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Consumption vs. income inequality, revisited
Numerous bloggers, often from the left, are jumping on the recent Cox and Alm NYT Op-Ed on consumption inequality. Via Greg Mankiw, here is one excerpt:
...if we compare the incomes of the top and bottom fifths, we see a ratio of 15 to 1. If we turn to consumption, the gap declines to around 4 to 1.... If we look at consumption per person, the difference between the richest and poorest households falls to just 2.1 to 1.
Here is Mark Thoma and here is Paul Krugman, both of whom offer good criticisms on the particular numbers. Nonetheless it would be a mistake to go back to focusing on income inequality, or for that matter rising income inequality. Keep in mind a few points:
1. Global income inequality is way down over the last thirty years.
2. Inequality of welfare, even within the United States, is way down over long time horizons, such as the last century.
3. We do not know how inequality of welfare in America is faring over say the last thirty years. This is a point of overriding importance. Just in case you missed it, let me repeat: when it comes to the kind of intra-nation inequality that we should really care about (if we are going to worry about intra-nation inequality at all), we "do not know." As in "know" and "not" put together. "Not" is the word of negation, by the way. And the last I looked, not = not, as it usually does on most Wednesdays. Would you like to hear more on what is implied by the conjunction of "not" and "know"?
4. We do know that welfare inequality doesn't track income inequality in any simple way, especially when new goods are being introduced, there is mass production, there is diminishing marginal utility, and non-marketed benefits and costs are important in human life.
5. Here is the latest and most serious attempt to weigh the problems with consumption data; overall it reinforces the importance of looking at consumption. And it is not denied that consumption inequality is much less than income inequality and also consumption inequality rising less rapidly over time.
Here are some previous MR posts on consumption inequality. Here is Andy Warhol on consumption inequality.
In general, when you see cherry-picking -- or lemon-picking -- of these numbers, you should be very suspicious.
Posted by Tyler Cowen on February 13, 2008 at 06:39 AM in Economics | Permalink
Comments
"Global income inequality is way down over the last thirty years."
Well, yes, although it depends how you measure it. Milanovich's Concepts 1, 2 or 3? 2 very definitely, 3, almost certainly, 1, not so much.
Posted by: Tim Worstall at Feb 13, 2008 7:04:30 AM
If 20% of household have an average of financial flows of $47,000 into mortgage principle and savings, why is our net savings rates zero? That is about 1.4 trillion dollars or over 10% of GDP. I also trouble picturing the average household that saves over 1/3 of their after tax income.
Posted by: joan at Feb 13, 2008 7:31:34 AM
This would suggest that consumption taxes (sales taxes) are disproportionaly paid by the poor.
Posted by: Mark Denovich at Feb 13, 2008 8:45:20 AM
"Global income inequality is way down over the last thirty years."
Does this statement still stand up given the recent changes the China's PPP GDP estimates?
Posted by: a student at Feb 13, 2008 9:06:14 AM
"This would suggest that consumption taxes (sales taxes) are disproportionaly paid by the poor."
Actually is suggests that they pay taxes more proportionally. By income the bottom 50% pays only 5% of taxes. Looking at this, they pay 33% of taxes.
Posted by: Tom at Feb 13, 2008 9:26:27 AM
Does anyone have any ideas about why the big econobloggers on the left (say, DeLong, Krugman, and Thoma) are more derisive than the big econobloggers with a free market bent (say, Cowen and Mankiw)? Or am I just failing to overcome my biases?
Posted by: Joey at Feb 13, 2008 9:39:59 AM
"Does anyone have any ideas about why the big econobloggers on the left (say, DeLong, Krugman, and Thoma) are more derisive "
When you have less to say you have to say it louder, and angrier.
Posted by: Tom at Feb 13, 2008 9:53:22 AM
"Milanovich's Concepts 1, 2 or 3? 2 very definitely, 3, almost certainly, 1, not so much."
Why do people love leaving cryptic comments that they know many people will not understand? Concept 1 is unweighted, 2 is population weighted, what is 3?
Posted by: Cliff at Feb 13, 2008 10:45:51 AM
In looking at economic inequality, what we want to look at is economic welfare. What we do not know (in this context "not know" = "have not estimated to a useful approximation") about inequality in welfare is even worse than Tyler says. Welfare is opportunity to consume over the time horizon that interests you. Ducking the question of different time horizons, this approximates to wealth (including human capital) plus the value of your chance of collecting social entitlements.
It would be nice to have some real idea of how economically unequal we are: anybody know any data resembling what we want?
Posted by: Diversity at Feb 13, 2008 10:51:13 AM
Concept 1 is counting by country, unweighted by population. Concept 2 is counting by country, weighting by population (in both cases we are using average income in each country). Concept 3 is to do away with measuring by country altogether, and treat the world population as one population.
"Why do people love leaving cryptic comments that they know many people will not understand?"....the answer to that question is probably something to do with my in jerkitude. Apologies, I usually control it rather better than that.
Posted by: Tim Worstall at Feb 13, 2008 11:12:58 AM
I, for one, would like to hear more about the conjunction of "not" and "know".
Posted by: David at Feb 13, 2008 12:45:29 PM
Bronx County is always near the bottom of many economic indicators. I think it's still in the bottome five of poor counties nationwide. I have a policy idea that would immediately boost the Bronx' per capita income, with only relatively minor investment required - make Michael Bloomberg move to the Bronx.
Posted by: bronxilla at Feb 13, 2008 1:44:39 PM
Here's why those numbers are highly misleading: As the article points out, "low income" does not necessarily mean poor. Many "low income" individuals are actually retired "rich" or middle-class people with non-taxable spending sources. Thus when you compare the consumption of the lowest income group with the consumption of the highest income group, you are including in the lowest income group many individuals who are in fact wealthy, or at least not poor--and this "raises the curve" for the lower income group.
If you want a better picture of inequality, you need to compare the highest consumption group with the lowest consumption group, without regard to income. Granted this might include some number of people who CHOOSE not to consume much, even though they make a lot of money, but in today's society I would wager that the effect of this group is much smaller than the effect of the retired wealthy and middle class.
Posted by: Doug at Feb 13, 2008 2:53:58 PM
The problem with being poor in America these days is not that you can't buy enough stuff, it's that you have live around other poor people.
Posted by: Steve Sailer at Feb 13, 2008 2:57:49 PM
The problem with being poor in America these days is not that you can't buy enough stuff, it's that you have live around other poor people.
Posted by: Steve Sailer at Feb 13, 2008 2:58:13 PM
My biggest problem with this graph is that Housing is a consumption metric, however the * on Financial Flows shows that Mortgage Principal is counted as a flow, not as housing consumption.
This means that those who are in the 1st quintile who are more likely to be paying Rent get their housing expenses counted as consumption, while those in the 5th quintile are paying mortgages, where the principal is not counted as consumption.
I don't believe that this effect will be small.
Posted by: JKF at Feb 13, 2008 3:55:13 PM
One factor that is extremely overlooked in all of these analyses of income inequality is the effect of the drug trade. Since we don't have official figures of the amounts of money being made in the blackmarket, we can't really know how many "lower income" individuals are just nominally lower income.
Posted by: Bandwagon Smasher at Feb 13, 2008 4:29:54 PM
Regarding the drug trade, I don't think it's a big impact. According to the research discussed in Freakonomics, the average street-level dealer doesn't make good money. Higher-level dealers probably make a lot, but there aren't very many of those. Also consider that the drug trade, including costs, is perhaps 1% of GDP. So my best estimate of how many lower income individuals are only nominally so is "few."
Posted by: Greg at Feb 13, 2008 4:49:19 PM
I would very much like to see Paul Krugman make an estimate of consumption by income.
Posted by: Floccina at Feb 13, 2008 5:08:31 PM
Grrr: "inner jerkitude" above.
Posted by: Tim Worstall at Feb 13, 2008 5:15:17 PM
Doug makes an excellent point, which I missed: binning people by income and then averaging their consumption will underestimate inequality.
While the ranks of the income-poor are swelled by the rich retirees, their apparent consumption is also inflated by these people.
Posted by: improbable at Feb 13, 2008 8:46:35 PM
I'm an optimist and I love how people say that those low income earners aren't really "poor." Why? Because it is. I read Sowell's Economic Facts and Fallacies the other day (a mostly brilliant book; read it). The damn truth of it is that over 30 years, when you measure individual people instead of those income brackets in and out of which people move, you see that the lowest quintile is just a temporary staying ground for most. Something like 75% of them over the past 30 years or something like that actually moved up to be in the top 40% of income earners (don't cite me on that). In other words, most of the "poor" are not waiting around for minimum wage increases because the people considered poor are constantly changing. It's misleading. There are only a small handful of truly poor people who have the misfortune of staying poor. Isn't America great?!
Posted by: Daniel Reeves at Feb 13, 2008 9:36:01 PM
I like it when Tyler gets grumpy.
Jeff
Posted by: Jeff Smith at Feb 13, 2008 11:02:00 PM
Dear Professor Pangloss - oops, sorry - Professor Cowen
Yes there are lots of conceptual complexities in measuring trends in inequality whether of income or consumption or welfare, and strictly speaking we do not know what are the definitive trends since no one as far as I am aware has done a fully comprehensive study. However, as you note studies suggest that consumption inequality has risen even if not by so much as income inequality, i.e. the trend is in the same direction.
Also you are happy to conclude that world income income inequality has fallen over the past 30 years. I think concept 3 is obviously the right basis for assessing this claim - treat the world as if it were one unit and rank people from poorest to richest. This suggests that inequality has fallen.
However, the data and conceptual complexities in reaching this conclusion are surely orders of magnitude greater than for reaching conclusions about US income inequality. The surveys are not consistent across countries - some are income surveys, some are expenditure surveys, not all countries are included, not all cover 30 years, almost none include government non-cash services and indirect taxes, and the method of adjusting to a common metric is debatable.
So why is it clear to you that world income inequality has fallen, but you think that US inequality is too difficult to make conclusions about?
Posted by: Disinterested Observer at Feb 14, 2008 12:48:58 AM
"So why is it clear to you that world income inequality has fallen, but you think that US inequality is too difficult to make conclusions about?"
Relative error is important not absolute error. The decrease in worldwide inequality is dramatic and easily dwarfs any methodological problems or uncertainties. On the other hand the decrease/increase in American consumption inequality is not very large although the methodological problems and uncertainties may be smaller than for worldwide inequality.
Posted by: assman at Feb 14, 2008 1:18:26 AM
