Prior to the election of Barack Obama, income inequality was a hot topic. Much of the credit for this should go to powerhouse New York Times columnist and economics Nobel Laureate Paul Krugman. His alarmed and pugnacious book about American income inequality, The Conscience of a Liberal, marked a high point of public interest in the subject, which has died down considerably since Obama took office and the recession took hold. Krugman argues that the widening income gap had chiefly political rather than structural causes and demands a political, largely redistributive response. Perhaps the presence of a Democratic president and Congressional majorities in Washington have invited the sense among Krugman-style egalitarian liberals that the matter is now in good hands and will be addressed in due time. But now, in a season of double-digit unemployment and rising poverty rates, it might pay to consider whether income inequality is really among our most urgent problems. Even governments have a limited attention span. More careful allocation of this and other scarce resources would be most welcome.
In this essay, I argue for following three points.
- The level of real economic inequality is lower than popular treatments of the issue have led many of us to think.
- The level of economic inequality is an unreliable indicator of a society’s justice or injustice.
- Inequality distracts us from real injustices that are given too little attention.
In the following I draw from my paper, “Thinking Clearly about Economic Inequality, published by Cato in July, though there are some fresh references and most of it is new.
Getting the Story Straight
The first step in getting a story straight is to identify the main character. Most discussions of economic inequality focus on the trend of nominal income inequality. The familiar story about nominal income inequality is that since the 1970s income inequality has been rising steadily and is now at levels not seen since the Gilded Age. I think this story gets on the wrong track at the start.
As far as I can tell, when most people are worried about economic inequality, they’re usually worried about inequalities in real standards of living — in the real material conditions of life. Income plays a crucial role in this story, but it’s a supporting role. An individual’s or household’s standard of living is determined rather more directly by the level of consumption than by the level of income. Current income does finance current consumption, but so do credit and savings. If we can directly inspect measures of consumption, and we can, then we probably should. When we do, we find that the familiar story of income inequality is rather misleading and that trends in consumption inequality are considerably less dramatic. Different datasets and analytical methods produce somewhat different results, but most stories of consumption inequality are stories of stability or a relatively mild rise.
The widely reported U-turn in inequality in the United States is an artifact of inappropriate use of family income as a measure of welfare. When well-being is defined to be a function of per equivalent consumption, inequality either decreased over the sample period [the 1990s] or remained unchanged.
[T]he increase in income inequality in the U.S. has been much more pronounced than the corresponding increase in consumption inequality. … Consumption inequality … has remained substantially stable.
And in the most impressively wide-ranging and technically sophisticated evaluation of inequality data I’ve seen to date, Jonathan Heatchote, Fabrizio Perri, and Giovanni Violente say:
First, consistent with basic economic theory, consumption inequality is substantially lower than income inequality. Second, the rise in consumption inequality is much smaller than the rise in disposable income inequality.
Even if we let income hog the spotlight in our story about inequality, a good deal of evidence suggests that income inequality has been overestimated. In a new paper weaving together several strands of recent evidence, Robert Gordon reports that improved use of income datasets “shows that there was no increase of inequality after 1993 in the bottom 99 percent of the population, and can be entirely explained by the behavior of income in the top 1 percent.”
What happened in the top one percent? The bulk of the evidence seems to point in the direction of changes in executive compensation. The debate over the details of these changes is too complicated to adequately address here, though I’ll touch on it below. For now let me just highlight the finding that there has been no increase in income inequality within the bottom 99 percent of the distribution for more than a decade.
A number of other recent studies indicate that measured income inequality has been overstated due to inadequacies in traditional methods for constructing price indices and estimating real income. For example, in the latest iteration of a much-discussed paper Christian Broda and John Romalis find that
the relative prices of low-quality products that are consumed disproportionately by low-income consumers have been falling over this period. This fact implies that measured against the prices of products that poorer consumers actually buy, their “real” incomes have been rising steadily. As a consequence, we find that around half of the increase in conventional inequality measures during 1994 – 2005 is the result of using the same price index for non-durable goods across different income groups.
Many popular narratives about inequality are grounded on the alleged fact that wages and incomes at the middle and bottom of the distribution have been stagnant for decades. It appears that this, too, may be an artifact of insufficiently sophisticated methods for constructing the price indices used to calculate rates of inflation. Using an updated price index, Christian Broda, Ephraim Leibtag, and David Weinstein [pdf] find that
the real wages at the 10th percentile increased by 30 percent from 1979 to 2005. In other words, the real wages of low earners have not remained stagnant, as suggested by conventional measures, but actually have been rising on average by around 1 percent per year.
No doubt there are sensible methodological objections to all these studies. But taken together they are impressive. Suppose we accept their upshot. Suppose economic inequality has actually increased very little lately. Suppose that the American lower and middle classes have over the last few decades enjoyed gains from economic growth equal to those enjoyed by the bulk of the upper class. Would you conclude that Krugman raised a false alarm? I hope you would. Would you say the United States’ socioeconomic system is really pretty fair after all? Would it change your opinions about what does or does not need to be done?
Maybe it shouldn’t.
Inequality Is Not an Indicator of Injustice
A good deal of popular liberal political and economic commentary treats a country’s level of economic inequality as a rough indicator of the justice or injustice of its institutions. This kind of pop liberal egalitarianism would suggest that the results laid out above should put our minds at ease. But I think the inequality-as-justice-barometer view is based on a mistake and is bound to confuse and distract us. The reason not to get up in arms about the United States’ level of income inequality is not that it’s really pretty decent, considering. The reason not to worry about it is that the level of income inequality is a fact astonishingly devoid of morally relevant information and at best shares a common cause with real problems.
The level of inequality within a country can be influenced by a variety of factors. Some factors, like the age composition of the population, are plainly irrelevant to questions about the justice or praiseworthiness of a country’s institutions. Some good things tend to make inequality rise. Some bad things tend to make inequality fall. The same level of inequality can have better or worse underlying causes. For example, the United States and Ghana have approximately the same level of income inequality, as measured by the Gini coefficient, but on any sensible account of justice or goodness, American institutions are a lot better. Neither the level nor the trend of inequality conveys the sort of thing we need to know in order to responsibly pass judgment on a society’s institutions or its social, political, and economic order.
If income inequality in the United States is symptomatic of injustice, the problem is unlikely to be the level of inequality as such, but the institutional mechanisms or social norms — such as predation by political elites or the systematic exclusion of ethnic minorities from economic opportunities — that tend to generate income inequality. If you believe that American income inequality does reflect injustice in the structure of America’s institutions, then it is important to identify precisely where and how the system is unjust instead of simply fixating on the fact that there is inequality. If the level of inequality is a knock-on effect of a more fundamental injustice, we should focus our attention on the original site of wrongdoing. The fire is the problem, not the people who look around when they hear the alarm.
Let me illustrate my point by examining two of the most popular inequality-influencing mechanisms: “skill-biased technical change” and executive compensation.
So, some innovations in technology increase the productivity of some groups of workers more than of other groups of workers. A worker’s wage reflects her productivity (among other things). And new technology can make some workers more productive while doing little or nothing for others. As it happens, a great deal of new technology over the past several decades has been “skill-biased,” meaning that it has enhanced the productivity of highly skilled workers more than less-skilled workers. This is a large part of the economics profession’s most popular theory of rising wage and income inequality.
So what are we to make of this? Taken by itself, the fact of “skill-biased technical change” seems neutral as a matter of justice or social morality. The actual distribution of skills may reflect injustice in, say, the education system. (I think it does.) But universal access to indisputably satisfactory schooling will by no means erase all the inequalities in skill that skill-biased technical change parlays into wage inequality. The mere possibility of this kind of morally neutral process widening the income gap should leave us skeptical of barometer-of-justice approaches to inequality. Of course, skill-biased technical change is not just a possibility.
The demand for skilled labor relative to supply is another piece of the “skill-biased technical change” story. Wages reflect productivity, but they also reflect supply and demand. The American educational system, the story goes, has not been producing skilled workers at a rate sufficient to keep up with the demand for them. This has contributed to an increasing wage premium for skilled workers, which has boosted inequality.
Is the low supply of skilled labor relative to demand also a neutral inequality-influencing factor? As with many factors that influence the level of inequality, I don’t think it is morally neutral, but I also don’t think its effect on nation-level inequality has much to do with it.
Unlike the fact that much new technology does not affect productivity uniformly, a shortage of skilled workers can be more or less directly alleviated by government policy. If injustice in the public school system is partly responsible for poor skills and flagging rates of growth in college admission, we can’t treat the low supply of skilled workers as a neutral fact. It reflects a real problem. Additionally, the United States could easily admit many more skilled foreign workers, but does not. In the context of rising demand for skilled workers, a not-very-generous cap on visas for skilled workers from abroad acts as a subsidy to American skilled workers, and this puts upward pressure on American income inequality.
Now, I would contend that the effect of the quota on visas for skilled foreign workers on the level of American income inequality is neither good nor bad. I think the real questions of justice here pertain to access to adequate education, the legitimacy of an implicit government-granted subsidy, and the openness of the United States’ labor markets to foreign workers. Maybe I’m wrong that these are the real issues. The point is that locating the real problems, whatever they are, is incredibly important. Fixing on income inequality and moving straightaway to thoughts of redistribution helps us do the wrong thing.
Let’s glance at CEO pay as a final example. Changes in executive compensation are almost certainly behind the dramatically disproportionate income gains in the top one percent of the distribution. After all the scholarly tweaks to the income datasets and the Consumer Price Index are done, that’s where the action remains. So why did those changes occur? I really don’t know why, but the story matters.
If the story boils down to a change in the tax code and a shift in social norms about compensation, then we’ll need to dig deeper. Was the change in the tax code wrong? Ill-motivated? A solution to some other problem with unforeseen consequences? Did the old norms of remunerative moderation collapse under the weight of Ayn Rand novels? Or what? Let’s say the story is that an old-boys network of scheming CEOs sitting on one another’s boards of directors conspired to give each other raise after massive raise with no regard for the interests of their firms’ shareholders and creditors. That’s a story of theft on a grand scale. But theft is an injustice whether or not it moves the Gini coefficient. Any rise in national income inequality due this or, say, Bernie Madoff’s boundless cupidity would be an epiphenomenon of injustice, the echo of a gunshot.
Keeping Our Eye on Injustice
There’s ample of reason to suspect that the gap in standards of living has widened a whole lot less than Paul Krugman and most everybody thought. My point is, So what? That fact doesn’t tell us what we need to know.
What’s really interesting is why inequality has been overestimated. If, for example, large systemic economic forces — expanded trade with China, Wal-Mart’s downward pressure on prices — helped make poorer Americans a good deal richer than we had thought they were…. Well, that’s terrific. And informative. This story suggests who might get hurt if the United States gets in a trade war in China, or if Wal-Mart unionizes and shifts some gains from trade away from consumers and toward its employees. Getting the story straight is the first step in making a better story.
Economic inequality is too easy. It makes us lazy in our quest to sniff out injustice, which, after all, is not so hard to find. There is overwhelming reason to believe that in the United States the deck really is stacked against some people. As a consequence, many millions are doing much less well than they might be.
Legions of inner-city kids consigned to abysmal public schools are systematically denied a fair chance to develop the capacities need to participate fully in our institutions, or to enjoy their potentially ample rewards. The United States imprisons a larger share of its citizens than any country on Earth, literally disenfranchising hundreds of thousands of men and women (though they are mostly men) and leaving hundreds of thousands more dispirited and damaged. Undocumented immigrant workers increasingly constitute a permanent economic underclass explicitly denied many of the basic legal protections of citizens, inviting both government and private abuse. And, at the level of culture, patterns of private discrimination continue to constitute for millions a web of real, seemingly inescapable barriers to opportunity and achievement, and help to generate self-reproducing patterns of diminished expectations and wasted potential. We should focus our attention and energy to the task of rectifying these vicious injustices.
Maybe fixing all this would decrease the variance in national incomes. But the idea that fixing all this somehow requires “fixing” the pattern of incomes is an excellent way to avoid the real problems and fix nothing.
Will Wilkinson is a research fellow at the Cato Institute and editor of Cato Unbound