Capitalism to Egalitarians: You’re Welcome!

by Will Wilkinson on May 19, 2008

I’ve posted on this paper once already, but it really, really, really deserves more attention. And people pay attention to Steven Levitt, so listen to him:

According to two of my University of Chicago colleagues, Christian Broda and John Romalis, everyone is wrong.

Inequality has not grown over the last decade — at least not very much. What we think is a rise in inequality is merely an artifact of how we measure things.

As improbable as it may seem, I believe them.

Their argument could hardly be simpler. How rich you are depends on two things: how much money you have, and how much the stuff you want to buy costs. If your income doubles, but the prices of the things you consume also double, then you are no better off.

When people talk about inequality, they tend to focus exclusively on the income part of the equation. According to all our measures, the gap in income between the rich and the poor has been growing. What Broda and Romalis quite convincingly demonstrate, however, is that the prices of goods that poor people tend to consume have fallen sharply relative to the prices of goods that rich people consume. Consequently, when you measure the true buying power of the rich and the poor, inequality grew only one-third as fast as economists previously thought it did — or maybe didn’t grow at all.

Why did the prices of the things poor people buy fall relative to the stuff rich people buy? Lefties aren’t going to like the answers one bit: globalization and Wal-Mart!

With the recent rise in food and energy prices, I wouldn’t be surprised if inflation is now rising more quickly for the poor. But it’s just huge if everyone has been so wrong about rising inequality over the last decade. If you think economic inequality matters, that’s because you think relative economic well-being matters.  If you think economic well-being matters, then what you care about is consumption, not income. So what you’re worried about, my egalitarian friend, is consumption inequality. If the trend in consumption inequality is flat, will you please make a note of it? Indeed, will you please communicate to your friends that, despite the outsized income gains of the wealthiest, America has become scarcely more unequal because capitalism has done so much of specific benefit to the poor?  Of course you will.

  • Passepartous
    It surely depends on the amount of your wealth that MUST be spent on stuff. If you have billions I can't see HAVING to spend it all to eat or satisfy your self-indulgence. So, where's the problem in measuring how rich you are?
  • Muirgeo believes that derivatives and other forms of magic have caused housing prices in his area increase by 50% in the last several years. Whereas "Eighty-eight percent of the increase in the median real price of a house in Seattle since 1989 is the result of land-use restrictions." So where does that leave us proposing government as a solution to addressing the rise in housing prices?

    Muirgeo also suggests that "the guys at the top took out their big chunks and left everyone below holding loans." But the guys at the top were the mortgage companies, the ones doing the loaning, which are now going bankrupt and asking the government to bail them out. So how exactly was it in their benefit to make loans to people who would be unable to pay them back?
  • muirgeo
    Micha,

    Derivatives and such are magic. They made houses in my area go up in value by 50% in several years. Then the guys at the top took out their big chunks and left everyone below holding loans on houses that were maybe 1/3 more then the value of the houses.

    Here's a good explanation of the trillion dollar financial heist that no one is talking about.

    http://docs.google.com/TeamPresent?docid=ddp4zq...

    I guess some guys call this capitalism but I call it high tech robbery and I call the people who defend it simple vacuous shills who contradict their own claims to free and competitive markets.
  • I'm not sure if muirgeo realizes that every time he refers to "wizardry" he is essentially admitting that he doesn't understand the thing in question and is therefore concluding that it must be magic. This does not speak favorably of muirgeo's worldview.

    And though I risk violating Godwin's Law, I can't help but point out the similarities between scapegoating investment banking "wizards" who get rich "while adding nothing to the nations real productivity and often taking from it," and, well, to put it bluntly, Hitler. This is how anti-Semitism begins, not with a bang but with a muirgeo.
  • muirgeo
    "...for the same reason that they don’t care about effort needed to earn high income..."
    Ned


    I'm sure a lot of effort, hard work and time goes into those Wall Street Wizards trying how to create complex investment products and asset bubbles that get them rich while adding nothing to the nations real productivity and often taking from it.

    The facts of how much wealth is accumulated using the government are well spelled out by David Cay Johnston, John Perkins, Kevin Phillips , Joseph E. Stiglitz and many other responsible knowledgeable authors.

    Ah but things never change there were plenty of well-to-doers comfortable supporting King George back in the day before the last revolution. At some point you're really not supporting democracy when you make excuses for such massive non-market, non-democratic concentrations of wealth.
  • muirgeo
    Here's a different version of the facts;

    http://www.youtube.com/watch?v=akVL7QY0S8A
  • Ned
    Will, unfortunately, I doubt that studies such as this one are going to have any impact on public opinion or public policy. The sad fact is that the real goal of taxation, for most voters, is not to help the ‘poor’ – it is to punish the successful (see the post above by one ‘muirgeo’, for example; comments on the Freakonomics web site were also much more scathing towards the study than those posted here).

    It is not realistic to expect people to gauge welfare of others using as a measure prices of goods they don’t themselves consume. In other words, what matters to most people is the nominal differences in wealth and income, not basket-of-goods adjusted ones – for the same reason that they don’t care about effort needed to earn high income (how much sympathy did people laid off from finance jobs get because their jobs involved long hours and lot of stress?).

    Nevertheless, keep up the good work.
  • Jim
    Will, I would be interested in seeing your response to Lane Kenworthy's post on this (link is in the trackbacks above).
  • It's sad what some will do to attempt to justify coercive redistribution, even after it's shown that doing so is not helping but hindering their goal of improving the wellbeing of the worse-off.

    And how in the world is success measured in terms of profit increases an indication of a zero-sum transfer?

    I see muirgeo's mastery of logic and economics hasn't improved much since he fled the comment threads at Cafe Hayek.
  • muirgeo
    It's sad what some will do to attempt to justify plutocracy. The saliant fact that the per cent of corporate profits in the finance industry rose from 10% to 40% from the early 70's to the present is fact enough for me to understand just how massive the transfer of wealth has been from the working class to the wizards of paper pushing on Wall Street. Oh yeah, those derivatives sure add lots to the productivity pie....NOT!

    If someone is trying to claim the current economy is a shining example of the success of free and competitive markets in a democratic society they have a lot of explaining to do in terms of their definitions of competitive, free, markets, democracy and oh yeah honesty.

    This is a rigged market just as it was in 1776 and change is in the air such that an economic royalist and his courts proud papers proclaiming otherwise will be, hopefully, overrun by the truth that people know as they live out their daily lives more and more on the edge.
  • Anonymous
    I agree. The VP's at the company where I work all make much more than a carpenter in the middle of Pennsylvania. But when you factor in the hours they work, job stress, the cost of housing in Boston, debt on business school loans, etc., I strong case could be made that the carpenter in Pennsylvania is better off.

    The trick is to have a high relative income for your region. Having a high income in a place where everyone earns a lot simply causes housing prices to shoot through the roof, making you no better off.
  • mk
    (To clarify: I should have explicitly specified that part of the increase in castle price each is due to it being bigger/awesomer than the last, and part due to inflation in the castle market.)
  • mk
    This is a very interesting paper, but there are some reasonable questions to be asked here.

    For example, let's take a fictional economy with two people: Mindy and Max.


    Mindy makes $100 a year, for 5 years.
    Max makes $1 billion, $2 billion, $3B, $4B, $5B, in the same 5 years. (His salary is going up by 1B each year.)


    Mindy buys the same goods every year and they do not change in price.

    Max buys a new castle for himself each year, each more wonderful than the last. Each year he spends all of his money except 0.5 billion dollars, which he keeps for savings.



    Is consumption inequality increasing between Max and Mindy? This depends on your definition of consumption inequality. I tried to get a definition by scanning the paper but I couldn't pull one out of the math in ~10 minutes. But based on what I've read my guess is that the metric might say consumption inequality does not rise (because castles are rising in price), which seems like a crappy definition of consumption inequality.
  • I have been trying to hammer home this point in various presentations and on the web for a few years, as has Don Boudreaux among others. You can check here for one example: http://hnn.us/blogs/entries/44568.html .

    Gonna have to read that paper I guess!
blog comments powered by Disqus

Previous post:

Next post: