"Whenever I go into a restaurant, I order both a chicken and an egg to see which comes first"

Monday, June 17, 2013

Great Gatsby Economics–Income Inequality Is Not All It’s Cracked Up To Be

E.J. Dionne, writing in the New York Times (6.17.13) raises the specter of income inequality one more time, and suggests yet again that it is a bad thing.  However he does not say why other than it simply feels wrong.  In a country that prides itself on economic mobility, enterprise, and the American dream, it seems a betrayal and a false promise if incomes grow at differing rates.  However, does income inequality contribute to injustice? Slower economic growth? Social and class divisions leading to revolt and anarchy? Hardly.

As Will Wilkinson writes in Cato Unbound, the issue is not so much income disparity as economic well-being.  That is, income disparity per se is not the problem, it is the perceived standard of living of each segment of society.  If one looks, then, at consumption as a more appropriate indicator, it is a more accurate measure of economic satisfaction.  It isn’t so much how many dollars you have in your pocket; it is what you can buy with them: 

The relative prices of low-quality products that are consumed disproportionately by low-income consumers have been falling over this period. This fact implies that measured against the prices of products that poorer consumers actually buy, their “real” incomes have been rising steadily.

Moreover, wages of low-income earners have been rising. According to Wilkinson, economists Christian Broda, Ephraim Leibtag, and David Weinstein, using an updated price index, conclude:

The real wages at the 10th percentile increased by 30 percent from 1979 to 2005. In other words, the real wages of low earners have not remained stagnant, as suggested by conventional measures, but actually have been rising on average by around 1 percent per year.

No one has really answered the question, “What’s the problem with income inequality?”

The same level of inequality can have better or worse underlying causes. For example, the United States and Ghana have approximately the same level of income inequality, as measured by the Gini coefficient, but on any sensible account of justice or goodness, American institutions are a lot better. Neither the level nor the trend of inequality conveys the sort of thing we need to know in order to responsibly pass judgment on a society’s institutions or its social, political, and economic order.

So what, then, should be made about the increasing concentration of wealth in the top 1 percent?  Nothing, if one applies the Pereto principle. Richard A. Epstein of the Hoover Institution notes that we should be more concerned about any declines in income, but  not about income inequality per se:

This conclusion rests on the notion of a Pareto improvement, which favors any changes in overall utility or wealth that make at least one person better off without making anyone else worse off. By that measure, there would be an unambiguous social improvement if the income of the wealthy went up by 100 percent so long as the income of those at the bottom end did not, as a consequence, go down. That same measure would, of course, applaud gains in the income of the 99 percent so long as the income of the top 1 percent did not fall either.

According to the data provided by Wilkinson, above, there is no indication that the rise in incomes of the 1 percent are hurting the 99 percent.  Again, it is an idealistic perception of social equality that drives liberal critics. Epstein poses a hypothetical situation to illustrate why growth of income is a more valid indicator of economic well-being than income equality.  He asks us to consider two hypothetical scenarios. In the first, 99 percent of the population has an average income of $10 and the top 1 percent has an income of $100. In the second, we increase the income gap. Now, the 99 percent earn $12 and the top 1 percent earns $130. Which scenario is better?

First, everyone is better off with the second distribution of wealth than with the first—a clear Pareto improvement. Second, the gap between the rich and the poor in the second distribution is greater in both absolute and relative terms.

Some critics are concerned about the rapid rise in income by the 1 percent.  First of all, the rise was more likely due to the financial jiggering that went on before the crisis, and there will certainly be an adjustment once regulation kicks in and the investment industry is restructured.  In other words, incomes will rise less slowly.  Second, the dramatic increase in CEO salaries was part of the pre-2007 boom, but it is a trend now being reversed.  Third there was also “re-timing” of income to avoid possible future tax liabilities, and that too will change once there is more clarity on the tax code.

Most importantly, it is the way in which incomes increased before 2007 which has to do with injustice and the general population, not the income disparity it produced.  One hopes that sanity will return to Wall Street and that whatever money is made, is made more responsibly and ethically.

Still, liberal policy-makers still want to exert idealistic and punitive pressure on the 1 percent – higher taxes, overly restrictive legislation, and invasive surveillance – without any real evidence that such forced income redistribution will have any positive effect on the 99 percent.  As Wilkinson and Epstein have suggested, it will not.

What about low-income wage earners, and how can one accelerate the growth of their income?  Dionne and others have rightly focused on education.  Without an education to graduate highly-skilled, productive, adaptable workers, students will always end up with low-skill, low-paying jobs.  However, they tend to ignore the social dysfunction which plagues many low-income communities.  Inner-city neighborhoods are characterized by high rates of crime, incarceration, drug use, violence, illegitimacy, and poor academic performance; and local leaders, encouraged by their white ‘progressive’ supporters, have done little to reject the concept of entitlement and to accept personal and community responsibility.

All of which leads me to comment on Dionne’s citation of “The Gatsby Curve” invented by Alan Krueger:

The Curve measures income mobility across generations. It turns out that the United States has far less “intergenerational earnings elasticity,” to use the technical term, than do many other countries, including Denmark, Norway, Finland, Sweden, Germany, or New Zealand. Economically speaking, “Born in the USA” doesn’t mean what it once did.

This, of course, is a loaded reference.  In a highly ethnically, geographically, and racially diverse population like that of America, and one whose immigration rates are still much higher than increasingly hermetic Europe, intergenerational mobility takes far more time.  No one has yet figured out how to break the cycle of racism, discrimination, and persistently poor performance of black Americans.  Hispanics face language and socio-cultural barriers.  Regional insularity persists, and the American South is a perennial loser in the race to the economic summit.

In conclusion, no one doubts that income inequality is a fact in America and that it may be growing; but few have explained exactly why it is a problem.  The knee-jerk response of ‘income redistribution’ has been discredited, for it does not consider the positive social, economic, cultural and other factors responsible for the growth of the wealthy; and the negative ones contributing to slower growth among those less well-off.  The Pareto Principle is key; and if no harm is done to the 99 percent by disproportionate increases of income in the 1 percent, then no problem exists.  The real task is to figure out a way to untangle the many threads that are holding back much of the population, so that incomes can increase as fast as at the top.

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