There’s a good argument going on at DiA over whether the widely-perceived increase in inequality in terms of wealth and income might not be overstated. (To follow the argument, start here and work backward.)
If I understand correctly, the argument that inequality has been overstated works something like this:
Apparently large increases in inequality really reflect different rates of inflation at different levels of wealth. Low-cost goods have largely remained low-cost and have increased in quality, so inflation for consumers in, say, the bottom three quartiles of income has been very low or even negative for some time. Meanwhile, while quality has also increased in high-end goods, their cost trajectory has been much more varied, with the prices of some good skyrocketing well beyond any measure of increased quality. (The typical example being the Sub-Zero refrigerator.) Therefore, the apparent increase in inequality is overstated; if you measure in terms of purchasing power relative to the actual basket of purchased goods, the wealthy haven’t gotten as much wealthier as you’d think, and the apparently stagnant wages in the bottom half of the income scale can actually buy a lot more than you’d think.
That’s a pretty persuasive argument if the data backs it up. Hold everything else constant and assume that two consumers are identical except that the one who earns more spends the excess on a luxury car, while the one who earns less buys an economy car. If, from one year to the next the prices of luxury cars go up, while the prices of other cars and all other goods as well as both consumer’s earnings stay constant, the second consumer will no longer be able to afford the car he wanted to buy, and will have to settle for a lower-end model. He will experience the loss of purchasing power we call inflation. The first consumer, on the other hand, will see no change in his purchasing power. He couldn’t afford the luxury car before, and he can’t afford it now.
That picture describes one widely-observed economic development. Two notable trends of the past twenty years have been the development of a mass upper class and the widespread experience, within that class, of a sensation that they are not keeping up with the truly wealthy, that their apparently high incomes mask an actual slipping of living standards. And to some extent, this sensation is an artifact of human psychology rather than economic reality. We don’t properly account for the enormous quality improvements in, say, computer technology, to the same extent that we account for the increase in cost in, say, gasoline.
And while it’s also not what people are talking about when they talk about inequality as a problem, the ability to substitute goods is relevant at every income level. If the price of beef rises but the price of chicken doesn’t, we’ll eat more chicken and less beef. Unless you believe that a beef-heavy diet is objectively superior, that substitution preserves purchasing power in the face of an increase in the price of one item in the basket. Larger-scale changes process similarly. If the cost of baseball tickets skyrockets out of reach, but the cost of a theater-like experience of watching baseball at home drops from astronomical to very much within reach, well, most of us will change our patterns of living, and go to fewer live baseball games and watch more games at home. Even if the price of gasoline skyrockets, more of us will telecommute or move closer to where we work; this will affect housing prices and patterns of wages and prices across a host of other sectors. The point being: in the very short term, a change in the price of one good in the basket will change the price of the basket, but pretty quickly the actual composition of the basket adjusts. That’s why you can’t measure inflation just by looking at a static basket of goods.
But not all goods are readily substitutable. And some of those that are not are really quite essential.
Consider some of the goods whose prices have certainly increased faster than the general rate of inflation:
- Higher education – Health insurance – Real estate (a proxy for safe neighborhoods with good schools)
The thing about goods like these is that there are no good substitutes. If the cost of health insurance rises inexorably, there’s not really anything you can substitute for that. Indeed, even if the quality of health care has improved in many ways – new surgical procedures, better prostheses, less-addictive pain medications, etc. – there’s no way to substitute other goods for health insurance to bring the overall proportion of health insurance expenditures back down. Instead, health care costs inevitably trade off against other goods.
Similarly with higher education – or education generally, using the cost of real estate as a proxy for the cost of public schooling. Any claims to an increase in quality in education will probably be laughed out of the room (houses certainly have gotten bigger on average, which is one crude measure of quality), but even if there were measurable increases in quality, there’s no real way to substitute other goods for education. If the cost of going to college goes up, you’ve got to pay it if you want to go to college – and the debt you take on will reduce your effective income well into the future. If the cost of living in a neighborhood with a good school goes up, putting it out of reach, you’re going to wind up living in a neighborhood with a not-so-good school. That your house in that neighborhood may be a bit larger than it would have been 25 years ago is small consolation: the essential good that you were trying to buy is now out of reach.
Which returns me to a frequent harping-point: inflation is unequally distributed across the basket of goods because productivity gains have been unequal in different sectors. When we see big gains in productivity in one sector and no similar gains in another sector, and individuals can adjust their purchases to take advantage of this, the economy as a whole experiences healthy growth without inflation, and everyone feels wealthier. But when we see no gains in productivity in an essential sector, that sector will chew up more an more of our income without giving us any higher return in terms of quality. And, since there’s always a segment of society wealthy enough not to be troubled by these kinds of changes in prices, what you get is a real increase in inequality.
There are other factors to consider when we look at the lowest-quintile income sector: the catastrophic failure of our worst schools, the pervasiveness of family breakdown, poor nutrition, competition from a huge pool of labor entering the global market (whether employed overseas or migrating here), dramatic increases in manufacturing productivity leading to lower overall employment in the sector (a global phenomenon), and the relative stinginess of the American welfare state, and no doubt other factors I haven’t mentioned. It’s probably helpful to think of inequality in terms of three different problems:
- The problem of poverty, particularly multi-generational poverty – The problem of lack of productivity growth in essential service sectors (health care and education) driving well-above-inflation price increases in these sectors – The problem of the rise of the “super-rich” particularly from changes in the financial services sector
The first of these is a vital moral problem, and I don’t intend to slight it, but I question how much it actually matters to overall economic performance. The last of these is mostly a cultural problem, albeit one that may have significant political implications. The middle problem strikes me as the one with the most important economic and social consequences.