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Thursday, May 03, 2007

Sources of "The Great Risk Shift"

I want to follow up on Jacob Hacker's recent defense of The Great Risk Shift against misinterpretations of his results relative to the results in a recent CBO report, and more particularly I want to follow-up on the response that his argument has received.

Recall that Jacob finds that household income volatility has been increasing in recent years, but both he and the CBO do not find increasing volatility of individual earnings. It is this difference between the results for individuals and the results for households that many people have focused on (even though Jacob's results are much broader than this one measure of risk as touched upon briefly below).

For example, the response from much from the right is along the lines of this from Rammesh Ponnuru at the National Review Online's The Corner:

Risk Shifts Back, by Ramesh Ponnuru, The Corner: Jacob Hacker has argued that income volatility has been increasing and that Americans are exposed to more economic risk than they used to be, and that liberal policies are required to provide some security. (I bought Hacker's empirical case, but not his policy prescriptions.) The Congressional Budget Office recently released a report suggesting that individual income volatility hasn't been increasing.

Hacker, in response , argues that the volatility of family income has been rising. ... Ross Douthat argues that Hacker has been "taking data that would seem to support the socially conservative contention that changing family structure has had a lot of negative externalities for vulnerable Americans, and using it to claim that 1) Republicans have shredded the safety net and 2) we need a much, much stronger one than what we currently have."

Here's more of what Ross Douthat at The Atlantic Online said:

Risky Business, The Atlantic Online: But the subtitle of Hacker's book, you'll note, isn't "How The Sexual Revolution Created Higher Levels of Risk For American Families and What To Do About It." ...[H]e's taking data that would seem to support the socially conservative contention that changing family structure has had a lot of negative externalities for vulnerable Americans, and using it to claim that 1) Republicans have shredded the safety net and 2) we need a much, much stronger one than what we currently have. The first point is at best debatable... The ... second point just amounts to the rather predictable liberal claim that a bigger welfare state is the answer to increasing family breakdown.

Before addressing these specific claims, let me make a more general point. There has been some doubt expressed about whether the data actually show increasing income volatility. While not conceding that there is a question here to begin with - there isn't much of one and it ought to end soon, see below - here's more evidence. First, there is the Hertz study which makes a strong case in favor of the view that family income volatility rose in the 1990s and thus this work reinforces Jacob's results. Second, there is the Los Angeles Times series “The New Deal”. This series is based on a study that uses different methodology than Jacob uses, but still finds a big increase in volatility since the 1970s just as Jacob finds. [Update: Here's one more study, though I should note it is also preliminary. Its conclusion, based on household-level earnings in the PSID, says "Households appear to have faced notably more uncertainty in the past twenty years than in the preceding few decades."]

Now let's turn to the more specific claims above. The first claim from Douthat is that 1), which says that the safety net has been shredded, is debatable. Jacob's point about public policy seems to be completely lost on most people in this debate. Yet government and private social spending is a quarter of our economy after taxes – it has to be considered as an explanation for changing volatility and risk, and the preliminary evidence suggests that social spending does not reduce family income volatility as well as it did in the past.

The other point that is missed is that Jacob's analysis of household risk goes well beyond income volatility. Thus, looking at income volatility alone, which has been the focus lately, misses a large part of the risk picture and hence misses the extent to which the social safety net has been shredded. Jacob discusses this in the link above.

Now let's turn to point 2) which claims that Jacob's results imply we need to strengthen the family to prevent breakups if we want to reduce economic risk. Many people seem to be jumping to the conclusion that the fact that individual earnings instability isn't the same as family income instability is tantamount to saying that family breakup drives the results.

But, according to the preliminary results, family breakup is not the most important reason for increasing income volatility for households. My understanding is that though the empirical investigation is ongoing, the most likely explanations for increasing income volatility are quite different from the "policy from liberals caused more family breakups, which in turn caused increased income volatility" explanation we are hearing from conservatives. The most likely explanations are:

  1. Families rely on two incomes now, so when one worker leaves the workforce, income drops. Likewise, there’s no potential second earner to bump up his/her hours when earnings/hours of the prime worker drop.
  2. There are more single individuals. This group has always had higher income volatility.
  3. Government taxes and benefits do less to cushion income shocks than they once did.
  4. People rely more on asset income, which is more volatile (probably a small effect).
  5. There’s more long-term unemployment (also likely a small effect).
  6. There’s more self-employment/independent contracting (again, this is likely to be small).

Finally, with regard to this entire debate that has erupted ever since the CBO report appeared, let me repeat and emphasize what I said in an earlier post. Jacob tells me that he is hard at work producing new estimates for public release that take account the many questions he has received on his work, methodological and otherwise, and that the results are holding up nicely and should be ready before too long. If you have any doubt about The Great Risk Shift, I hope you will wait until you’ve seen the new work before coming to any final conclusions.

    Posted by on Thursday, May 3, 2007 at 02:34 AM in Economics, Politics, Social Insurance | Permalink  TrackBack (0)  Comments (12)


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