149,963 a year in 2006. As shown in the first accompanying chart, they spent $69,863 on food, clothing, shelter, utilities, transportation, health care and other categories of consumption. The rest of their income went largely to taxes and savings.

The bottom fifth earned just $9,974, but spent nearly twice that — an average of $18,153 a year. How is that possible? A look at the far right-hand column of the consumption chart, labeled “financial flows,” shows why: those lower-income families have access to various sources of spending money that doesn’t fall under taxable income. These sources include portions of sales of property like homes and cars and securities that are not subject to capital gains taxes, insurance policies redeemed, or the drawing down of bank accounts. While some of these families are mired in poverty, many (the exact proportion is unclear) are headed by retirees and those temporarily between jobs, and thus their low income total doesn’t accurately reflect their long-term financial status.

So, bearing this in mind, if we compare the incomes of the top and bottom fifths, we see a ratio of 15 to 1. If we turn to consumption, the gap declines to around 4 to 1. A similar narrowing takes place throughout all levels of income distribution. The middle 20 percent of families had incomes more than four times the bottom fifth. Yet their edge in consumption fell to about 2 to 1.

Let’s take the adjustments one step further. Richer households are larger — an average of 3.1 people in the top fifth, compared with 2.5 people in the middle fifth and 1.7 in the bottom fifth. If we look at consumption per person, the difference between the richest and poorest households falls to just 2.1 to 1. The average person in the middle fifth consumes just 29 percent more than someone living in a bottom-fifth household.

Economic Mobility is Real

Wilson Mixon, from Division of Labour, sent me this graph -- which Wilson got from the Wall Street Journal --  summarizing IRS data on economic mobility that Thomas Sowell mentions here.

Different Data

Here's a letter that I sent today to the New York Times:

Paul Krugman continues his drumbeat message that ordinary Americans are stagnating economically ("Winter of Our Discontent," November 26).  But data that he frequently cites to support his claim (especially from economists Thomas Piketty and Emmanuel Saez) are not of real flesh-and-blood persons through time; they are of statistical categories such as deciles or quintiles of income earners. Changing demographics and movements of persons from quintile to quintile mask potentially huge changes in the underlying reality.

Sure enough, recent data from the IRS that are of real-life persons reveal that ordinary Americans are prospering.  Economist Thomas Sowell summarizes some germane revelations of these data: "People in the bottom fifth of income-tax filers in 1996 saw their incomes rise 91 percent by 2005. The top 1 percent ... saw their incomes decline a whopping 26 percent.  Meanwhile, the average taxpayers' real income rose 24 percent between 1996 and 2005."

Sincerely,
Donald J. Boudreaux

A caveat: I briefly looked for these IRS data on line and couldn't find them (a fact, I'm certain, due to my being pressed today for time).  Sowell doesn't say if these data are adjusted for inflation or not.  My guess is that they are so adjusted.  But even if the reported percentage changes are in nominal dollars, then (1) the growth by 2005 in the real incomes of 1996's bottom fifth of income-tax filers would still be an impressively large 73 percent, and (2) the fall by 2005 in the incomes of 1996's top one percent of income-tax filers would be even larger than what the nominal figures (if nominal they be) suggest.

UPDATE: Tom Armstrong sent to me the pdf containing the IRS data.

How Visible Are Differences in Incomes?

Here's a letter that I sent a few days ago to the Wall Street Journal:

Your readers identify genuine flaws in Arthur Brooks's argument that inequality of incomes in America is counteracted by near-equality of "happiness" (Letters, November 1).  The unhappy fact is that "happiness research" is a smorgasbord of foolishness.

Nevertheless, measures of inequality of incomes do indeed vastly overstate the inequality of material living standards.  Nearly all Americans enjoy easy access to the likes of microwave ovens, cell phones, the Internet, and MP3 players, as well as, of course, to food, clothing, and shelter.  So the differences separating the super-rich from ordinary folks are increasingly abstract and invisible.  I'm told that, say, David Koch has billions more dollars in his bank account than I have in mine, but I never see his bank statements.  The fact is, Mr. Koch is no better fed, clothed, or coiffed than I am.  And when he walks down the street, Mr. Koch's immense wealth does little to distinguish him from the many middle-class Americans who walk past him - all unaware that his portfolio is unusually hefty.

Sincerely,
Donald J. Boudreaux

A Note on Income Data

This letter appearing in today's edition of the Wall Street Journal makes a good point:

Mr. [Alan] Reynolds [in an October 25 WSJ article] uses the term "individual" income several times when explaining the top 1% of income earners, and therein lies his problem. If only the IRS taxed me and my working wife based on our "individual" income we would save several thousands of dollars per year. The problem is that both taxes and the statistics are based on "household" income, which is really a euphemism for "marriage" income. If the statistics were based purely on "individual" income, I'm sure the wage disparity would not be that much worse today as when Ward and June Cleaver were raising the Beaver.

What's happened is that women entered the workforce and in the past few decades educated women have had their incomes match or even exceed that of men. Educated and upper income people have a tendency to marry one another. And because lower-income people are less likely to be married than upper-income individuals, the statistics are skewed even more. To have an honest discussion on this subject you first have to start out with honest statistics.

Steve Walde
Easton, Conn.

Mario Rizzo on Income Differences

One of my former professors at NYU, Mario Rizzo, has this outstanding letter published in The Financial Times:

Why should we care about sharing out prosperity?

By Mario J Rizzo

Published: June 28 2007 03:00 | Last updated: June 28 2007 03:00

From Prof Mario J. Rizzo.

Sir, Lawrence Summers' article "Harness market forces to share prosperity" (June 25), on reducing income inequality, leaves several critical questions unanswered.

First, why should we care that income inequality is increasing? Was the previous distribution of income more just, simply because it was more nearly equal? Second, neither Professor Summers nor anyone else has a comprehensive understanding of the causes of recent trends in income distribution. In general, it is a bad idea to look for solutions to a "problem" whose causes we do not understand. Third, the whole idea of "sharing prosperity" seems to imply that prosperity is some kind of aggregate to which we all have some claim, much like members of a family. What justifies looking at society as a family? If it is, Prof Summers can just send me a monthly cheque without the need for legislation.

Finally, Prof Summers uses a shameful rhetorical trick. By suggesting a "solution" that steers a middle ground between excessive regulation and doing nothing (as if we do not redistribute income now), he appears to be very reasonable. Perhaps it is even more reasonable, however, to think through the rhetoric of increased redistribution before inventing new policies.

Mario J. Rizzo,

Department of Economics,
New York University,
New York, NY 10012, US

Find the error

Robert Frank wants higher taxes on the rich to finance universal health care coverage. His argument:

Providing universal coverage will be expensive. With the median wage, adjusted for inflation, lower now than in 1980, most middle-class families cannot afford additional taxes. In contrast, the top tenth of 1 percent of earners today make about four times as much as in 1980, while those higher up have enjoyed even larger gains. Chief executives of large American companies, for example, earn more than 10 times what they did in 1980. In short, top earners are where the money is. Universal health coverage cannot happen unless they pay higher taxes.

Can you find the logical error in the second sentence of that paragraph? It's subtle, but readers of Cafe Hayek should be able to find it. The error can be summarized in five words.

Frank goes on to argue that higher tax rates will not have significant incentive effects:

The surface plausibility of trickle-down theory owes much to the fact that it appears to follow from the time-honored belief that people respond to incentives. Because higher taxes on top earners reduce the reward for effort, it seems reasonable that they would induce people to work less, as trickle-down theorists claim. As every economics textbook makes clear, however, a decline in after-tax wages also exerts a second, opposing effect. By making people feel poorer, it provides them with an incentive to recoup their income loss by working harder than before. Economic theory says nothing about which of these offsetting effects may dominate.

If economic theory is unkind to trickle-down proponents, the lessons of experience are downright brutal. If lower real wages induce people to work shorter hours, then the opposite should be true when real wages increase. According to trickle-down theory, then, the cumulative effect of the last century’s sharp rise in real wages should have been a significant increase in hours worked. In fact, however, the workweek is much shorter now than in 1900.

Trickle-down theory also predicts shorter workweeks in countries with lower real after-tax pay rates. Yet here, too, the numbers tell a different story. For example, even though chief executives in Japan earn less than one-fifth what their American counterparts do and face substantially higher marginal tax rates, Japanese executives do not log shorter hours.

He's right that income and substitution effects work in different directions. He's also right that the work week has been getting dramatically shorter over the last century as people have decided to enjoy more leisure. But it's not clear that higher tax rates today will have no effect. His Japanese example is rather thin. Edward Prescott takes a more thorough look and comes to a different conclusion.

There is also a big difference between taxing a lawyer or doctor and taxing the owner of a small business. The biggest effect of dramatically higher tax rates would be to discourage risk-taking and the creation of new ventures.

UPDATE: Mankiw on Frank

The Income Race

Paul Krugman foresees an increasing left-leaning electorate. The cause?

The main force driving this shift to the left is probably rising income inequality. According to Pew, there has recently been a sharp increase in the percentage of Americans who agree with the statement that “the rich get richer while the poor get poorer.”

Could be. Could be that there really is a "sharp" increase in that percentage. But should there be, Paul? Should Americans agree with that statement? Is it true? Do the rich get richer and the poor get poorer? I know it sounds catchy, but is it true? I don't think Paul Krugman believes the statement is true that for a minute. I think he knows that the data that support that claim are unreliable. But he ignores the issue of whether it's true and goes on:

Interestingly, the big increase in disgruntlement over rising inequality has come among the relatively well off — those making more than $75,000 a year.

The implication is that even the relatively comfy, those making $75,000 a year or more, have come to believe that the system is rigged against them. But again, is it true or just something people believe after hearing it so many times? Whether you are rich or poor, no matter how much they make, there's no way you can have any feel for what's really going on in the income distribution. Opinion polls on inequality tell you what's going on in the media as opposed to what's going on in the real world.

Indeed, even the relatively well off have good reason to feel left behind in today’s economy, because the big income gains have been going to a tiny, super-rich minority.

Ah, a fact. Or at least an alleged fact. Krugman thinks those over $75,000 people are onto something. Maybe not that the rich are getting richer and the poor are getting poorer but something close enough, "the big income gains have been going to a tiny super-rich minority."

Enough hyperbole for you? I guess he could have written "the enormous, gigantic, income gains have been going to a teeny tiny miniscule super-duper rich minority."

On the face of it, it's a ludicrous statement. Of course, the "big" gains can't go to everyone. They have to go to a minority rather than a majority. If they went to a majority they wouldn't be the big gains, they'd be the typical gains.

And as I have written before, the evidence for this more modest claim is grossly misleading.

But the implication is that if I'm doing fine, even if my income is growing, I get resentful if I see that the income of others is growing a lot faster than mine. Do you feel that way? When you read about CEO's making a killing or Alex Rodriquez or Oprah or Jennifer Hudson making a ton of money, do you get angry and resentful?

Recently, LeBron James's 35,000 square foot house was in the news:

LeBron James' 35,440-square-foot house under construction in nearby Bath Township is shaping up as a castle fit for a king -- with a theater, bowling alley, casino and barber shop.

.....

A first-floor master suite, which includes a two-story walk-in closet, will be about 40 feet wide and 56 feet long -- bigger than half the houses in Bath Township.

The house has a dining hall, roughly 27 feet by 27 feet, a "great room" at 34 feet by 37 feet and a bigger, two-story "grand room," according to the Akron Beacon Journal, which reported on the blueprints.

The "family foyer" off the six-car garage near the elevator will be dwarfed by a "grand foyer" inside the front entrance with a sweeping, divided staircase leading to four second-story bedrooms. An outer wall will feature a limestone sculpture -- a bas-relief of LeBron's head, wearing his trademark headband.

Why is this a news story? Because people find it interesting. Do they resent it? Do you resent it? Do you resent that LeBron James whose only skill in life involves a basketball has received an enormous increase in income. He didn't start off rich. He's a perfect example of what's wrong with the standard analysis of the gains going to the super-rich. LeBron's salary catapulted him into the category of super-rich. He wasn't rich to start with. His income gains help create the super-rich category.

Do you resent it? Do you resent the fact that he can entertain millions with his skills?

LeBron James is doing much better financially than say, Julius Erving did when he played or even more dramatically, Bob Cousy, because James has had the good fortune to come of age at a time when America is much wealthier and the demand for basketball talent has skyrocketed while the supply has only increased modestly. True, he does what he does very well. But had he been born 30 years ago or 50 years ago, he'd make much less money. Does that push you to the left? Should it?

Ironically, the wealth of James and his extravagant house are generally a benefit rather than a cost for most Americans. Most Americans love the idea of extravagance. They don't get upset about James's house. They want to gawk at it. They want to see it featured in Architectural Digest or on television. If anything, James's wealth provides even more entertainment, not the resentment that Krugman thinks is the source of our political views.

The company I keep

Which of these is not like the other?

Here I am in the LA Times on inequality alongside Peter Singer (Princeton philosopher) and Sam Webb (head of the Communist Party). My take is different from their's.

Globalization and Income Inequality

Another investigation -- this one by Fernando Borraz and Jose Ernesto Lopez-Cordova -- of some of the economic consequences of freer trade finds that freer trade has not increased income inequality in Mexico:

Our findings strongly indicate that globalization has not raised income inequality in Mexico. On the contrary, we present compelling evidence showing that income distribution is more equitable in states that are more closely linked to the world economy and that those states exhibit larger declines in inequality. We also find some statistical evidence suggesting that deepening globalization results in reduced inequality, although our results are sketchier on this point, perhaps because such effect is only observable in the long run. As a potential explanation of why globalization might improve the distribution of income among Mexican households, we show that states that are more integrated to the world economy offer better work opportunities for low-skilled women relative to more educated female workers.

Liberty, Income Equality, and Tyranny

Having retrieved from my bookshelves my copy of Richard Pipes's Property and Freedom (for use in this post), I was perusing it just before returning it to its special place when I found this other insight, on pages 283-284, worthy of attention.  (This book is loaded with insights.  Picking out just one or two does the volume poor justice.)

The main threat to freedom today comes not from tyranny but from equality -- equality defined as identity of reward.  Related to it is the quest for security.

Liberty is by its nature inegalitarian, because living creatures differ in strength, intelligence, ambition, courage, perseverance, and all else that makes for success....  As Walter Bagehot observed over a century ago, "there is no method by which men can be both free and equal."

Ironically, the enforcement of equality destroys not only liberty but equality as well, for as the experience of communism has demonstrated, those charged with ensuring social equality claim for themselves priviliges that elevate them high above the common herd.  It also results in pervasive corruption, inasmuch as the elite which monopolizes goods and services, as must be done if they are to be equitably distributed, expects, in return for distributing them, rewards for itself.... In the contest between equality and liberty, the former holds the stronger hand, because the loss of liberty is felt only when it occurs, whereas the pain of inequality rankles every moment of the day.

A Note on Household Income and Women Entering the Workforce

Last May, Andrew Hacker wrote a thoughtful essay on income inequality for the New York Review of Books.  I wrote the following letter in response:

Dear Editor:

In his generally admirable essay on income inequality, Andrew Hacker discounts the significance of the 23 percent rise in median family incomes between 1982 and 2004 by saying that "this growth was almost entirely the result of the presence of additional earners, with more wives turning to full-time work" ("The Rich and Everyone Else, May 25, 2006).

True. But to the extent that women were released from housework by the greater availability of electrical appliances and better prepared foods, these gains in median household earnings represent real improvements for ordinary Americans. After all, housework - although uncompensated - has genuine and considerable value. Because much of the housework that in the past was done by "non-working" women is now done by appliances, supermarkets, and the like, the typical American household today still receives the value of housework plus the additional income women earn by working outside of the home.

I might also have added that the rate at which women entered the workforce was pretty much the same from 1982 on as it was for much of the 20th century.  For evidence, see the report mentioned here.

Patience is a virtue

Patience is a virtue, but it leads to income inequality. Even in the Amazonian rain forest. Interesting research reported in the Economist. (HT: Josh Hill)

Cowen, Gates, Boudreaux, and Regressive Taxation

Each of Tyler Cowen's New York Times columns is worth a careful read.  But today's column is one of his best (in my opinion).  He covers a lot of ground on the income-inequality debate, and covers it skillfully.

Here are his concluding paragraphs:

The broader philosophical question is why we should worry about inequality — of any kind — much at all. Life is not a race against fellow human beings, and we should discourage people from treating it as such. Many of the rich have made the mistake of viewing their lives as a game of relative status. So why should economists promote this same zero-sum worldview? Yes, there are corporate scandals, but it remains the case that most American wealth today is produced rather than taken from other people.

What matters most is how well people are doing in absolute terms. We should continue to improve opportunities for lower-income people, but inequality as a major and chronic American problem has been overstated.

.....

Earlier in this same column, Tyler notes that

Happiness, possibly the most relevant variable for a study of inequality, is also the hardest to measure. Nonetheless, inequality of happiness is usually less marked than inequality of income, at least in wealthy societies. A man earning $500,000 a year is not usually 10 times as happy as a man earning $50,000 a year. The $50,000 earner still enjoys most of the conveniences of the modern world. Even if more money makes people happier, it appears to do so at a declining rate, which places a natural check on the inequality of happiness.

Although I share Arnold Kling's skepticism of "happiness studies," the general point of the above reported finding is compelling.  Indeed, that same point is the one that has long led many people to argue for "progressive" income taxation.  It's the idea that an extra dollar of income to someone earning $500,000 annually is "worth less" to that high-income earner than is an extra dollar of income earned by someone earning $50,000 annually.

It's never been clear to me, though, why this fact (if it be a fact -- as I suspect it, generally, to be) -- was ever taken to support so unambiguously a case for "progressive" taxation of incomes.  First is the point Tyler makes: if an extra dollar of income in Bill Gates's pocket means less to Bill Gates than would mean to me, then the genuine economic difference between Gates's position and my position is less than it appears if monetary incomes or wealth is taken to be a precise and full measure of economic well-being.  While "redistributing" this dollar from Gates to Boudreaux might still increase "happiness" equality between Gates and myself, the alleged need for such "redistribution" in the first place is less pressing.

Second, given that Bill Gates almost surely has a greater talent for contributing to the happiness of humankind than I have, it's especially important that he continue to confront keen incentives to continue contributing to that happiness.  Precisely because an extra dollar in Gates's wallet means less to him the more dollars he earns, he needs to earn ever-more dollars per year in order to keep keen his incentives to innovate and produce and sweat the details of satisfying consumer demands.

While I do not support regressive income taxation, a theoretical case can be made in favor of it -- a case that has at least as much cogency and economic merit as does the case for "progressive" taxation of incomes.

The top 1% is a red herring

Ezra Klein is upset about inequality and those of us who try and take a more nuanced approach to the data. Here is his first reaction to my observation that almost everyone born in America after 1920 are among the richest people in human history:

This strikes me as comparable in usefulness to telling a poor person, "well, at least you've got good skin!" Yes, we're better off than we were a hundred years ago. No, that's not a sufficient answer, or even relevant comment, to questions of distribution and justice. If you don't think inequality is a problem or the current distribution of wealth is troubling, that's a position. If you're going to respond to the impoverished or the laid-off by explaining that thing sure were tough in 1912, that's not even an anecdote -- it's an utterly meaningless digression.

Actually the point was to show how arbitrary any claim of injustice really is by examining this slice or that slice of the income distribution. The other point was much more important. I care less about inequality and more about whether people are getting ahead and having better lives.

Klein relents a little bit in this post and admits there might be some legitimacy to my point about the historical record. But then he gives this argument:

The Libertarian choice of pre-1920s America is quite helpful to our case, because that's right about the time inequality in this country peaked and the American economy entered a long and fruitful corrective process.  Here's the Saez-Piketty data showing the income-share held by the top 1 percent:

Indeed, what you see in post-1930s America is an economic system explicitly attempting to reduce income inequality and distribute growth gains more broadly.

This is a beautiful example of how  hard it is to interpret  economic data. First of all, talking about the top 1% makes it sound like the data refer to the American Economic Aristocracy. The haves vs. the rest of us.  But the people in the top 1% in 1929 aren't the same people in the top 1% even in 1935, let alone much later. So this chart isn't about a particular group and how they fare over time.

But the subtler problem with this picture is that it doesn't tell you anything about how the rest of us are doing. It's the share of the top 1%. When they get more in a particular year, it sounds like that means there has to be less for the rest of  us. After all, if you get more of the pie, doesn't that mean less for me? But it doesn't, because it doesn't tell you about how big the pie is. If I get a smaller share of a bigger pie, I can have more to eat.

The opposite is also true. If I get a bigger share of a smaller pie, I can be worse off. It's hard to read Klein's chart, but if you go to Piketty and Saez's numbers (go to Table A3, column 3 for the fraction of income going to the top 1%, including capital gains) you'll see that the share going to the top 1% peaked in 1929 at 23.94%. In 1933, the number was 16.46.

Hurray! The rest of us, the bottom 99% were getting a bigger share in 1933. The economy was more fair! But there was nothing to cheer about. Real GDP per capita (cool tool—don't miss it), fell 29%.

Do you think that was a good time for the average American or a bad time? Do you think the fall in the average was a statistical artifact caused by the right-hand tail of the distribution being lopped off? No. The fall in the share of the top 1% had nothing to do with social justice or redistributive policy or the rise of unions. It had nothing to do with any attempt of any system to explicitly or implicitly do something. It was caused by a lousy economy that hurt the average person and poor people and yes, rich people. The share going to the rich fell because it became really hard to make a lot of money. But it also became really hard to make a little money.

And yes, I know I'm cherry-picking four years to make a point. It doesn't disprove everything people say about income shares. But it shows the danger of using income shares as a measure of well-being. I'll write about the longer trends in the data, soon.

Alan Reynolds has recently critiqued Piketty and Saez and Saez and others have responded. Maybe I'll talk about that in another post. But the biggest flaw isn't in their data. It's how they're used.

Homosexuality and Income Inequality

In this popular YouTube video, comedian Sacha Baron Cohen (aka: Borat) is in his gay fashonista character Bruno; Bruno is interviewing unsuspecting "gay converter" Pastor Quinn.  When Bruno asks the Pastor why homosexuality is wrong -- "So why is being gay so out this season?" -- Pastor Quinn responds: "because there are people who find homosexuality to be repugnant to them."

Bad reason.  Undoubtedly many people do find homosexuality to be "repugnant to them" -- but why should we care about these sentiments?  It's a big world with lots of people.  Inevitably, nearly every human activity, including many peaceful ones, will be repugnant to some people.  Some activities more than others, of course, but so what?  (Personally, it's very unpleasant for me to imagine my parents having sex -- "eewwww!" -- but I don't want to force them to sleep apart; I don't even want them to stop having sex.)

Civilized persons immediately understand that what consenting adults to with each other is no one else's business.  The fact that some people find other people's peaceable activities to be repugnant, upsetting, immoral, unpleasant, odd, or whatever, is utterly irrelevant -- or should be utterly irrelevant.  Person A's attitude about peaceable person B's actions is no justification for public policy aimed at saving person A from whatever disquiet he or she suffers as a result of person B's activities.

Now I have no idea what Pastor Quinn really does.  If all he does is to offer his services to persons who come to him voluntarily, I have no real complaint (although I must say that I find it a tad bit repugnant).

Most self-described "liberals" and "progressives" would agree with all that I write above.  So why do these "liberals" and "progressives" believe that income inequality is worthy of the state's attention?  No doubt, they find income inequality repugnant.  They don't like it and they want to do all that they can to rid society of it -- just as Pastor Quinn doesn't like homosexuality and wants to do all that he can to rid society of it.

One reason might be that some of these "liberals" and "progressives" believe that wealth is a fixed stock; the more that Bill Gates has the less that persons living in New Orleans's Ninth Ward have.  Whether or not this is true is a factual question.  But economics and history teach me that this fixed-stock-of-wealth view is robustly wrong.  In a market-oriented society (which the U.S. still is), the pattern of income "distribution" that emerges is merely the consequence of uncountable numbers of peaceful, consensual capitalist acts (affected, it is true, by tax policy -- which takes more money from high-income earners than from low-income earners).

My sense is that most of the antagonism toward income inequality does not rest on the fixed-stock-of-wealth view.  My sense is that most of this antagonism is surprisingly like the antagonism that Pastor Quinn and his flock have toward homosexuality: they find it repugnant and, therefore, conclude that their own sentiments are sufficient reason to try to solve the alleged problem.

Bad reason.

Mobility

One of the most important on-going debates in America is the question of inequality and mobility. I have argued on this site that many comparisons across time are misleading because they are snapshots of different people and therefore mislead about the ability of people to improve their situation in America.

A new book is out from anthropologist Katherine Newman chronicling the lives of 300 applicants who applied for fast food jobs more than ten years ago in Harlem.

There are many objections to be made about such a study. Most importantly, it is only 300 people. But you learn something from such a study about the range of possibility. Especially when it focuses on the least skilled and least likely to succeed. From the New York Times book review:

In 1993, Katherine S. Newman, then a professor in the anthropology department at Columbia University, began conducting interviews with 300 or so young men and women who had applied for just about the least promising jobs you could think of: flipping burgers and running registers at a fast-food franchise in Harlem. Two hundred of them were paid minimum wage to do mind-numbing work, and they were the lucky ones; the other 100 were turned down for those same ill-paying, mind-numbing jobs. It was, Newman says, a terrible time to be a low-wage worker in the inner city.

The reviewer, Times Magazine editor Paul Tough expected to find a dreary chronicle of failure:

Which is why it comes as such a shock when you read Newman’s histories of people like Adam (a pseudonym, like all the names in the book). The son of a mother on welfare, Adam dropped out of school after 10th grade, and he was turned down for a job at the restaurant. Doomed, right? Well, no: he is now earning $70,000 a year, with full benefits, as a union driver for an express delivery firm. Or Ebony, who was working behind the counter doling out burgers when Newman met her and is now a receptionist for a fancy law firm, studying to get her B.A. in political science at night. Or Jamilla, who quit her job in the kitchen to go on welfare, an unmarried mother raising her children alone, a classic desperate case — until she completed her G.E.D. and worked her way through culinary school. She is now a “stylish professional,” Newman reports, with a well-paying job in a restaurant in Saks Fifth Avenue. Shame? Try awe.

Newman doesn’t claim that these success stories are typical. About a third of the 40 people she tracked down and re-interviewed in 2002 were unemployed or still making the minimum wage. But most had moved up, and almost a quarter were what she calls “high fliers,” making $15.46 an hour or more. Newman’s fractions don’t tell you a whole lot, as she herself admits; she’s an anthropologist, not an economist, and her sample size is too small to prove much of anything. Her book is valuable, though, as a collection of carefully drawn portraits of people who got their start working at the bottom rung of the American economy — in a lousy job, in a lousy neighborhood, at the tail end of a recession — and in many cases managed to escape a situation that seemed inescapable.

There is much that can be done to help low-skilled workers. Giving them the chance to acquire better skills in better schools is the right place to start. But it is good to know that even among the least-skilled Americans, success is possible.

The standard comparisons of average hourly earnings across time do not tell us what is really going on in people's lives. Comparing average wages across time does not capture what is happening to the average or struggling worker.

Zero Sum Economics

The Washington Post reports (HT: Carrie Conko) on Forbes's list of the 400 richest people in America. Turns out they're all billionaires:

It's not news that Bill Gates is the richest person in America, according to Forbes magazine's annual list of the nation's 400 richest people, released yesterday. He has been for 13 years. Barring a second Stone Age in which computers are good only for hurling at other cavemen, Gates will always be rich.

The news is: On this list, $999 million is chump change.

For the first time, all 400 Gotbucks on the Forbes tally are billionaires, from Gates (worth $53 billion) down to the bottom, Los Angeles semiconductor magnate Sehat Sutardja ($1 billion).

So is this good news or bad news?

"It is a really big deal that it's all billionaires," said Forbes associate editor Matthew Miller, who edited the list and led the team that spent a year compiling it. "It shows economic growth and, as this magazine is a fan of capitalism, it shows progress."

The Post found one economist with a different perspective:

"I think it's very bad," said Dean Baker, a macroeconomist at the Center for Economic and Policy Research in Washington. "If the U.S. had experienced really extraordinary growth, then maybe that would be the reason" for all the billionaires. Baker pointed out that U.S. economic growth in the past 25 years -- the period that hatched this crop of billionaires -- is actually slower than in the preceding quarter-century, which produced only 13 billionaires.

Now that's quite an impressive cheap trick for an economist to use—Baker is ignoring the role of inflation in artificially creating billionaires. But I'll cut him some slack—maybe he's actually made the correction and figured out that we have more billionaires even after correcting for inflation. But it's the next line that's really special:

"If these people pull away so much wealth," he said, "that means everyone else has less."

If economists had to have licenses to practice their profession, that remark would result in a suspended license. He wouldn't be alone, unfortunately.

Two of the people on the list, by the way, are the founders of Google, Sergey Brin (No. 12, $14.1 billion) and Larry Page (No. 13, $14 billion). They created wealth, they didn't take it from others. They created wealth by creating something new that people valued. We pay nothing directly for Google and we Google users are better off along with Brin and Page.

By the way, Google was incorporated eight years ago, so when someone tells you that the top 1% now have this or that much of the wealth or income, remember that ten years ago, Brin and Page weren't in the top 1%.

Dynamics of Economic Well-Being

These two sentences in David Henderson's excellent essay today at Tech Central Station caught my eye especially:

A section of the Census report titled "Dynamics of Economic Well-Being" reports that if one used just a two-year period to measure poverty [rather than a single year], the stated poverty rate would be lower. What this means is that for many poor people, poverty is short-term.

Mankiw on the top of the top

Greg Mankiw has some interesting thoughts on just why la creme de la creme is doing well economically. And as usual, he manages to do it without yelling.

Inequality in Ability to Read Statistics

Alan Reynolds, writing in today's Washington Times, points out why some recent laments over growing income inequality should be discounted.  Here's an especially important passage in which Reynold's uncovers a significant error in Sebstian Mallaby's recent column on inquality:

[Mallaby] confuses the number of households with the number of workers. That's 100 percent wrong. He wrote: "Economic growth no longer seems to help the majority of workers; the proceeds flow to the top fifth or so of the work force." Not so. Half the proceeds from work and savings (not counting taxes or transfer payments) flow to the top fifth of households, not the top fifth of workers.

"Work Matters" is a chapter in my forthcoming book, "Income and Wealth," from Greenwood Press. Among much else, that chapter notes that Bureau of Labor Statistics surveys show an average of 0.6 workers per household in the lowest fifth, one in the second, 1.4 in the third, 1.7 in the fourth, and two in the top fifth. This is partly because there are many more singles in the lower-income groups (including students and widows), and many more two-earner couples with older children toward the top. There are 1.8 persons per household in the lowest fifth, but 3.1 in the top fifth.

The Census Bureau found that within the lowest quintile, the number of people who worked full-time all year in 2005 amounted to 3.2 million in the poorest fifth of households, compared with 9.3 million in the second fifth, 13 million in the third, 15.3 million in the fourth and 16.7 million in the top quintile.

That uniquely industrious top fifth -- every couple with an income above $91,705 -- accounted for 29.1 percent of all full-time, year-round workers. The top fifth surely accounts for more than half of all two-earner college-educated families over the age of 25. It should be neither a surprise nor complaint that they collect half of all income -- before taxes. If work did not pay off, the top fifth would not work so hard to produce at least half the U.S. economy's goods and services.

The Secret Mechanism

Coyote Blog has uncovered an article detailing the secret mechanism that is keeping you poor. It's by Kevin Drum in the Washington Monthly. Drum begins by quoting Ezra Klein at The American Prospect:

The concern [is] that, through mechanisms we're not entirely sure of, the very richest are siphoning off the economic growth before it flows through the middle and lower classes. The worry is about the distribution of growth, but the suspicion is that the distribution is being warped by the sheer level of inequality.

I love that phrase, "mechanisms we're not entirely sure of." Not entirely sure of? That implies that we have a pretty good idea but we're not completely confident we have it exactly right. When I asked a prominent editorialist at a major American daily how the rich are getting to keep everything for themselves he also confessed that the mechanism isn't entirely clear. OK, but can you give me the vaguest idea of how this secret cabal is managing to keep everything and leave us with nothing? If you really believe this is true, don't you want to have the BEGINNINGS of a theory as to how it's being accomplished?

Drum continues:

I'm not sure this gets the mechanism quite right, though.  There are two basic ways that unequal growth can happen:

1. The rich suck up vast amounts of income growth, and this leaves very little money for the middle class. Thus, wages for the middle class are stagnant or, at best, rising slowly.

2. Middle class wages are kept stagnant, and this frees up vast amounts of money from economic growth. The money has to go somewhere, and it goes to the rich.

Now, obviously, it doesn't have to be one or the other. It could be both. But I suspect there's a lot more analytic power in #2 than in #1.

So Drum suspects that there is an unspecified mechanism that somehow keeps the wages of millions stagnant freeing up all that growth for the rich to nab. The metaphor is a buffet table where the middle class is cordoned off from the food, leaving the rich to feast at their leisure.

It's a nice metaphor, but what does it have to do with the economic world you and I live live in, where people go to school, grow up, enter the job market and find work among millions of employers in competition with each other for our services? Yes, you can make the case that some sectors are less competitive than others. But what model or vision or theory of economic reality presumes a mystical mechanism that keeps millions of workers in thrall while somehow creating great wealth for others?

I can think of a few. Most of them have been discredited by time and events. But if you believe otherwise, you have to long for a revolution rather than tinkering with the minimum wage or the tax code.

But to be fair to Drum, he does try and flesh out "the mechanism" a bit:

But — government policies that affect #2 seem far more plausible. For example: Appoint members to the Federal Reserve who are obsessed with inflation and act to cool down the economy at the least sign that average hourly wages are rising. Make it harder to form unions in new industries, thus reducing the bargaining power of the working class. Support free trade agreements that put downward wage pressure on low-income workers. Support tax and deregulation policies that make middle class jobs less secure.

Let's take these one at a time:

Appoint members to the Federal Reserve who are obsessed with inflation and act to cool down the economy at the least sign that average hourly wages are rising.

I love the reference to hourly wages. They have been stagnant or growing very slowly. They are Exhibit A in the case that the average person is suffering while the fat cats feast. But average wages exclude benefits. Why would you use that measure as a measure of economic well-being? But the real problem with this first example is that if you cool down the economy when the little guy prospers, how do the rich get all the growth? There isn't any to be had.

Make it harder to form unions in new industries, thus reducing the bargaining power of the working class.

But the proportion of private employment that is unionized has been falling since the 1950's. Is that likely to be the mechanism at work over the last 10 or 20 years? During the first part of the post-war era, unionization was declining and average wages were rising. That can't be the mechanism.

Support free trade agreements that put downward wage pressure on low-income workers.

Free trade could put downward pressure on wages of some workers. But they also lead to lower prices which lead to a higher standard of living. Besides, I thought we were worrying about all the workers other than the fat cats. If low-income workers are suffer, in the zero-sum game world of Mr. Drum, shouldn't that benefit the middle class along with the rich?

Support tax and deregulation policies that make middle class jobs less secure.

Not quite sure what he's driving at there. Even so, less secure middle class jobs shouldn't explain how the middle class gets nothing. They should just get something less often.

The real problem with these theories of inequality is that they fail to see that the income distribution is an emergent phenomenon rather than under someone's nefarious control. Coyote Blog says it well:

What's bizarre about all of these statements is it treats wealth, and in this case specifically income growth, like a phenomena that is independent of individuals and their actions.  They treat income growth like it is a natural spring bubbling up from the ground, and a few piggy people have staked out places by the well and take all the water before the rest of us can get any.

Wealth and income growth comes from individual action.  Most rich people are getting more rich because they are intelligently investing and taking risks with their capital, applying the output of their mind to create new wealth.  There is no (none, zero, 0) economic correlation that says that if the rich get really rich, then there is less left over for the poor.

Secretary Paulson in a remake of Rashomon

Treasury Secretary Paulson made his first speech today. What did he say? Here are some headlines:

Paulson Calls World Economy `Robust,' U.S. Growth `Strong' (Bloomberg News)

Paulson: US Must Welcome Competition (AP)

Paulson Warns on Benefits (Reuters)

Evidently, he gave a special speech to the New York Times. The headline at the Times:

Treasury Secretary Sees Inequities in US Economy

Just a little bit different, huh? The Bloomberg and Reuters stories don't even mention the inequity theme. The AP story mentions it about 80% toward the bottom of the story:

Paulson said his top priorities would be achieving reform of Social Security and the other benefit programs, advancing the nation's energy security, bolstering global trade and addressing the problems of income inequality between the wealthy and lower-income Americas.

(Aim high, I always say, but this is a little ridiculous. After knocking off social security reform, Medicare reform, securing the nation's energy supply and encouraging trade—all in the last two years of a lame duck administration, he's going to tackle income inequality.)

Here's how the Times's story opens:

Treasury Secretary Henry M. Paulson Jr., delivering his first public remarks since taking office last month, pledged today to work with Democrats to revamp Social Security and Medicare, and in a gesture aimed at Bush administration critics he said he recognized that the economy was not benefiting all Americans.

“Amid this country’s strong economic expansion, many Americans simply aren’t feeling the benefits,” Mr. Paulson said in a speech at Columbia Business School. “Many aren’t seeing significant increases in their take-home pay. Their increases in wages are being eaten up by high energy prices and rising health care costs, among others.”

It will be interesting to see how the coverage of the speech evolves over the next 12 hours. Will wire services or other papers change their focus to this "concession?"

I know a lot of people find the Times to be a frustrating source of news and that their reporters are biased toward the left. A simpler theory is that the Times, like any other producer tries to please its customers. The average reader of the New York Times finds the Times's interpretation of the Paulson speech invigorating. Finally—the Bush administration admits its doing a horrible job for the average American. Left unresolved is what the Bush administration (or its Secretary of the Treasury) might possibly do to change this state of affairs, but the Times has an idea—it comes later down in the story after some discussion of the rest of Paulson's speech:

Though he spoke of economic inequalities, for example, he did not offer any hint of lack of enthusiasm for the administration’s record on tax cuts.

This isn't as absurd as Krugman's suggestion of raising the minimum wage as a way of fighting the unfair gains of the top 5%. But it's close. If the average American isn't sharing in the growth of the economy, letting the Bush tax cuts expire isn't going to make any difference.

The whole thing is a charade.

There are a bunch of people out there who believe or at least claim to believe that the average American hasn't shared in any of the extraordinary growth of the last 25 years. What these people (and the reporters for the New York Times) don't seem to understand is that if that's true, then increasing the minimum wage and raising taxes on the rich aren't going to solve the problem. If you really believe most of the gains of the last 25 or 10 or even 5 years have all gone to the rich, then the system is totally broken. You should be a real socialist. So either they don't really believe their claims about what's happening to the average American or they don't really want to do anything about it anyway. They just want to posture.

Krugman raises a false alarm

I'm a week late getting to this Krugman column (SR) (discussed here and here among many places) but it makes such important errors that it is still worth discussing. Krugman begins by saying that the economy may look healthy but appearances can be deceiving. He quotes an archetypal informed economist:

Informed economist: “But it’s not a great economy for most Americans. Many families are actually losing ground, and only a very few affluent people are doing really well.”

He continues:

Many observers, even if they acknowledge the growing concentration of income in the hands of the few, find it hard to believe that this concentration could be proceeding so rapidly as to deny most Americans any gains from economic growth.

Yet newly available data show that that’s exactly what happened in 2004.

Why talk about 2004, rather than more recent experience? Unfortunately, data on the distribution of income arrive with a substantial lag; the full story of what happened in 2004 has only just become available, and we won’t be able to tell the full story of what’s happening right now until the last year of the Bush administration. But it’s reasonably clear that what’s happening now is the same as what happened then: growth in the economy as a whole is mainly benefiting a small elite, while bypassing most families.

That's a very strong statement. Is it true? Krugman bases his claim on work by Piketty and Saez:

The answer comes from the economists Thomas Piketty and Emmanuel Saez, whose long-term estimates of income equality have become the gold standard for research on this topic, and who have recently updated their estimates to include 2004. They show that even if you exclude capital gains from a rising stock market, in 2004 the real income of the richest 1 percent of Americans surged by almost 12.5 percent. Meanwhile, the average real income of the bottom 99 percent of the population rose only 1.5 percent. In other words, a relative handful of people received most of the benefits of growth.

Wow. No wonder Krugman's alarmed--the average income of the top 1% grew a whopping 12.5% while everyone else is just limping along.

Krugman then dismisses the usual explanation for rising inequality--increasing returns to education. Curiously, perhaps, he doesn't give his own explanation. He simply states that the current administration and current Congress is unlikely to do anything about it.

There are two reasons to ignore Krugman's angst. The first I have written about before—it's incredibly misleading to talk about the top 1% gaining this much or that much year-to-year. 

THEY'RE NOT THE SAME PEOPLE.  Even if Piketty and Saez's numbers are perfectly estimated and analyzed, their numbers do not mean what Krugman implies--if you took the people in the top 1% in 2003 and added up their income, then did the same thing in 2004, the average rose by 12.5%. Piketty and Saez don't follow individuals. They just take the top 1% in each year. So what the numbers mean is the people in the top 1% earn, on average, 12.5% more than the people who were in the top 1% the year before.

Some of them, of course, are the same people. But it's not like the top 1% are sitting off to the side in their own guarded compound living like kings at the expense of everyone else, making the rules of the economic game that somehow let them do well while punishing others.

And because it's not the same people, you have to be very careful drawing conclusions about changes in the average American's well-being over time. As I've written before, those numbers are affected by immigration, divorce and demographic changes. The median can fall but the median person can still do better over time.

The other mistake in the Krugman analysis is that you really don't want to base a big policy conclusion on one data point. Do you really want to look at one year (one!) and draw big conclusions about something complex as the distribution of income?

Let's look at more than one year.

Here are the increases by decade, in the average incomes of the top 1% using the Piketty and Saez calculations (go here to read their original paper and click on the word "NEW" to download the file I used--it's Table A4 column 3 in the excel spreadsheet):

1920-1930   23%    
1930-1940     0      
1940-1950   15      
1950-1960   -5      
1960-1970   23      
1970-1980     1
1980-1990   71
1990-2000   46
2000-2004   -6%

What do you conclude from these numbers? One interpretation is that in times of strong economic growth--the 1920's, the 1960's, the 1980's and the 1990's for example, some people do really well, and that pushes up the incomes measured in the top 1%. Mediocre or negative economic growth is not good for the rich or other living things.

And in case you're wondering, excluding 2000—a very good year for the economy—and looking at just 2001-2004, the first four years of the Bush administration, you get an increase of 4%, a dramatically slower rate of increase than in the previous two decades.

The bottom line is that how the incomes of the top 1% move around is a complex phenomenon. it is foolish to look at one year and conclude that a small elite is keeping all the economic growth. I would also note that even if you wanted to change the distribution of income, it's hard to know which policy levers would be effective other than improving the educational system, a solution that Krugman seems to think is absurd.

Perhaps, but for absurdity, turn to Krugman's first recommendation for improving the problem he perceives of the richest of the rich getting all the growth. Krugman wants to RAISE THE MINIMUM WAGE. I'm not making this up:

Can anything be done to spread the benefits of a growing economy more widely? Of course. A good start would be to increase the minimum wage, which in real terms is at its lowest level in half a century.

Earlier in the article, he wrote:

There are a couple of additional revelations in the 2004 data. One is that growth didn’t just bypass the poor and the lower middle class, it bypassed the upper middle class too. Even people at the 95th percentile of the income distribution — that is, people richer than 19 out of 20 Americans — gained only modestly. The big increases went only to people who were already in the economic stratosphere.

And the first thing to solve the problem is an increase in the minimum wage?  No, if you really think that somehow the American economic system has been rigged to reward the rich then the first step to take is to double the marginal tax rate on the rich and use the money to increase the earned income tax credit or expand welfare programs. But increase the minimum wage? What was he thinking?

Inequality Kills

Global warming is routinely blamed for anything that goes wrong in the natural world. It turns out that inequality is the cause of everything bad that happens in the human world. Take this story from Reuters on the rising suicide rate in Japan. Here's the opening line:

The number of suicides in Japan is likely to have exceeded 30,000 for the eighth straight year in 2005, and analysts say a widening income gap is partly to blame for the nation's stubbornly high suicide rate.

Usually, a widening in something that causes something else would lead to a worsening of that phenomenon rather than leaving it "stubbornly high." So this is a bit strange. Then there's the classic, "analysts say." I wonder how many. I wonder what the justification is for saying it. Let's see:

Suicides rose in 1998 amid an economic slump and the number of those who take their lives has exceeded 30,000 every year since then.

"The bulk of the increase since 1998 is suicides by men who are middle-aged or older and have either been laid off or whose businesses have failed," said Masahiro Yamada, a professor at Tokyo Gakugei University.

Hmm. I thought it was the widening income gap that was the cause of the higher suicide rates. But here the cause seems to be bad economic times. They are not the same thing.

In 2004, there were 32,325 suicides in Japan, or 25.3 per 100,000 people, according to government data. Males accounted for over two-thirds of the total and health problems were the most common reason, followed by economic problems.

OK. Health problems and economic problems. Makes sense. (Sort of. How do you generalize in a reliable way about the reason for suicide? Where would the data come from?) But where is the role of the widening economic gap? Where are the analysts saying so?

Yamada, who has written that an income gap in Japan has widened recently following the breakdown of a traditional social safety net such as lifetime employment, said a rising risk of dropping out of the middle class was behind the high suicide rate.

So where does that conclusion come from? "Economic problems" and failed businesses are not the same as worrying about dropping out of the middle class. Sounds like more of a wild guess on the part of Professor Yamada rather than an analysis.

Note to Reuters: The letter "s" on the end of the word "analysts" implies there is more than one.

(HT: Peter St. Onge)

The Dark Lining of the Silver Cloud

Lou Uchitelle, in yesterday's New York Times, is desperate to find proof that workers are  losing ground.  He hangs his rhetorical hat on a subtle issue in trying to measure GDP, the treatment of research and development. Is it an expense or is it investment? Current calculations of GDP treat it as an expense, but a good case can be made that it's actually an investment. That changes the calculation of business profit and makes measured profits higher. That seems reasonable. But Uchitelle tries to make the case that workers are doing evven worse than we thought. Here's his summary of reclassifying R&D as investment:

This reclassification leaves no doubt that workers are being left behind as the G.D.P. expands. When R & D is counted as profit, the employee compensation share of national income drops by more than one percentage point. In a $12.5 trillion economy, that's big money.

What does the phrase "left behind" mean to you? Standing still? Falling back? Moving forward but not as fast as others? All of the above?  It's a vague phrase to give Uchitelle some wiggle room. But even so, a 1% change in compensation's share is not a big change unless you saw it persist year after year. There's always going to be some fluctuation. And is labor's share falling? Or is this 1% reduction a change in the level that has always been there but now we're measuring it properly?

Uchitelle immediately lets us know that workers even though they're being "left behind" are actually not really becoming worse off:

Measured in dollars, wages aren't actually falling, but workers are losing ground. "If capital income is going up and wages stay the same, then the share of total national income that goes to labor goes down," said Sumiye Okubo, an associate director of the bureau, who is directing the experimental project.

So we're back to a favorite theme at the Times's. People are still getting ahead but some are getting ahead faster than others.

In fact, labor's share of the economic pie, measured in the traditional fashion without the correction for R&D as an investment, is remarkably constant, as this report from the St. Louis Fed by Michael Pakko shows:

The top line is compensation going to workers. It is remarkably steady at 70% of national income going back to 1948. It doesn't go any higher than 73% and it doesn't fall below 67%. The lower line is wages and salaries, a series that some pessimists use because by ignoring the increasing role of benefits in compensation, it misleads about how labor is doing relative to profits. This picture makes it clear that labor's share measured in the traditional manner without accounting for the intangibles, hasn't fallen since the 70's. Or the 1950's even. This picture is makes it difficult for the pessimists to claim that the top 1% are getting everything or that corporations rule the world. So I can understand the desire to reclassify GDP calculations to find a gloomier conclusion.

Changing the way we account for R&D and moving this number around by something on the order of 1% isn't going to be much of a story. But there are other changes that people are considering in how to measure labor and business's share in GDP—how to treat advertising, for example, or the adoption of technology:

Such intangibles now approach $250 billion a year, up from only $11 billion in the 1970's, the three economists calculate. If these intangibles, along with R & D, were incorporated into G.D.P. on the profit side as capital investment, labor's share of national income would decline from a fairly steady 65 percent in the 1950's, 60's and 70's to less than 60 percent today.

I don't know where Uchitelle gets his numbers. The Fed study shows the share steady at 70% not 65%.

The long decline doesn't show up in the standard G.D.P. accounts, which ascribe nearly 65 percent of national income to labor. "The hidden earnings from these knowledge investments have not been shared equally with workers," Mr. Hulten said.

I can believe that if you reclassify some expenses as investments, you can boost business profits and business's share of GDP. There may even be a decline over time in labor's share as Uchitelle and the authors of the study he mentions are right. But is there any reason that all gains should be shared equally? Is there an economic reason? Here are Uchitelle's reasons for the decline he perceives:

Two reasons seem likely. Some of the profit is probably going to the wealthiest Americans — the upper 1 percent whose incomes have risen sharply, in part from dividends and other forms of corporate earnings.

The economic argument that Uchitelle and Hulten (one of the study's co-authors) seem to be making is that since 1970, there has beena  big increase in technology and R&D and advertising. These changes have increased inequality by lowering labor's share. But do they really believe that increases in R&D and technology are bad for workers? I'd think that workers benefit from technology and R&D. Does Uchitelle really believe that the benefits of R&D and technology accrue mostly to the top 1%? But here's the real kicker:

Then, too, most of the nation's workers are bereft of bargaining power. Unless that returns, labor's share of national income seems likely to continue its decline.

Bereft of bargaining power? What does that mean? I assume Uchitelle means the decline of unions. But the steadiness of labor's share goes back to the 1950's. And unionization in the private sector has been falling steadily since the 1950's. Tough thesis to prove.

Ironically perhaps, just above Uchitelle's piece, in the print edition of the paper, was this piece by Ben Stein arguing that envy is a destructive emotion:

Years ago, I went to a 12-step program on Point Dume, a lovely area in Malibu, Calif. At the time, I was making a modest living and was petrified about money many nights. I would walk my magnificent German short-haired pointer, Trixie, near the homes of fabulously wealthy stars and moguls and then return to my shabby rented cottage.

At the meeting, I complained about the maddening truth that so many people near me on Point Dume had so much more money than I did, and a smart woman named Jennie said: "Instead of thinking about what you don't have, think about what you have. You have the handsomest son on the planet. You have the perfect dog. Concentrate on those. When you are tempted to feel envy, remember that envy is as bad as strychnine for you. Make a list of what you do have that is good in your life, and then the envy will lift."

Good advice.

The Persistence of Constraints

I was on the Diane Rehm Show earlier today talking about inequality—you can listen to by going here. The highlight is toward the very end when Diane Rehm announces that I don't believe inequality exists, just a slight misreading of what I had been saying.

One of the challenges of playing the contrarian in this kind of debate is how easy it is to bring in other factors that have nothing to do with the debate but are in the vicinity. One of those is that there are poor people. So if you deny the importance of inequality as a pressing social problem, you are inevitably confronted by suggesting you don't care about poor people. The two issues are related, but analytically distinct.

The other tangential issue that comes up is that the middle class is having a hard time. It came up on the show a few times—the idea that people have to go into debt to buy a nice house or to make ends meet.

The implication is that the economy isn't working well. After all, if it were working well, then people could just get by with what they have. It's tempting to counter with the point that going into debt is usually a sign of outgo exceending inflo and rather than borrowing, maybe people should spend less. Borrowing to live a lifestyle you can't afford tells us more about the people doing the borrowing than it does about the economy.

But I think that misses a much deeper point, a point I first saw made by Thomas Sowell but I can't remember where. The point was that people always want more than they have.  Always. It has nothing to do with the material age we live in. It has nothing to do with whether the economy is working well. Inevitably, our desires outstrip our resources.

Why is the middle class struggling so much today? The middle class always struggles in the sense that the people in the middle class would like more than they have. So do the people at the bottom and the top. If we all could be content with the small houses that people had in 1950 or even 1970, houses with fewer square feet, houses with fewer bathrooms, houses with fewer bedrooms, houses without an office or guest room, houses with modest kitchens and smaller dens and smaller televisions in those dens, then yes, we'd all have a lot less strife in our life. If the middle class were merely content with living as the upper middle class did in 1950, the middle class could relax and be content.

But relaxing and settling for less is not how most of us are made, rich or poor. The Talmud asks: who is wealthy? And the answer is: he who is content with his lot. Few reach that level, not because they are financial failures but rather because of their natures.

The same is true for how "busy" we are. Of course, we're busy. Of course, we fill up our lives and schedules with more and more. Most of us don't cut off the bottoms of our shoes and learn to play the flute. There isn't enough time to go around. There are only 24 hours a day and we all die. We want to have as much life as we can.

The fact that we all feel busy and that we feel the pressure of financial issues has nothing to do with our economy and everything to do with our nature. Religion is a much better place to search for a cure for that ill than economic policy.

Riffing on Wealth Inequality

David Schmidtz’s essay asking “when inequality matters,” along with Russ's Econoblog debate on inequality, got me thinking….

Perhaps today’s most significant inequality is the one separating residents of industrial societies (for example, the United States and Japan) from residents of subsistence and oppressive nations (for example, Niger and North Korea) – an inequality fundamentally of freedoms that manifests itself starkly as an inequality of living standards.

But within any industrial society – especially a dynamic, entrepreneurial one – a good case can be made that the greatest inequality is that which separates one generation from the next. The “distribution” of material resources consistently favors younger generations. I’m materially better off than my parents, who are materially better off than were their parents, who were materially better off than were their parents. This pattern probably holds true for about the past 200 years.

(By the way, I put “distribution” in quotation marks because, as David Henderson once reminded me, income and wealth in market economies aren’t “distributed” in any meaningful sense of that term; income and wealth are created and initially owned by those who create it. Wealth isn’t created and then distributed. The pattern of wealth's possession is determined by the process of its creation. Therefore, what we call “redistribution” of wealth is really distribution of goods confiscated mostly from their creators.)

Does this intergenerational inequality matter? Not to me. I neither fret about it nor believe it to be the consequence of any ethical breach or failure of the economy. I feel no guilt or shame for being wealthier than my parents, and I feel nothing but delight knowing that my son, over the course of his life, will almost surely be wealthier than I’ve been over the course of my life.

Americans born in 2000 generally will enjoy greater wealth over their lifetimes than will Americans born in 1960. The greater good fortune of this younger generation has nothing to do with greater merit of the younger generation. They’re simply luckier than their parents. So, does this luck differential justify “redistribution” from our kids to us?

Some such “redistribution” does take place today – largely in the form of Social Security transfers and as a consequence of government deficit spending.  But even with this “redistribution,” future generations will likely be wealthier than we are for no reason other than the fact that they’re younger than us and the economy in which they will spend their lives will feature a deeper division of labor and more technological knowledge than now exists.

Now I suspect that very few people get hot’n’bothered by the unequal “distribution” of wealth across generations. If my suspicion is correct, then it’s likely true that the reason many more people are bothered by unequal “distribution” across persons at each point in time is due not to philosophical considerations of the sort offered by John Rawls but, instead, because … because…. why, exactly? The answer (to me, at least) isn’t obvious.

One possible response is that we can’t see or interact with people in the future, so the envy and resentment that erupt when we see people wealthier than us aren't triggered by the greater wealth of future generations. That greater wealth in the future is an abstraction, not a palpable reality.

But how much of current wealth differences are palpable realities? I seldom see billionaires – and when I do, it’s surprisingly difficult to notice that they are wealthier than me.

Of course, there are very poor people in the U.S. – homeless people, even people living in mobile homes or in government housing projects.  Such poor people routinely see middle-class Americans living in ranch or red-brick colonial homes, and driving shiny new Toyota Camrys.  But what’s to be done? Simply transferring money from rich to poor is unlikely to do much to improve the living standards of these poor people.  So maybe we should instead focus on “redistribution” not so much to raise the living standards of poor people but to lower the living standards of wealthy people – so that homeless folks, and people living in mobile homes and in housing projects, won’t see people a great deal richer than they are.  By how much should living standards of the rich be reduced?

Are there any principles that apply here?

A blogoff on inequality

Here's my back-and-forth on inequality over at the Wall Street Journal's Econoblog.  The other side is Heather Boushey of the Center for Economic and Policy Research.  No subscription required.  Comments are open to let me know what I missed or could have done better on.

When Does Inequality Matter?

In this new release from Cato Unbound, one of my favorite philosophers, David Schmidtz, offers deep and intriguing thoughts on the question of inequality.

Although the entire essay is worth a careful read -- indeed, it's worth two or more careful reads -- here's my favorite paragraph:

In a race, equal opportunity matters. In a race, people need to start on an equal footing. Why? Because a race’s purpose is to measure relative performance. Measuring relative performance, though, is not a society’s purpose. We form societies with the Joneses so that we may do well, period, not so that we may do well relative to the Joneses. To do well, period, people need a good footing, not an equal footing. No one needs to win, so no one needs a fair chance to win. No one needs to keep up with the Joneses, so no one needs a fair chance to keep up with the Joneses. No one needs to put the Joneses in their place or to stop them from pulling ahead. The Joneses are neighbors, not competitors.

Thanks to Will Wilkinson for the pointer.

Please Do Your Job

The headline:

Study Finds Rich-Poor Income Gap Growing

The story by Mark Johnson of the Associated Press begins:

The disparity between rich and poor is growing in America as the federal minimum wage has remained flat for years, union membership has declined and industries have faced global competition, according to a study released Thursday.

Interesting.  Let me try a different first sentence:

The disparity between rich and poor is growing in America as the Red Sox won their first World Series in 86 years, Mars came very close to the earth and the global frog population plummeted. 

I don't actually believe that the disparity between rich and poor is growing.  At least I don't believe the numbers that supposedly tell us so.  Or more accurately, I don't believe that the interpretation of the numbers is the right one.   But even if the interpretation is the right one,  how can an Associated Press story list the supposed causes of that growing disparity as if they were facts rather than the pet agenda items of the groups that put out the study?

The story continues:

The report by the Center on Budget and Policy Priorities and the Economic Policy Institute, both liberal-leaning think tanks, found the incomes of the poorest 20 percent of families nationally grew by an average of $2,660, or 19 percent, over the past 20 years. Meanwhile, the incomes of the richest fifth of families grew by $45,100, or nearly 59 percent, the study by the Washington-based groups said.

Families in the middle fifth saw their incomes rise 28 percent, or $10,218.

The figures, based on U.S. Census data, compare the average growth from 1980-82 to 2001-03, after adjusting for inflation.

The poorest one-fifth of families, the report said, had an average income of $16,780 from 2000-03, while the top fifth of families had an average income of $122,150 — more than seven times as much. Middle-income families' average income was $46,875.

This is fake analysis.  It's comparing two snapshots over time and pretending that the people in the snapshots are the same people.  The implication is that if you were a poor family in 1980, you barely got ahead while the rich families, turbo-charged ahead of everyone else and left them in the dust.  The rich get richer and the poor basically stay poor.

But they're not the same people in the two snapshots.  The comparison of the two snapshots is close to meaningless.  The bottom quintile of families today includes a bunch of people who weren't there in 1980.  Some of the families are recent immigrants to the United States seeking opportunity.  Some of the families are young and just starting out.  Some are the result of a divorce that has dumped one or both partners into poverty and it will take time for them to recover. 

And most importantly, some of those rich families today that have allegedly zoomed ahead were poor in 1980 but have become rich in the meanwhile, an experience that is the exact opposite of what the headline would have you believe.

In short, the people who did the study are lazy.  But I expect them to be.  They're from the  Center on Budget and Policy Priorities and the Economic Policy Institute.  That's their job—to produce pessimistic analyses that make people think the rich are getting richer and the poor are getting poorer and to claim a causal connection between bad times and weakened unions.

But that isn't Mark Johnson's job.  Mark, your job is to inform.  Or maybe to help sell newspapers.  But either way, it doesn't speak well of you or your job to simply run the press release from the  Center on Budget and Policy Priorities and the Economic Policy Institute under your byline.  If your job is to inform, you might want to interview a few people who don't think about the world in the same way as the CBPP and EPI.  If your job is to sell newspapers, a little tension and counterpoint make more interesting reading.

To be fair to Mr. Johnson, he did call someone who didn't work for the people who did the study to add some "balance" to the story.  So who did he call?   Another pro-union activist:

Trudi Renwick, an economist with the union-backed Fiscal Policy Institute in New York, said globalization, the decline of manufacturing jobs, the expansion of low-wage service jobs, immigration and the weakening of unions have hurt those on the lower end of the economic scale.

After some data on state-level inequality, Mark Johnson finally quotes someone "on the other side," someone from the business community:

Matthew Maguire, a spokesman for the Business Council of New York state, said the money earned by the state's wealthiest residents is "something that everybody who cares about New York should be pleased about."

"New York's wealthy pay huge sums in taxes and those wealthy people and their taxes make it possible for New York to provide the nation's most generous social service programs to less fortunate New Yorkers," he said. "It also reflects the fact the state is a magnet for immigrants who come from the four corners of the globe to a state they see as symbol of economic activity."

Isn't this rich?  (Aren't we a pair?)  The voice from "the other side" accepts the analysis as true but disputes the implication that rich people getting richer is bad.  It's good!  What a loveable counterpoint.

And then Johnson closes the piece giving more space for Trudi Renwick's agenda, the same agenda of the Economic Policy Institute:

Renwick said the government "needs to continue its commitment to correcting the natural outcomes of the marketplace" by raising the minimum wage with inflation and by tax policies like the earned income tax credit.

Renwick also suggested that governments, when giving tax breaks to companies, insist those companies provide jobs that pay higher wages.

That's it.  Not one quote from someone who is skeptical of the analysis.  Not one quote from someone without an ax to grind.

Mark, call someone else other than union-backed economists or business lobbyists.  Call someone at a university.  Or if you want to stick with think tanks, call Robert Rector at Heritage.  He can explain why the numbers you swallowed are silly.  Do your job.

The Lake Wobegon Fallacy

One of the principles of journalistic ethics is "balance."  One person's opinion is often balanced by someone else's opinion on the other side.  This principle is ignored in reviewing movies, books or concerts.  It is ignored on the sports page—when the home town team plays badly and loses, the reporter rarely goes out to get a quote from the "other side."  The one place that balance lives and thrives is the news section.

Any data or statistic that is announced will usually get an optimistic assessment and a pessimistic assessment.  This creates a market for gloomy assessments and a market for cheerful assessments.  There are certain commentators who are known to be pessimists and others who are known to be optimists.  I have a feeling that the pessimists do a better business for the same reason that people like horror movies.  The pessimists usually have an agenda.  Increasing the proportion of people who think the world is doing badly increases the demand for reform.

For some think tanks and agenda-driven economists, the world is always going to hell in a handbasket.  Things are always getting worse.  Every silver cloud has a dark lining.

News from Boston finds that nearly 1 in 20 Boston households are millionaires.  That's the awkwardly-worded headline in the story from the Boston Globe.  (Households aren't really millionaires, individuals are.  But you get the basic idea).

Now there are many things to quibble about when evaluating that number of 1 in 20.  But basically it's good news for Boston and a sign of its economic health.  Boston, in fact, ranks first among all cities.

But in the fourth paragraph comes the gloom in discussing a forecast that Boston will be getting even more millionaires in the future:

But the jump in millionaires may also drive up prices for numerous services and goods, including housing. Down the road, some economists worry about the deeper social implications of a rapid rise: The rich will enjoy ever more of life's luxuries, while the poor struggle to pay rent and dig out of debt.

Rents may indeed rise and that may cause some hardship.  But the basic premise of the paragraph is that the world is a zero-sum game where one person's wealth comes at the expense of others.  Imagine saying the same thing looking at the history of the 20th century.  The standard of living grew by a factor of 10 to 30 fold (it's hard to measure) but can you imagine an economist adding the gloomy caveat that all the luxury that resulted and improvements in health care  and longevity over the 20th century would be tough for poor people?  Poor people in 1900 are among the people who benefited the most from the growth in wealth.

But the story in the Boston Globe goes one step further than finding the dark lining in the silver cloud.  It pioneers a new insight from statistics using Mark Zandi of Economy.com, one of the regulars in the market for gloom:

Economist Mark Zandi said he sees two classes emerging in Boston and nationally: One earns above the region's median family income, about $75,000 in the Boston area, and lives in comfort, with job security, stock holdings, and little debt. The other half earns below the median, has far less job security, and worries about credit card debt and student loans.

''This reinforces the view that the folks who are doing well are doing very well, and the folks who aren't doing well aren't doing very well at all," said Zandi, chief economist for Moody's Economy.com. ''The middle class is bifurcating. It's becoming two classes."

It's early in 2006 but this may be the best quote of the year, or maybe even the decade for saying something that is true but totally meaningless.

Two emerging classes?  A bifurcating middle class?   One below the median and one above.  I hope Mr. Zandi was misquoted.  Because as far as I know, there has always been a group below the median and a group above it except in Lake Wobegon.  And those groups are pretty evenly weighted.  Oh, usually around 50-50.  Half above and half below.

If you worry that only 50% of the population earns more than the median, you are going to be worried for a long long time.

Lucas on Redistribution

Finally got around to reading this essay by Robert Lucas on growth.  (Don posted these thoughts earlier.)  I was struck most by his concluding paragraph:

Of the tendencies that are harmful to sound economics, the most seductive, and in my opinion the most poisonous, is to focus on questions of distribution. In this very minute, a child is being born to an American family and another child, equally valued by God, is being born to a family in India. The resources of all kinds that will be at the disposal of this new American will be on the order of 15 times the resources available to his Indian brother. This seems to us a terrible wrong, justifying direct corrective action, and perhaps some actions of this kind can and should be taken. But of the vast increase in the well-being of hundreds of millions of people that has occurred in the 200-year course of the industrial revolution to date, virtually none of it can be attributed to the direct redistribution of resources from rich to poor. The potential for improving the lives of poor people by finding different ways of distributing current production is nothing compared to the apparently limitless potential of increasing production.

In America, at least, many people feel that the improvement in the well-being of the poor comes from government programs that protect the poor from greedy businesses.  Without such protections, the dog-eat-dog world of ruthless capitalism would grind the poor to dust.
It is worth reading this sentence one more time:

But of the vast increase in the well-being of hundreds of millions of people that has occurred in the 200-year course of the industrial revolution to date, virtually none of it can be attributed to the direct redistribution of resources from rich to poor.