Archive for the 'Inequality' Category

Reducing inequality: what’s the problem?

April 13, 2009

I’ll be doing a series of guest posts at Crooked Timber this week on strategies for reducing income inequality in the United States. I’ll cross-post them here.

Here’s the problem (more discussion here):

There are two linked components to this rise in inequality: the surge in incomes for those at the top of the distribution and the slow growth of incomes for those in the middle and at the bottom.

Is this really a problem? Would it be better if income inequality were reduced? I think so, for the following reasons.

1. Fairness. Market processes have produced enormous incomes for various financial operators, CEOs, entrepreneurs, athletes, and entertainers in recent decades. A good bit of this is due to luck — being in the right place at the right time, genetic talent, having the right parents or teacher or coach, and so on. I don’t mind some inequality due to luck, and I recognize that monetary incentives are helpful. But the current (or recent, I should say; the downturn will reduce top incomes somewhat) magnitude of inequality in America strikes me as unfair. An income of several hundred million dollars when the minimum wage gets you about $15,000 is too much inequality. What’s the proper amount of income inequality? I don’t have a precise answer, but that doesn’t mean it’s wrong to feel that our current level is excessive.

2. Inequality’s consequences. Even if you don’t worry about exorbitant incomes in and of themselves, there’s no avoiding the fact that they have consequences for the incomes and well-being of Americans in middle and lower parts of the distribution. The social pie isn’t zero-sum. But our economy hasn’t grown faster in the past few decades than it did before, so the dramatic jump in incomes among those at the top has come in part at the expense of the rest of us. The following chart offers one way to see this. It shows GDP per family and median family income over the past six decades. Relative to growth of the economy, incomes in the middle (and below) have increased slowly since the 1970s.

As Robert Frank has pointed out, super-high incomes also have led to an arms race in consumption, especially in housing. Spending among the rich has escalated dramatically, encouraging middle- and upper-middle-class households to take on more and more debt in order to keep pace.

Over the past decade a number of social scientists have looked at the effect of inequality on other societal outcomes. We have studies suggesting that inequality is bad for education, health, crime, economic growth, economic mobility, civic engagement, political participation, political influence, and political polarization. I’m not convinced that all of these findings are correct, but some of them are quite plausible.

So what should we do? Stay tuned.

Posted in Inequality | 3 Comments »

Outliers, Opportunity, and Luck

January 11, 2009

In Outliers, Malcolm Gladwell relates a series of stories — about Canadian hockey players, Bill Gates, the Beatles, Jewish lawyers, Chinese schoolchildren, and others — which reveal that

It is not the brightest who succeed… Nor is success simply the sum of the decisions and efforts we make on our own behalf. It is, rather, a gift. Outliers are those who have been given opportunities — and who have had the strength and presence of mind to seize them. (p. 267)

It’s a good book. We should be wary of generalizing, as Gladwell does, from a small sample of cherry-picked cases. (Imagine the outcry from progressives at a book written by someone like Charles Murray that relied on this type of evidence.) Yet Gladwell’s stories are nevertheless compelling, and the details nicely illustrate what large, representative samples can’t.

My chief complaint about Outliers concerns Gladwell’s choice to frame his key causal factor as opportunity rather than luck. This leads to some odd interpretations and policy recommendations.

Consider Joe Flom, an attorney whose story is recounted in chapter 5. Because he is Jewish, Flom is denied jobs at the top corporate law firms in New York City in the 1940s, despite his top-flight educational credentials and evident ability. He joins a small start-up firm and focuses on hostile takeovers. At the time such takeovers were rare, so this wasn’t an especially lucrative line of business. But decades of practice puts Flom and his firm in perfect position to benefit when hostile takeovers become common in the 1980s, and he ends up rich and famous. Is it best to think of the discrimination Flom encountered as an “opportunity”? Or would we do better to label it (initially bad, then good) “luck”?

Gladwell’s main recommendation is that we as a society extend to everyone the thing that so benefited his success stories. He calls it opportunity. But he suggests that the key for Bill Gates was being at a junior high school that before almost any other had a computer terminal hooked up to a mainframe, living close to a university that provided him free access to a computer system, and having parents who allowed him (or didn’t notice) to sneak out in the middle of the night to use that university computer. For the Beatles it was getting invited, as teenagers, to play long sets for weeks at a stretch at a strip club in Germany. Can these types of “opportunities” be made widely available? Of course not. Their benefits couldn’t possibly be foreseen by a social planner, and in any event they aren’t replicable on a large scale.

At various points in the book Gladwell emphasizes the importance of parents’ traits, attitudes, and behaviors in contributing to success. This plays a central role in the story of Chris Langan, a genius who was raised in circumstances that stifled his capacity to later take advantage of his mental ability. How do we extend to more children the opportunity to experience good parenting? That’s a tall order in a society committed to limited interference in family affairs. As I see it, the only viable strategy here would be to take parenting out of the hands of parents to a greater extent. I don’t mean by force, of course. But if child care and preschool were available at sufficiently good quality and low cost, many less-than-stellar parents might be induced to utilize it. Interestingly, Denmark and Sweden have been engaged in an experiment along these lines since the 1970s, when their governments began providing extensive funding for early education. We have only limited study of the effects, though, and even in these circumstances parents’ impact is likely to be significant.

I’m fully in favor of expanding opportunity. But the real message of Gladwell’s book is that individual success tends to be heavily influenced by luck. That, in my view, should encourage us to think not only about how to increase opportunity, but also about whether a bit more redistribution from the lucky to the less fortunate would be just.

Posted in Book reviews, Inequality | 4 Comments »

Should Congress put a cap on executive pay?

January 4, 2009

Robert H. Frank says no. A wiser approach, he suggests, is to raise tax rates on the highest earners.

I agree. The motivation for limiting executive compensation is understandable. But the logistics of a true cap are problematic, and the merit of singling out executives as opposed to entertainers, athletes, and non-executive financial high-rollers is questionable.

Posted in Inequality, Taxes | 2 Comments »

Luck vs. Effort?

December 21, 2008

What you think ought to be done about inequality likely hinges on your view about whether financial success is determined more by luck or by effort. Progressives generally believe luck matters more, while conservatives say effort does.

This way of framing the question is wrongheaded. It suggests that the traits and behaviors conservatives emphasize — hard work, will, initiative, drive, focus, persistence, discipline — are largely independent of luck. And that encourages progressives to deny or minimize their importance in influencing success.

Thus Matthew Yglesias:

To get rich in the United States you pretty much have to work hard. But the idea that success is due to hard work ignores the fact that there are all these other people working hard and not succeeding. Hard work is much more common than success. And advantages of birth and dumb luck are making the difference — separating the hard-working partner at the corporate law firm from the hard-working guy who moved the furniture into the law firm’s office.

And Ezra Klein:

Since we justify income inequality by understanding success as an outcome of virtue, there’s a tendency to ascribe achievement to diligent effort rather than the market’s amoral decisions to attach high value to certain spheres of labor and low value to others. The important variable for success, however, does not seem to be hard work but profession. If you’re in a high-value profession, hard work can do you a lot of good. If you’re not, it may not do you much good at all.

Drive, diligence, and other virtuous qualities are themselves heavily influenced by luck. They are to a considerable extent a product of factors over which we have no control: our genes, what happens in utero, birth order, our parents’ traits, childhood nutrition and health, early social experiences with peers, stumbling into an occupation that suits our interests and abilities.

Conservatives tend to say the success and rewards that go to Michael Jordan, Warren Buffett, Bill Gates, and others like them are a result not only of their skills and of being in the right place at the right time, but also, perhaps mainly, of their effort. Even if true, this doesn’t diminish the role of luck. For their effort is itself largely attributable to good fortune.

Posted in Behavior, choice, Inequality | 20 Comments »

Presidents and Income Inequality

December 9, 2008

With an incoming Democratic president, should we expect some reversal of the rise in income inequality that has characterized much of the past generation? The following chart, from Larry Bartels’ book Unequal Democracy, suggests reason for optimism. Using Census Bureau data covering the period from 1948 to 2005, Bartels finds a much more egalitarian pattern of income growth under Democratic presidents than under Republican ones.

Bartels’ book is social science at its best: careful empirical research on questions at the forefront of current political and policy debate. His finding of a strong association between president’s party and income inequality is just one of the many interesting and important ones in Unequal Democracy.

That finding seems to have become accepted as an empirical fact by economic and political commentators. A sampling: Dan Balz, Alan Blinder, Tyler Cowen, Kevin Drum, Andrew Gelman, Ezra Klein, Paul Krugman, Andrew Leigh, Brendan Nyhan, Dani Rodrik, Theda Skocpol, Michael Tomasky, Will Wilkinson, Matthew Yglesias, Julian Zelizer.

Is it correct? The story struck me as convincing for the period through the end of the 1970s, but less so for the years since then. So I went to the data. Here’s a summary of my conclusions:

Bartels’ account of the first portion of the post-World War II era seems to me compelling. From the late 1940s through the 1970s, Democratic and Republican presidents tended to have sharply contrasting fiscal and monetary policy orientations. This difference in policies appears to have contributed to sizable differences in income growth for families at various points in the income distribution. Families near the top tended to do equally well irrespective of the president’s party, but families in the bottom 80% fared better under Democrats. Income inequality in the United States changed little over the period as a whole, as increases under Republican presidents were balanced by declines under Democratic presidents.

Since the 1970s the story has been very different. Income inequality has risen sharply, and the correlation between president’s party and movement in inequality has been much weaker.

If we focus on the bottom 95% of the income distribution, as Bartels does, we observe a notable partisan difference in inequality trends and in patterns of income growth in the lower half of the distribution during this period. Contrary to Bartels’ conclusion, this partisan difference exists mainly for pretransfer-pretax income, suggesting that transfer and/or tax policy differences have not been a key driver. To the extent presidents have mattered, the effect seems more likely to have operated via union strength and/or the minimum wage.

To fully understand post-1970s trends in income inequality in the United States, it is critical to include developments at the top of the distribution, which Bartels does not do. If we turn to data that include the top 1%, we find only a weak association between president’s party and changes in inequality since the 1970s. Republican and Democratic presidents have pursued contrasting tax policies, and those policies appear to have made a difference for inequality. But their impact has been swamped by trends in pretax income. At the moment we know relatively little about the factors driving the dramatic increase in the share of economic growth going to those at the top of the distribution, and even less about what role presidents have played.

The following chart is, I think, the best representation of what’s happened since the late 1970s:

The full paper is here.

Posted in Inequality, Living standards, Politics | 6 Comments »

Vote Republican if You Want Equal Pay?

September 13, 2008

In a Wall Street Journal op-ed, Casey Mulligan points out that over the past half century the pay gap between women and men has shrunk more under Republican presidents than under Democratic ones. The following chart shows this. The data are from the Census Bureau.

Mulligan argues that the best way to achieve equal pay is therefore “to work for a labor market that creates opportunities for women like it did during the Reagan and the Bush years.” But as the next two charts indicate, the Republican advantage in closing the gender pay gap owes mainly to slow earnings growth for men during Republican administrations, rather than rapid earnings growth for women.

More here and here.

Posted in Gender, Inequality, Politics | 7 Comments »

Slow Income Growth for Middle America

September 3, 2008

The economic challenges and strains facing middle-class Americans are likely to get a good bit of attention between now and election day, at least from the Obama campaign. They include sluggish income growth, heightened financial insecurity, rising health care and college costs, and falling home values. Each of these is important, but the most critical in my view is slow growth of incomes.

The following chart tells the story. It shows inflation-adjusted GDP per capita and median family income from 1947 (the earliest year for which the income data are available) to 2007. To facilitate comparison of the over-time trends, each is indexed to its 1973 level. Since the mid-to-late 1970s, growth of income at the median has been slow — very slow — relative to growth of the economy. The current decade, with no improvement at all in median income, is especially striking.

The dashed line in the next chart shows what median income would have looked like had it risen in sync with per capita GDP. The difference is huge: in 2007, the median family’s income would have been $91,000 instead of $61,000.

Various excuses and rationalizations have been offered: It’s okay because Americans now get more in employer benefits instead of in their paycheck. Family size has shrunk, so slow income growth isn’t a big deal. A lot of those in the bottom half are immigrants, and even with slow income growth they’re better off than they would have been in their native country. None of these is compelling (see here or here).

The disconnect between economic growth and middle-class income growth is due largely to rising inequality. In the past several decades much of the economy’s growth has gone to those at the top of the income distribution.

Faster income growth wouldn’t render other middle-class strains irrelevant. But it would help.

Posted in Inequality, Living standards, Middle class | 26 Comments »

Jobs with Equality

July 31, 2008

My new book is titled Jobs with Equality. It’s available from Oxford University Press (the publisher), Amazon, Barnes and Noble, and others.

I’ve put the introductory chapter online.

Here’s a summary:

Income inequality has been rising in many of the world’s affluent countries, due to a variety of economic and social shifts. Redistribution can help, but government revenues are threatened by globalization and population aging. Like a growing number of observers, I see an increase in the employment rate as a way out of this impasse; it enlarges the tax base, allowing tax revenues to rise without an increase in tax rates. The question is: Can egalitarian institutions and policies be coupled with employment growth?

In the book I assess the experiences of rich nations since the late 1970s. I examine the impact on employment of six key policies and institutions: wage levels at the low end of the labor market, employment protection regulations, government benefit generosity, taxes, skills, and women-friendly policies.

It turns out that there is no parsimonious set of institutions and policies that have been key to good (or bad) employment performance. The comparative experience features multiple paths to employment success, including low-inequality ones. This suggests reason for optimism about possibilities for a high-employment, high-equality society.

Cover blurbs:

“This new book is a worthy successor to Lane Kenworthy’s much-acclaimed Egalitarian Capitalism. Combining academic rigor with a reader-friendly style, he explores how we might reconcile what many consider incompatible goals: more employment and greater equality. Drawing on systematic and empirically rich analyses, Kenworthy argues against any simplistic policy formula. The book makes especially lucrative reading when, in the latter half, it identifies the key ingredients of a win-win strategy. Jobs with Equality is destined to generate debate, all-the-while that it affirms Lane Kenworthy’s status as a leading scholar of social inequality.”  — Gøsta Esping-Andersen, Universitat Pompeu Fabra

“On the premise that high employment is essential to the realization of egalitarian goals in the contemporary era, this important book explores how social policies and institutional arrangements in advanced capitalist societies have affected employment growth over the last three decades. Kenworthy synthesizes existing literature and presents new empirical findings based on original cross-national data and measurements. His most important contribution is to explore multiple determinants of employment performance and interactions among these determinants in systematic fashion. Very sensibly, the analysis yields policy recommendations that are specific by institutional context. For students of comparative political economy, the particular questions that Kenworthy addresses are now settled for some time to come.” — Jonas Pontusson, Princeton University

Chapter list:

1. Introduction

PART I   EQUALITY

2. Why Should We Care About Inequality?

3. Sources of Equality and Inequality: Wages, Jobs, Households, and Redistribution

PART II   JOBS

4. Measuring and Analyzing Employment Performance

5. Low-End Wages

6. Employment Protection Regulations

7. Government Benefits

8. Taxes

9. Skills

10. Women-Friendly Policies

11. Toward a High-Employment, High-Equality Society

Posted in Abroad, Employment, Inequality, Living standards | 7 Comments »

Rising Inequality Hinders Upward Mobility

July 27, 2008

We expect that each generation of Americans will have higher incomes than preceding ones — that, in other words, there will be upward absolute intergenerational mobility. Data from a report by the Economic Mobility Project suggest some reason for concern.

The data are for various generations of families with a man in his thirties, thereby holding stage of the work career constant. The question is how much family income (adjusted for inflation) increases across generations, with a generation defined as 30 years. As the following chart shows, the median income of these families increased by about $12,000 between 1964 and 1994. Between 1974 and 2004, in contrast, it increased by only $4,500. The gain from generation to generation declined. And this is despite the fact that a growing share of these families have two earners rather than just one.

This could be because economic growth slowed. Or it could be due to rising inequality; a larger and larger share of the economy’s growth has gone to families at the high end of the distribution and less and less of it to the rest.

The second chart here suggests that rising inequality may have been more important than slow economic growth. From 1964 to 1994, the average annual growth rate of GDP per capita was 2.2% and the growth rate of median income for families with a man in his thirties was 0.9%. From 1974 to 2004, GDP per capita grew at an annual rate of 2.0% while median income for families with a man in his thirties grew at 0.3%. The drop in income growth across generations was much sharper than the drop in growth of the economy.

Upward mobility is a key element of the American ethos. Slowing inequality’s march would help (more here and here).

Posted in Inequality, Living standards, Mobility | 8 Comments »

Is the U.S. a High-Inequality Country if Mobility Is Taken into Account?

July 20, 2008

Here is the conventional wisdom about income inequality in the United States compared to other rich countries:

The U.S. is the most unequal.

However, these data are based on households’ income in a single year. Averaging income over multiple years tends to reduce measured inequality. This is because of mobility; some people move up and/or down in the distribution over time. If the United States has more such mobility (relative intragenerational mobility) than other countries, the conventional single-year measure shown in this chart may overstate U.S. inequality relative to other countries.

Does the U.S. improve if we measure inequality using income averaged over a longer period of time?

Markus Gangl (University of Wisconsin), Joakim Palme (Institute for Futures Studies in Stockholm), and I have a paper that averages income over 18 years in Germany, Sweden, and the United States. Eighteen years isn’t a full work life, but it’s the best we can do with existing panel data sets. The following chart shows the findings. As the number of years over which income is averaged increases, the amount of measured inequality decreases. But it decreases at the same rate in each of the three countries. America’s position does not improve.

The full paper is here.

__________

* These numbers are my calculations from the Luxembourg Income Study database. To make them as comparable as possible to the data in the second chart here, they’re for households with a head age 25 to 59. Income is with government transfers included and taxes subtracted.

Posted in Abroad, Inequality, Mobility | 10 Comments »

Rising Inequality Has Not Been Offset by Mobility

July 13, 2008

Income inequality in the United States is typically measured with data from a survey that asks around 50,000 households what their income was in the previous year. According to these data, inequality has increased sharply since the 1970s (see the second chart here).

But this survey includes different households each year. It therefore misses any mobility — movement of households up and down in the distribution over time — that occurs. If mobility has increased, the conclusion that there is more inequality might be misleading. Even if the gap between the top and bottom increases over time, if households change places with greater frequency, the inequality of their average income — “true” inequality — may have stayed more or less the same. Rising mobility can offset rising single-point-in-time inequality.

The type of mobility at issue here is relative intragenerational income mobility. Has it increased in recent decades?

To find out, we need panel data — data for the same households (or individuals) over a number of years. There are three main sources of such data. Each suggests the same conclusion: relative intragenerational income mobility in the United States has not increased.

A standard way to assess mobility is to divide households into quintiles (five equally-sized groups) based on their income at the starting time point. Then we look at the share of each of these groups that moves up (or down) in the distribution between time 1 and time 2. More movement indicates more mobility.

One source of data is the Panel Study of Income Dynamics (PSID), a panel survey of nearly 8,000 households begun in 1969. The following chart shows the share in each of the bottom four quintiles that moved up over three successive decades beginning in 1969. (There’s no significance to the choice to show movement up; the graph could just as well show the share moving down. The point is whether the shares increase over time.) The shares were calculated by Katharine Bradbury and Jane Katz. (See also this earlier analysis by Peter Gottschalk and Sheldon Danziger.) There is no indication of an increase in mobility from the 1970s to the 1980s to the 1990s.

A second data source is income tax returns, which are analyzed in a U.S. Treasury Department report (see table A-5). The data are from a sample of returns filed by taxpayers age 25 or older in the initial year. Here too the period examined is roughly a decade. In this study there are two periods: 1987-96 and 1996-2005. The next chart shows the shares moving up in each of the two periods. Again the data do not indicate an increase in mobility.

A third data source is Social Security earnings records. These records are available since 1937. Wojciech Kopczuk, Emmanuel Saez, and Jae Song have used them to study changes in earnings mobility. They conclude that “short-term and long-term mobility among all workers has been quite stable since 1951.”

The fact that all three data sources suggest the same conclusion doesn’t necessarily mean it’s correct, but it offers good reason to favor that conclusion. Rising income and earnings inequality in the United States does not appear to have been offset by increased mobility.

Posted in Inequality, Mobility | 5 Comments »

Can Mobility Offset an Increase in Inequality?

July 6, 2008

Income inequality in the United States has increased since the 1970s. Has that increase been offset by mobility?

It could be. Half a century ago Milton Friedman (in Capitalism and Freedom) suggested sensibly that a proper understanding of inequality requires taking mobility into account:

“A major problem in interpreting evidence on the distribution of income is the need to distinguish two basically different kinds of inequality: temporary, short-run differences in income, and differences in long-run income status. Consider two societies that have the same distribution of annual income. In one there is great mobility and change so that the position of particular families in the income hierarchy varies widely from year to year. In the other, there is great rigidity so that each family stays in the same position year after year. Clearly, in any meaningful sense, the second would be the more unequal society.”

Some find the following metaphor (originally from Joseph Schumpeter) helpful. Think of an apartment building with units of varying size and quality. It has a few penthouse suites that are large and feature lots of amenities, a multitude of modest two-bedroom units, and a number of barebones single-room units. This is inequality. Suppose, however, that the residents regularly switch units. Most people live much of the time in the low- or mid-level units, but they go back and forth between these, and many occasionally get to live in a penthouse suite. This is mobility. (Specifically, it’s relative intragenerational mobility.) This mobility reduces the amount of inequality — true, genuine, long-run inequality — among the residents.

Income mobility does reduce income inequality. When inequality increases, however, mobility has to also increase if it is to offset that rise in inequality.

This is a simple, perhaps obvious point. But it’s an important one. The rest of this post illustrates it with the aid of some graphs.

To begin, imagine 100 households at two points in time. Suppose, for simplicity, that there are five different incomes in the society at time 1 and one fifth of the households have each of these incomes. (It’s not important for the illustration, but the incomes I use in these charts are the average after-tax incomes of the five quintiles of the U.S. income distribution in 1979 and 2005. The data are here.)

In one scenario, shown in the first chart, no household’s income changes from time 1 to time 2. Each household’s average income is therefore the same as its income at each point in time. “True” inequality — inequality when income is averaged over time 1 and time 2 — is the same as single-point-in-time inequality.

In another scenario, depicted in the second chart, the income levels stay the same at the second point in time. The level of single-point-in-time inequality is thus the same at time 2 as at time 1. But some of the households switch places. Some that start with the lowest income move up to the lower-middle, others to the middle, and a few to the top two incomes. Similarly, some that begin at the top stay there, while others move down.

For each household, the plus (+) and hollow circle (o) indicate its income at time 1 and time 2, respectively, while the solid marker (♦) is its average income. The pattern of the solid markers makes it clear that inequality of average income is lower in this scenario than in the first chart; lots of households’ average income is in between the five levels of the first chart. The Gini coefficient confirms this. The Gini is a standard measure of inequality; it ranges from zero to one, with larger numbers indicating greater inequality. The Gini for average income in the mobility scenario is .286 (second chart), compared to .320 in the no-mobility scenario (first chart).

Now consider what happens when single-point-in-time inequality increases from time 1 to time 2, as has happened in the United States since the 1970s.

The third chart shows a society in which inequality increases from time 1 to time 2 and there is no relative mobility. With the rise in single-point-in-time inequality, inequality of average income is greater than in the first chart. The Gini is .373 in the third chart, compared to .320 in the first chart.

Can mobility offset this rise in inequality? The fourth (and last) chart shows a scenario in which single-point-in-time inequality increases exactly as it did in the third chart but there is relative mobility. The amount of mobility is the same as in the second chart; the same number of households move up or down among the quintiles and by the same (relative) amount.

Mobility does reduce “true” inequality compared to the no-mobility scenario depicted in the third chart. But the Gini coefficient for the fourth chart is much larger than for the second chart. These two scenarios have the same amount of relative mobility. But with single-point-in-time inequality having risen in the fourth scenario between time 1 and time 2, the same degree of relative mobility does not produce the same amount of “true” inequality (inequality of average income).

The bottom line: Income mobility helps to reduce income inequality. But if single-point-in-time inequality rises, mobility can only offset that rise if it too increases.

Single-point-in-time income inequality has risen sharply in the United States since the 1970s. Has mobility increased too? Stay tuned.

Posted in Inequality, Mobility | 5 Comments »

More on Inequality and Prices

May 21, 2008

Will Wilkinson defends the notion of separate price indexes for the poor and the rich. I don’t have a problem with that per se. The point I tried to make in my previous post concerns its relevance for our assessment of how much inequality has increased.

In his original post on this, Wilkinson writes “If you think economic inequality matters, that’s because you think relative economic well-being matters. If you think economic well-being matters, then what you care about is consumption, not income.” I disagree. We should care about inequality of income not simply because it contributes to inequality of well-being, but also because it contributes to inequality of capability.

Even if consumption inequality has increased only a little, the rise in income inequality has produced a noteworthy increase in inequality of capability. The rich aren’t forced to purchase goods and services whose prices have increased more rapidly; they could switch to the same consumption bundle as the poor if they wished.

In my view the Broda and Romalis analysis is important for our understanding of (absolute) poverty, rather than inequality. They find that the prices of goods poor Americans tend to purchase have risen less rapidly than the overall inflation rate. I can’t assess whether they’ve accurately analyzed the data and how much measurement error the data contain. But if the finding is correct, it suggests that the trend in living standards for America’s poor was more favorable (or less unfavorable) between 1994 and 2005 than income data imply.

Posted in Inequality, Poverty | 17 Comments »

Inequality and Prices

May 20, 2008

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.

Posted in Inequality | 14 Comments »

Top Incomes in the U.S. and Abroad

May 11, 2008

A key aspect of the rise in income inequality in the United States since the 1970s is the soaring incomes of the top 1%. Is this development unique to the U.S.?

Tony Atkinson, Andrew Leigh, Thomas Piketty, Emmanuel Saez, and others have used tax records to estimate the top 1%’s share of total income in a number of countries. Leigh has made a few adjustments to enhance comparability across the countries and posted the data on his website. He has a nice paper on the issue, which includes a version of the two charts shown below. (For more data and analysis see here, here, here, here, and here.) The data are for pretax incomes excluding capital gains.

It turns out that other English-speaking countries have experienced a similar trend:

Is this, then, simply the norm? No. In other affluent nations, the top 1%’s income share has increased only slightly or not at all during this period:

What accounts for these differing developments? We don’t know. Hypotheses abound, including differences in market competition, norms, labor power, government partisanship, tax systems, corporate governance practices, and demand for entertainment, athletic, and English-speaking executive talent. Because the data are relatively new, however, there has been limited systematic analysis as of yet.

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