Consumption vs. income inequality, revisited

by on February 13, 2008 at 6:39 am in Economics | Permalink

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.

Tim Worstall February 13, 2008 at 7:04 am

“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.

Mark Denovich February 13, 2008 at 8:45 am

This would suggest that consumption taxes (sales taxes) are disproportionaly paid by the poor.

Tom February 13, 2008 at 9:26 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.

Tom February 13, 2008 at 9:53 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.

Diversity February 13, 2008 at 10:51 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?

David February 13, 2008 at 12:45 pm

I, for one, would like to hear more about the conjunction of “not” and “know”.

Doug February 13, 2008 at 2:53 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.

Steve Sailer February 13, 2008 at 2:58 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.

Bandwagon Smasher February 13, 2008 at 4:29 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.

Floccina February 13, 2008 at 5:08 pm

I would very much like to see Paul Krugman make an estimate of consumption by income.

improbable February 13, 2008 at 8:46 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.

Jeff Smith February 13, 2008 at 11:02 pm

I like it when Tyler gets grumpy.

Jeff

assman February 14, 2008 at 1:18 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.

assman February 17, 2008 at 1:38 am

Better i have a complete study.
http://www.prb.org/Articles/2005/DidWorldwideInequalityDropBetween1960and2000.aspx

There have been massive increases in life expectancy in developing countries and this is enough to conclude that worldwide inequality has been reduced. Nothing so spectacular can be seen in the developed world.

disinterested observer February 19, 2008 at 2:43 am

Assman

The study you cite is based on countries not individuals, so effectively assumes that everyone in a given country enjoys the same proportional increase in income and the same proportional increase in life expectancy. Now in the case of the two biggest countries – China and India – we know that income inequality has increased, so the assumption of everyone having the same proportional inccrease in income is simply incorrect.

In any case this doesn’t answer my question – why are you and Professor Cowen more certain about this trend than about trends in US income/welfare inequality?

Matthew January 27, 2009 at 4:17 pm

Interesting conversation here. Are you guys/gals students or just interested citizens? I wish the whole country was as engaged as you are!

I just want to point to a couple issues.

First, there is some confusion over whether or not global income inequality (Milanovich’s concept 3) has fallen over the past thirty 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.”
In fact, if you use only Milanovich’s analyses as the basis for your comparison, then you arive at a few conclusions: 1: international inequality has unambiguously risen over the past thirty years, 2: population weighted international inequality has unambiguously fallen over the past thirty years, but this is 100 percent due to China, since they experienced break neck growth rates and have almost a 5th of the world’s population and 3: there is no trend in global (concept 3) inequality (also see Anand and Segal 2008).

In fact, Milanovich’s published analysis of concept 3 inequality (the 2005 book) only covers 1988 to 1998, which showed a rise between 1988 and 1993, followed by a decline from 1993 to 1998. However, his recent analysis of the same data extended to 2002 shows an increase again back to 1993 levels (http://74.125.95.132/search?q=cache:KLqiwjVJecoJ:www.nes.ru/english/research/conf-papers/conf-2006-fall/Milanovich.ppt+milanovich+concept+3+inequality&hl=en&ct=clnk&cd=2&gl=us).

So, it seems like the likely story here is that inequality at least stopped rising as quickly as it had been over the last 30 years, and that this is fully explained by China’s growth (rather than growth across all poor countries, which would show up in the concpet 1 trend).

Second, As to whether we can be more / less certain about the trend in global income inequality vis-a-vis US inequality, I think it is almost a complete absurdity to say that we could be more or even equally certain about the trend in global inequality, given all the issues with data comparability that arise when you want to compare across countries rather than within a country. Moreover, anyone who doubts that US income inequality did not rise after the late 1970s through today is just simply fooling themselves…the data are very clear regardless of how it is measured. You simply cannot expect to have any thing other than rising inequality in a country that is shedding un / low skilled employment in formerly high-wage manufacturing jobs and trying to replace them with low paying service sector jobs at the same time that high skilled workers are receiving a wage premium at historically unprecedented levels…not to mention the gutting of the small welfare state that we used to have. Come on, you can debate whether or not this is a “good” thing or a “bad” thing–the normative debate–but you can’t really debate the empirical part.

Anand, Sudhir and Paul Segal. 2008. “What Do We Know about Global Income Inequality?† Journal of Economic Literature 46(1): 57-94.

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