The Inequality Myth

Brad Schiller, professor of economics at American University and the University of Nevada, Reno writes on the inequality myth:

While there is some substance to these fears of widening inequality and middle-class stagnation, the situation is not nearly as clear-cut. Demographic changes in the size and composition of U.S. households have distorted the statistics in important ways.

First, we can easily dismiss the notion that the poor are getting poorer. All the Census Bureau tells us is that the share of the pie consumed by the poor has been shrinking (to 3.4% in 2006 from 4.1% in 1970). But the “pie” has grown enormously. This year’s real GDP of $14 trillion is three times that of 1970. So the absolute size of the slice received by the bottom 20% has increased to $476 billion from $181 billion. Allowing for population growth shows that the average income of people at the bottom of the income distribution has risen 36%.

They’re not rich, but they’re certainly not poorer. In reality, economic growth has raised incomes across the board.

The Census data originate from an annual survey of households. The data don’t track individual households from year to year, but instead just take a snapshot of the households in existence in March of each year. From these annual snapshots, we try to infer what’s happening to the typical household over time.

The “typical” household, however, keeps changing. Since 1970 there has been a dramatic rise in divorced, never-married and single-person households. Back in 1970, the married Ozzie and Harriet family was the norm: 71% of all U.S. households were two-parent families. Now the ratio is only 51%. In the process of this social revolution, the average household size has shrunk to 2.57 persons from 3.14 — a drop of 18%. The meaning? Even a “stagnant” average household income implies a higher standard of living for the average household member.

Last year, the Census Bureau published a new set of income statistics that adjusted for changing household size and composition. In a single year (2006), this “equivalence-adjusted” computation increased the income share of the poor by 8% and reduced the standard measure of inequality (Gini coefficient) by 4%. Such “equivalency” adjustments would mute unadjusted inequality trends even more.

A closer look at household trends reveals that the percentage of one-person households has jumped to 27% from 17%. That’s right: More than one out of four U.S. households now has only one occupant. Who are these people? Overwhelmingly, they are Generation Xers whose good jobs and high pay have permitted them to move out of their parental homes and establish their own residences. The rest are largely seniors who have enough savings and income to escape from their grandchildren and enjoy the serenity of an independent household. Both transitions are evidence of rising affluence, not increasing hardship. Yet this splintering of the extended family exerts strong downward statistical pressure on the average income of U.S. households. Had the Generation Xers and their affluent grandparents all stayed under the same roof the average household income would be higher, but most of us would be worse off.

The supposed decline of the poor and middle class is exaggerated even more by the dynamics of population growth. When people look at the “poor” in any two years, they think they’re looking at the same people. That’s rarely true, especially over longer periods of time.

Since 1998, the U.S. population has increased by over 20 million. Nearly half of that growth has come from immigration, legal and illegal. Overwhelmingly, these immigrants enter at the lowest rungs on the income ladder. Statistically, this immigrant surge not only reduces the income of the “average” household, but also changes the occupants of the lowest income classes.

To understand what’s happening here, envision a line of people queued up for March Madness tickets. Individuals move up the line as tickets are purchased. But new people keep coming. So the line never gets shorter, even though individuals are advancing.

Something similar happens with the distribution of income. People keep entering the distribution line from the bottom. Even though individuals are moving up the line, the middle of the line never seems to move. Hence, an unchanged — or even receding — median marker could co-exist with individual advancement. The people who were at the middle marker before have moved up the distribution line. This is the kind of income mobility that has long characterized U.S. income dynamics.

When you look at the really big picture, it’s apparent that living standards are rising across the entire spectrum of incomes. Just since 2000, GDP has risen by 18% while the population has grown by 6%. So per capita incomes have clearly been rising. The growth of per capita income since 1980 or 1970 has simply been spectacular.

Some people would have you believe that all of this added income was funneled to the rich. But the math doesn’t work out.

The increase in nominal GDP since 2000 amounts to over $4 trillion annually. If you assume that all that money went to the wealthiest 10% of U.S. households, that bonanza would come to a whopping $350,000 per household. Yet according to the Census Bureau, the top 10% of households has an average income of $200,000 or so. The implied bonanza is so absurd that the notion that only the rich have gained from the economic growth can be dismissed out of hand. Clearly, there is a lot of economic advancement across a broad swath of population. Dramatic changes in household composition, household size and immigration tend to obscure this reality.

That broad swath of economic advancement shows up in personal consumption. According to the Labor Department, personal consumption spending has risen by $2.5 trillion since 2000. More Americans own homes and new cars today than ever before, despite slowdowns in both industries. Laptop computers, iPhones and flat-panel TVs are fast becoming necessities rather than luxury items.

The average American household is doing pretty well. The evident gap between income realities and political rhetoric may help explain why the “two Americas” theme, first asserted by John Edwards and since echoed by Mrs. Clinton and Mr. Obama, may ultimately fail to resonate with voters. On Election Day, voters may well turn to the candidate with the greater focus on a strong economy that increases everyone’s income.

The full article can be found here.

This is one of the many reasons why I don’t particularly care about income inequality. I could think of many scenarios where income inequality, as far as poverty alleviation and a rise in mobility is concerned, is a good thing. The above demonstrates one of those scenarios.

11 Responses to “The Inequality Myth”

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  2. Jon says:

    I think that’s mostly true, but from my perspective doesn’t tell the whole story.

    Let me tell you my story, which supports the way I see things. I’m just mulling this over and I don’t have tons of statistics to back up what I’m saying, but this is how I see it and I need to look into proving my perceptions.

    My Dad raised 7 kids in a roughly 2000 sq ft 4 bedroom home. When we were teenagers we owned 4 cars, which were shared by all drivers. My Dad was not an exceptional student. He managed a business degree and worked for Ford. My Mom stayed at home for the first 15 years of marriage, then substitute taught maybe once a week for $40 a week. The cars weren’t great, the house didn’t have central air, we didn’t have a lot of cool electronics, but we did OK.

    Now, let’s look at how things have changed from that time to now in my life. I have a much better education than my Dad. I’m far more skilled in the market place. I’m a Mechanical Engineer. We use CAD tools and analysis tools today that mean that I alone can perform duties that probably would have required 4 or 5 engineers when my Dad was working. So at least a quadrupling of efficiency. The internet has made production more efficient, inventory management more efficient, etc. Staggering improvements in home building, car manufacturing, computer design and development. Huge changes in efficiency.

    But do I have more than my Dad? Well, my house is a little nicer. It has central air. My cars are a little nicer. I can take better vacations. My wife has worked at some points during our marriage, but she doesn’t work now. She will again when the kids are a little older. Things are better. But I only have 2 kids. What if I had 7? Could I get by and stay afloat? I’d have to get rid of the vacations and a lot of other perks, downgrade the home, etc. And I don’t have a pension. And social security may not be there. Maybe I’m better off. I tend to think I am. But how much better off? Maybe 25%. Tops.

    How about the super rich. Are things better for them? No question. The richest man in the world was maybe worth $5 billion when I was a kid. Today he’s worth over $60 billion. Correct for inflation and you’re still looking at an improvement for them on the order of 600 or 700%.

    How is it that we’ve seen staggering improvements in efficiency over the last 20 years, yet it’s not entirely clear that I’m better off than my father when my education is far superior? And I have what would be considered a good job. It is unarguable that the rich are richer. But it’s a little unclear that the poor are better off.

  3. My situation is very different…I, and most of my friends, are significantly better off than our parents were.

    Btw, I think you underestimate how better off you are than your fathers generation. Just look at the advancements in technology (compare even your worst car to your dads best, in his time), medical innovation (when would you rather get sick? today or in your dads age), and quality of life metrics (leisure, computer, etc) and all other basic things that come with economic growth and it multiplies that 25%.

    More importantly, I don’t really care whether the rich are getting richer…if it means the poor are also getting richer that’s enough for me. In fact, more income inequality may be needed to improve the standard of living of all, see here.

  4. Jon says:

    I have no problem with the rich getting richer provided that their earnings are earned through free market forces, and not via the power of the government or the power of manipulation. Without the use of force your standard of living would improve 3%/year rather than .3%, and the rich would also improve 3%/yr rather than 30%. You are content with the crumbs from the master’s table even though you’ve earned a seat at the table. .3% is better than nothing, but if the free market is the gage you’ve really earned more.

  5. Agreed. I hate rent seeking just as much as the next guy. 😀

  6. Gerardo says:

    I dont get it. When one is poor…you are poor. There is lots of pain and suffering. The kinds of changes that you all are talking about are minimal.
    Its like saying shit…I had three hairs in my head and now I have four. It doesnt matter. You are still bald–meaning you aint got no hair. Much like you have little of anything when you are poor.
    Where as the rich person got extremely rich over the same time. He went from a Will Smith Flat Top to a Dr. J AFRO.

    Its like the anti bilingual ed folks praising immersion programs touting the successes of their policies…citing improved test scores. (what they usually dont tell you is that its like a 3% increase on a test score from 23% to 26%). It doesnt matter at that level you still aint going to college, and usually you havent mastered English at a fluent level. You can improve 3% by teaching to the damn test!
    So to make a long story short poor and poorer is still a fucked up situation to be in any way you want to cut it…

  7. You prove my point Gerardo.

    If poverty is your concern, then poverty should be what you address. If income mobility is your concern, then income mobility should be what you address. Simple concept no? Yet liberals have a hard time understanding it.

    Income inequality is not the same thing as poverty, or lack of mobility. Income inequality measurements really tell us nothing about how the average joe is doing, only how the rich is doing compared to the average joe. Think of these two scenarios:

    Scenario 1

    In your parents generation, in real wages, the middle class made x and the rich made y.

    Today the middle class makes 2x and the rich makes 4y. In this case, income inequality has increased (significantly) yet everybody is better off because of it.

    Scenario 2

    In your parents generation, in real wages, the middle class made x and the rich made y.

    Today we let in a significantly higher amount of immigrants than in your parents age, especially poor immigrants from Mexico. What do you think that is going to do to income inequality? Those poor immigrants are going to bring down the mean of the middle and lower class – making income inequality look worse yet the world is clearly better (as far as real wages, poverty reduction and wealth go) than it was yesteryear yet income inequality measurements would show the opposite.

    There are many other circumstances I could give as well.

    In other words, as long as the middle and lower class are getting more than they used to, who cares how much the rich are getting? An economy is not zero sum…one persons gain is not another persons loss. Most of the time the rich work to increase the size of the pie not to aggrandize more of it. So unless one is a ‘hater’ at heart, I don’t see why we should worry too much about how much the rich make.

    On the other hand, if you can show me that income mobility, real wages, and/or real standard of living has decreased and/or slowed, then you will have my attention. But the reality of the situation is that that is not what has happened. In fact mobility, real wages, and standard of living have all increased, oftentimes dramatically since your parents generation.

    There is a reason why the left, and really only the left, focuses so much on income inequality – its a great way to make a rosy picture look bad, and the populous just fall for it everytime. Its as economist Arnold Kling has said, ‘when you have nothing else to criticize, you always resort to income inequality’.

  8. ..its “Populace” in the last paragraph.

  9. Ah, yeah. Thanks! Forgive me, I was an ESL student…still trying to recover.

  10. How much do you want the government to do?

    Back around 1972, I took a vacation to Asia by myself. I spent a couple of weeks in Japan, a few days in Taiwan, and a few days in Hong Kong. One day, I was walking around downtown Taipei, the capital of Taiwan, and passed by a female who was lying on a piece of cardboard on the sidewalk begging for money. To this day, she is the most pitiful human being I have ever encountered. She was the size of a small child, badly deformed, and probably unable to walk. I couldn’t tell if she was an adult or child. Judging from her face, I guessed she was probably a leper. My reaction, perhaps naively, was why wouldn’t the government intervene and put this poor human being in some sort of facility where she could at least be fed, cared for and made to be comfortable.

    Over 35 years later, I have not changed my view.

    Yet, there is a definite limit on what I think the government, especially the US Government should do to help out its citizens. There are, without doubt, people out there who are physically and/or mentally unable to care for themselves through no fault of their own. In those cases, I feel government must provide a safety net to take care of these people.

    However, when it comes to others who are physically able to take care of themselves, I feel differently. I don’t feel it is the business of government, through the tax-payers, to nurse everybody in our country through life. (Admittedly, there is a big gray area when children of irresponsible people are concerned.) Unfortunately, we seem to have lost sight of that in the US.

    In my view, the primary role of government is to protect the country (from invasion etc)and protect the citizens from crime. Aside from that, the government must also provide an infrastructure (roads, bridges etc), hospitals and schools, the latter preferable at the local level. Also, the government, through its laws, should ensure that everyone has an equal opportunity to pursue life, liberty and happiness. It does not have the obligation to ensure equal results. In other words, the government should not try to ensure that every citizen has the same education, income and professional status. Unfortunately, individuals are different when it comes to all the factors that go into having a good and successful life. This has nothing to do with race or gender-it is an individual thing. When government engages in social engineering, the results are usually unsuccessful at least and disastrous at worst.

    One example is Lyndon Johnson’s so-called Great Society, which featured in the wake of the Civil Rights Era, a system of welfare for people on the lower end of the ecomonic scale. A large proportion of those receiving welfare were African-Americans. Yet, welfare, in spite of its good intentions, created an entire generation of people who became dependent on the government. As part of this government-inspired system, there were financial disincentives for 2-parent families. As is usually the case, good intentions led to unintended consequences. Since that time, we have witnessed what I consider to be the greatest disaster to befall black America-the break-up of the black family. Black illigitimacy, about 25% in the worst days of Jim Crow, has reached 70% today (to be fair, white illigitimacy has also risen, albeit not so dramatically). In my view, the lack of stable 2-parent families is the real root cause of all the problems that exist in black communities-drugs, gangs, crime, violence, lack of respect for women and what have you. Yet, we continue to delude ourselves that is all due to on-going white racism.

    Another issue is when the government tries to create a solution (ie, a program) to fix every perceived problem. Not only is the government stepping beyond its true role, but it necessarily must increase its size, wealth and power in order to do so. New agencies must be formed, more laws and regulations passed, more government employees must be hired, additional bureaucracy created, and more money must be collected in the form of taxes. The result is that more and more wealth must be taken from tax-payers and more power is given to the government.

    Sound familiar? Sure it does because it is happening right here in the US, especially in places like California and Massachusetts. In fact, this is the prime point of difference in the philosophies of liberals and conservatives. Liberals perceive a problem, and immediately, they want a solution. Who is best equipped to bring the solution? Government of course. So it is fair to say that liberals favor a bigger and stronger government. I have already outlined the costs of such a government above.

    A prime example of a government that set out to make everyone the same was the former Soviet Union. The Russian Revolution sprang from a reaction to centuries of autocratic Czarist rule that featured many social-economic inequalities. Under Lenin, the non-Russian nationalities and Jews were given more equality. This eventually dissolved under Stalin, who favored Russification-even though he himself was a Georgian. At any rate, what resulted was a huge centralized, totalitarian state that provided little incentive for anyone to try to get ahead through their own talent and initiative. As for political and civil liberties, we all know what that was like.

    Yet today, even though the Soviet system has been discredited, there are those here in the US that want to move us in that direction, at least as far as Western European-style socialism.

    As someone who actually worked for the US Government for 25 years, I am of the firm opinion that government is, by its very nature, inefficient. Actually, as a DEA agent, I would maintain that federal law enforcement, at least at the working agent level, is one of the more efficient government entities. However, DEA’s efficiency ended when it came to HQs in Washington. Then it became just another bureaucracy. Most other federal agents I knew said the same about their own agencies. By the way, I would still defend the need for federal law enforcement agencies due to the trans-national nature of criminal organizations that routinely cross state or international boundaries. It is essential to have an agency that can coordinate with their own offices-and have working relationships with international police agencies as well.

    Notwithstanding the above exception, if government, by its very nature is inefficient, why, in a free market democracy, should we entrust it with more and more responsibility and power? For example, why should we centralize education in Washington? Why should we turn over health care to a Washington bureaucracy?

    Let me expound on that a bit. As for education. At the public level, it is a mess, especially in our large cities. Not all of that is the fault of the schools since so many pupils are bringing a lot of issues with them to school. But how can it be solved-or how has it been solved by this thing we call the Department of Education? Yet, we keep hearing about the need to pour more and more money into a failed system. Do I have the answer for the failure of public schools in our major cites? No, but I refuse to believe it will be achieved by raising taxes. Places like Washington DC, LA and New York have the highest money expenditure per student in the nation-and they are all gross failures. We will never fix it by raising taxes, property taxes or otherwise, yet, that is exactly what the politicians want to do. It’s like when a baseball team keeps paying a huge salary to some guy that hits .220 year after year.

    In the area of health care, we have decided that we are in the midst of a health care crisis-even though we have the best health care in the world. It is estimated that we have some 40 million people without insurance. Out of that total, of course, some 12 million are illegal aliens. In addition, there is a large proportion made up of younger workers who decide at their age that they don’t need health insurance and would rather have the extra money. So for their benefit, some want to scrap our whole system and turn it all over to the government-who will only screw it up for everyone. But, you say, why can’t we have a system like Canada’s or the UK’s? Everybody is covered there, right? Yet, why do so many Canadians and Brits come to the US when they need serious medical treatment? Primarily, it is because the bureaucracy forces them to wait several months to obtain major surgery (in which time, they may die), or, in the case of Canada, a patient may have to travel across country to a place where a certain kind of surgery can be performed.

    No thank you.

    To me, the best solution is not to chip away at our free-market system. Like it or not, the profit motive is what makes it successful. Yes, we like to demonize our oil companies, our insurance companies and our pharmaceutical companies for raising prices without considering the cost of oil exploration or the influence of world demand, or the cost of research, development and approval of new drugs. Let’s just have the government impose price controls and take over the whole operation-as if that will solve all our problems. It won’t. It will just screw it up.

    Now let me turn to the latest “crisis”, the one that has the red phone ringing in the White House at 3 am: The housing and foreclosure crisis. So now, we want the government and the tax-payer to come to the rescue of people who took out unwise loans and bought homes that were beyond their financial means. In other words, we want to protect people from the consequences of their unwise decisions. What’s next? Will we protect gamblers who go to Las Vegas and lose all their money?

    Now, I am not arguing that businesses who violate the law or engage in shady practices should be protected. If a lending company engages in deceptive practices, or a company like Enron breaks the law-then certainly there should be laws to deal with that and there are. However, people who borrow money or take out a mortgage need to act responsibly and read the fine print. I have bought three homes in my life time. I never bought a home I couldn’t afford, and I always knew what the terms were. Bottom line? It is not the business of the government-using tax-payer money-to protect individuals from their own bad decisions. In this vein, I would also argue against government bailing out failed companies and corporations from their bad business practices-even if jobs are lost from a company’s bankruptcy. The Chrysler bailout was a prime example.

    It is tempting to insert a political argument into all this since the Democratic Party and its two remaining presidential candidates all want to impose more government involvement on the rest of us. Yet, the performance of the Republicans in recent years has been less than stellar. Mainly, they have gone to Washington and become part of the problem as well. They have deserted their roots-and have paid the price at the polls. In fact, very few of us would look at this government we have now and try to argue that it is operating well. Then why should we want to give it more power and responsibility in solving every perceived problem? Maybe, just maybe, we should look to ourselves to solve our own problems.

    In spite of our shortcomings, there is no other country on earth that provides its citizens with the opportunity to rise above the circumstances of their birth and become successful through their own hard work, initiative and performance. Everyone is free to succeed-or fail on their own. We should not be demanding that government take us by the hand and lead the way to success, rather we should be demanding that it get out of our way. The more we want our government to be our servants, the more we will discover that they have become our masters.

    gary fouse

  11. Jamie Lin says:

    Mr. Schiller made several fetal mistakes in his arguments. First, when dismissing “the poor are getting poor,” he did not use the same “dollar” to measure the pie. In “2007 dollar” terms, the poor’s pie should have been $471 billion in 2007 versus $218 billion in 1970. Taken 93% increase in number of households into consideration, each household’s pie has only increased by 11.7% in 38 years – while the economy expanded by 307%. More importantly, being poor or rich is relative. Therefore, even if the author did not make the first mistake, the poor indeed has been getting poor with only 36% (or 12%) increase in pie size in comparison to 300+% gain for other classes.

    Moreover, the author wrongly accused new immigrants of being a drag to the poor’s advancement. Not only did he raise no evidence to support his assessment, but he also used an largely incorrect model, a ticket line, to explain new immigrants’ entrance into the system. By various measures, new immigrants are a very positive factor to this economy, especially in promoting growth and equality. For example, since the creation of E-class investment visa in 1990, almost 200,000 new immigrants have joined the US economy through each investing more than $1 million and creating more than 10 jobs. Not only have these people not dragged the poor, they have instead increased the pie while distributing a lot of the gain to lower class through paychecks, stock options and other various forms of employee compensations. Besides, over 40% of PhDs that are currently working in US are not native. These PhDs certainly would earn anything but below median income or bring more inequality. It’s very easy to see how the ticket line model is off as new immigrants certainly do not all enter this economy from the back of the line and how dead wrong the author was in blaming new immigrants for bringing inequality.

    Jamie Lin

    New York, NY

    An NYU Stern MBA and a proud new immigrant entrepreneur who has created many jobs

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