The Great Risk Shift

That is the new book by Jacob Hacker which should, and probably will, have a big impact on national debate.  The main argument is that American incomes have been growing steadily riskier.  (Here is a related article by Hacker, and here is U.S. Census data.)  A few points:

1. The most convincing of the graphs is the one which shows "Americans’ Chance of a 50 Percent or Greater Income Drop."  In 1970 this risk was at about 7 percent; it has been rising upward and now stands at a little over 16 percent.  I would be happier if the relatively wealthy were excluded from this diagram, although I doubt if those people are driving the results. 

2. Chapter two blames the new ethic of personal responsibility, and associated policy changes, for increased income volatility.  Data suddenly are absent, and I cannot help but note that most forms of domestic government spending, including social insurance programs, have grown steadily.  Nor can Clinton welfare reform be blamed here.  This is the weakest chapter in the book.

3. Chapter three on risky jobs is not strong on data compared to the contrasting results found in this working paper and also the writings of John Haltiwanger and others.

4. Chapter four on families discusses divorce, but we do not learn how much of the growth in income volatility stems from family splits.  The author does point out that the divorce rate peaked in the 1980s yet income volatility continues to climb.  The relative importance of divorce is the one question this book should have answered, and could have answered, but didn’t answer.

While divorce raises income risk, it may lower utility risk, especially for women.

I am also dismayed that the author cites a U.S. savings rate of zero, overstates the risk of housing investments (if all homes exogenously became very cheap even homeowners are better off), and cites the dubious book The Two-Income Trap.  There is not enough discussion of asset values and new possibilities for consumption smoothing.  How volatile are the data on consumption?

5. Chapter five on risky retirement focuses on pensions and nails it.

6. I don’t buy chapter six on "Risky Health Care."  The real risk of dying too young, or being severely crippled too young, has never been lower.  Again, risk is more than just financial risk.

The bottom line: We do need pension reform.  Otherwise Hacker needs to separate out the importance of divorce and better distinguish financial risk from utility risk.  If people are spending more money to lower their utility risk — most of all spending on divorce and healh care — the results are suddenly less troubling.  I am far from certain this is the relevant scenario, but Hacker does not establish, or even try to establish, the contrary.

Addendum: Arnold Kling argues that, in a risky world, we should strengthen incentives to save.

Comments

very nice points, tyler. it's really difficlut to get to the heart of the matter when the author is writing a book for the masses & doesn't have the time nor the inclination to go into the logic behind the reasoning for the argument.i suspect the popular media will(as usual) tom-tom this book without really discussing it's implications. however, this is a good way to shine some light on the issue.

Thanks for skipping the rhetoric and going straight to the data. I look forward to blogging this.

Tyler, could you please specify what is dubious about "the two income trap"?

if all homes exogenously became very cheap even homeowners are better off

I don't see this.

We do need pension reform.

Can you offer (or link to) a brief outline of why this is and what reforms would be helpful?

bernard Yomtov, try "if all cars exogenously became very cheap even carowners are better off."

Is housing all that different? I don't think so.

I'm confused about the home prices decline thing. If I buy a house for $400K with $40K down and tomorrow all houses are worth 50% including mine being worth $200K, how is this not bad for me?

Sure the next house I buy will only cost $200K but right now I'm $160K upside down on a mortgage and my lazy brother who doesn't even have a job has a higher net worth than I do. What am I missing?

Mike L. -- The only flaw I see in your reasoning is that mortgages are usually "recourse loans," meaning that the lender can come after the homeowner's other assets if the mortgaged home itself is not worth enough to cover the amount due. So the only way to get out from under all the debt on the first house would be to file for bankruptcy, which would increase subsequent borrowing costs substantially.

Guest 15 and BillWallace, good points. If you downgrade (which income loss and consolidation due to marriage collapse to), you lose, at least in the short term. Decades from now I suspect you'll still be better off assuming you've moved a couple times, your kids are probably better off, and everyone who didn't downgrade or have investment property is no worse to much better off.

Aside: I'm more interested in falling prices due to better technology (e.g., robot construction) than typical real estate booms and busts.

So don't go deep into debt to hold a potentially rapidly depreciating asset.

The issue of divorce rates is misleading because it only measures families created by marriage. With more middle class couples opting to have children out of wedlock, the data you have to look at is single-parent households. Volatitilty would remain high whether the couple was legally married or not.

I'm very skeptical about the increasing risk meme, because it seems to me to contradict the other widespread meme of the day, that class mobility is decreasing. They can't both be true, and we can't at present measure either one very well, so it seems safest to me to assume that, since people are complaining vociferously about two incompatible changes, neither one is actually happening.

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