Diatribes - Computer, Economic & Political

This blog is really just for me. If you find something interesting on it, leave me a comment. If you disagree with something, let me know what and why. In this blog I am just putting some of my thoughts for computers, the economy, politics, and other topics in writing.

08 October 2009

Economic Inequality - does it matter?

I've been thinking a lot about the rising income gap. Is it really rising? Does it matter? We'v heard a lot about the top 1% of earners, but as long as the rest of us aren't worse off, should we care? Now I think we should, though I didn't think so before.

Economic Destabilization
One argument for why we should care is that income inequality causes economic collapses. The two peaks in income inequality line up nicely with 1928 and 2007.
But does inequality really drive recessions? This graph doesn't line up well with recessions in 1948, 53, 58, 60, 74, 81, 90, or 2001. Why does income disparity affect larger depressions/recessions, but not smaller ones? Would this relationship mean that nations with higher income disparities should have deeper recessions? Could it be, that the graph is only showing that the rich own most of the overpriced assets before the bubbles burst? Is the disparity driving the recession, or is something else driving both? I am skeptical.

Disappearing Middle Class
The story about a disappearing middle class is pretty standard now, but it doesn't seem to line up well with careful analysis. The middle class hasn't gotten poorer or stagnated. Thomas Cooley (NYU economist) explores this in good detail in a series of two consecutive articles. Many other economists agree. The amount of income isn't fixed, and the rich getting richer doesn't necessarily mean everyone else is getting poorer.

Last week, the CBO came out with a paper (PDF warning) on just this issue. In real dollars, no income bracket has seen earnings fall in the last 30 years. However, nearly all the gains have been concentrated in the higher percentiles of earners. So lower percentiles have seen their income shrink as a share of total income, but the purchasing power has stayed about constant and absolute standard of living has been rising. Total amount of income in the world isn't fixed, the the gains to the top 1% haven't come from the losses of others.

There is disagreement over these findings. Other organizations have reported falling earnings. The difference seems to be largely a result of selecting different deflators (the price index used), household income groupings, and whether or not to include fringe benefits (e.g. employer contributions to healthcare plans). The deflator is important because the CPI basket has expanded in the last 30 years to include many things that didn't exist 30 years ago (thus cannot be priced). So we have many different deflators, each with its own weakness.

How you count households matters too, because in the last 30 years we've seen a massive decline in married-couple households and an increase in no-spouse households for both genders. When two people live together, when do you count them as a single household and when are they two households (e.g. roommates) in the same house? So this stuff is tricky, and just citing numbers doesn't really convey any meaningful information.

Other Factors
Others have made the argument that larger income gaps are correlated higher crime rates, homelessness, and other bad things. This may be true, I don't know, but I haven't seen any data suggesting this is true.

I've also seen the argument that a huge gap makes a "fairness" argument. A bank CEO's labor surely isn't a million times more productive/valuable than a minimum wage laborer, right? Well, that's true, but wages aren't reflective of just productivity, they're also a function of scarcity. Very few people can do a bank CEO's job; a lot more can flip burgers. That's not to say CEOs aren't overpaid - the inbred relationship between boards and executives almost ensures they will be - but it is to say this kind of argument isn't reflective of how the world actually is.

Decreased Economic Mobility
One argument does hold some weight for me. Someone pointed me to an academic paper which reinforced previous findings that inequality increases efficiency and capital accumulation to a point, then at some point that when income inequality becomes large, it becomes more difficult to accumulate capital and efficiency suffers. Essentially, it is harder to get out of lower income brackets.

So the inequality problem isn't about rich people benefiting at the expense of the poor, it is about immobility between the groups. That theory makes a lot of sense to me, and it seems consistent with the flat growth of real income in all but the highest brackets. This is bad for a lot of reasons, but I think "fairness" is an appropriate reason to bring up here. Future prospects of higher income gets people to work harder and better. If people don't expect to "move up," so to speak, this can create permanent classes, instability, and general unfairness.

We Should Care

To me, economic immobility is a good reason to care about income inequality. I don't know what is causing the inequality - some have suggested higher levels of education and technology may be driving forces, others suggest corruption and graft - but that perhaps a topic for another post. I also don't know what the remedy is, again perhaps a topic for another post.


Blogger Aaron said...

I've taken a good amount of classes in this kind of subject- Econ Development Policy, Development of Latin America, and now Inequality and Poverty in Latin America. First, I might say my studies thus far have been generally in inequality in developing countries, but some of what I've learned applies to developed countries.

Regarding Economic Destabilization- I don't think many economists would argue income inequality causes economic collapses. I think it's there's a definite correlation but not causation- simply, inequality, according to Kuznets U-curves naturally increase during rapid growth. 1920s and mid-2000s had pretty high growth, particularly in the financial markets so it doesn't surprise me to see that. It's just a case of an inequality-producing industry that also creates economic depressions when poorly regulated.

One interesting thing I have noted, I'm working on 2 papers on Brazil's inflationary crisis in the early 1990s as my semester-long project, and that is that inequality, in one of the world's largest economies, has no real strong correlation during recessions. Some, like the 1990s inflationary crisis, create a more equal society, as you said about the "overpriced assets."

As for the disappearing middle class, I think it bears some mention. We've seen a significant amount of downward mobility, especially in the last 2 years, that is pretty concerning. The Minneapolis Fed article you linked to confirms some of the worries, essentially, that while real wages have not been decreasing...they certainly have not matched the pace of economic growth. That is troubling to me. Taxes and debt have certainly increased since the 1980s in most areas.

As for why inequality is bad...that's not a blanket statement pro-poor growth economists are making. Inequality without mobility and high poverty is bad. There can be a perfectly equal society that is poor as dirt (Cuba) and an unequal society with relatively low poverty. (US) There's plenty of evidence of lower returns and lower efficiency for capitalists in unequal society, as well as societal problems such as crime and political stability.

A strong middle class, which generally means a lower amount of income equality, is proven often to be the impetus for a stable society with high growth rates. That's why inequality troubles me.

Also, you've read the statistic that CEO's in the last 15 years went from an average of 30x the normal worker to something like 500x? That is obscene to me, because in many cases, they are screwing the workers they are laying off. More than anything is they aren't successful- I think most of us would grumble about CEO pay if they were producing, but what about the ones like Home Depot or Carly Fiorini who ran their companies into the ground and still made millions out of it? I have no evidence of this, but to me, there is too much CEO-Board fraternization. It distorts executive compensation, making it much higher than the market wage- essentially, they create the CEO scarcity.

09 October, 2009  
Anonymous Sean said...

I generally agree with your comment, a lot of it was kind of a restatement. I don't know anything about south america so the bit about brasil was interesting too. As for poverty, I'm only thinking about the US, at least that's where all the data I've looked at comes from, so high levels of poverty aren't really relevant to the discussion.

I will disagree on one point. We haven't seen downward mobility. The minnesota fed article explicitly said that - real wages have NOT decreased. Real wages are indexed to inflation, they're not nominal. So purchasing power has not fallen.

As for the rest, lets stick to the statistics rather than annecdotes about CEOs laying people off to pad their bonuses. I said the top 1% has seen a massive increase in wealth, no doubt. But others haven't lost in real terms, at least according to the OMB.

The increase of the top 1% doesn't come at the expense of the middle class or lower class - again, their real income is not falling. It just means they're only keeping up, while the top 1% is pulling further ahead. I think we should care about this, but we should care for mobility reasons NOT because any group is getting poorer.

09 October, 2009  
Blogger Aaron said...

We haven't seen downward mobility.

I disagree. The Fed article said that overall wages have not decreased. True. But wages only affect the employed. But that doesn't affect unemployed people, and I think with the depression and unemployment at 10%, there's a lot of people who were on the edge before that has dropped in the class.

The increase of the top 1% doesn't come at the expense of the middle class or lower class - again, their real income is not falling.

Yes, but a proportion of the created wealth is going disproportionately to the richest. Just because it doesn't directly impoverish people doesn't mean it's not coming at others expense.

As for the rest, lets stick to the statistics rather than annecdotes about CEOs laying people off to pad their bonuses.

It's a fixed budget for a company, so obviously one is coming at the expense of the other, right? We can stick to statistics- 10% unemployment, and record payouts for CEOs. That's not right.

09 October, 2009  
Anonymous Sean said...

1. I wouldn't call unemployment downward mobility unless those who were laid off re-enter the workforce at a much lower wage. I haven't seen any data showing that to be the case. Can you show me this data? And are you sure the unemployed are left off the income bracket charts? The data I've seen just doesn't support this assertion, but I'm open to changing my mind.

2. The new wealth is disproportionately going to the wealthy, but who measures their own well being against someone like John Thain? E.g. I don't say, "well, I got a 2% raise to match inflation, but this guy got a massive raise, so I'm worse off." Instead, I measure my well being in terms of purchasing power, and if my real wages are steady so is my purchasing power regardless of how much Charles Prince made.

3. Companies absolutely don't have a fixed budget. Revenue increases and decreases. If the CEO doesn't take a big paycheck that doesn't mean the money would've been paid out to workers, it could have stayed as cash reserves, been giving out as dividends, or invested. Also, again, I'd need some kind of citation for "record payouts for CEOs" - it could be true, saying so doesn't make it so. However, the latest data I've seen doesn't seem to support your assertion. The perception is there, but I suspect that's more due to media exposure than actual salaries increasing.

10 October, 2009  

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