Posts tagged ‘income inequality’

On Income Inequality

Most folks who lament income inequality have the following model in their head:  Wealth comes at a fixed rate from a fountain in the desert, and the rich are the piggy ones who hog all the output of the fountain and won't let anyone else in close to drink.  The more anyone takes from the fountain, the less that is available for everyone else.  And this was probably a pretty good model for considering pre-capitalist societies.  The actual robber barons, before the term was abused to describe successful industrialists of the 19th century, were petty nobles (ie the government of the time) who did absolutely nothing useful except prey on those around them and on those who passed by conducting rudimentary commerce, taking from them by force.  That is not how most people become wealthy today, with the exception of a few beneficiaries of cronyism (e.g. Terry McAuliffe).

These issues are dealt with quite clearly from a surprising source -- this review by an economist of the movie "Elysium".   I don't really get the schtick at the end with the Adam Smith cameo, but the rest is quite good

Postscript:  A while back I was reading the Devil's Candy (terrific book) and thinking about movie-making.  Perhaps it is not surprising that wealthy movie stars think in zero-sum terms.  I suppose much of their success can be thought of as zero-sum.  If I get the part, someone else does not.  If I get an extra point of the gross, that is less for everyone else.  If this movie does well, that probably means less revenue for another movie that came out the same weekend.   Particularly for actors trying to make it or on the rise, movies have a fixed sum of value and they are trying to grab a larger share of that value.

It is interesting that in their own sphere of influence, I never hear about such folks seeking any sort of income redistribution.  Perhaps I have missed it, but I never hear Matt Damon say "hey, take one of my gross points and split it up among all the craft folks on the movie, or share it out with the 20 guys who didn't land my part."

Inequality Metrics Exclude Effects of Government Actions to Reduce Inequality

I have seen this fact a number of times and am always amazed when I read it, since poverty figures are never, ever presented with this bit of context

LBJ promised that the war on poverty would be an "investment" that would "return its cost manifold to the entire economy." But the country has invested $20.7 trillion in 2011 dollars over the past 50 years. What does America have to show for its investment? Apparently, almost nothing: The official poverty rate persists with little improvement.

That is in part because the government's poverty figures are misleading. Census defines a family as poor based on income level but doesn't count welfare benefits as a form of income. Thus, government means-tested spending can grow infinitely while the poverty rate remains stagnant.

Rector argues that poor today is very different than poor in  Johnson's day, and that perhaps we might celebrate a bit

Not even government, though, can spend $9,000 per recipient a year and have no impact on living standards. And it shows: Current poverty has little resemblance to poverty 50 years ago. According to a variety of government sources, including census data and surveys by federal agencies, the typical American living below the poverty level in 2013 lives in a house or apartment that is in good repair, equipped with air conditioning and cable TV. His home is larger than the home of the average nonpoor French, German or English man. He has a car, multiple color TVs and a DVD player. More than half the poor have computers and a third have wide, flat-screen TVs. The overwhelming majority of poor Americans are not undernourished and did not suffer from hunger for even one day of the previous year.

Remember what I presented a while back.  This is what the Left thinks, or wants us to think, American income inequality looks like -- our rich are richer than comparable European welfare states because our poor are poorer.

click to enlarge

And this is what income inequality in the US actually looks like -- our rich and middle class are richer, but our poor are not poorer.  A less redistributionist approach floats all boats.  I compared the US to many European welfare states, using the Left's own data source.  Here is an example, but hit the link to see it all.

click to enlarge

Do We Care About Income Inequality, or Absolute Well-Being?

I have a new column up at Forbes.com, and it addresses an issue that has bothered me for a while, specifically:

Do we really care about income inequality, or do we care about absolute well-being of our citizens?  Because as I will show today, these are not necessarily the same thing.

What has always frustrated me about income inequality arguments is that no one ever seems to compare the actual income numbers of the poor between countries.  Sure, the US is more unequal, and I suppose from this we are supposed to infer that the poor in the US are worse off than in “more equal” countries, but is this so?  Why do we almost never see a comparison across countries of absolute well-being?

I have never been able to find a good data source to do this analysis, though I must admit I probably did not look that hard.  But then Kevin Drum (in a post titled “America is the stingiest rich country in the world”) and John Cassidy in the New Yorker pointed me to something called the LIS database, which has cross-country income and demographic data.  I can't vouch for the data quality, but it has the income distribution data and it struck me as appropriate to respond to Drum and Cassidy with their own data.

In short, Cassidy made the point that the Gini coefficient (a statistical measure of income inequality) was higher in the US than for most other wealthy western countries.  Drum made the further point that the US is "stingy" because we do the least to coercively alter this pattern through forced redistribution.

But all we ever see are Gini's are ratios.  We never, ever see a direct comparison of income levels between countries.  So I did that with the data.  I won't reiterate the whole article here, but here is a sample of the analysis, in this case for Sweden which has one of the lowest Gini ratios of western nations and which Drum ranks as among the least "stingy".  This is the model to which the Left wants us to aspire:

click to enlarge

 

I argue that the purchasing power parity(ppp) numbers are the right way to look at this since we are comparing well-being, and on this basis Sweden may be more equal, but more than 90% of the people in the US are better off.  Sweden does not have a lower Gini because their poor are better off (in fact, if you consider the bottom quartile, the poor are better off in the US).

We are going to see months of obsession by the Left and Obama over income inequality -- but which country would you rather live in, even if you were poor?

Read the whole thing, there are lots of other interesting charts.

Wal-Mart and GINI

I am working on some posts on income inequality, especially as compared between nations.  One thing I have been thinking about is whether the US GINI (a measure of income inequality) is overstated because the US has a tiered retail system that gives lower income people access to lower prices (though for sometimes lower quality goods).  We have Wal-Mart and Family Dollar, discount retail concepts that are rare, and often illegal (due to limitations on retail discounting) in European countries.

On a sort of purchasing power parity basis, I wonder if this has any impact in narrowing the US effective GINI.  Of course, this mitigating factor is somewhat mitigated itself by the fact that a number of urban areas with some of the poorest families (e.g. Washington DC) restrict entry of these low-cost retail establishments.

I Would Go Where the Jobs Are

Bloomberg does a ranking of where one should go if he is unemployed.  Before we go to their ranking criteria, lets think about what criteria I would recommend to someone:

  1. Go where the jobs are.  Duh.  Pay particular attention to where there are jobs that match your skills, but in general a rising tide will lift all boats (e.g. you don't just have to be an oil field worker to find opportunity in North Dakota, they are paying a fortune for waitresses and retail clerks to handle the new demand).
  2. Look at pay for your skills vs. cost of living.  Manhattan may pay the most for waitresses but living costs there are insane.  You can get good work in Vail, Colorado over the winter but good luck finding a low cost place to live anywhere nearby.
  3. Think about tax rates.  You may be exempt now, but hopefully as things get better you will care about income tax rates, and if you are unemployed you certainly are going to care about sales tax rates

OK, so let's look at Bloomberg's ranking criteria.  They also have three:

  1. Unemployment rate.  So far so good.  Go where the jobs are.
  2. State unemployment payment rates.  Seriously, their criteria is not cost of living or average payments for new workers, but how much one can extract from the government for NOT working?  But OK, this still makes some sense  (though there are a lot of barriers to crossing state lines for a better unemployment deal).
  3. Income inequality.  WTF?  What in heavens name does this have to do with unemployed people and how easily they can improve themselves.  Is this psychological -- ie you will feel worse about being unemployed if there are a lot of rich people around?  The average unemployed American is a service worker (if you are a skilled manufacturing worker, say a machine operator, and can't find work, you are in a minority).  Rich people drive demand for service workers.

Today's Quiz

What state has the highest income inequality?

Hint:  Think Hunger Games

 

 

 

Answer here.  It turns out that this was a trick question.  It was not any of Districts 1 through 50.  It is the Capitol, the District of Columbia.  By far.  Second place New York (district one) is not even close.

Land Use Regulation and Income Inequality

I don't have time to comment or peruse the study in depth, but this looks interesting.  From Randal O'Toole:

Harvard economists have proven one of the major theses of American Nightmare, which is that land-use regulation is a major cause of growing income inequality in the United States. By restricting labor mobility, the economists say, such regulation has played a “central role” in income disparities.

When measured on a state-by-state basis, American income inequality declined at a steady rate of 1.8 percent per year from 1880 to 1980. The slowing and reversal of this long-term trend after 1980 is startling. Not by coincidence, the states with the strongest land-use regulations–those on the Pacific Coast and in New England–began such regulation in the 1970s and 1980s.

Forty to 75 percent of the decline in inequality before 1880, the Harvard economists say, was due to migration of workers from low-income states to high-income states. The freedom to easily move faded after 1980 as many of the highest-income states used land-use regulation to make housing unaffordable to low-income workers. Average incomes in those states grew, leading them to congratulate themselves for attracting high-paid workers when what they were really doing is driving out low- and (in California, at least) middle-income workers.

As Virginia Postrel puts it, “the best-educated, most-affluent, most politically influential Americans like th[e] result” of economic segregation, because it “keeps out fat people with bad taste.” Postrel refers to these well-educated people as “elites,” but I simply call them “middle class.”

I have not read the study, but I think the word "proven" in the first sentence likely goes to far.  Economic systems are way too complex to absolutely show one variable among millions causes another.  I am convinced that the way we have regulated the housing market and promoted home ownership has reduced labor mobility.

OWS and Philip Rearden

I have been reading a lot of the data flying around of late about income inequality and mobility.  And it struck me that income mobility may be a large part of what is driving many OWS protesters.

Despite assumptions to the contrary on the Left, wealth is not a zero-sum game.  Steven Jobs got richer by making me better off.  But the one thing that is zero-sum is presence in the top 1%.  When someone joins the club, someone, by operation of basic math, drops out.

That does not mean that the other person who drops out is poorer, it just means that they are no longer as rich relative to their peers.  This same effect works int he top 10% and 20%, etc.

Looking at OWS protectors, they seem to be disproportionately children of the upper middle class or even of the rich.  They have expensive college educations, live in nice homes, and have gobs of stuff (OWS must be the most iPhoned event in history).  My guess is that they are of the upper two quintiles, or at least their parents were.

I am wondering if the problem is not income inequality but too much income mobility.  After all, a third of the top two quartiles in 2001 had dropped into the bottom three in 2007 (while an equal number moved up). Are these the angry proletariat, or are they children of the well-off who are upset their college degree in puppetteering did not automatically keep them up with the Joneses?   Are they, in other words, Philip Rearden?

 

Speaking of Income Distribution

This chart, from a book by Branko Milanovic via Carpe Diem reinforces a point about income distribution I make all the time -  for all we talk about income distribution in this country, our poorest 20% would be middle class in many countries of the world.  While I would love to see our poor doing even better, it begs the question of whether distribution or absolute prosperity is more important.

Just to give you a feel for reading the chart, the US's lowest ventile, or bottom 5%, have income that would put them in the 68th percentile worldwide.    Our poorest 20% (the first 4 ventiles) would be upper middle class or better in Brazil, China, and India.

When comparing to European social democracies, it turns out that while the US's income distribution is wider, that is almost entirely due to the top end being higher.  The poorest 10% make about the same as the poorest 10% in Europe, and I would argue that this analysis (from a leftish think tank) actually underestimates a quality of life advantage for American poor, who come out higher even than the middle class in Europe on things like living space and appliance ownership.

Perhaps more importantly than income inequality, income mobility remains high in this country. More on income inequality concerns here.

Why Are Democrats Promising to Raise Prices?

My new column is up at Forbes, and is on the Democratic push to raise the prices of Chinese goods (either through currency policy or tariffs).  This has to be one of the craziest campaign themes of all time -- please, let us raise your prices.

We should be thrilled that the Chinese government and its people see fit to spend their own money to subsidize lower prices for American businesses and consumers.  Last week, President Obama put substantial pressure on the Chinese prime minister to revalue Chinese currency, a revaluation that would have the effect of raising prices of all Chinese goods in the United States.  What possible sense does such a move make, particularly in a recession?

Christian Broda and John Romalis, a pair of University of Chicago economists, have been doing work on income distribution.  A couple of years ago they published a paper that showed how our measures of income inequality may be exaggerated because the metrics assume that both rich and poor experience the same rate of inflation.  In fact, the researches found, over the last decade or so the poor have seen much lower rates of inflation than the rich, in large part due to goods of the type imported by China and sold at Wal-Mart (another institution Democrats like to demagogue against).

Sadly, prices for low-income Americans could be even lower were it not for past protectionist measures.  When one looks at the goods that have the highest import tariffs, one sees the very same goods that typically make up a disproportionate share of the poor's purchases:  Tobacco, clothing, tires, auto parts, fruits and vegetables.  All of these have their prices raised 20-350 percent by import tariffs.

This means that at the same time Democrats have again raised issues of rising income inequality, they are trying to stop some of the most powerful forces at work mitigating these income differences.  There is no question that if Democrats are successful in changing China's currency policy and/or imposing new tariffs (taxes) on Chinese goods, prices will rise for all Americans, but particularly so for the lower income brackets that are supposedly the Democrats' constituency.

The most frustrating part of this whole effort is that it is aimed at a myth: the declining American manufacturing base.  In fact, American manufacturing output continues to hit new all-time highs "” despite the current recession, American manufacturing output today is still 40% higher than it was in 1990.

Wal-Mart and Income Inequality

First, I have not doubt that income inequality--  in whatever way the folks who care about such things measure it -- has increased.  The analysis that has been making the rounds of liberal blogs show the rich "capturing a higher share" of total output.  The very terminology here reveals their faulty core assumption, treating wealth as a zero-sum that must be grabbed and fought for and can only be gained to someone else's disadvantage.  They always write about incomes as if GDP is a sort of natural fountain in the desert, and the piggy rich crowd in too close to get more than their fair share of water from the fountain.

This is silly.  Wealth is created from the minds of human beings, and there are human minds that create far more wealth than others, and are able to keep some of that wealth for themselves as a reward.  I say "some" because even the richest people tend to keep only a small percentage of the wealth they create.  Sum up the benefits we all get from our iPods and iPhones and iPads, and the total number dwarfs what Apple shareholders have made from these devices.

Anyway, the actual point of this post was to revisit the notion that there are different inflation rates for the rich and poor (via Carpe Diem) that may be skewing income inequality numbers

Using scanner data on household consumption of non-durable goods between 1994 and 2005, we document that the relative prices of low-quality products that are consumed disproportionately by low-income households were falling over this period. This implies that non-durable inflation for the 10th percentile of the income distribution has only been 4.3 percent between 1994 and 2005 (0.4 percent per annum), while the non-durable inflation for the 90th percentile has been 11.9 percent (1.0 percent annually), and 13.4 percent (1.2 percent annually) for the richest 5 percent of households in the sample (see chart above)."...

"A large literature has focused on the rising inequality observed in official statistics, but have mostly abstracted from the fact that these official measures are based on a single price index for a representative consumer. This assumption is not crucial in a world with a stationary relative price distribution or where an identical basket of goods is consumed by different income groups. However, using household data on non-durable consumption, we document that the relative prices of low-quality products that are consumed disproportionately by low-income consumers have been falling over this period.

This fact implies that measured against the prices of products that poorer consumers actually buy, their "real" incomes have been rising steadily. As a consequence, we find that around half of the increase in conventional inequality measures during 1994"“2005 is the result of using the same price index for non-durable goods across different income groups. Moreover, given that the increase in price dispersion does not seem to be specific to our sample or time period, the overstatement in the increases in inequality from official measures can be even more significant, changing our view of how progress has been distributed in recent decades substantially."

The price of a night at the Four Seasons has gone up more than the price of a shirt at Wal-Mart.

Immigration and Income Inequality

Income inequality was the topic de jour during much of the election.   The left argued that median wages had stagnated, and tried very hard to date this stagnation from 1980 so that it could be blamed on Ronald Reagan.   Others have argued that the the whole median family wage stagnation thing was overblown, as 1) families had changed alot over 30 years;  2) Compensation had changed (such that wages were less of total compensation with the rise in value of health care plans); and 3) individuals matter, not quartiles, and individuals were doing well and still had mobility between income bands.

My sense is that the income inequality numbers have always been fraught with problems.  For example, rich people have huge incentives to manage the income numbers on their tax returns, so trying to draw conclusions about top earners from their tax returns is a bit dangerous.  Just the shift from C to S corps and LLC's over the last 30 years has fundamentally shifted what income high net worth entrepreneurs show on their tax returns.

All that being said, I think it is clear the income gap has grown, and it really started growing in this country around 1970.  Whether this matters is a different story - its clear from comparing to European countries that while our gap has spread vs. their income gaps, its almost 100% because our rich are richer than their rich.  Our lowest quintile is pretty comparable (here).  If that is the case, its an interesting question to see if this bothers folks.

Anyway, I think there still is work to be done to fully explain and rationalize these income inequality numbers.  But I still find it hard to believe they are not somehow related to immigration.  After all, dropping 20 million new immigrants, many of them quite poor, into the bottom quintile of US workers over the last 20 years certainly tends to pull down medians.  Just compare these two charts, with income inequality on the top and the percentage of residents in any given year that are foreign-born (legal or illegal immigrants).  I fitted the two charts together manually to get the time scales to line up, I don't have time to replot them together as I should.  Click to enlarge.

income-inequality

Its hard to see, by the way, how the top chart really reflects a trend starting with Reagan (as much as the left so desperately wants it to be true).  Something happened around 1970 to reverse the curve.  I have offered one possible cause.  I do so reluctantly, because I don't want to be misunderstood -- I am a big supporter of open immigration and would hate to give the anti-immigration folks any ammunition.

Anyway, you are welcome to discuss.  It is something I am thinking about but don't have an answer for.

Postscript: This is the chart comparing the top and bottom US deciles to countries in Europe on an absolute dollar basis. The conclusion I draw is that our poorest are in about the same shape as the poorest in Europe, but our rich are richer than in Europe.  Given this, does our income inequality still worry you?

http://www.coyoteblog.com/photos/uncategorized/2007/08/30/study2.gif

The reason the analysis is done this funny way is that what one usually sees is some country like Chad with the poor at 80% of the median income.  But 80% of almost nothing is still almost nothing.  So this chart converts everyone to apples and apples - almost.  I still think it underestimates how well off the US poor are, maybe some sort of exchange rate vs. PPP problem.

Differential Inflation

I am seeing an increasing number of articles of late about differential inflation rates, and how changes in income inequality may be overstated by using a single inflation rate for rich and poor.  The argument goes that lower income folks who spend a relatively high share of income on goods that Wal-Mart and China have made cheap are experiencing a lower inflation rate than wealthier folks who have seen huge price increases at their favorite Four Seasons resort.  Mark Perry has two interesting articles along these lines.

US Poverty Rate

Tyler Cowen links to Lane Kenworthy Saying:

]Poverty comparisons across affluent nations typically use a "relative"
measure of poverty. For each country the poverty line "” the amount of
income below which a household is defined as poor "” is set at 50%
(sometimes 60%) of that country's median income. In a country with a
high median, such as the United States, the poverty line thus will be
comparatively high, making a high poverty rate more likely...

There is actually at least one study out there by a left-leaning think tank that sort of addresses this (though not exactly).  The study first shows US and European income of the bottom 10 percentile vs. the median income of that country.  Not surprisingly, since US median income is so high, the bottom 10 percentile have a low share.  BUT, they then do the numbers a second, time, showing the bottom 10 percentile income in each country all compared to US median income, ie all with the same denominator,  here, the US poor do at least as well as most European countries.  The comparison shows clearly that while the US has more income inequality, it is not because our poor are poorer but because our rich and middle class are richer.   Here is that second study:

Study2

Poverty Ain't What it Used to Be

The Heritage Foundation has an interesting study out on the population that lives below the poverty line.  While we typically get lots of headlines like "A million more people in poverty,"  the real headline should be "Poverty ain't what it used to be."  Create a mental image for yourself about poverty then read the first part of the article.

I won't repeat the studies points -- you can read them at the link or you have probably seen the study already linked around the blogosphere (e.g. Captains Quarters, Cato-at-Liberty, Reason, Maggie's Farm).  Reading the descriptions, its clear that most of our visual images and assumptions about US "poverty" don't line up well with this list.   This is by design.  Progressives who want more transfer payments and more government interventionism work hard to create a stark mental image of poverty through anecdotes, and then try to apply that mental image to a much larger population based on a very different definition of poverty than in this mental image. 

However, this approach may be set to backfire.  By defining poverty broadly to try to pump up the numbers, they are at risk of people losing sympathy for the poor.  I can see the progressive reaction now -- they are going to say (correctly) that buried in these numbers are a hard core of people who are really destitute.  And they are correct.  But they only have themselves to blame for burying these folks in a larger group whose lives don't match our mental picture of poverty.  And the poverty numbers aren't the only place where this approach is taken. 

I am sure you have heard the commercials that say something like one in six kids in America are hungry.  It's a crock.  There are at most perhaps 2-3 million people in this country who are really destitute.  The Census department found that only 6% of the people below the poverty line, about 2 million people, reported they sometimes did not have enough food to eat.  Sure, that sucks.  Which is why I volunteer with my kids at the local food bank.  But it's way, way short of the numbers activists try to use to justify huge new government programs and transfers.

Other thoughts

One issue not discussed, but covered in other studies, is the transience of people in the bottom quintile of income.  Most of us imagine the same people in poverty survey after survey, and again that is probably true for the hard core of 2-3 million.  But many of the rest move out of poverty over time.  In particular, we have had a huge influx of immigrants (legal and illegal) over the last several decades.  These folks are all counted in the poverty numbers.  Many immigrants arrive below the poverty line, and then work their way out of it. 

In a related post, Brad DeLong looks at what life was like even for the well off in 1900, and one can easily come to the conclusion that being poor today might be better than well off in 1900.  I made a similar point in this post, when I compared the life of the very rich in 1850 to the middle class today.  All of this is empirical proof that wealth is not zero-sum, as assumed by progressives, but is created and expends.  My post of the zero-sum wealth fallacy is here.

I've made the point for a long time that our poor are better off than the middle class in most countries of the world.  This living space comparison is an example - our poor typically have more living space in their homes than the middle class in Europe, or the well-to-do in many other countries.  But there is always that issue of income inequality that is raised, to which I typically answer "so what?"  If the poor are better off in the US, does it matter if the rich are really, really better off?  Note sometime the language that is always used in income inequality discussions.  You will hear folks talking about the "share of total income" as if income is a spring bubbling up in the desert, spewing a fixed amount of wealth, and the rich are the piggy folks up front getting more than their fair share of this limited resource. 

Leftish studies love to show how the US economic model is so much more heartless than those wonderful Europeans.   Below is a typical chart they use, and it will bring us full circle to our original point about measuring poverty.

Study1

Wow, those heartless damn Americans!  Letting those children suffer.  But wait, we talked earlier about definitions of poverty - how do they define poverty here?  It turns out that poverty is defined as income 50% or less of the median income in that country.  Yes, you heard that right -- the standard for poverty changes country to country.  So the US has the worst results here because in large part, since it has the highest median income of any country in this survey, it has been given the highest poverty line.  Of COURSE we will have higher poverty numbers if you give us a higher poverty bar.  The honest way to do this study would be to set an absolute poverty line and apply it to each country on a purchasing power parity basis.  But of course, the progressives would not like the results of such an honest study.

BUT, someone in this study made a mistake -- they should lose their socialist decoder card for this.  Because in a fit of honesty, they actually restated one of their charts on a relatively fair basis.  Here is the original income equality chart:
Study3

You get the point, the US sucks as always -- our poor are the poorest.  But are they?  Again, the standard in each line is the median income of that country, so it is a changing standard in each case.  But what if we restated it all to a common dollar amount.  This is where the progressives fell into a fit of honesty.  They restated this chart so that every bar is a percentage of the US median income.

Study2

Now we see the real story - except for Norway and Switzerland, our poorest folks are about on par with those in other western countries, and this is WITHOUT the crushing burden of welfare state regulation and taxation.  Further, the poor in the US are much more mobile than those in other country -- the ranks of our poor will have turned over much more than any of these other countries in 10 years.  Finally, my bet is that if you did this chart without recent immigrants, the US poor would best most every country in Europe in terms of income -- US has a lot of immigration and it is disproportionately poor vs. immigration into other European countries (note that most poverty numbers include illegal immigrants, but most official immigration numbers do not include illegal immigrants).

So, if our poor are doing just as well, then I leave it as an exercise to give any rational reason why the fact that our rich are doing much better matters one damn bit.

Barf

The average federal worker now makes over twice the wages and benefits of the average private worker
Edwards_fed

Maybe they have some sort of incentive plan, receiving a percentage of the value they have personally destroyed.  Because sure as hell none of them are producing anything.  If the Democrats want to fight income inequality and take on excessive compensation that is set without oversight, I might suggest beginning with the federal government. 

Postscript: TJIC has pointed out that he and I, though we tend to agree, often express ourselves differently.  Here is my prediction of TJIC's response to this article:  "We going to need a lot more rope."  How's that, Travis?

How's That Welfare State Working Out For You

Note: Lots of updates at the bottom

We have all heard that the US is backward vs. our much more enlightened bretheren in Europe on income inequality.  The general argument is that US is somehow a worse place because out income inequality is higher than in most European countries.

My reaction has always been, so what?  Why should I care about how well I am doing vs. the richest folks.  Shouldn't I care more how I am doing on an absolute scale?  And in fact, on an absolute scale, our poor are doing better than everyone else's poor, and better than many nation's middle classes.  I thought this analysis of poverty was interesting:  It is the number of people (per million) in a county living on less than $11 per day  (lower number and rank is better)

Per Capita Population Under $11 per Day

Poverty1

So, nations of Europe, how is that welfare state working out for you?  Socialist paradise Norway is 20 times worse!  How long will your poor be happy being told that, well, yes, the poor in the US are better off than you are, but you should feel better, because our rich in Europe are doing much worse than the rich in the US.

PS- Stats from NationMaster.com, a database of country by country statistics of all sorts.  Cool site, which also has a state by state counterpart.

Update:  Now that I have had time to poke around, I cannot find this data in the sources quoted, so it must be considered potentially suspect.  The sources quoted actually try to make the point that US lags Europe in fighting poverty, so the conclusion of the chart above is not even consistent with the sources.  (my guess is the data comes from the Luxemburg Income Study). However, it is interesting that this source material makes the same mistake I am trying to correct for here:  That is, it defines poverty as a percentage of the median income in the particular country, rather than an absolute value, such that a country can have poor who are better off but still fail on the metric.  You can see that here, where US has high poverty as on a "percent of median income" definition, but since we have the highest incomes in the world, it effectively gives the US the highest poverty bar to clear.

Here is what I am looking for:  Ideally, I would like to find a comparison of the median income say of the bottom quintile of each country, compared in absolute dollars on a PPP basis across countries.  I would like to see the number both before and after government transfer payments.  Europe, in their welfare economies, do better on poverty metrics when government transfer payments are included (and I am almost sure the chart above is before government transfer payments).  However, I would argue that for the long term health of the economy, you would like to see how the poor are doing before these payments.  Ultimately, and I will borrow a bit of environmentalist language here, this is going to be the most sustainable economy, where the poor gain wealth on their own, not from the welfare system.  In fact, the welfare state, and this was my original point, actually suppresses self-earned income of much of the poor by eliminating the incentive to work.  That is why I still think the chart at the top may be correct.

Update #2:  One other difference between the US and European nations is that we are much more open on immigration (yes, it may be illegal, but we pretty much still allow it).  These immigrants, legal or not, are counted in our economic and poverty stats.  If we assume there are about 15 million mostly poor illegal immigrants, plus millions of other quasi-legal immigrants, plus millions more who got amnesty in the 1980's, these immigrants add at least a fast five percentage points to any poverty metric the US is measured on. 

I have been surfing tonight, and it seems there are a ton of studies showing that US poverty is growing for some reason.  Duh.  Tens of millions of absolutely poor people, mainly from south of the border, have come to the US over the last several decades.  It is no secret all these immigrants are poor -- that is why they are coming here, to find something better for themselves.  Of course we have had a surge in poverty - we have been importing it like crazy!  I happen to be pro-immigration, but I am fed up with these studies that try to pin the blame on growing poverty in the US on government transfer payment policy.  It's the immigration, stupid!  Several studies particularly lament the fact that childhood poverty is rising in the US.  Can anyone think of a way this might be correlated to tens of millions of strongly Catholic Mexican immigrants, each and every one committed to large families?

Income Inequality and Game Theory

Consider this situation:  You are a member of a four-person rock band.  Each member of the band has contributed somewhat equally over time, and band revenues have always been split evenly, 25% to each member, though its total earnings on an absolute basis have been small  However, the band has suddenly become the next U2.  It is likely the band will make tens of millions of dollars over the coming years.  Just as this is happening, the other three band members come to you and threaten to make you Pete Best.  They will allow you to stay with the band, but only if you accept a reduction in your share of the earnings to 10%.  You perceive this move as unfair given your equal contribution to the band to date.  However, even 10% of the band's new fortunes would be a LOT of money (and fame) and you honestly believe that even a 10% share is better than you could do with any other band or occupation.  What do you do -- take 10% or quit?  (assume you want to be famous and you have no legal recourse against the other members)

In an analytical vacuum, one might predict that any rational person would take the deal -- while it is less than might be hoped, it is certainly a better deal than one could get any place else.  A pure profit maximizing decision would be to stay with the band (and watch you back at night for more knives).

However, numerous studies and surveys have shown that in fact, a  large number of people would choose to give up the money rather than feel cheated.  Just look at the number of professional football players who have held out for a whole season to try to get a better contract.  In every case, the present value of the salary lost for that season is far greater than any increase in salary in the future from taking the tough stand.  But these players would rather be paid nothing than feel underpaid.

TJIC had a pointer to an interesting article on game theory.  In it, the author talks about this behavior in the context of a game that divides up pies, and summarizes:

Apparently, making money is not the players' only concern; participants have a sense of pride and care about how they are treated by others, economists have concluded. Thus, offers perceived to be "unfair" are rejected out of a desire for revenge.

In fact, revenge and/or envy has been tested in a number of games, where scientists gave players trailing in the game the ability to spend money solely to take away money from the leading players  (e.g. you can spend your last $10 to make $10 of your opponents money disappear).  There is something in human behavior that wants to bring down the winners, even when doing so makes one worse off himself.  (Question to Red Sox fans:  would you accept a lifetime bad of the Sox from the World Series if you were guaranteed the Yankees would never make the World Series either?)

I guess I don't really have a problem with such behavior in consensual transactions (though I personally work pretty hard to purge my ego from business decisions).  My problem comes when people motivated in this way vote in our society that has proven to have inadequate protections of the minority, at least when we refer to the minority of rich and successful

In Closing of the American Mind,  Allan Bloom tells the story of a question he used to ask his classes vis a vis income inequality.  He would ask something like "Would you vote for a law that reduced income inequality but at the same time reduced total wealth, such that the poor might get a larger slice of a smaller pie, and might even be worse off on an absolute basis afterwards."  Apparently, he would get solid majorities for "yes" and in fact I have been in classes where this same question was asked and at least 40% said "yes."  This is a situation a bit similar to the one above, but without it being personal.  In other words, no one has explicitly hosed you, they have just done better.

I hope you can see the parallel.  Large numbers of people are willing to pay (or equivalently make less money) to reduce the earnings of people who are wealthy and/or successful. They are even  more willing to do so if they think that they have been treated unfairly.  Which is why you see so many politicians and media outlets working so hard right now to convince the middle class that current income distribution patterns are somehow "unfair."  Politicians are pandering to this base human emotion, the desire to spitefully bring someone else down (in the case of income equality laws, someone the person has likely never even met or transacted with) even if it makes oneself worse off.   

I can understand why Pete Best might harbor a grudge against the Beatles.  But why do so many Americans harbor a grudge against people they have never met, just because they make more money?

More Zero Sum Economics (Sigh)

I have tried many times to combat the absurdity of zero-sum economic thinking.  Unfortunately, Democrats seem to be testing income-inequality messages as their lead horse to ride in the upcoming elections, so we are going to hear a lot more of it.  It bothers me even more when smart liberals like Kevin Drum buy into the zero sum thinking.  To his credit, he doesn't totally buy into this mess from Paul Krugman:

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.

But then he goes onto say nearly the same thing:

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.

And finally, this stupendously ridiculous statement:

After all, the income from economic growth has to go somewhere, and if it's not going to the middle class it's going to end up going to the rich. Where else can it go?

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. 

Here is his solution:

Now, there's certainly no reason to reduce marginal tax rates on the hyper rich in an effort to make inequality even worse than it otherwise would be. But as unjustified as this is, tax cuts aren't the main issue. Median wages are. Focus government policy like a laser on improving the wages of the middle class, and reductions in income inequality will follow.

And how the hell does he suggest the government do that?  Seriously.  Can anyone tell me one single thing the government can do to improve middle class wages that does not involve tax policy?  Well, we can back into his solution from this paragraph where he lists things the government can do that are bad for the middle class:

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.

So presumably, his solution to increasing middle class wages is: 1) allow inflation to run at a higher rate 2) encourage unionization  3) adopt protectionist measures for uncompetitive industries and stifle free trade  4) increase regulation on businesses and reverse deregulation in industries (presumably like airlines and telecoms).

I'm no Julian Simon, but if we could structure a bet as to whether these policies would help real middle class wages, I would sure take the opposite side from Mr. Drum.

Here is my theory for what is going on, if you even accept that middle class income stagnation is real and not a symptom of our difficulty measuring the benefit of improving products and technologies.  I think much like technological advances from time to time in the past have caused restructurings in the labor market for blue collar workers, we are going through the same thing, really for the first time, with white collar middle class workers.  Technology and globalization offer all sorts of opportunities for companies, and the result is a real restructuring of how many types of white collar workers are used.  Until this restructuring is complete, wages may stagnate, since any wage pressure will just lead to companies implementing changes from their backlog of streamlining opportunities.

At some point we will work through this, and wages will rise again.  If anything, I think the government does damage by slowing this process down.  Note that nearly every one of Drum's suggestions would slow or stop this restructuring.  This is one of the ironies of progressives -- despite their name, what they don't like about capitalism is the change.   They want safety and predictability from the inherently unpredictable.  So protectionism slows global outsourcing, and also reduces the pressure for cost improvement.  Regulation tends to lock in current practices and make changes harder.  Ditto strong unions.

One of the reasons I like some of what Bill Clinton did was that in the early 90's, he faced tremendous pressure to take many of these same steps, trying to halt the economic restructuring that was occurring due to competition from Asia.  He didn't have the government step in, though, and he supported free trade, and the country thrived.  His fellow Democrats (including his wife) should learn from that.

update:  A real economist (unlike me and probably Paul Krugman) discusses inequality and unionization

update #2:  More real economists, this time the awsome guys at Cafe Hayek, pile on.

Followup on Income Inequality

Several people say that I have missed the point in my post here - that the issue is
with mobility, particularly in multiple generations.   They argue that
the rich of the next generation are likely to be the kids of the rich
of this generation, that success now depends on education and
connections that only the wealthiest can buy for their kids.   

A couple of thoughts on this.  First, the Times's own data (plus
many other studies) doesn't bear this out, particularly with new
immigrants.  Thomas Sowell addresses this in more depth here and here,
and suggests that the explanation may lie more in values and
aspirations than in purchased stuff.  Marginal Revolution, for example,
had this thoroughly depressing story featuring a study by Harvard economist Roland Fryer on the social pressures in many African-American and Hispanic neighborhoods to under-perform in school.

My other thought on this is that to the extent social mobility is
slowing in this country, our public education system is a major
culprit.  Forget for a moment about quality issues.  Schools have
increasingly emphasized self-esteem over achievement and competition.
Standards are lowered, and the value of exceeding standards or
improving performance is downplayed.  Without other influences,
students will walk out of public schools with a value system vis a vis
achievement and competition and performance that leaves them totally
unprepared for the real world.  I am reminded of one of Bill Gates' pieces of advice to graduates

Rule 8: Your school may have done away with winners and losers, but life HAS
NOT. In some schools they have abolished failing grades and they'll give you as
MANY TIMES as you want to get the right answer. This doesn't bear the slightest
resemblance to ANYTHING in real life.

Kids with parents who have achieved in some way in the world are likely
to overcome this by the example and exhortations of their parents.  But
what happens to kids without this example?  Or kids (lacking voucher
programs) who can't afford to escape the public school system cult of
mediocrity for high-achievement private schools or home schooling?

Ironically, the very people who bemoan income inequality and lack of
mobility are the very same people who have gutted the public education
system.  These are the people who deal with inequality by flattening
down the peaks, which is exactly what they have done in schools,
eliminating valedictorians and substituting social promotions.