Saturday, November 06, 2010

On Income "Inequality"

I stumbled upon an article lately on my Google Reader feed that ranted somewhat predictably about how income "inequality" has risen significantly in the United States and how the middle class in the US has stagnated over the past 2-3 decades. Here's the link

It is a very provocative article as most poorly reasoned articles are. The worst part of it is that the author attempts to place the blame for "inequality of incomes" on Corporate America without rhyme or reason. In this post, I ponder on the possible reasons for stagnation of middle-class incomes. There are several of them and the most obvious ones have nothing to do with Corporate America or conservative economic policies.

Let's look at certain portions of the article that are worthy of repudiation.

globalization's significant profits were captured by a small corporate elite in the U.S. and a new corporate elite and rising middle class in China and India. The American middle class got very little of it. No wonder people are mad.......Americans accept income and wealth inequality to a much larger degree than Europe........... Looking at the stats on inequality gives us an idea of why so many are angry at the business elite — it's the highest since the 20's and getting worse

Okay. So the moot point is that while incomes have soared in the top bracket, the "median" income of the "representative" Middle American has stagnated over the last few decades notwithstanding the outstanding economic growth during the same period.
I checked up the income stats on wikipedia and it appears that this contention is quite compelling on the surface.

Sluggish Growth in Median American Incomes
Data 20031979
Median (50th)$43,318$38,649
95th percentile$154,120$111,445

We observe that while the 95th %ile income has risen by nearly 40% between 1979 and 2003, the median incomes have remained quite stagnant. On the surface, this might seem like an indictment of Reagan era deregulation and the increasing preponderance of economic conservatism in the US since the late seventies.

But there are several problems with this story.
Think about Individuals and not some mythical "Middle American" : Anybody with an iota of sense can readily see that the 50th %iler who earned a median income of $38,649 in 1979 is not necessarily from the same household as the 50th %iler who earned $43,318 in 2003. It is quite possible that someone who was at 50th %ile in 1979 now has a gainfully employed son who is closer to the 80th %ile on the income distribution curve.

The American Middle class has changed in constitution since the late seventies. Several households have moved up the economic ladder as one would expect in any society bustling with private economic activity. Then, the natural question is that if most households have been upwardly mobile over the past three decades, why have median incomes remained stagnant?? The answer could well be immigration.

Immigration likely to push down median Incomes: A lot of people emigrate to the US with the hope of working their way out of poverty in their native lands and entering the "middle class". These immigrants are often unskilled and poorly educated and hence unlikely to land up with jobs that fetch them more than the median US income.

Households that have immigrated in the eighties and nineties did not feature in the dataset that generated a median income of $38,649 in 1979. Which is why it is highly irregular and inappropriate to compare two very distinct datasets from 1979 and 2003 and make sweeping statements about stagnant "middle class" incomes in the country.

So, does that mean the US should place restriction on immigration to help solve this "problem" of seeming income inequality? No. Reducing inequality of incomes should never be an end in itself. Most recent immigrants to US earning less than the median income are quite happy with their adopted country and wouldn't want to return to their roots. Take for instance a waiter in an ethnic Indian restaurant in NYC (Saravana Bhavan for eg). The guy probably earns $20,000 in his present role which perhaps places him at the 40th %ile on the income distribution curve. It is quite likely that percentile-wise he was much better off in his native country, prior to immigration (given that median income in India is barely $500 p.a). Yet, immigration makes sense for this guy as he is better off being a 40th %iler in NYC than an 80th %iler in Trichy, TN.

The Tamil waiter's immigration to US has contributed to a drop in the median American income. Nevertheless, it is welcome as the waiter's immigration was a personal preference and leaves him better off than he otherwise would've been in his native town.

"Inequality" could be an outcome of personal choices : Let's consider Bob, a successful corporate executive of yesteryear who used to earn the equivalent of $300,000 back in 1979. He has a daughter - Alice who has led a rather comfortable life thanks to her father's affluence. Unlike her father, Alice has little aptitude for business. She has always evinced keen interest in Native American history and wants to specialize in the same and eventually end up as a professor of Native American history in one of the eastern colleges. Alice is 30 years old now in 2003 and is well settled in a Boston college enjoying her role thoroughly. Her annual income is in the vicinity of $50,000, not even one-fifth of what her father used to earn in 1979!!

Is this an instance of downward intergenerational mobility? Yes. Nevertheless, it is an outcome of personal preferences and shouldn't be bemoaned. Alice is less well off than her parents in terms of monthly cash-flow. But she loves her job and probably enjoys more leisure than her father ever did in all his working life!

This little story emphasises an important point that's often overlooked by liberals who bemoan income inequality :

"It is quite likely that the 50th %iler enjoys more leisure and leads a less stressful life than the 95th %iler!"

Distribution of Leisure fairer in recent decades : Back in 1900, the distribution of Leisure was terribly unfair in the Western world. The rich were not just wealthy in terms of cash but also leisure, with little accountability. The workers who slogged 18 hours a day in unwholesome sweatshops, had neither the income nor the leisure to compensate for the lack of income.

Today, the distribution of leisure is distinctly fairer. The clerk in a Federal office may languish at the 50th %ile of the income curve, but he is quite probably placed much better (perhaps 90th %ile+) on the leisure distribution curve! The corporate executives of today enjoy far less leisure and peace of mind than the landed gentry who constituted the affluent class in the 19th century.
Disclaimer : This is only a hypothesis. But I do wish someone undertakes a study that examines how the distribution of leisure has shifted over the past 100 years in favour of the lower income groups.

Writers in the press who talk about rising income inequality in America seldom think about the points discussed in this post because of their obsession with aggregate nation-wide statistics and an indifference to what the statistics actually mean in the context of average individuals and households. Which is why we keep reading pieces where "pundits" use statistics such as the ones used in this post to launch a tirade on outsourcing and corporate executive compensation.

Inequality of outcomes need not necessarily always be a plot hatched by Wall Street wolves or neo-conservative policy makers. People who think so misunderstand not just economics but also human nature. Economics is a social science that concerns real people gifted with a free will. To reduce these people to a statistical abstraction is not just downright unfair, but bad science.

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Great post. Totally agree with two of your points (1. Look at rise of income levels of individuals and 2. Effect of immigration). Regarding your third point I think there will be very few examples of such cases
Shrikanth, why don't you write a nice book on your theories? I'm sure it would be a hit!
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