Friday, May 30, 2003

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Regarding income inequality

OK, my take on the income inequality situation. [What the hell took you so long?--ed. Sorry, the teaching and research are more time-consuming at the moment.] This will probably be a letdown after talking about it for so long. I have three basic points:

1) Measuring static inequality is in some ways unfair, since the question is whether individuals and families experience upward mobility over time. This Urban Institute report has some valuable background information on the question of mobility vis-a-vis inequality. The money graf:

[S]tudies of relative mobility have produced remarkably consistent results, with regard to both the degree of mobility and the extent of changes in mobility over time. Mobility in the United States is substantial according to this evidence. Large proportions of the population move into a new income quintile, with estimates ranging from about 25 to 40 percent in a single year. As one would expect, the mobility rate is even higher over longer periods—about 45 percent over a 5-year period and about 60 percent over both 9-year and 17-year periods. (emphasis added).

Furthermore, this lengthier Urban Institute report contains an interesting tidbit from a 1992 Treasury Department study on mobility during the 1980s, which was a decade in which by static measures the rich got richer and the poor got poorer:

The Treasury study uses income tax return data between 1979 and 1988, tracking the adjusted gross income of a group of households that paid income taxes in all ten years examined. The study finds that 86 percent of individuals who were in the bottom quintile in 1979 had moved up by 1988. An individual in the bottom quintile in 1979, in fact, was more likely in 1988 to be found in the top quintile than in the bottom one. (emphasis added)

Does this vitiate Kevin's argument? No, not really. If you read the report, it turns out that income mobility in the U.S. is not appreciably different than it is in, say, Scandinavia. Furthermore, mobility has not changed as income inequality has increased -- if anything, mobility has shrunk for those without a college education. Still, an implicit implication of those who fret about rising inequality is that such a rise will lead to greater class stratification -- and that's not happening.

2) So, if we stipulate that income inequality is rising, is this squeezing out the middle class and the poor? The answer is no. If you care only about income, the poorest percentage of the population made great strides during the late nineties, completely erasing any losses from the previous twenty years. Business Week pointed this out in an April 2002 story. Some key grafs:

Real wage gains for private-sector workers averaged 1.3% a year, from the beginning of the expansion in March, 1991, to the apparent end of the recession in December, 2001. That's far better than the 0.2% annual wage gain in the 1980s business cycle, from November, 1982, to March, 1991. The gains were also better distributed than in the previous decade. Falling unemployment put many more people to work and swelled salaries across the board: Everyone from top managers to factory workers to hairdressers benefited. Indeed, the past few years have been "the best period of wage growth at the bottom in the last 30 years," says Lawrence F. Katz, a labor economist at Harvard University....

What's more, workers with a wide range of skills and occupations thrived over the past decade. In the '80s business cycle, real wages of blue-collar and service workers fell substantially. Blue-collar wages, for example, declined by 3.5% from 1982 to 1991. But in the '90s, real wages for these less-skilled jobs rose by 12%. Full-time cashiers saw their median weekly earnings jump by 11% (adjusted for inflation), while auto mechanics' pay went up by 14%, after falling sharply in the 1980s. Hairdressers got an almost 18% boost. That's despite Clinton-era welfare reform and a huge influx of immigrants, both of which were expected to hold down wages at the bottom. [Not to mention claims that economic globalization would cause a race to the bottom in wages]....

It's important to step back and quantify how the productivity gains of the 1990s were distributed. Consider nonfinancial corporations, where annual productivity growth accelerated from less than 1.8% in the 1980s to 2.2% in the 1990s. Over the course of the 1990s business cycle, this increase in added productivity translated into $812 billion in additional output, measured in 2001 dollars. Out of that sum, an astounding $806 billion--or 99%--went to workers in the form of more jobs and higher compensation, including exercised stock options. In effect, not only did the economy speed up in the 1990s but the workers got a bigger share of the pie.

So, the rich may be getting richer, but this is not at the expense of the poor. It's also worth pointing out that even though income inequality is rising, but as Mickey Kaus loves to point out, poverty has fallen over the past 20 years -- though not in a linear fashion. The decline in poverty was more pronounced among African-Americans than the rest of the population, by the way.

3) OK, so rising inequality is not causing an absolute drop in poor families. Still as Kevin argues in an e-mail, increasing inequality means that, "people who successfully move into the middle class are moving into a class that's not as good as it was for their parents, relatively speaking."

Actually, I'd argue the reverse -- more people are enjoying a middle class that's, on the whole, better off that prior generations. Consider two basic staples of a "middle class" lifestyle -- a college education and home ownership. This table shows that between 1980 and 2000, the percentage of all Americans aged 18-24 enrolled in a college or university increased by 40%. A greater fraction of Americans are receiving the college education so necessary for achieving a higher income. Furthermore, this fraction is considerably higher than any other OECD nation except for Canada (click here for some basic cross-national comparisons on education).

What about home ownership? This web site points out that home ownership rates have been steadily rising over the past decade. In 2001, 67.8% of American households owned their home -- the highest rate of home ownership since the Census Bureau began reporting these statistics in 1965.

But what about other quality-of-life issues, like crime, health, safety, and the environment? Gregg Easterbrook wrote a great New Republic piece in January 1999 demonstrating that on every social indicator imaginable, things were improving across the board for ordinary Americans over the past twenty years.

Calpundit's original point was that the distribution of benefits from economic growth over the past 20 years was skewed too much towards the rich. However, the fact remains that the rest of the population has received substantial benefits during the same period.

Furthermore, Americans don't begrudge the rich getting richer. Part of this has to do with the aforementioned mobility -- part of it is probably due to a greater discomfort in the U.S. to income redistribution than in other OECD countries. David Brooks makes this point repatedly (click here and here). His main point:

Income resentment is not a strong emotion in much of America.

If you earn $125,000 a year and live in Manhattan, certainly, you are surrounded by things you cannot afford. You have to walk by those buildings on Central Park West with the 2,500-square-foot apartments that are empty three-quarters of the year because their evil owners are mostly living at their other houses in L.A.

But if you are a middle-class person in most of America, you are not brought into incessant contact with things you can't afford. There aren't Lexus dealerships on every corner. There are no snooty restaurants with water sommeliers to help you sort though the bottled eau selections. You can afford most of the things at Wal-Mart or Kohl's and the occasional meal at the Macaroni Grill. Moreover, it would be socially unacceptable for you to pull up to church in a Jaguar or to hire a caterer for your dinner party anyway. So you are not plagued by a nagging feeling of doing without.

Brooks, by the way, is hardly the first person to make this point about Americans.

Economic growth over the past 20 years was a Pareto-optimizing move. It's not clear to me that the income from the richest 5% could have been redirected towards the poorest 20% without some deadweight loss in income. And given that the lower and middle classes have substantially benefited from the 1980-2000 economic boom, and their lack of resentment towards those who are perceived to have benefited disproportionately, it seems pointless to argue ex post that there should have been a greater focus on redistribution.

UPDATE: A comment on Arnold Kling's blog points out -- correctly -- the criticisms of the Treasury study that I cite above. I still cited it because the study does address the question of class stratification -- i.e., whether, over time, individuals and households do see natural rises in income due to increased work experience.

posted by Dan on 05.30.03 at 11:14 PM


Agreed, except for one point: Phillips' argument IS vitiated by the mobility data.

This is a convenient shell game played by the left. They point out that RELATIVE income mobility increased only modestly in the 1980s from the 1970s, and is only modestly greater in the US than in Scandinavian countries. In other words, we all agree that for all decades and countries, we're talking about the typical family earning about $X per year and having two or three "good years" and one or two "bad years." in a given decade.

But you need to consider RELATIVE mobility along with the changes in the spread of incomes in the ABSOLUTE - which was in fact the initial complaint from the Left.

If all income groups moved up in the absolute in the 1980s, and the higher the group, the bigger the gain, and pretty much the opposite occurred in the 1970s, then for a family to hold its own RELATIVE to other families meant something completely DIFFERENT in the 1980s than it meant during the 1970s - in the 1980s it was a matter of whether your family's increase was as great as your neighbors' increase, while in the 1970s it was a matter of whether your family's decrease was as great as your neighbors' decrease.

More importantly, while in the 1980s the frequency of "good years" increased only modestly, just how good a "good year" was changed significantly for the better - pre-tax. We know it improved even further post-tax.

So what you have is a family of 4 making $45K per year in real dollars, and in the 1970s there are a few bad years in which it makes $40K and a few good years in which it makes $48K.

In the 1980s the family of 4 making $45K per year has some "bad" years in which it holds stable at $45K and a few good years in which it makes $51K. What's more, the family only got to keep $1K of the $3K "good year benefit" in the 1970s, while in the 1980s it got to keep $4K of the $6K "good year benefit."

Essentially the argument of the Left on the mobility question can be reduced to this: the cost of playing decreased slightly, the frequency of winning, already substantial, increased only slightly, therefore doubling the jackpot earned in each round made no difference to the average player.

posted by: Patrick on 05.30.03 at 11:14 PM [permalink]

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