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Thursday, January 25, 2007

Bruce Bartlett and Tyler Cowen on Inequality

Bruce Bartlett writes about income inequality:

Is Income Inequality Really a Problem? by Bruce Bartlett, Commentary, NY Times: With Democrats back in charge of Congress, it is not surprising that we are seeing a revival of interest in the issue of income inequality. In his response to President Bush’s State of the Union address on Tuesday, Senator James Webb, Democrat of Virginia, complained that corporate C.E.O. compensation has risen from 20 times that of the average worker 40 years ago to 400 times today. Such obscenely large payouts may result from nothing more than the operation of Adam’s Smith’s invisible hand, but even many conservatives are wary of defending it that way.

One free marketer who is not afraid to do so is Alan Reynolds of the Cato Institute, whose new book, “Income and Wealth,” is a thoroughgoing attack on those who would redress income inequality through higher taxes. The cure, he says, would be far worse than the disease.

This is not new territory for Reynolds, one of the original “supply-side” economists who convinced Ronald Reagan and the Republican Party to support large tax rate reductions in the 1970s. ...

While Reynolds covers the waterfront of issues related to income distribution, he has lately been enmeshed in a debate about whether income inequality has or has not risen as much as most people believe it has. ...

Reynolds has been criticized for making too much of inherent limitations in the data that have been known for many years and for ignoring evidence that conflicts with his thesis. Most economists would probably agree with Gary Burtless of the Brookings Institution... Even accounting for the factors Reynolds cites, there are too many different sources all showing a rise in income inequality, from Census Bureau and Federal Reserve data based on surveys to Securities and Exchange Commission figures on executive compensation, which come straight from corporate filings. No matter how you slice it, the distribution of income has become more unequal over the last 20 years or so...

Personally, I am willing to concede the point, but I would prefer to come at the income distribution question in a different way. I have long sought a study showing exactly what the cost of inequality is. If my real income does not fall, how am I hurt when Bill Gates makes another billion dollars? After all, the economic pie is not fixed. What he gets doesn’t come at my expense, so why should I or anyone else care? ...

In every debate on the subject I have ever engaged in, those advocating redistribution were not concerned about inequality per se. They were bothered by poverty and an infinite list of unmet social needs that they believe could be cured if we just spent more money on them. Since people like Gates clearly don’t need all their wealth in any meaningful sense — he would be just as well off materially with only 10 percent of what he has — redistribution appears to be a costless way of making many people better off while not really hurting anyone. In other words, the argument for redistribution is, at its core, not moral but purely utilitarian — the greatest good for the greatest number.

If it were costless to play Robin Hood and take from the rich and give to the poor, it would be hard to oppose. But there are costs. We really don’t want the Gateses of the world sitting around clipping coupons. We want them out there thinking of new products and businesses to make themselves richer, because in the process they will improve the quality and lower the prices of goods and services we use, employ workers ..., and so on. Nor do we want the poor sitting around waiting for handouts. We want a balance in which incentives are preserved both at the top and the bottom of the income distribution. ...

Perhaps ... redistribution measures would be justified if there were evidence of income stratification. But all the evidence we have tells us that there is considerable movement up and down the income scale... Karl Marx’s 1865 observation remains valid: “The position of a wages laborer is for a very large part of the American people but a probational state, which they are sure to leave within a longer or shorter term.”

Perhaps a better way of addressing the issue might be to ridicule the excesses of those with great wealth the way gossip columns and Web sites make fun of “celebrities” like Paris Hilton. It could be a better way of encouraging the wealthy to engage in socially beneficial activities, such as donating funds to poverty relief, instead of buying yachts and jewels.

The topic of inequality has been discussed here in some depth, so just a couple of things. Many of the statements presume that compensation at all income levels is determined in competitive markets. If it isn't, and I don't think it's hard to make the case that many of these markets (e.g. CEOs) are not competitive, then compensation at the margin is greater than it would be under an efficient outcome.

As for the claim about stratification and income mobility, that's been covered before as well:

The American Dream gains a harder edge, By David R. Francis, CSMonitor.com: The American dream, at least on the economic side, is fading. … Today … the odds of a son or daughter rising above their parents in such a financial predicament have shrunk. "Income mobility has declined in the last 20 years," says Bhashkar Mazumder, an economist at the Federal Reserve Bank of Chicago. What that means is that the US is becoming less of a meritocracy, where skill and intelligence determine success, and becoming more of a class-bound society, where economic background, including the better education money can provide, matters more. … Most Americans don't believe that to be true, surveys show. But academic studies suggest that income mobility in the US is no better than that in France or Britain. It's actually lower than in Canada and is approaching the rigidity of Brazil. That marks a change from the past… From 1950 to 1980, Americans were more and more likely to see their offspring move up - or down - the income ladder. … Today, it could take five or six generations to close the gap between poverty and middle-class status, calculates Mr. Mazumder. … [Income Mobility Papers by Bhashkar Mazumder.]

Next, Tyler Cowen also takes up the topic of inequality:

Economic Scene Incomes and Inequality: What the Numbers Don’t Tell Us, by Tyler Cowen, Economic Scene, NY Times: The growing inequality in wealth and income has led many people to question whether the contemporary American economy is rigged in favor of the rich. While there is little doubt that the gap between the wealthy and everybody else has widened in recent years, the situation is not as unfair as some of the numbers seem to imply.

Much of the measured growth in income inequality has resulted from natural demographic trends. In general, there is more income inequality among older populations than among younger populations, if only because older people have had more time to experience rising or falling fortunes.

Furthermore, more-educated groups show greater income inequality than less-educated groups. Uneducated people are more likely to be clustered in a tight range of relatively low incomes. But the educated will include a greater range of highly motivated breadwinners and relaxed bohemians, and a greater range of winning and losing investors. A result is a greater variety of incomes. Since the United States is growing older and also more educated, income inequality will naturally rise.

Thomas Lemieux, professor of economics at the University of British Columbia, estimates that these demographic effects account for about three-quarters of the observed rise in income inequality for men and 69 to 95 percent of the observed rise in income inequality for women (The American Economic Review, June 2006). ...

Alan Reynolds ... goes further... Mr. Reynolds ... describes the observed rise in income inequality as a statistical illusion. The consensus of professional economists is that Mr. Reynolds goes too far. The long-term trend of rising income inequality is evident in many different studies, including those of executive compensation, even if some estimates are exaggerated.

In any case..., income is not the only — or even the most — important measure of inequality. For instance, inequality of consumption ... does not show a significant upward trend (Dirk Krueger and Fabrizio Perri, “Does Income Inequality Lead to Consumption Inequality?” January 2006). Consumption, of course, is not an ideal indicator of well-being; a high or steady level of purchases may reflect growing debt, and the ease of buying a big-screen TV does not reflect a comparable ease in buying good health care.

Happiness, possibly the most relevant variable for a study of inequality, is also the hardest to measure. Nonetheless, inequality of happiness is usually less marked than inequality of income, at least in wealthy societies. ... Even if more money makes people happier, it appears to do so at a declining rate, which places a natural check on the inequality of happiness.

Studies of personal happiness, based on questionnaires and self-reporting, indicate that the inequality of happiness is not growing over time in the United States. Furthermore, the United States has an inequality of happiness roughly comparable to that of Sweden or Denmark, two nations with strongly egalitarian reputations. (See the symposium in Journal of Happiness Studies, December 2005.) ...

If we look at leisure, from 1965 to 2003, less-educated groups experienced a bigger boost in free time than more-educated groups (Mark Aguiar and Erik Hurst, Federal Reserve Bank of Boston Working Paper). In other words, the high earners are working hard for their money and perhaps they are having less fun.

So matters are not as bad as the critics have suggested. ... Income and wealth inequality measures, taken alone, provide a misleadingly pessimistic picture.

The broader philosophical question is why we should worry about inequality — of any kind — much at all. Life is not a race against fellow human beings, and we should discourage people from treating it as such. Many of the rich have made the mistake of viewing their lives as a game of relative status. So why should economists promote this same zero-sum worldview? Yes, there are corporate scandals, but it remains the case that most American wealth today is produced rather than taken from other people.

What matters most is how well people are doing in absolute terms. We should continue to improve opportunities for lower-income people, but inequality as a major and chronic American problem has been overstated.

I don't see why "Happiness [is] possibly the most relevant variable for a study of inequality." As Tyler notes, "Even if more money makes people happier, it appears to do so at a declining rate, which places a natural check on the inequality of happiness." So, we shouldn't expect that making the wealthy even wealthier will affect the distribution of happiness.

That is, if we start with one wealth distribution that is unequal, and then give even more wealth to the people at the very top (as has happened), they won't get any happier and happiness inequality will be unchanged.

But if the same wealth were given to the lower end of the distribution, would the happiness gap still remain unchanged? I don't see how a static happiness gap when wealth is flowing to the top of the distribution implies that inequality has not increased. It only means that those receiving the additional wealth don't appreciate it since it makes little material difference in their lives.

Update: Steve Kyle at Angry Bear also comments on Tyler's article.
Update: Felix at economonitor follows-up, and adds more from Robert Shiller and others on the topic.

    Posted by on Thursday, January 25, 2007 at 12:42 AM in Economics, Income Distribution | Permalink  TrackBack (0)  Comments (79)


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