Sorry to be posting so much on this topic of inequality, but I’ve been meaning to do some thinking and writing on this and now seems an appropriate time.
Karl Smith, at Modeled Behavior, in an excellent discussion of consumption inequality versus income inequality (my underline):
First, none of this undercuts the basic argument of Will’s paper which is that concentrating on income inequality is not particularly useful. It is entirely possible for someone to have high levels of income but moderate levels of consumption. Its not immediately clear that this is someone whose income it would be beneficial to redistribute.
Something is driving them to save so much. It could be paying off past debt. High earning professionals might have significant educational debt that they are paying off. It might be that this bit of income is transitory, a one year bonus. Or, it might be that they have really high risk aversion. This last point, I think, is key.
This is why I don’t always like looking at just consumption inequality because once you’ve started there you start to draw assumptions about everything else. Why should we assume that consumption inequality is low because people are saving so much? It could also be that it is too difficult to spend that level of money.
Thought exercise: The discussion started at refridgerators, so let’s stay there. As a useful measure of income inequality, let’s look at a worker-to-CEO ratio:
A CEO makes 260 times his worker. Now we started this discussion saying that the worker gets a perfectly fine IKEA refridgerator for $350. Now the CEO’s “budget” for refridgerators is 260 * $350 = $91,000. Here is a fun internet challenge – fine me a refridgerator that costs that much.
The most expensive refridgerator I could find is around $17,000: “European appliance maker Gorenje has unveiled the most expensive fridge in the world designed for those to whom money is no object…The £10,000 fridge-freezers, named ‘The Eye-Catchers’, of which there are 10 available, are studded with 7000 Swarovski crystals, to make the black surface glitter and sparkle like a starry night.” (If you can beat that, leave a comment. Searching for high-end refridgerators online is surprisingly engrossing.) Assuming our CEO has 5 houses, he could buy one for each (half the market!) for about $85K. He has spent the practical limit possible in refrigeration, but statistically consumption inequality is still less than income inequality.
I don’t mean that exercise to be glib, but I know many people in the medium range of financial analysts who don’t spend anywhere near as much money as they like because of limited time and bandwidth. There’s always a giant 3-month vacation they want to take, but there is always more work to be done. So the money goes to housing, which they enjoy in the offhours, but the rest is saved. There are plenty of people out there who want to help you spend your money, but inequality is at the point where there is simply a ton of money to spend and it isn’t effortless.
And just because the rich save more doesn’t necessarily mean they are more risk-adverse. There are a lot of middle-class people who save a little but put it straight into risk-free government bonds or their homes (until recently viewed as safe), and a lot of rich people who save a ton but give it all to high-risk high-fee hedge funds. There are many who’d rather “consume” the thought that their money is doing some beta-netural pair-trading backflips at a hedge fund shop rather than another expensive dinner. Back in grad school, I remember a friend telling me as a rule for investments and portfolio selection “People maximize utility, while the rich maximize wealth.” Sadly it is difficult to get reasonable estimates of that, and even the theory isn’t necessarily clear on what should happen.
All rock stars want to make money, and for the same reasons everyone else in a liberal society wants to make money: more toys and more autonomy.
I like that because it is robust to both a practical sense of autonomy as well as a more philosophical one. You can do more things that are not simply consumption, like take a year off work or not worry about insurance if you want to leave your spouse, and the capacity for self-governance, a central building block for classical liberals, is deeper and more robust.
I think we are doing fine by the toys/consumption issue; the autonomy issue worries me. Keeping my comparative advantage in stochastic risk management instead of philosophy, one thing I think of when it comes to autonomy is the ability to exert control over one’s life course and insure against risks. At this point in the game I think that has seriously unwound. I think there’s an argument that inequality is effecting fixed costs like housing and education, and the way the unraveling of a social contract involves transferring risks back to individuals increases inequality. I’m of the belief that our capability to instill a governmentality of individualized self-governance is impossible without a project of broad risk-sharing, and that it’s time to re-engineer a new social contract capable of pulling that off. Without it what we are left with the worst of both worlds – completely atomized and highly insecure.