Thinking Clearly about Inequality

Will Wilkinson has a fantastic new paper at Cato: Thinking Clearly about Economic Inequality.

You can see leveling in quality across the price scale in almost every kind of consumer good.19 At the turn of the 20th century, only the mega-rich had refrigerators or cars. But refrigerators are now all but universal in the United States, even while refrigerator inequality continues to grow. The Sub-Zero PRO 48, which the manufacturer calls “a monument to food preservation,” costs about $11,000, compared with a paltry $350 for the IKEA Energisk B18 W. The lived difference, however, is rather smaller than that between having fresh meat and milk and having none…

The general effect of the democratization of luxury is to increase demand among the wealthy for nonmanufacturable, inherently scarce “positional goods” whose signal of relative socioeconomic status will not be so swiftly diluted by broad mass-market diffusion.

Ezra Klein and Jim Manzi had some follow-up questions. I want to ask him a few questions, but before that a few extra theory ideas to drive the discussion.

Consumption Cascades

There are a lot of economists who argue things about consumption and positional cascades, which is a fancy way of saying “keeping up with the Joneses.” Someone buy a really nice car, so everyone else in the neighborhood has to spend more than they wanted on their car to keep up. I’m not always sure how much stock to put in this. I have a post sitting in pending I’ll probably never publish about how MTV’s My Super Sweet Sixteen is the show of 21st century inequality in the pre-crisis state, and how we need squads of critical theorists to study it scene-by-scene. (I’m obsessed with watching it.) The thing to take away from it is that a lot of the inequality in spending in the 21st century is best describe not as envy-generating but grotesque. I find watching the people watching the spectacles most interesting; they have to place themselves positionally to it without necessarily being jealous of it. All things equal, it is probably best to be the person having an five-figure Egyptian-themed 16th birthday party. They’ll certainly have health care later on. Failing that, it is almost as fun to be the person who attends but makes fun of it. But it still sets the agenda.

I often worry that economist go to this language to invoke themes of stratification, inequality of access and life choices, and power, without having to do any of the heavy lifting or probing questions that follow such an inquiry. (I have a friend who was part of a feminist economics listserv back in the day. She would start to talk about power, and then get cut off with a “no no no; we can’t say ‘power in the household’, we have to say ‘information asymmetries in the household’ instead. That’s the only way we can get taken seriously.” She did not go to economics graduate school. I hope she forgives me if I do.)

Notice that when it comes to households we suddenly have this second layer kick in; there are pooling effects when it comes to certain cities, and if controlling for urban living for college degrees can absorb large degrees of inequality then we have to worry that that is cutting off people being able to deploy their human capital in an optimal way. This is different than someone having a nice house making others jealous – this is about the actual ability to partake in the economy itself. I can go on at this at length; the key is that in addition to whatever effects “keeping up with the joneses” has, there’s another layer that goes directly to opportunities that is equally valid.

Lifetime Earnings

It’s weird to me how easily lifetime consumption smoothing can be invoked to any debt structure. Is consumption smoothing an assumption on how people behave, or a normative statement how they should behave? Here’s Milton Friedman in 1957: “The permanent income component is not to be regarded as expected lifetime earnings… It is to be interpreted as the mean income at any age regarded as permanent by the consumer unit in question, which in turn depends on its horizon and foresightedness.” It is crazy how far to the right of Friedman a lot of economic commentary has gotten – we know people don’t smooth their income; and if there is uncertainty has to how much money they’ll make they shouldn’t. I discussed this in a post that responded to Conor Clarke on consumption smoothing.

Poor Consumption

People in the bottom quintile famously consume $18,000 while only earning $11K-15K. There’s a lot of debate on how to interpret that statistical point. Some think it is measurement error, some think it is large spending fueled by debt. I also want to point out if some of that consumption is fueled by the illicit underground economy there’s a massive survivorship bias – people that are killed or end up in jail don’t get zeros noted as their consumption, though that obviously influences their payoffs for taking on that risk. I’m not sure where that literature stands.

Questions for Will Wilkinson

1) Ezra Klein and others have already brought up debt as a critique of consumption and the lowest group of consumers. How does the analysis, that consumption has remained stable because it has been fueled by debt, hold up for the middle class? Some claim that, for the groups that consume the least, debt isn’t likely to be large enough to drive instability in the larger economy; that may be true, but it strikes me as less true for the middle-class. Is there a sense of how this question is going to be approached?

2) In so much as the previous analysis is true, that consumption is more or less flat but the riskiness of that consumption has outpaced the earnings, is this a moral or ethical problem? We know that rational agents need to be compensated for taking on more variance in earnings; in so much as the modern middle class has taken on more volatility without taking on more earnings, is there is a moral problem here?

3) I’m not a huge fan of arguments predicated on the statement “the poor are poor because they choose to be poor.” But in so much as the middle-class has become an over-leveraged risky enterprise, that in itself could influence marginal decision making against investing in additional human capital – it may be better to just sit back and buy the IKEA refrigerator instead of trying to invest that money in oneself to move into the middle-class. Does this have moral implications?

I doubt this is a big problem in the general human capital sense, but I imagine it is a huge problem in the decision to have children. Given that having a child is like dropping a volatility bomb into the household (last I read some data it is the one of the biggest predictors of defaults), and there is a story where this volatility is driven in part by inequality, particularly in that housing bundles a child’s education with it, does that have moral or ethical problems?

4) Some people have argued we should cut some of the “financial innovations” of the past 30 years in order to stop a bidding war on housing. Richard Serlin has argued (part one, part two) that we should cap interest rates to keep this bidding war on housing from going out of control.

Assuming it would work (big assumption!), what are the ethical and moral implications in such a move? In so much as it would decrease inequality by decreasing “choices”, that may lead to a wasteful bidding war, what should be our moral thought guiding the decisions in how to move here?