The Myth of Income Inequality

[_Droopy]

http://www.aei-ideas.org/2011/10/5-reas ... -is-wrong/

Sorry, the story just doesn’t hold together. According to left-wing think tanks, columnist and bloggers—and, of course, the Occupy Wall Street radicals—the top 1 percent have been exploiting the 99 percent for decades. The rich have been getting richer at the expense of the middle class and poor.

Really? Just think for a second: If inequality had really exploded during the past 30 to 40 years, why did American politics simultaneously move rightward toward a greater embrace of free-market capitalism? Shouldn’t just the opposite have happened as beleaguered workers united and demanded a vastly expanded social safety net and sharply higher taxes on the rich? What happened to presidents Mondale, Dukakis, Gore, and Kerry? Even Barack Obama ran for president as a market friendly, third-way technocrat.

Nope, the story doesn’t hold together because the financial facts don’t support it. And here’s why:

1. In a 2009 paper, Northwestern University economist Robert Gordon found the supposed sharp rise in American inequality to be “exaggerated both in magnitude and timing.” Here is the conundrum: Family income is supposed to rise right along with productivity. But median real household income—as reported by the Census Bureau—grew just 0.49 percent per year between 1979 and 2007 even as worker productivity grew four times faster at 1.95 percent per year. The wide gap between the two measures, if accurate, would suggest wealthy households rather than middle-class families grabbed most of the income gains from faster productivity.

But Gordon explained that this “compares apples with oranges, and then oranges with bananas.” When various statistical quirks are harmonized between the two economic measures, Gordon found middle-class income growth to be much faster and the “conceptually consistent gap between income and productivity growth is only 0.16 percent per year.” That’s barely one‐tenth of the original gap of 1.46 percent. In other words, income gains were shared fairly equally.

2. A pair of studies from 2007 and 2008 conducted by the Federal Reserve Bank of Minneapolis supports Gordon. Researchers examined why the Census Bureau reported median household income stagnated from 1976 to 2006, growing by only 18 percent. In contrast, data from the Bureau of Economic Analysis showed income per person was up 80 percent. Like Gordon, they found apples-to-oranges issues such as different ways of measuring prices and household size. But in the end, they concluded that “after adjusting the Census data for these three issues, inflation-adjusted median household income for most household types is seen to have increased by 44 percent to 62 percent from 1976 to 2006.” In addition, research shows that median hourly wages (including fringe benefits) rose by 28 percent from 1975 to 2005.

3. A 2008 paper by Christian Broda and John Romalis from the University of Chicago documents how traditional measures of inequality ignore how inflation affects the rich and poor differently: “Inflation of the richest 10 percent of American households has been 6 percentage points higher than that of the poorest 10 percent over the period 1994–2005. This means that real inequality in America, if you measure it correctly, has been roughly unchanged.” And why is that? China and Wal-Mart. Lower-income families spend a larger share of income than wealthier families on goods whose prices are more directly affected by trade. Higher income folks, by contrast, spend more on services which are less subject to foreign competition.

4. A 2010 study by the University of Chicago’s Bruce Meyer and Notre Dame’s James Sullivan notes that official income inequality statistics indicate a sharp rise in inequality over the past four decades: “The ratio of the 90th to the 10th percentile of income, for example, grew by 23 percent between 1970 and 2008.” But Meyer and Sullivan point out that income statistics miss a lot, such as the value of government programs and the impact of taxes. The latter, especially, is a biggie. The researchers find that “accounting for taxes considerably reduces the rise in income inequality” over the past 45 years. In addition, “consumption inequality is less pronounced than income inequality.”

5. Set all the numbers aside for a moment. If you’ve lived through the past four decades, does it really seem like America is no better off today? It doesn’t to Jason Furman, the deputy director of Obama’s National Economic Council. Here is Furman back in 2006: “Remember when even upper-middle class families worried about staying on a long distance call for too long? When flying was an expensive luxury? When only a minority of the population had central air conditioning, dishwashers, and color televisions? When no one had DVD players, iPods, or digital cameras? And when most Americans owned a car that broke down frequently, guzzled fuel, spewed foul smelling pollution, and didn’t have any of the now virtually standard items like air conditioning or tape/CD players?”

No doubt the past few years have been terrible. But the past few decades have been pretty good—for everybody.

[_Kevin Graham]

Meanwhile, in other real news, poverty hits record highs in America, offering little more than a death sentence for those it ensnares.

[_Gadianton]

Hi Droopy,

Let's get the misrepresentation of you and your source of your source's primary source out of the way. The primary source material is a real economics paper titled, "Misperceptions About the Magnitude and Timing of Changes in American Income Inequality." "The myth of income inequality" and "5 reasons why inequality is a myth" misrepresent the source material substantially. There is a big difference between arguing the existence of inequality, and arguing about the rate the inequality is increasing or decreasing. Holding that the top 1% have been exploiting the rest of us for decades is consistent with the belief that inequality between rich and poor hasn't changed much. In fact, it's really, really consistent with that position. And take a look at sentence 1 from the NBER paper:

"The evidence is incontrovertible that American income inequality has increased in the United States since the 1970s."

There you have it, Droopy. Inequality is real, and it is increasing. It's just not increasing as much as many people think. A much better question for your think-tank source that addresses this paper: if the US has embraced an increasingly market-oriented position, why isn't the inequality shrinking, rather than increasing or remainting constant? Either free-market economics doesn't work very well, or politics hasn't really been moving toward greater freedom.

The NBER paper may be the first legitimate source you or your sources have ever cited. Congratulations. I've downloaded it, and will follow up on it when I have some time. I doubt you will have an interest in reading the actual paper since it's real research, however, so I won't make big plans for a discussion. But thanks for the first link you've ever provided that's been worth reading.

[_Droopy]

Hi Droopy,

Let's get the misrepresentation of you and your source of your source's primary source out of the way.

No need, as neither I nor my source misrepresented anything.

Holding that the top 1% have been exploiting the rest of us for decades is consistent with the belief that inequality between rich and poor hasn't changed much.

Perhaps, but not on sound logical grounds or with respect to the conclusion of the study.

In fact, it's really, really consistent with that position. And take a look at sentence 1 from the NBER paper:

"The evidence is incontrovertible that American income inequality has increased in the United States since the 1970s."

That's an interesting sentence, found on page 1. Somehow, however, you forgot to quote the first sentence in the paper proper - the first sentence of the abstract, which says:

The rise in American inequality has been exaggerated both in magnitude and timing.

This, of course, is perfectly in harmony with what the AEI commentary said when it said:

In a 2009 paper, Northwestern University economist Robert Gordon found the supposed sharp rise in American inequality to be “exaggerated both in magnitude and timing.”

Further, the AEI author never argued that income inequality did not exist, nor did he mention anything about hoary Marxist/New Deal populist class war notions that the top 1% are exploiting the rest of us.

There you have it, Droopy. Inequality is real, and it is increasing.

Yes, and as both the AEI commentary and the original study concur, it is rather trivial:

This paper shows that a conceptually consistent measure of this growth gap over 1979 to 2007 is only one-tenth of the conventional measure. Further, the timing of the rise of inequality is often misunderstood.

And, less your usual pompous snark, you may have at least condescended to read the study you claim shoots down the AEI piece:

The rise of American inequality has been exaggerated in magnitude, and its impact is now largely in the past. Standard commentary laments the slow growth of median real household income and concludes that over the past three decades (1979‐
2007) the gap between growth of income and productivity has been 1.46 percent per year. But this “conventional” gap measure is riddled with measurement and conceptual inconsistencies. Our “alternative” gap measure grows at only 0.16 percent over the same period, only one‐tenth as rapidly as the conventional gap, and it does not grow at all during the 1979‐1995 period when inequality was growing fastest. In fact, we show that income‐productivity gaps have virtually nothing to do with inequality.

The alternative growth gap is zero when inequality grew fastest before 1995, became Inequality negative when inequality grew further during 1995‐2000, and was strongly positive in 2000‐07 when inequality decreased.

Gadianton:
It's just not increasing as much as many people think.

Hmmm...didn't the AEI piece ague...exactly that?

A much better question for your think-tank source that addresses this paper: if the US has embraced an increasingly market-oriented position, why isn't the inequality shrinking, rather than increasing or remainting constant?

No, the question for you is: why is the existence of income inequality even an important issue to address at all? Poverty is a condition worthy of study and reflection, but income inequality per se, except under certain conditions (including extreme, government-induced conditions), in a nation of overwhelming middle class affluence, seems a bit misplaced. Should I really care if my boss is doing better than me if I'm doing well (and opportunities for further economic betterment abound)?

[_Gadianton]

the AEI author never argued that income inequality did not exist

Might be better to change your titles then to something that doesn't declare income inequality to be a myth. How about, "The myth of increasing inequality," or even, "Myths about income equality?" "Five myths about income inequality," that's good. "Five reasons why inequality is a myth," however, is a misrepresentation of the source material.

No, the question for you is: why is the existence of income inequality even an important issue to address at all? Poverty is a condition worthy of study and reflection, but income inequality per se, except under certain conditions (including extreme, government-induced conditions), in a nation of overwhelming middle class affluence, seems a bit misplaced. Should I really care if my boss is doing better than me if I'm doing well (and opportunities for further economic betterment abound)?

I don't have a great deal of sympathy for middle class people who agonize over getting ahead. I personally don't care if my boss does better than me. But, inequality is interesting from an economics perspective (to the extent that a boring subject can be interesting). In an "ideal" market, there should be less inequality than there is. I suspect that law and policy are ultimately to blame, not free markets, as many socialists believe. I think that policies aimed to fix inequality are prone to backfire. That doesn't mean I think the rich shouldn't be taxed more, I reject "trickle-down" economics as essentially Keynesian. So yes, the author of that article should wonder why inequality isn't decreasing if markets are less inhibited. Perhaps free-markets don't work very well, or perhaps markets aren't less inhibited.

[_moksha]

As the footman said to the valet, "Mitt can take out one of those street urchins from 20 feet away with a single jar of Grey Poupon".

[_Analytics]

No, the question for you is: why is the existence of income inequality even an important issue to address at all?

That is an interesting question.

Just to give some perspective of where I’m coming from, I’ve flown over 100,000 miles this year. Most of it has been to third-world countries.

Flying business-class in a wide-body jet from America to a third-world country is something I wish everybody could experience. The waiting areas outside of the huge planes are always crowded. But when you travel first-class, you are sipping complementary wine in a comfortable chair in a spacious private lounge until they announce your plane is boarding. When they make the announcement, you head to the plane. The hardest part of the whole process is to make your way through the throngs of coach passengers so that you can board in the dedicated first-class passengers lane with the red carpet.

Once you get your seat, the flight attendant immediately takes your jacket and places it on hanger, and offers you your choice of bottled water, orange juice, or Champaign. It’s hard to fully explain how luxurious the next 10 hours are—when the folks in the back of the plane get a tiny plastic package of peanuts and a coke served in a six-ounce plastic cup, in first-class you enjoy scotch with a mixed nuts—cashews, macadamia, walnuts, and the like—served in a china dish. But they warm the nuts before they serve them to you. You play with the 20 buttons that adjust your seat until you get it just right. You put on the Bose noise-cancelling headphones that the airline provides (assuming you didn’t bring your own), and choose from one of hundreds of music stations or movies.

Then the food starts coming out. The cheese plate is served on a chilled plate with chilled silverware. The soup is truly gourmet. There are 10 varieties of bread in the basket, and each piece is warm and fresh. You read the biography of the chef on the last page of the menu, and you can tell from the presentation and quality of the entree that they spare no expense to make the food at 30,000 feet just as luxurious as it would be in a 5-star restaurant on the ground. The flight attendant pleasantly laughs when you can’t decide which wine you’d like, and cheerfully pours you a glass of each.

Finally, after you finish your Häagen-Dazs sundae with a glass of fine port, you are as satisfied as a human being is capable of being, completely full with luxurious food and drink. You push the button on your seat labeled “zzzz”, which lays the seat completely flat. You snuggle with your feather pillow under your down comforter, and have an excellent night sleep.

In the morning, the flight attendant is waiting to serve you a cup of hot, fresh coffee served in a really nice mug. You know that since a limo will be picking you up at the airport you won’t have to drive, so you decide to ease out of your pampered state slowly, and ask her to add some Bailey’s Irish cream to the coffee.

When I have those experiences, I don’t think, “Gosh, I wish that things were more equal. Wouldn’t this plane be nice if the four-feet of legroom I’m using were evenly distributed to the coach passengers, and that the fine food in which I’m indulging were taken away from me and evenly distributed to the huddled masses starving in the back?" But I do think of the place where I’m going. Even though I’ll be staying in a five-star hotel, the country as a whole not only has a high level of inequality, it also has a high unemployment rate.

While the finer things in life are quite enjoyable, in and of themselves, they don’t make you happy. I believe that people in the working class can be just as happy as the rich, provided they can find work. But I wonder—is a strong middle-class required in order for the economy to have full employment? If the inequality in America continues to become more like that of a third-world country, will the unemployment rate follow suit?

While I earned my lifestyle through incredibly hard work and a little bit of luck, it would not be possible for me to produce what I do without the economic environment in which I live. That being the case, are the riches with which I’m compensated fully mine? When people argue that the economy would be better off if the government were so small it could be drowned in a bathtub, I wonder if they’ve ever been to Haiti where that is in fact the case.

So to directly answer Droopy’s question, my economic perspective is based on the reality that there must be a macro-economic balance between production, capital investment, consumption, and savings. In other words, there can only be full employment if the market demands the amount of work associated with full employment. A strong middle class has a strong demand for goods and services, which results in a strong jobs market. Inequality matters because if the wealth we jointly produce is successfully horded by a small subset of the population, unemployment and poverty will result.

[_Gadianton]

Flying business-class in a wide-body jet from America to a third-world country is something I wish everybody could experience

C'mon Analytics, you ain't flying on no jet, your opinions derive from your desire to get a free cell phone and a couple grand in tax credits. Admit it.

When people argue that the economy would be better off if the government were so small it could be drowned in a bathtub, I wonder if they’ve ever been to Haiti where that is in fact the case.

I do have to ask: imagine Haiti as it is today. Now, increase taxes to employ and army of government workers who will build roads and at least one bridge for Droopy in case he visits, then, lower interest rates. All better?

While I earned my lifestyle through incredibly hard work and a little bit of luck, it would not be possible for me to produce what I do without the economic environment in which I live. That being the case, are the riches with which I’m compensated fully mine?

I feel the same way. I don't have a good answer to that question, but, I am aware of my relative luck when considering my situation relative to the world average, the inefficiency of markets in my favor, and so a few grand here and there "robbed" from me by the government doesn't offend me. I don't like it necessarily, I just don't take it personally. If I want more, it's in my power to fix the situation, it's just a matter of giving up time spent on hobbies and doing real work.

[_Analytics]

I do have to ask: imagine Haiti as it is today. Now, increase taxes to employ and army of government workers who will build roads and at least one bridge for Droopy in case he visits, then, lower interest rates. All better?

Of course not. But if we added to the list a robust public education system and a police force that was paid enough to do its job without relying on crooked cops, it would be a step in the right direction.

My point is that a strong government is a necessary condition for a vibrant economy, but it isn't a sufficient condition.

I feel the same way. I don't have a good answer to that question, but, I am aware of my relative luck when considering my situation relative to the world average, the inefficiency of markets in my favor, and so a few grand here and there "robbed" from me by the government doesn't offend me. I don't like it necessarily, I just don't take it personally. If I want more, it's in my power to fix the situation, it's just a matter of giving up time spent on hobbies and doing real work.

When discussing the plight of the proletariat, the apologists for the bourgeoisie will often say something to the effect that wages are tied to productivity—workers earn what they are paid and are paid precisely what they deserve because that is the value they contribute to their employers. Anything that would change this relationship between a man and his paycheck—such as a tax—constitutes a form of robbery.

I find that line of thinking ludicrous. While the relative productivity between two people doing the same job in the same environment can be measured, measuring the total productivity of people in our economy is a fundamentally impossible task. Employees, employers, capitalists, and the government are all in a symbiotic, synergetic relationship. Not only is the whole greater than the sum of the parts, we are all building our castles on the giants that built the civilization in which we now live.

If I get paid $100,000 a year, that is because that is the compensation package I negotiated—not because it is the actual value that I contribute to my employer and customers. If the government takes $15,000 of that in federal income tax it is the same thing—that is simply the deal that was negotiated.

[_Gadianton]

My point is that a strong government is a necessary condition for a vibrant economy, but it isn't a sufficient condition.

Understood. But, just to point it out, in the libertarian arguments for smaller government, a "small" government is a necessary, but not s sufficient condition for an economy to grow. ;) Even the "anarchists" of the Austrian School would not argue that any anarchy would work. A lot of education, "enlightenment", and in my view, indoctrination would be needed. Further, what constitutes a "small" government is an open question. Equity and foreign exchange markets are offered of examples of near market efficiency, but these markets can't exist in a vacuum without any regulation.

If I get paid $100,000 a year, that is because that is the compensation package I negotiated—not because it is the actual value that I contribute to my employer and customers. If the government takes $15,000 of that in federal income tax it is the same thing—that is simply the deal that was negotiated.

This is true. In fact, the more capable employees often make less. Less capable employees, if they have some initiative, may find it difficult to keep a job long term, but in the process they learn how to write their resume, get through interviews, negotiate pay, and so on. Oh well, I've never seen the labor market offered as an example of market efficiency.