Inequality Forum at Cato Unbound

Will Wilkinson is hosting a forum at Cato Unbound, which are always interesting, on economic inequality. Here’s Will’s lead essay, which is a recap of his previous white paper from the summer. Lane Kentworthy has the first response. Check it out!

I’ll throw in some additional thoughts here.

Consumption versus Income Inequality

Here is Will:

As far as I can tell, when most people are worried about economic inequality, they’re usually worried about inequalities in real standards of living — in the real material conditions of life. . . An individual’s or household’s standard of living is determined rather more directly by the level of consumption than by the level of income.

So a few things of note. One is that if there’s income inequality, and there is less consumption inequality, by definition there’s an increase in savings inequality. All savings is is future consumption. Given the miracle that is compounding interest, one could make an argument that savings actually reflects more consumption, since you can consume much more tomorrow with that savings than I’ll be able to do without it.

Another is that consumption inequality has been kept in check by a massive leveraging among the middle and lower classes. The data shows this out. We found here that leveraging among the middle-class has increased greatly, and among the lowest quantiles as well. Digging further into the Fed document presented there, the leverage
ratio increased across all age groups, so it is not just a matter of consumption smoothing.

Over in the Business College…

A lot of these inequality studies are carried out by economists, so it is natural to their theories to look at consumption. That’s all people are at bottom in the theory – Robinson Crusoe sitting alone on his island, waiting for some coconuts to grow so he can eat them.

I prefer to look at individuals less as eating machines and more as firms, firms engaged in the neoliberal entrepreneurial business of leading their lives. Here we can brings some additional techniques, ones that would never look just at the owners assets, since they need to be match by his liabilities. Alternatively, if we look at the rewards, we need to look at the risks. And by any measure, the risks and liabilities of running a middle-class family firm have skyrocketed.

As a quick measure, we used the Merton Model of credit risk back here to price a CDS contract on a middle-class family. All the measures we would use, from a current ratio of assets to the level of volatility face by families on their incomes, lead us to conclude that, as far as businesses go, you should start looking to see if you can take a short position in the middle class.

Autonomy

What good is money for? Well, in a liberal society, it’s good for two things: more things and more autonomy. The things part is down – as Will is quick to point, goods at the lower end of the consumption scale are cheaper and better working over the past few decades. So even if many consumers have not seen their incomes rise, they feel richer since the goods they are getting are cheaper. True dat!

What I’m more interested in is the autonomy end of it. What about the ability to leave an abusive partner or job without worrying about health care? Travel, spend more time with your family, feel a sense of financial security, etc? Here people less worried about income inequality would say that consumers are in better position to take advantage of this as well since they are richer.

So what they have a cheaper basket of certain goods. Now though autonomy isn’t commodified and sold on a market, the items that we associate with it, insurance, education, perhaps housing, have all seen skyrocketing prices, an effect that blocks out the first effect. This leaves consumers noticeably poorer than they would be otherwise. You’d need to construct a separate index and see the effects played out; I hope researchers are able to do that.

Priorities

Will says that we should deal with the mechanisms of what creates inequality rather than being worried about inequality per se. That’s completely fair. But the question can be flipped – how much should we use the idea that inequality will be generated by our actions to guide what we should do?

Let’s take a thought example from the past year. Let’s say that government can either (a) bail out the financial sector or (b) allow judges to cramdown mortgages in bankruptcy, forcing (let’s say) a haircut on the financial sector to help middle and lower class families.

We went with (a), and not with (b). We could (should!) have done both! Now experts are already starting to worry that a rebound in the stock market combined with a long decline in housing is going to aggravate inequality even further than it was.

Now should inequality have been a guide here? Here I’ll confess that I think many liberals, myself included, have a slippage between inequality and un-fairness. I think it is in the interest of fairness to allow judges to cramdowns bankrupt mortgages, and I see that not having this go through exacerbates inequality. The same with unequal educational access, ‘under-banked’ communities, etc. I would note that I think these things are unfair because they increase inequality. Will would want me to be able to justify that they are unfair a priori, independent of distributional effects.

This is fine for how it goes, but there are many cases where the impact on distributional effects are part of the argumenting force for unfairness. Will points to unequal educational access. But why is that bad? Because it decreases opportunities for investment in, and deployment of, human capital. Why should we assume that? We should assume that because we can see the inequality in income and life chances after the fact.

I would love for Will, who is better with talking this through than I, to go further in this line. I would add this overlaps with one of my projects I’m thinking about, the financialization of the economy over the past 30 years – an event that has generated a large amount of inequality. I think Will thinks inequality is like the color blue, where I think inequality is like a tingling in your arm – a sign something terrible may happen, and that it should get check out immediately.

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16 Responses to Inequality Forum at Cato Unbound

  1. pushmedia1 says:

    I’m confused by your definition of real income… If prices are going down then real income is rising. How is it confusing substitution and wealth effects to suggest real incomes are rising?

  2. Mike says:

    Yeah, I see what you are saying (confused mention of change in income removed from text). I’m willing to concede the price-index arguments for the time being – My point is more direct – we have a basket of consumer goods that are cheaper, but a basket of other ‘goods’ that are much more expensive.

    I think the way we look at it the first basket dominates the picture we paint, while things more associated with autonomy (both as purchasable goods, as units of risk faced and more abstractly) have had their prices skyrocket, swamping out gains from the first basket. I’d like to see this quantified more clearly if possible, of course.

  3. Not the Mike You're Looking For says:

    Put more simply, the discussion should be about wealth inequality, not income inequality.

  4. Rebecca Z. says:

    Time inequality. The more wealth you have, the more responsibility you can farm out; even if you’re working too many hours. When you’ve got to work two jobs, schlep the kids to school/day care, clean the house, plan the food etc., the lack of time leaves you unable to do other important things including engaging in the political system, volunteering in the community, or sleeping.

    All three have a great impact on quality of life.

  5. ComparedToWhat says:

    I haven’t read the Cato debate, but posing the question in terms of “inequality” seems somewhat irrelevant… then again I’m not much good at econ lingo.

    The relevant issues are disparity, mobility and legitimacy. Does growing disparity (of income, of educational attainment, of autonomy) and what appears to me pretty much simultaneous and likely consequential decline in social mobility justify questioning the legitimacy of the “Anglo-Saxon model”?

    Empirically, I’d like to learn more about the US economy from the late 1940s to the late 1960s. In this era we were paying down the debt run up during the Depression and WWII. Toward the end began industrial hollowing, the unequal playing field being excused by the perceived need to fight revolutionary Communism in East Asia.

    I like this take on the current situation.

  6. Pingback: Inequality Redux «  Modeled Behavior

  7. statatheleft says:

    You write:

    “if there’s income inequality, and there is less consumption inequality, by definition there’s an increase in savings inequality.”

    I’m not sure this is true. Income inequality without consumption inequality could also represent high income volatility without any real implications about relative savings rates.

    We can imagine person A makes $50k in year 1 and takes year 2 off, while person B does the reverse. Ignoring interest, which doesn’t change the story much, let’s say they both consume $25k in each year. Then we have a lot of income inequality, but the consumption equality is a hint that inequality overall is not too much of a problem (although volatility may be).

  8. David says:

    Rebecca Z’s “time inequality” comment is not consistent with the data. Leisure activities increase enormously with less education and lower income. Home production is approximately equal across groups, or low wealth people do slightly less. It’s not that being poor means that you live life rushing from place to place. In fact, their leisure has been growing in recent years. This is mostly sleep and TV.
    This is actually a pretty crappy data point. Amongst young (<35) high school dropouts they increase their "leisure" time by 4% every year while employed, and even faster if they become unemployed. I read this data as a "giving up" indicator. So they are able to enjoy the basic consumption basket with minimal effort, but the finer things ("autonomy goods," if you want) have become too expensive for them to possibly reach them.

    • Rebecca Z. says:

      Dave, I didn’t describe people in poverty; I described people in the middle class; people who can’t afford to pay to have the house cleaned, the laundry and shopping done, and the kids picked up from school. Middle class incomes used to be based on one working partner in the family; now it requires two. Those hours the second partner must work to maintain a middle-class standard of living an example of shifting inequality.

      The measure shouldn’t be leisure time, but time to partake in social/civil activities that improve our daily lives; activities like PTO, running for local school board or planning board, volunteering.

  9. David says:

    That makes a lot of sense, that two income households necessarily have less free time because you don’t have someone specializing in home production stuff.

    So my earlier comment was pretty unfair, actually. Because I’ve been doing a bunch of stuff with American Time Use survey stuff, and not showing where I get my numbers. Unfortunately, not all the sruveys ask people their income, so I don’t know how middle class people have behaved, so I use education level as a proxy.
    So on a per person basis, the average working person works fewer hours, does more home production and takes more leisure. Amongst men, there’s a pretty stark line between high school dropouts, high school grads and college grads. Dropouts have increased leisure a lot when young, and in middle age they increase home production, but at the expense of work hours. High school grads take more leisure when young, but by the time they get to middle age, it’s fallen by a lot. That’s a lot of what you’re hitting, probably. They, however, ramp up home production in this period, so income doesn’t rise. This must be exactly what you’re saying with driving car pool.
    college grad, however, take split their time almost exactly the same, though when employed they seem to take less home production and work more.

  10. Mike says:

    David,

    This is really sharp stuff. To echo Rebecca Z, I think the inequality debate often focuses too much on poorest 1% versus richest 1% ; there’s a lot of room in the middle where inequality is playing out, which is why I like looking at the risk statistics in the median/mean areas and seeing how those processes are evolving. If only because I wonder how much there is a, as you allude to, “giving up” versus “maxed out” discontinuity – to keep it in econ terms, if the returns to human capital load on too much vol, it may be better to just sit back and feel special-inflation-adjusted rich with your massive cheap TV.

    What happens in the “some college” category, if you have it? Even if you had income, I always like to see a set of results conditioning on education.

    Also – how does the “Purchasing goods and services” time budget do as you go up the socio-economic ladder? As an aside, I still wonder if consumption inequality is a function of not being able to spend money fast enough. Do the rich/high-human-capital crowd spend little time on shopping? Are middle-class people spending a lot of time on shopping? Are they ravenous affluenza-sufferers, or hunting for bargains on stagnant paychecks?

  11. Mr Econotarian says:

    Here is inequality: you will be paid in line with the ability of your skills to earn your employer money. If you are paid more, your employer goes out of business. If you are paid less, you will jump ship for the next employer who can pay more.

    A worker with a graduate degree in engineering will make more than somone with a bachelors in English, and that person will make more than somone with just a high school degree.

    If you want to equalize incomes, eliminate all high-skill jobs (as many poor countries have), or eliminate most low-paying jobs and enjoy the unemployment of unskilled and young people (as many countries in Europe have). Then you get income equality.

    • Not the Mike You're Looking For says:

      This argument assumes that the economy works entirely the same way as it does in textbooks: equal access to education and other capital goods, perfect information so that nobody benefits from personal connections, no preferential treatment from the government, etc.

      We don’t live in that world. Just ask someone who’s parents *weren’t* able to pay for the education they needed to become an engineer. Libertarianism is the ideology of people who were born on third base but believe they hit a triple.

  12. Chris says:

    Here is inequality: you will be paid in line with the ability of your skills to earn your employer money. If you are paid more, your employer goes out of business. If you are paid less, you will jump ship for the next employer who can pay more.

    Just because another employer *can* pay more doesn’t mean that they will. If the cost of hiring a different (equally-skilled) worker is less than the cost of paying you more money, why should your employer pay more to retain you or another employer pay more to headhunt you?

    In fact, I think a large part of the return to capital is found in the gap between the productivity of labor and the cost of labor.

    That doesn’t eliminate the importance of valuable skills — but the unequal distribution of skills in, e.g., the U.S. is itself a consequence of an educational system that might as well have been deliberately designed to perpetuate class differences across generations. (Not to mention that provision of public services can blunt the effect of present income on the next generation’s development.)

    Furthermore, there’s a big difference between observing that inequality is *present* and measuring (or changing) its *extent*. The postwar boom did not eliminate either high-skill or low-skill jobs, but the distance between their wages was far smaller than in the post-Reagan period. Your theory is unable to explain this phenomenon.

  13. Will’s desire to turn “income inequality” into irrelevance has never made sense to me. We have seen a statistically relevant rise in income inequality. According to the book Pay without Performance, by Lucian Bebchuck and Jesse Fried, the increase in executive compensation has been unprecedented:

    “Between 1992 and 2000, the average real (inflation-adjusted) pay of chief executive officers (CEOs) of S&P firms more than quadrupled, climbing from $3.5 million to $14.7 million. Increases in option-based compensation accounted for the lion’s share of the gains, with the value of stock options granted to CEOs jumping ninefold during this period. The growth of executive compensation far outstripped that of compensation for other employees. In 1991, the average large-company CEO received approximately 140 times the pay of the average worker; in 2003, the ratio was about 500:1.”

    We can firmly believe, as Will does, that this is irrelevant, because the workers all have fridges and TVs. But the income gap is hardly irrelevant. For whatever reason, people at the top have been lavished with rather hefty salaries without being held accountable for poor management. They get paid handsomely no matter what (Dick Fuld being a rather lonely exception.)

    The results of funneling tons of money into the C-Suite has been catastrophic for the economy. Rick Wagoner, who’d been in the C-Suite of GM for nearly 2 decades, was supposed to get a $20 million retirement package – but it was knocked down to $10 million. Boo hoo. He got a $10 mil golden parachute to run his company into the ground to the point that nothing but a government bailout could guarantee its existence. That’s a sign of terrible business leadership that should not be rewarded at all.

    A year after our government devoted nearly a trillion in cash plus all the assorted loans and guarantees and warrants to prop up the financial system, the bailed out bankers are announcing record bonuses.

    Concurrently, we see record unemployment. Record unemployment! At such a time, it makes absolutely no sense for anyone – not even the libertarians – to engage in such a debate about “inequality.” We’re seeing some of the most unequal distributions of income and wealth ever witnessed in American history. If the economy was booming, perhaps Will’s argument would have more relevance. But today, it’s irresponsible.

  14. Pingback: Cato Unbound » Blog Archive » October 2009: Best of the Blogs

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