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.
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.
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.