Ezra Klein on Consumption, Debt, and Inequality

Ezra and I chatted a bit on Bloggingheads about the ideas in his post replying to a bit of my paper, but I had yet to read the post, my response was off-the-cuff, and I think I can do better.

So, I noted in my paper that nominal consumption inequality has increased much less than income inequality (and I go on to argue that real consumption inequality may have dropped). Ezra says:

You'd think the fact that our ears are still ringing from the deafening “pop!” of the consumption bubble would, in some way, impact this analysis. But it doesn't. Nor does the word “debt.” But that's how many households have kept their consumption high amid widespread wage stagnation.

Megan McArdle posted an excellent reply, for which I am grateful:

I think it's easy to overstate the contribution of debt, for two reasons.  First, many of the discussions on consumption equality focus on the poor, who were still relatively credit constrained even at the height of the bubble.  And second, income inequality figures exclude both taxes and government benefits.  Things like the EITC and Section 8 vouchers really have made a quite substantial improvement in the ability of the poor to consume.

So I don't think we actually know how much of a difference consumer credit made to equalizing consumption between rich and poor.  I suspect that the continued mechanization of formerly labor-intensive tasks has made a greater difference, but then you'd expect me to say that.  The data we want will not be available for several years, especially since period immediately following the financial crisis will be very atypical*, and therefore not useful in assessing the longer term trend.

Let me add that I don't think pre-recession wage stagnation has been exactly widespread. It has been suprisingly focused on low-skill, male workers. Also, to be exactish, money wages can stagnate or fall while total compensation rises. And total labor-market compensation can stagnate or fall while total disposable income, including government transfers, increases. (Additionally, income from “informal” markets tends to be under-reported, but likely shows up in consumption surveys.) So, as Megan points out, a steady level of consumption for a household with stagnant wages (and no savings) needn't imply increasing debt. That said, I suspect many lower-income households have over recent years increased their level of debt, and I suspect that this has played some small role in keeping consumption inequality in check. But we shouldn't infer from the bust following the boom that this was mostly “bad” debt. I think improved access to formal credit markets has been a net plus for lower-income households. And even if some of this increase in debt took the form of sub-prime mortgages, not all of that turned out bad.

More to the point, the economy tanked due to a burst housing bubble. I agree that there was, in some relatively clear sense, overconsumption of houses–a good generally bought on credit. The reasons for this are many, but first among them is that the government, in many ways, rather encouraged house-buying. The economy-wide delusion about the long-term trend of housing prices seems to have been both a cause and effect of the bubble, as well as a cause of highly unrealistic individual/household estimates of wealth that could safely be borrowed against now. So, yeah, lots of people who wrongly thought they were house-rich ran up their credit cards. I think it's safe to say that there was “too much” debt-financed consumption. But I would hazard to guess that, on the whole, this would tend to widen rather than narrow the income and consumption gaps. As I note in my latest column for The Week:

“High-income households are highly exposed to aggregate booms and busts,” report Northwestern University economists Jonathan A. Parker and Annette Vissing-Jorgensen in a recent National Bureau of Economic Research working paper. They estimate that our current bust is hitting the income and consumption of households in the top 20 percent of income earners significantly harder than the households in the 80 percent below. And the higher up the distribution you go, the harder the hit is likely to be.

That incomes at the top are now so sensitive to aggregate consumption (it didn't use to be that way, Parker and VIssing-Jorgensen say) would seem to at least partly explain the coincidence of very high average debt-levels and high levels of inequality that Ezra emphasizes later in his post.

Folks were running up their credit cards because they thought they were house-rich. They thought they were house-rich because they were in the middle of a housing boom that made the current and future value of their houses look a lot higher than they really were. Those with compensation schemes highly sensitive to changes in aggregate demand–high income households–saw a disproportionate rise in already high income as consumption boomed. So income inquality went up. And now they same households have likely seen a rapid drop as consumption has fallen off a cliff. So income inequality went down. At least that's part of the story. And it remains conjectural until the relevant stats finally roll it. (Also, I think it remains that the primary cause of rising income inequality has been the rise in returns to human capital investment [pdf], and that hasn't gone anywhere.)

So, I think Ezra is probably right to suspect some kind of correlation between high levels of income inequality and high levels of average indebtedness. Both levels partially reflect the housing-bubble-driven boom in consumption. But I don't think it would be right to imply (as Ezra seems to in his post) that the high level of inequality somehow independently contributed to the crash.

Unequal to the Task

I'm been really grateful for the suprising (to me) amount of attention my inequality paper has gotten. There have been a raft of really thoughtful replies, and I want to give them all the thoughtful responses they deserve. I've been overloaded the past couple of weeks, in part by this daunting task. But I'm going to try to address some of the most notable replies, despite the fact that eons will have passed in blog time by the time I get to all of them. I hope folks won't feel too slighted by my slowness to respond.

Fed Independence: Too Important to Verify

David Boaz has a good post on the economists petitioning against an audit of the Fed on the grounds that its independence from politics is so precious. David concludes:

The Fed can be independent and unaccountable and undemocratic, or it can be subject to the political whims of elected officials; neither is a very attractive prospect.

I don't see the choice as quite so binary. There are degrees of independence, accountability, and politicization. One reason to want an audit of the Fed is to establish whether or not it has actually been acting with sufficient independence. The question is already in the air. To attempt to impede an inquiry into the question by stressing the high value of independence is obviously to beg the question. Those who prize independence, if they really do, ought to be all the more keen on an inquiry. The importance of Congress asserting the authority to inquire is that, otherwise, the Fed can use the ideal of independence as cover for what may be in fact extremely political decisions.

There is a big difference between mundane countercyclical central banking and the liberal use of emergency powers. The distributive consequences of the Fed response to the financial crisis are enormous, and I don't think it's unreasonable to demand  a justification for the fact or the details of the response. Was there really an emergency that called for the Fed's action? There weren't WMD in Iraq. Maybe the financial crisis wasn't going to blow up the entire economy.

The question of which firms got how much of what kind of transfer through the Fed's excercise of discretion is inherently political, not in the sense of “partisan,” but in the sense that the Fed was picking winners and losers. I want an account of why these decisions were made the way they were.

Is the worry that no inquiry or audit could be designed that would not devolve into delegitimizing populist point-scoring or policy-warping political armtwisting? I suspect a main worry is that the Fed's use of discretion was not independent of who in the Fed system knew whom on Wall Street, of who had what kind of pull, etc. And revealing this, even in a sober and responsible manner, would expose the Fed's failure to act with the sort of impartiality and objectivity at the heart of any useful notion of independence. Of course, the art of central banking is the art of telling lies so that they will come true. Telling the truth about the Fed may create expectations of future partiality that will hinder the central banker's ability to manipulate expectations in a theoretically ideal way. So the theorists band together to defend the Fed's right to lie, or at least to stay mute when citizens are owed some justification, about its suspected partiality in the use of emergency discretion. To make this kind of defense of the importance of independence is really to defend the economic importance of maintaining the perception of independence. But this is to assume the legitimacy of useful lies, an assumption that cannot be granted merely on the basis of the self-asserted authority of “experts.”

The attitude of many macro and monetary economists about the operation of the Fed reminds me more than a little bit of the attitude of neocons about defense and foreign policy. Something with the flavor of: “You people are too stupid to understand the real existential threats out there–to understand how we, the big boys, are keeping you safe. You should be grateful, but we don't ask for gratitude. We're just asking you to shut up and believe what we, The Serious People, tell you to believe. Or else.”

I have to admit that this doesn't sit well with my liberal sensibility.

Peter Singer on Health-Care Rationing

Via Conor Clark, I find Peter Singer in the NYT saying this:

If the Department of Transportation [followed the principle that it was impossible to put a dollar value on human life] it would exhaust its entire budget on road safety. Fortunately the department sets a limit on how much it is willing to pay to save one human life. In 2008 that limit was $5.8 million. Other government agencies do the same. Last year the Consumer Product Safety Commission considered a proposal to make mattresses less likely to catch fire. Information from the industry suggested that the new standard would cost $343 million to implement, but the Consumer Product Safety Commission calculated that it would save 270 lives a year — and since it valued a human life at around $5 million, that made the new standard a good value. If we are going to have consumer-safety regulation at all, we need some idea of how much safety is worth buying. Like health care bureaucrats, consumer-safety bureaucrats sometimes decide that saving a human life is not worth the expense. Twenty years ago, the National Research Council, an arm of the National Academy of Sciences, examined a proposal for installing seat belts in all school buses. It estimated that doing so would save, on average, one life per year, at a cost of $40 million. After that, support for the proposal faded away. So why is it that those who accept that we put a price on life when it comes to consumer safety refuse to accept it when it comes to health care?

I find this bizarre and confused. Maybe I've missed it, or I run in the wrong circles, but I never had the impression that the argument against government rationing of medical treatment was that you can't put a price on human life. Of course you can! Individuals do it all the time through their rationing–through occupational choices, consumer choices, residential choices, transportation choices, and health and medical choices, all of which reveal how much the individual is willing to pay to avoid an X% risk of death. As Singer mentions, this is how the Consumer Product Safety Commision comes to estimate the cash value of a life: by taking an average of revealed willingness to pay in these kinds of individual choices. The argument against government rationing of medical care is not that life is infinitely valuable, but that government has no legitimate authority to decide how much an individual should be allowed to pay.

Suppose Peter Singer came along and told you that the data show that, on average, Americans value their lives at six million dollars, and that therefore you shouldn't be able to spend seven million dollars on yourself, since your whole life isn't even worth that much. Would you be impressed? I hope not!

Individuals trade reductions in risk of death against other goods in the context of their own limited budgets. (I.e., they ration their resources.) What you are willing to pay to reduce the risk of death depends in large part on how much you've got to spend. If individuals with a ton of money spend boatloads on medical care, they are thereby revealing how much they are willing to pay to reduce the risk of death and are thereby pushing up the average willingness to pay for extra life. For the government to step in and limit spending on medical treatments on the basis of the fact that the limit reflects the average willingness to pay for extra life is exactly like government stepping in to limit how much individuals can pay for extra safety features on a car on the basis of what people do tend to pay. This stupidly takes an evolving average as normative while cutting off the possibility of further evolution.

Of course, the government, like individuals and families, has a limited budget. So if the government is going to pay for medical care, it has to ration. And that very fact is an argument for limiting the government to only paying for the care of people who are unable to pay for a minimum of care themselves.

Manzi's Questions on Inequality

Besides being a brilliant guy, Jim Manzi is to my “right” politically, which I think makes his worries about inequality particularly interesting. He has kindly taken the time to read my paper and has some questions. I'll take them in turn.

1. Let’s assume that the social mechanisms that produce some highly skewed income distribution do not violate any norms of justice. Can a sufficient degree of inequality be itself a violation of a norm against very high inequality? If our minds are evolved instruments, and have evolved to regard such an outcome as inherently wrong, then is it valid in Will’s philosophy of justice to declare a norm against it?

I think there is good evidence that there is an evolved sense of “fairness” relevant to questions of distributive justice. But distributive justice, in the first instance, deals with the distribution of the gains from cooperation in small groups. It's not clear that this capacity has any relevance to questions of the pattern of holdings in the vast populations of contemporary nations states–questions light-years from any posed by life on the Pleistocene savanna. And, in any case, that a capacity evolved, and was adaptive at some point in the history of the human lineage, does not even establish a presumption of normative authority for the outputs of that capacity. So, my answer is a very strong No.

2. Given my views on social science, I think that it would be all but impossible to build a convincing analytical case for any non-obvious phenomenon that can not be subjected to controlled experimentation because it extends across all of society over a long period. So I agree that an analytical proof that sufficient inequality will lead to a political dystopia does not exist and will not be forthcoming. But that is different than saying I do not believe it to be a problem. Is it Will’s judgment that, in our current social and political context, current levels of economic inequality are not dangerous?

First, let me emphasize that a main point of my paper is that real material inquality is much lower than nominal income and consumption measure lead many people to think. The reason is that these measures aren't measures of real material inequality. I argue that there is good (though not drop-dead) reason to believe that standards of living have become more equal over time. That said, given my views on social science, I think it's wrong to think of levels of inequality, measured anyway you like, as a cause of anything in the absence of auxilliary hypotheses about the relation of the inequality level to real mechanisms of social change. As I argue in the paper, inequality and other very bad things often have a common cause. For instance, places with a great deal of corruption and political predation often have, for those very reasons, extremely high levels of economic inequality. When distribution is determined primarily through political means, there will be a great deal of conflict over control of the state. So these kinds of places tend to be marked by strife and instability. And thus you will in fact find a reasonably strong correlation between income inequality and instability across countries. But inequality doesn't drive the instability. Rather, the causes of instability also drive up inequality.

So, to answer Jim's question, (1) real material inequality in the U.S. is lower than most people think and (2) the level is not dangerous. (3) Some part of the level is surely driven by dangerous mechanisms (e.g., political redistribution with little perceived legitimacy), but then the injustice and danger lies in the mechanism, not in the mechanism's knock-on effects on equality.

3. To put my cards on the table, I think that inequality, as it interacts with other facts about contemporary American society, is a problem. But, I think that, even more fundamentally, it is an indicator of a much more severe problem. As globalization continues inexorably (in practical terms, this has very little to do with McDonald’s in France, and almost everything to do with the economic rise of Asia), U.S. income inequality is a demonstration that many — probably most — Americans don’t have the capabilities required to maintain anything like their current standard of living in competition with a global labor force. Does Will think this is accurate, and if so, is it a problem?

I don't think this is even close to accurate. I see most signs pointing in the direction of a rising standard of living for most Americans. The worry makes sense only if you (1) see world economic growth as a zero-sum game, which it most certainly is not, or if you (2) think the standard of living of most Americans is, like the standard of living of Michigan autoworkers, a result of direct of indirect subsidies that cannot be sustained in the face of increasing global competitiveness, which it is not. Globalization does squeeze out the kind subsidies that do prop up many people's wages. Maybe a declining standard of living due to disappearing subsidies is a source of social instability–or at least a source of new demand for inefficient protectionism. This is, in fact, why some scholars think “trade adjustment assistance” and other forms of redistribution are so important. But then, again, inequality is a symptom here, not the disease. If people get out the pitchforks when their subsidies are removed, inequality per se has nothing to do with it. What people are angry about is a declining standard of living. (And, yes, some people care about relative decline, but their frame of reference is generally local, not national.) If some other form of subsidy is needed to buy civil peace and/or buy out resistance to good trade policy, then that might be a good reason for redistribution. In my view, to see it as an issue of inequality is simply to lose focus.

Vet Spending

We have a Viszla and no children. He gets “ultra-premium” dog food, ridiculous toys, and relatively expensive treats (because he likes them better!) When we were deciding on a vet, we picked the place run by people with degrees from Cornell, because we looked it up and Cornell is the top-ranked vet school. I'm pretty sure we're not economizing. And I'm pretty sure Robin Hanson's on the right track. But it is possible to call around and get accurate quotes on the cost of neutering your dog. I didn't happen to call around because Winston gets the very best! (Also, I figured prices wouldn't vary that much in a competitive market.) I don't think Winston is impressed, but we're pretty happy with ourselves.

Thinking Clearly about Economic Inequality

In honor of Bastille Day, and my sister's birthday, I give you my long-in-the-works Cato paper on inequality. Here's the very compressed abstract:

Recent discussions of economic inequality, marked by a lack of clarity and care, have confused the public about the meaning and moral significance of rising income inequality. Income statistics paint a misleading picture of real standards of living and real economic inequality. Several strands of evidence about real standards of living suggest a very different picture of the trends in economic inequality. In any case, the dispersion of incomes at any given time has, at best, a tenuous connection to human welfare or social justice. The pattern of incomes is affected by both morally desirable and undesirable mechanisms. When injustice or wrongdoing increases income inequality, the problem is the original malign cause, not the resulting inequality. Many thinkers mistake national populations for “society” and thereby obscure the real story about the effects of trade and immigration on welfare, equality, and justice. There is little evidence that high levels of income inequality lead down a slippery slope to the destruction of democracy and rule by the rich. The unequal political voice of the poor can be addressed only through policies that actually work to fight poverty and improve education. Income inequality is a dangerous distraction from the real problems: poverty, lack of economic opportunity, and systemic injustice.

Read it, talk about it, complain about it, blog it!

This is best read with my collaborator Brink Lindsey's “Paul Krugman's Nostalgianomics: Economic Policies, Social Norms, and Income Inequality” as a more empirically-focused companion piece.

Whereof Game Theory Cannot Speak….

Conor Clarke's interview with Thomas Schelling is fascinating. And also a bit confusing. And disappointing. Schelling is one of my intellectual heroes. But in this interview, he seems to bounce back and forth between the kind of reasoning I  learned from his work and a kind of aspirational moralizing that I learned from his work to distrust.

For example, when Schelling speaks as an economist, he makes a great deal sense to me:

I think the best hope for India is to grow its economy as fast as it can in order to outgrow its vulnerability to climate change.

[…]

If I were to come clean to the American public I would say that, except for a very low probability of a very bad result — which is the disintegration of the West Antarctic ice sheet, which would put Washington DC under water — we are probably going to outgrow any vulnerability we have to climate change. And in case we'll be able to afford to buy food or import it is necessary. You know, very little of the US economy is susceptible to climate. All of agriculture is less than 3% of our gross product. Forestry may be endangered. Fisheries may be endangered. But recreation might actually benefit!

So if we can double our GDP in the next 70 or 80 years, even if we lose some of our GDP from climate change — even if we lose 10% of our GDP from climate change — we're still ahead so much that the effect of climate change wouldn't be noticed. But it would be pretty disastrous in a lot of the less developed parts of the world. And that's why I think it's crucially important not to demand anything of China, India and so forth that will significantly impede their economic progress.

Right on.

But I feel like Schelling is not very enlightening on questions about policies that will affect future generations. For example:

[Clark] I wanted to ask more question, to go back to the moral issue here. It does seem to me that the strongest case for mitigating the effects of global climate change is a moral one. It is based on not on our own interest but on the interests of people in the developing world who don't yet exist. But it also seems to me that — while I don't know much about game theory — collective bargaining theories generally assume the participants are rational and self-interested. So how does one go about making sense of an arrangement where we must set our self-interest aside? How does one make the moral case in a situation like this? Or is my description of collective bargaining just totally idiotic?

Well, I think you have to realize that most people have very strong moral feelings. I think in a lot of cases they're misdirected. I wish moral feelings about a two-month old fetus were attached to hungry children in Africa. But I think people have very strong moral feelings. In fact, I'm always amazed by the number of people who at least pretend they're worried about the polar bears.

That's not wrong, but it's terrifically weak stuff. Which is not very surprising. There is little for a game theorist to do but moralize here, since game theory doesn't apply here. As readers of Derek Parfit know, deliberation about harm to future generations is doubly confusing because it's not even quite right to say that, although we can affect people in the future beyond our deaths, those people can't affect us. Who are “those people” we are talking about? There is a temptation to see future populations as determinate but simply yet-to-be-realized. That's wrong. Future populations are indeterminate. What we do now, the results of the games we are playing presently, determines who will and will not exist in the future.

So, for example, if we anticipate that the burdens of global warming will fall most heavily on future people in particular regions, we can mitigate those harms in any number ways. We could encourage a lower birthrate later by encouraging various techniques of birth control now. The fewer future Bangladeshis there are, the lower the possible total harm to future Bangladeshis. But… I'm not a fan of this idea. However, in some ways, economic growth is a form of birth control, since birthrates tend to fall with income growth. So, not only does greater wealth allow for greater adaptation, it lowers the expected total harm of current activities by reducing the expected population. Does anybody try to model this?

Or, to take another tack, if the negative consequences of today's actions will fall most heavily upon poorer people in certain regions a century hence, the regions most likely to benefit from warming, and those best equipped to adapt, can open themselves more fully to immigration from places where the greatest harm is predicted. We could increase the gains to warming by increasing the proportion of the world population residing in areas likely to benefit from it. Now, that sounds crazy. But it's just as much a possibility as massive wealth transfers from rich to poor countries, which Schelling recommends (and which, based on the record of development aid, I would anticipate to have many negative consequences).

The interesting question is how we coordinate now to facilitate any prevention or mitigation strategy. And Schelling is not even very helpful here. He is clearly worried. But, at the same time, he sounds pessimistic about the possibility of really effective coordination. It sounds like he thinks the best developed countries can do is to announce the intention to do something and start doing it, while basically hoping that it makes a difference. And the best advice he gives is not advice, but moral exhortation. And even then, it's pretty indirect. He exhorts churches to do more exhortation about climate change.

And one thing that I think ought to help but doesn't is that — and my impression is that maybe this is slightly changing — the organized churches in American don't take seriously preserving the heritage that God gave us. I've heard congressmen confess to being devote Episcopalians say that what god gave us ought to be preserved. But I get no impression that Protestants and Catholics are sermonizing on the importance of preserving the bounty of the earth, the richness of the species, or preserving the planet as we would like to know it. And I think that if someone could mobilize the church to be interested…

I spent a long time concerned with smoking behavior. And when I was a boy the churches were very adamant about smoking. And my grandfather, who was sort of devout, he wouldn't hire a boy to mow the lawn if he knew the boy smoked. And we know how potent the churches can be, because nobody smokes on campus at the University of Utah. And nobody smokes among the Seventh-Day Adventists or the Jehovah's Witnesses. And the Mormons aren't supposed to drink coke and coffee, let alone smoke.

And I think the churches don't realize that they could have a potent effect in not letting so much of gods legacy — in terms of flora and fauna — be destroyed by climate change.

More than a bit disappointing.