A paper by Christian Broda and John Romalis implies that inequality may not have changed as much as we thought in recent decades, and the result is getting lots of publicity. But Lane Kenworthy doesn't think the claim about inequality is very compelling:
Inequality and Prices, by Lane Kenworthy: Steven Levitt and Will Wilkinson point to a new paper that Levitt says “shatters the conventional wisdom on growing inequality” in the United States. The paper is by Christian Broda and John Romalis, economists at the University of Chicago.
Here’s their argument: Income inequality has increased over time. But analysis of consumption data indicates that people with low incomes are more likely than those with high incomes to buy inexpensive, low-quality goods. In part because those goods increasingly are produced in China, their prices rose less between 1994 and 2005 than did the prices of goods the rich tend to consume. Hence the standard measure of inequality, which is based on income rather than consumption, greatly overstates the degree to which inequality increased. The incomes of the rich rose more than those of the poor, but because the cost of living increased more for the rich than for the poor, things more or less evened out.
Their point that the prices of some goods have risen less than the overall inflation rate, and that this is due in large part to imports from China, seems perfectly valid and worth making. It has important implications for our understanding of how absolute living standards for America’s poor have changed over time.
But I’m not sure why Broda and Romalis, or Levitt and Wilkinson, think this should alter our assessment of the trend in inequality. Do they mean to suggest that the revealed preference of the poor for cheap goods is exogenous to their income? In other words, people with low incomes simply like buying inexpensive lower-quality goods, and they would continue to do so even if they had the same income as the rich. Likewise, the rich simply have a taste for better-quality but pricier goods, and they would continue to purchase them even if they suddenly became income-poor. If this is the assumption, I guess the conclusion follows. But I can’t imagine the authors, or anyone else, really believe that.
Actually, Levitt may believe it. “How rich you are,” he says, “depends on two things: how much money you have, and how much the stuff you want to buy costs” (my emphasis).
Consumption is worth paying attention to. But income is important in its own right because it confers capabilities to make choices. What matters, in this view, is what you are able to buy rather than what you want to buy. If a rich person with expensive tastes gets an extra $100,000, she can continue buying high-end clothes and gadgets. Or she can choose to purchase low-end Chinese-made products and save the difference. Suggesting that if she opts for the former there has been no rise in inequality is not very compelling.
And on the consumption data, recall Gordon and Dew-Becker's statement:
The paper concludes that data on consumption inequality are too fragile to reach firm conclusions...
[Felix Salmon also responds in "Rich-Poor Inflation Differentials: Smaller Than You Might Think" (there's a rebuttal comment from James Surowiecki), and my indirect response is here. My point was that an assessment of how imports of low-priced manufactured goods impacts the welfare of the working class has to include all of the changes that have hit labor and product markets as a consequence of increased international trade, and when you do that, it is far less clear that workers have benefited overall even if you take the Broda and Romalis result as given.]