Inequality and Prices

Steven Levitt and Will Wilkinson point to a new paper that Levitt says “shatters the conventional wisdom on growing inequality” in the United States. The paper is by Christian Broda and John Romalis, economists at the University of Chicago.

Here’s their argument: Income inequality has increased over time. But analysis of consumption data indicates that people with low incomes are more likely than those with high incomes to buy inexpensive, low-quality goods. In part because those goods increasingly are produced in China, their prices rose less between 1994 and 2005 than did the prices of goods the rich tend to consume. Hence the standard measure of inequality, which is based on income rather than consumption, greatly overstates the degree to which inequality increased. The incomes of the rich rose more than those of the poor, but because the cost of living increased more for the rich than for the poor, things more or less evened out.

Their point that the prices of some goods have risen less than the overall inflation rate, and that this is due in large part to imports from China, seems perfectly valid and worth making. It has important implications for our understanding of how absolute living standards for America’s poor have changed over time.

But I’m not sure why Broda and Romalis, or Levitt and Wilkinson, think this should alter our assessment of the trend in inequality. Do they mean to suggest that the revealed preference of the poor for cheap goods is exogenous to their income? In other words, people with low incomes simply like buying inexpensive lower-quality goods, and they would continue to do so even if they had the same income as the rich. Likewise, the rich simply have a taste for better-quality but pricier goods, and they would continue to purchase them even if they suddenly became income-poor. If this is the assumption, I guess the conclusion follows. But I can’t imagine the authors, or anyone else, really believe that.

Actually, Levitt may believe it. “How rich you are,” he says, “depends on two things: how much money you have, and how much the stuff you want to buy costs” (my emphasis).

Consumption is worth paying attention to. But income is important in its own right because it confers capabilities to make choices. What matters, in this view, is what you are able to buy rather than what you want to buy. If a rich person with expensive tastes gets an extra $100,000, she can continue buying high-end clothes and gadgets. Or she can choose to purchase low-end Chinese-made products and save the difference. Suggesting that if she opts for the former there has been no rise in inequality is not very compelling.

15 thoughts on “Inequality and Prices

  1. “people with low incomes simply like buying inexpensive lower-quality goods, and they would continue to do so even if they had the same income as the rich. Likewise, the rich simply have a taste for better-quality but pricier goods, and they would continue to purchase them even if they suddenly became income-poor.”

    You hit on the same concern I had. I don’t think the preference is symmetrical. I would think a case could be made that the poor would more readily change their tastes if they had more income. Likewise, I think it possible that there would be more reluctance to change on the part of the “rich” were they suddenly to become poor – or there would be a lag in the adjustment compared to the adjustment of the poor.

    I think many of us are reluctant to “downscale” once we’re used to a certain level (either quantity or quality) of consumption.

  2. So by this “logic,” high-income consumers would be even better off if they simply purchased the same inexpensive, low-quality Chinese-origin goods that lower-income consumers purchase. Silly high-income consumers! Look at the opportunities they’re missing!

    A pox on that entire line of “logic”…

  3. Lane’s comments make sense to me. I too don’t see what Christian Broda and John Romalis’ paper has to do with the growth of inequality. Levitt is implicitly saying that we should use a different deflator (based on the market basket of goods that groups actually consume) for different income classes to calculate their real income growth. That is an interesting idea, but seems to miss much of the purpose of index numbers (in any case, the phenomenon Broda and Romilis describe has been going on since the triumph of the industrial revolution — things have tended to get cheaper relative to services — altho it may have accelerated in recent decades).

    There are reasons to question (not deny) the conventional wisdom on the growth of inequality in the US. There are some pretty good reasons to believe that the growth in economic inequality is often overstated. Broda and Romilis do not add to these arguments, although their argument is interesting in its own right (and, perhaps, reinforces the arguments of those who use the GDP deflator rather than the CPI and total compensation rather than taxable income to estimate real income growth).

  4. It’s an especially silly way of looking at things considering that for some of the goods in question (especially food, health care, plastics with safety ratings), the quality of the goods also affects their role in a person’s life. Buying cheap mass-produced food (Doritos, etc) is very different from buying high-quality food (wild Alaskan salmon), and while they are substitute goods in that they both provide calories, they’re not substitute goods in the same way as TVs of different sizes.

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  6. If a rich person with expensive tastes gets an extra $100,000, she can continue buying high-end clothes and gadgets. Or she can choose to purchase low-end Chinese-made products and save the difference. Suggesting that if she opts for the former there has been no rise in inequality is not very compelling.

    In your hypothetical, no one would argue that inequality did not rise, because all this new approach would do is decrease the judged magnitude of that rise in inequality – that is, if the rich get more, and the poor get the same, then no matter how you evaluate it, more is greater than zero, and zero is zero, so inequality has risen. But that’s not the real situation: the poor have gotten more income as well, so to judge inequality, you have to compare the two income increases.

  7. Their analysis also leaves out replacement costs, which have shot up for the poor who now get to buy cheap crap that falls apart regularly instead of plain old cheap stuff.

    I can remember when buying stuff cheap meant that it was ugly and functional and lasted forever even though you hated it. Nowadays, it’s still ugly, less functional, and brings new meaning to planned obsolescence.

    Walmart is a huge culprit here, pushing their vendors to cut costs year over year, which means lesser quality components and cheaper assembly. So I have none of the brand X underwear I bought 5 years ago, but I still have most of the pairs of that same brand I bought a decade before that.

  8. I’ll rehash a comment I just put on Will’s site. And a caveat: I’m not an economist.

    I think Lane is suggesting that the “poor bundle” of goods sucks, while the “rich bundle” is awesome, and thus there is a big hidden gap in well-being.

    Yes, that is true. But is the rich bundle getting more awesome with time? Or is the poor bundle getting more sucky? I think neither of those is true– in order to have a valid price index, I think you have to fix the awesomeness of the bundle to some constant value (even if you have to change the bundle occasionally when there are new products, etc. — the total awesomeness of the bundle stays constant, no?)

    If bundle-awesomeness within one index is indeed constant across the years, then relative bundle-awesomeness among two different indices is also constant. Therefore, there is no problem with Broda/Romalis’ analysis.

    Did I miss something?

  9. Qualitative change has always been hard to capture in any index that measures “cost of” or “standard of” living.

    I think a point that was being made (and that I agree with) is that the demand for goods by the poor may not be equally elastic to the demand for goods by the rich.

    My guess would be there would be more upside elasticity for the poor than downside (fewer choices to the downside?). And possibly less elasticity in both directions for the rich. If you’ve got wealth, $4 a gallon to refill an Hummer may mean less, and the reluctance to get rid of the Hummer and replace it with something more fuel-efficient may be less of a pressing matter.

  10. This argument seems to be theorists trying to disprove theories by imagination.

    The central theme is that global trade has increased its offerings in both variety and volume over the years. The gain in the variety of goods is being shared by both global producers and global traders.

    That is accepted theory so far. If we wish the find the limits of theory, then we have to ask what happens when the next increase in goods variety cannot be supported by investment. Toward equilibrium, that is, do the good producers automatically start reversion back to a lesser variety of goods? I doubt it.

    You guys are trying to reinvent the human mind to fit some new theory.

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  13. Only Proves the Point…..
    I’ve looked at the original paper and seems to me that, logically, the findings only reinforce the argument that inequality is widening. Following simple economics, what we see is that rich people with extra money are driving up prices in the markets they participate in — high-end durables, high-end services, courtside NBA tickets, etc. — and so, of course, their “basket” would inflate relatively rapidly.
    The poor can only bid relatively weakly in a different market — e.g., cheap shoes and t-shirts — and that not only keeps demand-driven inflation down, it also attracts (only) bottom-feeding sellers.
    So, the silver lining is that the rich gouge each other and the poor find flimsier goods…. But that only underlines the dynamics of growing inequality.

  14. “Consumption is worth paying attention to”

    Indeed – it is the only thing that ultimately matters. If it were only the prices of things bought only by the rich that was falling, you would see that as benefitting the rich and not the poor, and therefore as increasing inequality.

    By the same logic, falling prices for things bought mainly by the poor decrease inequality.

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