Shattering the Conventional Wisdom on Growing Inequality

Inequality is growing in the United States. The data say so. Knowledgeable experts like Ben Bernanke say so. Ask just about any economist and they will agree. (They may or may not think growing inequality is a problem, but they will acknowledge that there has been a sharp increase in inequality.)

Wal-MartPhoto: Jim, Wal-Mart Supercenter in Suwanee, Georgia.

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!

China is able to produce clothes, electronics, and trinkets incredibly cheaply. Poor people spend more of their income on these sorts of things and less on fancy cars, expensive wine, etc. According to Broda and Romalis, China alone accounts for about half of their result.

So if the sorts of people who break store windows in Davos care about the poor, they might need to rethink some of their ideas about globalization’s impacts.

MIT economist Jerry Hausman (who taught me econometrics in my first year of graduate school) and co-author Ephraim Leibtag have analyzed the impact of the entrance of a Wal-Mart superstore on local food prices.

Not only are Wal-Mart’s prices lower, but its entry also induces competitors to lower prices. The impact is much larger on the poor than the rich, both because the poor are more likely to shop at Wal-Mart and because they spend more of their income on food.


Ikke Leonhardt

Please correct me if I'm wrong, Mr. Levitt, but doesn't taking that into account reveal that poorer people are now even less capable of purchasing high-end products? How is that contrary to the notion that inequality is rising?

Actually it seems like the gap is bigger if you look at things that way. That rich people are maybe not so better off, and poorer people are not really worse off, but the distance between both groups is huge.

Ben

I find it very amusing that few of these reader comments support the assumptions of the paper.

Hardly "shattering" anything, no?

-Ben

what the

very poor post; didn't quite expect levitt, of all people, to ignore real income differences and the importance of "soft" factors, fairness concepts, and institutions. it's a shame, really. this post should be deleted.

Myron W

Also remember that whatever the decline in the marginal cost of consumer goods might be, the marginal decline in income from having low skill, labor intensive jobs offshored to China is 100% for those low income workers who get laid off.

Aggregated figures don't convey the real life situation for real life people...

Mark B.

Purchasing power is actually much greater for the rich, they just have choices as to where to spend that power. It could be on squid pancakes and expensive wine, or it could be on a 30 pack of Miller High Life. Regardless they have more purchasing power.

Put another way, in an effort to wear my bias on my sleeve: Just because the rich make stupid purchases that are more expensive does not mean that they are more equal with poor people than first expected. It just means they buy expensive things.

Perhaps this is more of a psychological/marketing question than an economic question. What about having money pushes a person to purchase more expensive things? Is it because they can, or is there something else going on there.

Doug

The only real explanatory power this study seems to have is giving us a handle on the incessant whininess of the rich -- despite their huge gains in the share of national income, they don't feel that much better off, because the stuff they want to buy keeps getting more expensive. Of course, the main reason it's getting more expensive is that the people who buy it have more money.

Implication: Pulling some dollars out of the top end via an increase in marginal tax rates might not make much difference, since it would simply dampen the rate of price increases in the cost of goods consumed by the rich.

But conservative economists might not like that...

Felix

I can buy crappy clothes that fall apart in a couple weeks but I can't afford high quality health care or fresh, nutritious food.

Low-priced consumer goods does not equal equal distribution of resources. This analysis bites.

Maya Cadwell

This is a compelling argument, and a half truth. Income and access to capital offer much more than mere purchasing power. In all fairness to my friends at U of C, a basket of goods is not a sufficient measure of (in)/equality. It is access to schools, culture, private calculus tutor, ballet lessons, piano lessons, lacrosse and track, art history, language, vacations; the ability to teach our children what they will need to compete with absolutely anyone when they graduate from college or graduate school... From this standpoint, that I would call a 'socio-economic/intellectual/ intangible basket of goods', the gap between the rich and the poor has indeed widened. Wealth offers access to a better life for future generations. I fully agree with Ricardian based analysis and think when said analysis is taken to this extreme, one wonders if it's not a form of misapplication.

T

Arghh!

Didn't you guys posted about that even the merely weathly pay a smaller percentage of taxes relative to their income than their less wealthier peers?

http://freakonomics.com/2008/05/01/taxes-warren-buffett-and-paying-my-fair-share/

OK, maybe the rich are now paying more taxes now (as a % of their income) than ever compared to 10 years ago (I highly doubt that!), but the manuscript you pointed out haven't addressed this. Or maybe I am missing something here?

JPD

To Billy,

That's the beuaty of the free market. If they raise their prices up crazy high or start sticking it to their consumers someone will come in and eat up a portion of their market share because they can do the same for less.

Unless of course Wal-Mart tanks it's business and Congress decides to bail them out, too. Then there would be no incentive for them to run a sound business, much like Bear Stearns, etc.

The sad thing is now that I've seen it happen once, I plan on seeing it happen again. Which is truly, truly sad.

Colin Chaudhuri

I have to say, while I don't disagree with the findings of this study (and its subsequent consequences for public policy), I find it strange that a rebuttal to this research has been covered previously in this blog; our conception of fairness. You have previously mentioned research regarding different ape groups regarding giving ourselves rewards. Without rehashing the entire study, one of the basic conclusions was that if we don't feel our share of the spoils is just, we will reject any share out of hand.

I know I am going to come across as a bit Michael Moore here, but at some point the low prices for consumer goods will no longer mask our jealousy and anger at hedge fund managers' pay packets (As usual, sports is ahead of the game in predicting this sort of phenomenon. You can listen to any sports talk radio station around the country and hear the anger and disgust fans have for players salaries and lifestyles. While most of us have a sense that fame and fortune is part of the reward for making it in pro-sports, at some point that accceptance turns to resentment). Its a bit dissapointing that you didn't acknowledge the income disparity isn't just your ability to buy stuff, but your sense of self worth and fairness.

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Nathaniel

I don't see how stagnating or declining wages are made "better" by the consolation prize of being able to buy lower-quality minimal price goods that in turn encourage stagnation or decline in local wages.

Great, so someone's income hasn't gone up, but now they can buy lead-tainted food for half the cost they used to be able to buy good quality food, while the good quality food has increased in cost by 50%? How is that in any way a benefit? This sounds more like upper-class rationalization than a true economic measurement. Milk prices, beef prices, grain prices are not lower than they were ten years ago. The only prices that have gone down are on the lowest-quality goods that don't last as long, like shirts that are now half the cost but only last a third as long. There's no net win for anyone involved but the investment bankers.

Mike Ralls

One part of US inequality that I have always wondered about but have been unable to get an answer on is the role of immigration. The US has taken in literally tens of millions of immigrants over the last generation, almost all of whom came from countries with lower incomes than the US, and many of whom have taken low paying jobs in the US. If we look at just native-born Americans, does that significantly change the inequality figures?

Chris

http://www.boston.com/business/articles/2008/05/19/the_rich_splurge_on_bargains/?rss_id=Boston.com+--+Latest+news

Coincidentally, here is an article from today discussing the recent price drops for luxury items. Maybe the WallMarting of luxury goods was delayed and is only now happening.

Travis

It's been said a few times now, but this article and unfortunately this blog post seems mostly vacuous.

Talking about inequality in absolute terms, it is very easy to show that it is growing in the united states. Just go to the US census website and look at the numbers.

in 1980 (i think) the top 5% of the US earned 4 times the median income. In 2007, the top 5% of the US earned 6 times the median income. In absolute terms, the gap is growing.

The fact that there is no more marginal utility for the super rich to buy super expensive goods and the price of WalMart esqe products has reduced is ultimately just a bunch of hand waving.

I would think an economics site would point this out also and am slightly disappointed that this was agreed with in the blog post. However, saying things like "Poor people can buy the same amount of clothes or more than before because the prices have been driven down via globalization" is pointless, because for most people the measure of wealth has little to do with how many pairs of jeans they can buy.

Additionally, Using things like TV's, Stereos and other luxury goods to measure economic prowess is misleading.

For a TRUE representation, look at purchasing power AFTER what most people consider necessities are taken into consideration. For example, in 1983 vs 2008, what was the inflation adjusted income of a (poor/rich) family AFTER rent, health insurance, transportation, utilities and food.

Ultimately, if you look into it, the amount people spend on food relative to their total income has gone down, but the amount spent on rent, health insurance and transportation has gone up immensely and ultimately, AFTER the necessities are considered people in lower income brackets have less buying power than they did 25 years ago.

The only thing that masks that fact is that we now have much cheaper food and clothing relative to the normal income, and prices of what used to be considered luxury goods has dropped into the range at which the sacrifice is small enough to buy it.

Ultimately, the rich have more security and expendable income than they had 25 years ago, and the poor or median have less security and expendable income than they had 25 years ago. The gap is growing and trying to blur that with the fact that Tshirts, TV's and toys are cheaper than before is very very silly.

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Tom

All Americans are better off in terms of their purchasing power than a generation ago.

If you take out first generation immigrants (there's a lot of them and they are almost all poor), the poor and middle class have been progressing about as fast as they have for the past few generations.

The rich have gotten much richer than they have for many generations, because the world (and most of the people in the world), has made great strides in the past generation, and those with the capital and connections to profit from global finance and global trade have benefited.

So the rich have won big, as have poor people in poor countries like India, Vietnam and China (they're still a lot worse off than Americans). Non-rich Americans have won some, lost some. This situation will persist until the third world makes quite a lot more progress (several generations).

We should look to deal with it, because the fundamentals are not changing, and are a really good thing for the world as a whole. I think the rich should embrace buying off the poor and middle classes with such things as government-provided healthcare and upgraded infrastructure and education. The populist backlash that seems to be building will hurt everyone if we don't avoid it, especially the world's poor.

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Caleb

Has purchasing power really gone up if we, the poor, are offsetting our savings on lower priced food and clothing with a much higher percentage of our incomes going to health care and education?

For every dollar I earn, I have a lower percentage to spend on neccessities. Fortunately, I get a better deal for my reduced percentage so I can survive but if my purchasing power was as weak as twenty years ago and my other expenses were as high as they are now, I would be incentivized toward a non-consensual re-distribution of wealth toward the upper classes.

Zaheer Ellias Najeeb

To get a more realistic understanding, when you take the difference between the money earned and money spent, shouldn't you differentiate between capital assets and other expenses.

Mike

Why is everyone talking about polarization? Even if the rich are now much richer than the poor and the inequality is increasing, why should that mean there's nobody in the middle?

I am not rich or poor. I have enough to get by, and enough for some minor splurges now and again. I don't get it. Maybe some poor people would think I'm rich, but that's beside the point.

The fact I find troubling is that nobody ever seems to look at this issue in the form of a graph. If you plot income on the x axis, and population on the y, what do you get today vs. years ago? Even if the graph shows a long tail going WAY farther out on the X axis, showing more people getting really rich, that doesn't tell us anything about the main body of the curve. Seems to me that the REAL ISSUE. But every time I hear the data, it's just in terms of how far that tail stretches relative to the bottom.

Ben VC

Rich people aren't bound to purchase higher-priced goods than the less-rich: no-one is foisting Rich People Rice or Rich People Gasoline on them. If rich people are feeling the pinch from higher-priced luxury goods it's because they are unwilling to substitute for lower-priced goods. It's almost laughable how easy it is to brush this paper aside as meaningless: why should we stop being concerned about income inequality because rich people's caviar and high-octane gas is more expensive? Boo hoo, cry me a river!!