Optimal Income Inequality?

The NY Times has published an impressive piece by Thomas Edsall about consumption and income inequality.   If you read this long piece, I have the feeling that most of the RBC community will embrace David Autor’s points.   If you agree with every word he writes, what is the policy prescription?   I would suggest that the Heckman Equation is the best answer.

When I lecture about “progress”,  I ask students to think about their demand for a time machine.  Which subgroups of the population would prefer to live now versus living in the past?  For the urban poor, would they prefer to be in 2013 Los Angeles or 1913 Los Angeles? How much would they be willing to pay not to live their lives in 1913 Los Angeles?  I would pose the same question to the urban rich.  Since there are no markets for time machines, we can’t use revealed preference methods to measure “progress”.

Economists continue to debate balancing the effort incentive effects due to inequality (think of a golf tournament’s non-linear payoffs to first place versus 5th place) versus the envy and “unfairness” introduced by inequality.   Our colleague Robert Frank has argued that we have “keeping up with the Jones” preferences.    How strong is this desire?  How many of us are focused on our own absolute level of well being versus relative well being?   Perhaps more importantly, how do we bring back Horatio Alger ?  Can you move from rags to riches in modern America or must you move to France?

UPDATE:  I agree with the first comment below.  Why Nations Fail and 13 Bankers highlight that economists are thinking about the links between the concentration of resources and political power.

Author: Matthew E. Kahn

Professor of Economics at UCLA.

47 thoughts on “Optimal Income Inequality?”

  1. Fifteen years ago, the inequality debate may have been hard manly incentives versus soft fuzzy intersubjective preferences and fairness. This kind of loads the terms of debate, doesn’t it?

    But we’ve learned a lot since then. A fair number of hard manly arguments against inequality have developed since then: inequality promotes rent seeking; inequality creates financial instability; inequality destroys human capital; etc.

    1. Ditto. And I think it’s funny that people think it’s good to spend more on early childhood ed - or so I gather, since I’m not willing to fish through that guy’s entire website — but they are probably against unions and living wages. If people weren’t so poor, we could probably get rid of half our government agencies. And, it’s not like the money’s not here, is it?

      1. In fact, I’ll go further and say that ECE spending is great, and should be done for a thousand good reasons. But, it won’t do jack about inequality.

        1. Very important point. Focusing on ECE when the kids are growing up in a *designedly* low-capital environment (read: dilapidated ghettos concentrated with struggling, minimum wage workers) is wind pissing.

    2. …inequality promotes rent seeking…

      True, but the most important principle here is that a huge chunk of inequality is due to rent collection. Ie, opportunities for rent collection cause greater inequality.

  3. Can you move from rags to riches in modern America or must you move to France?

    Well yes, if you are a low-skilled worker immigrating from Mexico for example, and compare your riches in America to what you had in Mexico. That should count, no?

  4. That the poor have benefited from the scraps that have fallen from the table of society doesn’t mean they should be happy with it. The 1913 vs 2013 argument is bogus, quality of life can improve for every one, but more so for some compared to others. You may as well ask whether a poor person would exchange no healthcare today for leeches and skull drilling.

    Thinly veiled attempt at a rising tides argument.

  5. Well, when people informally talk about inequality, they may actually mean one of two things: relative inequality of income, irrespective of a country’s average standard of living, and (either relative or absolute) poverty. Oddly enough, the term “poverty” is often avoided, like “working class” (whereas the term “middle class” has become more expansive to include pretty much everyone earning a living). I suspect it may be because “poverty” and “working class” have the smell of “socialism” (or at least what some Americans mistakenly believe to be socialism), plus maybe our great national lie, our inability to admit that we have a poverty problem (or, just as bad, the claim that nobody is poor who doesn’t deserve it).

    With respect to the former, inequality is a somewhat destructive economic force, as Ebenezer points out, but (assuming that the quality of life at low levels of income is still adequate), does not cause direct and personal suffering.

    However, that is assuming that the consequence of living below the relative poverty line is still a pretty good deal, and it’s something that the article doesn’t adequately address.

    Unfortunately, in the actual world, life as a poor person in the United States is not exactly like placing 5th in a golf tournament. Millions of Americans do not know where there next meal will come from, have to ration their light usage so that they can afford heating in winter (or at least minimize the debt they’ll be running up from that), and have not access to adequate healthcare.

    Absolute poverty in the United States is one of the worst in the developed world (and it’s even worse when you start talking about child poverty). Various analyses based on the Luxembourgh Income Study and others have detailed that very clearly. Absolute poverty, to be clear, is measured against a fixed income, not relative to a country’s average income. E.g., the percentage of Swedes below the US poverty line is lower than the percentage of Americans below the same poverty line.

    Life expectancy for the working class has declined over the past two decades. The rising tide may have lifted some boats, but it’s also started to drown people without boats.

    In addition, being poor in the United States puts you in a much worse situation than elsewhere in the developed world. There is a fairly widespread belief among many Americans that if you are poor, you’re probably responsible for it, and thus an institutionalized reluctance to do much for the poor. This means that the American poor often rely on a combination of inadequate ad-hoc measures to stay afloat: running up credit card debt (at a disastrous APR), depending on charity for food, forgoing health insurance. This is not only less efficient than a functioning social safety net, it is also often personally destructive, a vicious circle that it is difficult to get out of once you’ve got dragged into it, because it’s pretty much about digging while already in a hole. Being poor in France, Germany, or Scandinavia still sucks, but it sucks much less than in the United States.

    Overall, we don’t actually compare well, either historically (unless you wind the clock back a century or so to the times of stone age capitalism) or in an international comparison, when it comes to poverty. In fact, we do pretty poorly. Of course, we’re still beating the third world, but that’s a pretty low bar to clear. (“In your face, Uruguay, Jamaica, and Uganda. Keep trying, Rwanda.” [1])

    [1] Yes, Jon Stewart was talking about the GINI, i.e. income inequality, not poverty. It still drives the point home pretty well.

      1. A few points: First, it can be instructive to look at Figure 2 of this presentation about child poverty that adds a few more countries and also classifies them culturally. Generally, the Scandinavian countries perform best, central European countries in the middle, and anglophone and Southern European countries worst (with some outliers). You can argue a bit about badly we are doing exactly and that it’s not quite that disastrous, but we are not doing well by any reasonable metric when it comes to absolute poverty given our wealth.

        Second, the situation is generally worse with respect to child poverty in the United States. Our old age poverty is comparatively low, and we have Social Security and Medicare to thank for that (at least in part), but that also means that for children and working age people, the situation is worse. I have little doubt that with a functioning social safety we could improve our standing a lot.

        Third, I cannot stress enough that even at the same income level, it’s so much better for a low income person to live in a Scandinavian country or Germany than in the United States, because they’re so much better covered when it comes to the essentials of life. The life of the American poor is plagued so much more by the inefficiencies of poverty. Consider, for example, the sheer number of Americans who work two jobs just to make ends meet (including to not be homeless), leaving them exhausted and without time for other things. Time is a substitute currency for the poor: It allows one to research shopping bargains, cook yourself, walk or use public transport in lieu of having a car, and generally save money through extra effort. Working two jobs deprives them of even this substitute currency (never mind the negative health effects).

        A final note on relative poverty: I don’t want to downplay this too much. Relative poverty still leads to social exclusion, and in particular in a free market economy, where you have to compete with others, to lack of opportunity (consider, e.g., the price of attending college). I wouldn’t be surprised if our exceedingly high relative poverty is a major contributor to our lack of social mobility.

        1. Time is indeed a substitute currency for the poor, but I’m not sure Katja picked the best examples. I know a number of poor people: they’re not that good at shopping for bargains or cooking for themselves. The first is a luxury for those with information and the leisure to process it; the second requires some small investments, and the great luxury of predictably structured time. In my experience, the substitute currency is often spent queueing: for medical care, for bureaucratic convenience.

          Otherwise, the usual. What Katja says.

          1. Otherwise, the usual. What Katja says.

            Not to be a suck up, but I find her posts to be very, very good.

          2. Katja’s virtues are well-established. I believe she was voted coolest commenter by the bloggers/contributors. I think that was last year? I too learn a great deal from her. And she holds down a job, too!

          3. I think (as Katja sorta says) that time used to be a substitute currency for the poor. But the combination of long commutes, multiple jobs and artificial scarcity has pretty much gotten rid of that. Now time is a substitute currency for the middle class.

  6. Every time I see Horatio Alger invoked, my gorge rises and I suspect the person mentioning him either of bad faith or of ignorance. I will admit that I’ve never read anything by Alger - has anyone read him, other than for a defined academic purpose, in the last several decades? - but according to everything I’ve read about him, Alger worshipped the existing class system, and authored book after hastily written book in which a morally impeccable young striver beavered away, demanding no great social change, until they were benevolently recognized by some member of the elite and offered a sort of transmutation through grace into the ranks of the elite - adoption as a surrogate son and heir of some sort, generally. In other words, paternalistic nonsense that, despite how it is remembered in our middle-school Social Studies classes, preached not ambition for genuine advancement but rather complacent acceptance of what is, in the expectation of reward. Theology, not sociology or economics. Viewed from another perspective, it would make more sense for us to revile the propaganda of Horatio Alger, much as we denounce the way exploited and oppressed peoples were exhorted to emulate Lei Feng in the Cultural Revolution or Stakhanov in Stalin’s Russia.

    1. I read a bunch of Horatio Alger books when I was a kid. Loved ’em. If I find a couple in a used book store, I’ll give them to my boys to read.

    1. one more example of why we should be able to preview our posts…. Sorry about the mess, but the unpretty link works if you cut it off after ‘poor’.

      1. Fixed for you by the management. Yes, we need preview. I often find myself correcting my own comments.

        1. I realize the subject matter isn’t the most popular thing among the hosts here, but I suggest checking out Pete Guither’s drugwarrant.com from a design feature point of view. His WordPress blog has the most robust and convenient commenting tools I’ve seen anywhere (outside of admin access): live as-you-type wysiwyg comment preview (much more convenient than clicking a preview button before clicking again to post) where you can check your links and formatting before posting, followed by a five-minute window after having posted the comment in which you can either re-edit your comment or delete it entirely. Many times I’ve wished for similar features while posting a comment here.

          1. …and THAT broken link wasn’t even my fault. I hit my back button and confirmed: the link I posted was ‘<a href=”www.drugwarrant.com”>Pete Guither’s drugwarrant.com</a>’. No idea why the software here appended a samefacts.com link onto the beginning, breaking it.

            Ain’t this boogie a mess!

          2. …And I should mention that I find the thumb-up thumb-down comment feature quite useful as well. Often I would like to express agreement with a comment, but have nothing to add aside from my agreement. I find the ability to add to a thumbs-up count to comments I like far preferable to posting ‘ditto’ comments.

          3. It’s because links to other sites need to be prefixed by http:// (or whatever scheme prefix is needed).

            A link of the form of http://www.example.com within an HTML anchor tag is generally assumed to be relative to the current page (automagic conversion of links may or may not suffer that problem).

            And yes, that’s a rather annoying usability problem; few people are familiar with the technical details of the HTML spec (and shouldn’t have to be).

          4. Heh. Yes, the automagic conversion actually added the http:// in front of the www dot example dot com that I had written.

          6. Katja,

            Right you are! It’s obviously been too long since I’ve done any web programming. I had totally forgotten the http anchor and then didn’t notice it’s absence when I went back to confirm my link. Then I copied and pasted from my browser history and your sharp eye caught the error. Thanks for accurately explaining the cause of the screw-up. I blame my browser for not enforcing the http part when I type in a URL — LOL!

  8. I suggest you have the golf prize money backwards. The default reward in a sporting contest is that of the ancient Olympics: the laurel goes to the winner, the rest get nothing. The laurel/gold medal/green jacket/yellow shirt by itself is the sufficient incentive for the losers to compete. In any case, the prize money for 5th place isn’t a significant incentive to perform on the day.

    Awarding silver and bronze medals and prize money for nth place looks like modern soft-heartedness. Perhaps it’s rational calculation by sports organizers. One self-interested argument for spreading the prize money is to allow more sportsmen to make a living and over time allow more interesting competitions with a range of good entrants.

    1. Depends on my health. For those with resources, 1913 had indoor plumbing and heating, automobiles, electricity, telephony, and music reproduction. All I would really miss (if you gave me health) is this fine blog and air conditioning.

      1813-or even 1863-is another matter.

  10. Penicillin, the big 5 vaccines (Tetanus, Polio, Pertussis, Diptheria, Smallpox), and electricity/refrigeration are very hard to compete with.

    1. Also, don’t forget the availability of reliable contraceptives. And washing machines (mundane as that may sound, remember how laundry was done a century ago and the amount of manual labor it involved). Washing machines and reliable contraceptives probably did more for women than any policy measure in history.

      1. I should have said electricity/refrigeration/running water. (I’ve washed many, many clothes with a wringer washer-an automatic washer is easier, but wringer washer and running water is WAY easier than having to haul water.)

      1. This may seem flippant, but economists have a habit of introducing these false dichotomies. Technological advancement is the primary reason life is better than it used to be, and economists have nothing valuable to say on that front.

      2. I was trying to answer the “would you rather be poor now or rich in 1913?” question.

        But inequality-high degrees of it-were essential to all those developments. (Societies with genuine equality have very few researchers.)

        1. Sam,
          I’m not fan of a Harrison Bergeron society myself. Few of us are. But you don’t need a high degree of inequality for most of these technological advances. Medicine became a big money game just about the time that major health innovations slowed down. (There was a long time when patenting medical advances was simply not approved of.) The Japanese managed to create all kinds of cute li’l gizmos with much less income inequality than the US. Come to think of it, these gizmos often developed from pre-Thatcher UK basic research. The Soviets weren’t half bad in developing the technologies they cared about-mostly military.

          I’ll grant that there is currently a strong association between inequality and innovation in the informatics industry. (I would add financial services, except I share Paul Volcker’s take on the role of innovation in that business.) But apart from informatics, I see little international or historical relationship between technological progressivity and inequality.

  11. But inequality–high degrees of it–were essential to all those developments.
    Yes, would Salk have ever developed his vaccine if he couldn’t have reaped the massive financial rewards from a patent?

    1. Wrong question.

      Would Salk ever have discovered his vaccine if he’d been working 8 hours a day in a factory?

      2. Wait, is it somehow not blindingly obvious to you, as it is to everyone else, that in this context, and in the context of recent politics, inequality refers to disparate and disproportionate rewards to work?

    2. Wrong question.

      Would Salk ever have discovered his vaccine if he’d been working 8 hours a day in a factory? That would have been typical in the 50’s.

  12. Pingback: Why Inequality Matters « The Reality-Based Community

  13. Heckman is simply channeling Jesus Christ. When JC told his apostles to wash the feet of the poor he was simply pointing to the economic truth that helping the poor is the best way for a people to do well.

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