Spending and Inequality

I want to jump in with 2 cents on this exchange about status spending at the Inequality forum at Cato Unbound. Elizabeth Anderson:

One single mother, desperate to see her daughter wear socially accepted clothes, couldn’t pay her utility bills because she spent her income on a pricey t-shirt for her daughter.

Will Wilkinson:

all of us, rich or poor, are capable of taking responsibility for our consumption decisions…Our priorities are our priorities; they are to a significant degree up to us. We can change them. I wonder if Anderson believes that the mother in her story made the right decision. If not, I wonder if she thinks that it was within the mother’s power to explain to her that her daughter why paying the utility bill must take priority over fashion and that, indeed, taking responsibility in this is something to be proud of. I don’t think that straitened economic circumstances strip people of their agency or deny them the dignity of wisely exercising it,

So here’s the counter-intuitive idea for the day. The problem is, in many cases, that struggling working and middle-class families spend too little on discretionary items. Wha-wha-what? Here’s a similar story from Elizabeth Warren’s money-planning guide, All Your Worth:

The day I [Elizabeth] met Brandi I thought she would wear a hole right through her shirtsleave where her right hand kept rubbing her left arm. She explained that she and Bret both worked hard – really hard. Bret takes overtime whenever he can. They don’t go to movies and they never eat out….They were desperate to get out of debt, but whenever they started to pull out of the hole, something always went wrong.

When their 4-year-old was invited to a birthday party, Brandi cruised the aisles at the discount store. But Theresa was desperate to have the $18 Princess Tea Set for her “best friend ever”. In the car on the way home, the little girl refused to look at the $4.88 plastic doll that Brandi had bought over Theresa’s protest. After a long silence, she asked her mother quietly, “Why can’t we ever do anything nice?” Brandi later told me: “That’s when I lost it. I was bone tired. Tired of always coming up short. Theresa is such a good kid, and she just wanted a stupid birthday present for her best friend and I didn’t have the money. I started to cry and I couldn’t stop. It was so bad I had to pull off the road…I’m not a crier. I’m really not. But she’s just a little girl.”

Brandi and Brett came to my office laden with files and bills, ready for a marathon session of let’s-figure-out-the-money. After we went over some of the numbers, I leaned back and told them they were spending too little on the extras. They were stunned. I explained that their real problem had nothing to do with birthday presents or haircuts; their real problem was that they were spending way too much on their basic monthly bills.

You find this very quickly with many families. In the story above, the family spent too much on housing relative to their earnings, and had also purchased a new car that was too much of their monthly budget. The new car was almost $18/day (a Princess Tea Set every day!). The problem isn’t that they are extravagant on the little things, it’s that their fixed expenses are too high. When trouble hits, as it always does, it’s very difficult to cycle out of fixed expenses.

To use a blunt example, if you are someone in the business of wanting a government so small you can drown it in a bathtub, that t-shirt, or that Princess Tea Set, is the equivalent of an initiative to drop $50m from the Federal budget. Sounds nice, but does it really make a difference? Or are there some fixed (or this case, committed to) costs that can’t easily be turned down?

This is in part a problem of financial education, and I’m not sure how to make the momentum take hold other than just to blog about it. Our thinking is dominated by thinking about marginal effects – cut out that cup of expensive coffee and you’ll be fine! – and a certain type of morality mapped onto the household budget. But thinking of the household as a firm that has liquidity constraints and fixed expenses helps explain why many families suffer better than the current ways we discuss it.

Because if all you are looking at is consumption, those fixed costs that can’t be turned down easily are consumption of course. And if all you look at is consumption, when you see someone whose arms are flailing while they bop up and down in a sea of debt, you can’t even form the question of whether they are drowning or waving at all the suckers on the beach not consumption-smoothing.

Inequality

But does it have any implications for inequality as being discussed right now, or policy more generally? A big fixed cost are cars. That definitely has status competition associated with it, and I imagine spending on cars is probably the one place where I’d see a Robert Frank style status competition really making a difference for families. A bigger issue is that many families with two working parents need two cars, which is in part decisions made collectively on how to fund public transit and how the suburbs came about. Health care and other insurances are also a big budget item that have gotten more expensive.

But I think the biggest issue where inequality itself can drive fixed expenses is housing. From Real Wage Inequality by Enrico Moretti:

Abstract. A large literature has documented a significant increase in the difference between the wage of college graduates and high school graduates over the past 30 years. I show that from 1980 to 2000, college graduates have experienced relatively larger increases in cost of living, because they have increasingly concentrated in metropolitan areas that are characterized by a high cost of housing. When I deflate nominal wages using a new CPI that allows for changes in the cost of housing to vary across metropolitan areas, I find that the difference between the wage of college graduates and high school graduates is lower in real terms than in nominal terms and has grown less. At least 22% of the documented increase in college premium is accounted for by differences in the cost of living.

So a fair amount of the increase in income inequality at the top end of the distribution gets dumped into housing. It gets dumped into housing because the places people need to live in order to deploy the human capital they’ve accumulated are expensive. Moretti’s paper takes the expensiveness of high human-capital places as exogenous, and a new young person shows up to the model and has to decide whether or not to move to an expensive city.

Moretti goes on to imply that people get no utility from this; it’s like a toll booth on the road to being upper-middle-class. That’s fine, but housing isn’t elastic at all; and the more hot money gets dumped by the elite into the market the worse the competition for housing resources must be for everyone else. My question would be how much does that have a feedback mechanism within inequality? It’s a tough question to answer, and I hope Moretti or others take it up. But the idea that a large chunk of the income increases of the top 10% of the distribution gets dumped straight into housing would have some effect on the other 90% of people living there and elsewhere strikes me as common sense enough from the conclusion.

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8 Responses to Spending and Inequality

  1. L. Haug says:

    “That definitely has status competition associated with it, and I imagine spending on cars is probably the one place where I’d see a Robert Frank style status competition really making a difference for families.”

    You can’t really believe that status competition is driving most car purchases in the working class. There is no status associated with a Camry or a Honda or a Ford. It’s not that these are bad cars, but the percentage of people who are “Well, I could buy a Kia, but a Camry is a cooler car” is vanishingly small. Now, maybe the status issues play themselves in terms of explaining why people buy new cars as opposed to old ones, but we really need to see some meaningful research into this question, instead of an aimless citation of Robert Frank and your speculations on what people might be feeling.

  2. While I find Moretti’s view point some what persuasive, I also have contrary evidence sample size one.

    I moved from Florida to Boston to attend graduate school. I have now been in Boston for 5 years and am returning back to Florida soon. I have used my elevated wage that I have earned in Boston to secure employment with the same wage in Florida. My fiancee is actually going to be paid more in Florida than what she receives currently in Boston, such is the demand for her skills. Yet, our cost of living in Florida will be cut in half from what it is here in Boston.

    So my question back, would be how does his study control for people who move to cultural centers with universities like San Fran, NYC, and Boston, which have a much higher cost of living but then return to their original homes after securing professional experience and further education.

    His thesis prima facie is believable but people are not trapped into staying in the city with higher cost of living.

  3. What I find interesting – the debate on income inequality focuses entirely on consumers. And the despicable expenditures of the poverty stricken suckers at the bottom of the barrel.

    What I’d like – I’d REALLY like to see the libertarians to take a look at the consumption decisions of CEOs – like John Thain’s decision to spend more than a million dollars to renovate his office at a time when his firm was bleeding out money by the billions.

    I’d like to know what libertarians like Will Wilkinson think of CEOs like Jack Welch – leaders who secretly negotiate large sums of money for business-irrelevant expenses like flowers and dry cleaning into their retirement packages.

    I’d like libertarians to focus on the ridiculous consumption of leaders who consume far too much – especially when compared to the failures of their businesses. That’s the unequal equation in this whole consumption debate that the libertarians need to start exploring….

    I’d like Moretti to focus on jobs. Where are the jobs? What are people earning in the low-cost areas he feels people should drift to after college (after accumulating the astronomical debt required of a 4 yr college degree these days)?

    I feel strongly that many economists these days are like GHW Bush on the campaign trail back in the early ’90s – when he expressed shock at the discovery that stores used scanners at the check out counter. Economists seem flummoxed by the realities that face people who live outside of college campuses or Wall Street.

    The cost of cars, houses, health care and college have skyrocketed since 1980. Have wages truly kept up? Most people in the middle class would say no. But economists like Morretti seem to feel that consumers just spending their money all wrong. Seems he failed to learn from the crash of 2008 that math can prove all sorts of “facts” that are not necessarily true.

  4. burritoboy says:

    “Economists seem flummoxed by the realities that face people who live outside of college campuses or Wall Street.”

    This is nothing new: Pigou, Alfred Marshall’s great disciple, sat on a commission with Keynes in 1930 and 1931. Pigou still couldn’t figure out – in 1930 – why Great Britain had had a high unemployment rate (well above the pre-WWI figures) since 1918. That is, Pigou had no explanation for the biggest economic phenomenon in his own nation, and hadn’t gotten anywhere after working on the problem for 13 years. Keynes spent the commission meetings telling Pigou he was full of shit (correctly), and the commission got nothing done.

    In fact, since the Chicago School is really just another version of Marshall’s neoclassicism, the Chicago School faces the exact same theoretical problems as Pigou did in 1930.

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  7. This is a great post. I completely agree with everything until the very end. I don’t understand why housing isn’t elastic. It seems like each person needs 500 sq ft of space in a decent area, and the marginal utility of additional space or fancier areas decreases rapidly.

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