David R. Henderson  

Scott Winship on Inequality

Policy Implications of the Mar... Three Laws of Major Mismatch...
The idea that our economy is held back by inequality is echoed in the claims of some of the nation's most prominent economists. Princeton professor (and Nobel laureate) Paul Krugman and David Card of the University of California, Berkeley, contend that inequality hurts economic mobility. Princeton's Alan Krueger (now chairman of the White House Council of Economic Advisers) and Columbia's Joseph Stiglitz (another Nobelist) think it dampens economic growth. Along with Raghuram Rajan, former chief economist of the International Monetary Fund, Stiglitz also argues that inequality was behind the financial crisis. Cornell economist Robert Frank and former labor secretary Robert Reich are convinced that it fuels the indebtedness of the middle class. The Massachusetts Institute of Technology's Daron Acemoglu believes that inequality enables economic elites to capture the machinery of government and thus ultimately produces national decline.

But while the credentials of these advocates may be impressive, their arguments are not. Some of these economists seem to think that arguments made for popular audiences do not require the same rigor demanded in academic papers. Others won their well-earned accolades doing groundbreaking research on subjects unrelated to the consequences of inequality and have little expertise in this area. In some cases, these authors examine inequality in America in light of findings from developing countries, failing to acknowledge that the circumstances of those other nations are so different from ours that they render this research inapplicable to the United States. In still other cases, these economists carelessly mistake correlation for causation.

These are paragraphs 2 and 3 of Scott Winship, "Overstating the Costs of Inequality." The whole piece is excellent.

One correction on the above: Robert Reich is not an economist. The Wall Street Journal editorial page started labeling him one during the 1992 Clinton campaign and the label seems to have stuck.

Another excerpt:

As to the claim that the incomes of most Americans have stagnated during the period in which those of the wealthiest Americans have soared, [Richard] Burkhauser's figures suggest otherwise. His research shows that the middle fifth of the income distribution was actually more than one-third richer in 2007 than it was in 1979. The Congressional Budget Office corroborates this estimate, and research by the University of Chicago's Bruce Meyer and Notre Dame's James Sullivan suggests that the increase may have been 50% or more. Such growth could be called "stagnation" only in relation to the golden age of the post-war boom, when the incomes of the middle fifth of Americans doubled over 20 years. Income growth has certainly slowed for poor and middle-class families since then, and not only in the United States: In a range of European and English-speaking countries, demographics and other factors have combined to yield lower rates of economic growth. But there is simply no clear evidence that this slower growth is being caused by rising inequality.

One correction: Where he writes, "was actually more than one-third richer in 2007," he means "had incomes that were more than one-third higher in 2007." "Rich" refers to wealth, not income, and his data are on income, not wealth.

One argument that I wish Scott had taken on is this one:

There are a number of reasons why, in theory, inequality might reduce growth. It might dampen overall consumption: The rich spend proportionally less of their incomes than the non-rich do, and when a greater portion of the nation's overall wealth flows to those who will not use it for direct consumption, economic activity could decline.

If the rich, by which term, again, I assume he means "the highest-income people," spend a lower percent of their incomes on consumption than others do, then presumably they save it. And that saving translates into investment, which increases the capital stock. So if the claim about the saving rate of "the rich" is true, then growth should be higher. Scott does a beautiful empirical job but the theoretical point he could have made is also strong.

His version with footnotes is here.

HT to Scott Winship.

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CATEGORIES: Income Distribution

COMMENTS (9 to date)
Jack P. writes:

The wealth/income distinction is crucial, as confusion over rising(?) wealth inequality implied by a recent viral youtube video suggests. Great inequality in wealth, if it does not imply great inequality of consumption/wellbeing or political influence, is not worrisome. So most people are concerned about income (really, consumption) inequality, which is much less pronounced than is wealth inequality.

The other issue: Is income inequality a cause or an outcome? I believe it is an outcome. Many commentators believe it is a cause. None of us has proof either way. I believe if we foster growth, prudence, saving, then inequality will decrease without harming prosperity. If we attack inequality directly through higher taxes on the upper class, we will lower inequality at a potentially great cost.

kebko writes:

A broadly wealthier society leads to a more varied life cycle. We stay in school longer and retire earlier than we ever have before. This, ironically, is the result of having higher broadbased income expectations, yet it in turn results in a statistically more unequal population.

We're comparing the incomes of students and retirees today to the incomes of uneducated workers 40 years ago, and declaring stagnation.

Keith E. writes:

"...saving translates into investment, which increases the capital stock. So if the claim about the saving rate of "the rich" is true, then growth should be higher."

Why is this point so often lost in the popular press?

Jim Rose writes:

david, to be fair, Reich studied Philosophy, Politics, and Economics at Oxford University. His J.D was from yale law school.

many lawyers contribute to economics debates, but most of these do not claim to be economists

Maximum Liberty writes:

Inequality also has benefits, which I suppose someone could try to quantify.

The one that comes to mind is that proposed innovations need two kinds of markets: markets for investors willing to take a chance on them and markets for consumers willing to take a chance on them. I'll focus on the latter. Historically, new consumer products start out expensive. Many of them are temporary status symbols. Think of various consumer electronics. The initial sales are small but the high price helps the manufacturer pay for capacity. Then the price comes down. How does the manufacturer ever build up to capacity without some group of rich people willing to blow a wad on oddities?


Chris Koresko writes:

David Henderson: "Rich" refers to wealth, not income, and his data are on income, not wealth.

Point well taken. But it seems to me that a more important error is the use of the word "inequality" to describe what would be more properly called "income variance" or "income diversity".

The word "equality" has a specific meaning in the American political context, and that meaning has little to do with the money one makes. In fact, the American idea of equality includes a rejection of income (or wealth) as a legitimate determinant of one's status before the government and the law. In short, we are all created equal, regardless of our incomes.

Using the phrase "income inequality", especially when shortened to "inequality", turns this fundamental idea on its head -- it implicitly ties income to social status or even personal worth, and suggests that any differences in income or wealth are unjust, regardless of the reasons for them.

Economists really should stop abusing the language this way.

Jack P. writes:

@Chris K.: You are correct, but if economists talk about income variance or income diversity, they won't be able to get their message across, as for better or worse everybody says income inequality.

There are other examples. A public good to an economist is not the same as a public good to the layperson (or other academics). I have given up and use the cumbersome expression "non-rival and non-excludable good or service" when I am talking about the economic one, and I use the term public good the same way everyone does, which is to say vague and fungible.

Thomas Boyle writes:

On the left, "diversity" is a good thing, and opposition to it is "intolerance".

I shall refer to "income diversity" henceforth! And go back to trying to get off the wrong side of the diversity...

Pave Low John writes:

An average American worker walks down a street and spots an expensive European sports car parked against the curb.

The old American response: "Wow, what a nice car, I can't until I've earned enough money to buy something like that!"

The new American response: "These rich SOBs! It should be illegal to buy something like that!" [keys the car as he walks by]

Class Warfare: Sowing hate and discontent since 1789!

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