"Is Income Volatility Really Rising?"

I've presented quite a bit of Jacob Hacker's work here, so it's only fair that I also present intelligent responses to it. Justin Wolfers has the details, and I added a few comments at the end:

Is Income Volatility Really Rising? For Whom?, by Justin Wolfers: Jacob Hacker’s Great Risk Shift described rising income risk over recent decades as an important and quite general phenomenon. While there’s been plenty of controversy around that claim, the most careful analysis I have seen roughly supports Hacker’s contention. ...

What Hacker actually shows is that the average level of income volatility is rising. But we know that an average can hide as much as it reveals. And this is the point brilliantly developed in a provocative new working paper by my Wharton colleague Shane Jensen, and my former colleague Stephen Shore (full paper available here; warning, there are some econometric pyrotechnics involved).

Income volatility is not a single number — some people’s incomes move around over time more than others. And while Hacker and others have documented a rise in the average level of income volatility, Jensen and Shore document changes in the entire distribution of different people’s income volatilities.

A stock market analogy might be useful: some stocks are more volatile, some are less, and it is interesting to see what is happening to the volatility of different types of stocks, and not just some mythical “average stock.”

The Jensen-Shore findings are pretty stark and are sure to stir the policy debate: Despite sharp growth since the 1970’s in the average level of income volatility, median income volatility is basically unchanged. (There are some differences in samples and methods..., but I would be surprised if that explains much.)

Indeed, there’s been no change in income volatility for most of the distribution:

Here’s the punch line:

The key driver of rising average levels of income risk is that life among the already risky has become even riskier. Indeed, you really need to look to the riskiest 5 percent of the distribution to find the rise in income risk. And this rise in risk among the already risky is so great as to be responsible for nearly all the rise in average income volatility. And who are these riskiest 5 percent? Jensen and Shore find that they are particularly likely to be self-employed.

The Jensen-Shore analysis yields an interesting scorecard: Hacker was right on average, but wrong for 95 percent of us. ...

Perhaps the debate about the Great Risk Shift isn’t such a big deal after all: the best argument for a social safety net is that there is too much risk, not that risk has grown.

Full details, including technical wizardry, here.

I'll keep an eye out for any response from Jacob Hacker, but let me anticipate what he might say. This is from an email he sent in response to earlier questions about his work (the email addresses questions raised by a CBO report that comes to different conclusions about income volatility, something Justin Wolfers discusses in parts of the post above that I didn't include, and something that Jacob Hacker and Elisabeth Jacobs discuss and attempt to resolve here). I think Jacob Hacker would argue that income volatility is just one dimension of the risk shift he was talking about:

[F]amily income volatility is scarcely the only measure of economic insecurity or the “risk shift” that I and others have discussed. Only one chapter in my book is about family income instability. The rest are about pensions, health care, the decline in traditional job security, the increasing debt burdens reflected in families’ financial balance sheets—in short, about the whole range of economic risks that Americans face. Many of these risks, such as health costs, retirement insecurity, bankruptcy, and mortgage foreclosure, either do not show up in the incomes of working-age people or show up only weakly.

As I put it in The Great Risk Shift, “The up-and-down movement of income among working-age families is a powerful indicator of the economic risks faced by Americans today. Yet economic insecurity is also driven by the rising threat to families’ financial well-being posed by budget-busting expenses like catastrophic medical costs, as well as by the massively increased risk that retirement has come to represent, as more and more of the responsibility of planning for the post-work years has shifted onto Americans and their families. When we take in this larger picture, we see an economy not merely changed by a matter of degrees, but fundamentally transformed—from an all-in-the-same boat world of shared risk toward a go-it-alone world of personal responsibility.”

Comments

[Michael Kelly]

As income volatility rises so would the lifetime tax burden of those who face higher income volatility, especially when we have an alternative minimum tax and tax rates that rise with annual income.

That raises some interesting questions about whether certain groups are actually incurring a greater tax burden than they would have in the past -- even so-called "rich" taxpayers.

[Richard H. Serlin]

I don't have time now to go through this in detail, but quickly, there's a lot more to it than just income volatility. If you take two people, or firms for that matter, with equal income volatility, and one has zero debt while the other has debt equal to a years income at high unregulated interest rates, then the second is at far greater risk of financial disaster. Debt levels have skyrocketed over the last generation.

In addition, the risk of devastation from medical costs is tremendously higher over the last generation, even for those who have insurance. Even if there were no change in income instability, this alone would greatly increase risk. See, for example, this article from the New York Times.

Then, there's the Two Income Trap phenomena of Harvard's Elizabeth Warren. Fixed expenses went from 54% of the budget with just one spouse working (leaving the other in reserve to go to work in a crisis) to 74% for the average couple, with both spouses working.

There's just so much more that has increased risk over the last generation than just income volatility.

[Richard H. Serlin]

Sorry, rushing, rushing. Here's the link to the New York Times article:

http://www.nytimes.com/2008/05/04/business/04insure.html

[Fan]

Hacker's claim about other forms of risk makes intuitive sense. However, I would expect this to be reflected in income statistics at some point. Could someone incur enormous bills, yet continue to receive income as usual (disability coverage? continues to work anyway (possible if the medical bill is e.g. incurred for a child)?). Income volatility is about gross, not net. I suppose it's possible, but it's a strain.

Likewise with retirement; if you're going to be poor in your retirement at some point you're going to be poor. Perhaps this doesn't show up as volatility because it's a one-time switch?

It's all rather confusing.

[robertdfeinman]

I'm going to propose the "defining moment" theory. In many people's lives there is some event that changes their outlook forever after. Even if things go back to the same as before, they never quite feel the same internally.

The prominent one in the news now is those returning from service in the two ongoing wars. Even those who seem to suffer no PTSD or other overt psychological effects are seen by their friends and family to have "changed". Perhaps they have just lost some of their youthful idealism or something.

I think many people have also had such defining moments when their economic stability was upset. This could have been a loss of a job (involuntarily) by themselves or a close member of their family or even a friend or co-worker. A single event like this might not show up statistically, but could still affect people's feeling of security.

Similar feelings could be as a result of health issues, or debt pressures and collection issues.

Once burned, twice shy. How do we measure this?

[Bruce Wilder]

rdf: "How do we measure this?"

jw: "The key driver of rising average levels of income risk is that life among the already risky has become even riskier. Indeed, you really need to look to the riskiest 5 percent of the distribution to find the rise in income risk. And this rise in risk among the already risky is so great as to be responsible for nearly all the rise in average income volatility."

All this talk of "median" volatility or "average" volatility sets off alarm bells for me. Variance is a population characteristic. Of course, in any given cross-section, the individuals showing the greatest value-change are a small proportion of the whole population. Duh. You might as well as poo-poo rising cancer rates, by pointing out that only a small proportion get cancer in any five year period. This is just dumb.

[tkw]

The problem with the Freakonomics post is that it glosses over a key difference between Hacker's work and the Jensen/Shore paper, namely that Hacker measures the volatility of family income, while Jensen and Shore measure the volatility of men's earnings. It is quite possible for men's earnings volatility to stay flat or decline while the volatility of family income as a whole rises; this can happen, for instance, if the covariance between the earnings of husbands and the earnings of wives has increased over time.

In fact, this appears to be what has happened: see, e.g., http://www.urban.org/publications/411688.html.

[Real Person from the Real World]

They can say what they want, but if it looks like a duck, quacks like one, and walks like one, it is a duck. Everyone I know is less certain of income and faces increased risks.

[save_the_rustbelt]

robertf makes a good point.

Reminds me of a comment from an IBM employee (paraphrasing, I can't find the original quote).

"Lou Gerstner's mansion used to be my pension."