Wednesday, July 15, 2009

Income Inequality

Matt Yglesias says:

And you really don’t want to find yourself suggesting, as I think people sometimes do, that we ought to be monomaniacally focused on the income gap question. After all, consider an African-American woman working as a nurse in North Carolina in the late 1950s relative to a white male executive at North Carolina’s largest bank. There would have been a substantial gap in their incomes. But if you flash forward to today and compare an African-American woman working as a nurse in North Carolina to a top executive at Charlotte-based Bank of America you’ll find a much larger gap.

Thinking about the issue more comprehensively, though, it’s of course clear that the overall gap in social equality between two such people is smaller today than it was in the days when the African-American woman would be explicitly excluded from a wide range of social practices and opportunities open to the banker. I don’t think there’s any reason to believe that the decline of Jim Crow caused income inequality to grow thus forcing us to make an explicit tradeoff, but it’s still worth understanding which aggregate sets of social changes have and haven’t been for the better.

I credit Matt for making the point that there is a smaller difference between the two today then there would have been 60 years ago, even if there is a larger real difference in income. However, this brings up a larger point that is one of my big pet peeves in regards to income inequality. The pure difference between the richest among us and those farther down on the income spectrum is a very misleading stat. To explore why this is so, let's go through a very simple thought experiment. Suppose Town A has 100 families, half of which have an income of $100,000 a year, and the other half make $5,000. Additionally, there is little to no interaction between the two groups, including through charities. Now suppose Town B has 100 families, half make $1,000,000 and the other half mark $50,000. Town B has higher income inequality in the most literal sense of the word, but no one in the lower half of Town B would trade places with someone in the lower half of Town A, all else being equal.

This is obviously an unrealistic situation, but it shows us the absolute difference in income is a misleading way to look at inequality. The fact that the richest portion of the population saw there income grow far more than the middle class means relatively little. What matters is how much better (or worse) off the middle class and poor are today than they were back then. If there are policies that can capitalize on the increased incomes of the richest to help the poorest, then that matters. Not that there is a bigger difference.

There may be a larger difference in income between the nurse that Matt mentioned in his post and the banker, but the nurse is still far better off now than the one from the 1950s. In addition to the improved (albeit no where near acceptable) race relations, the nurse saw her income grow and can afford a lot more luxuries today. She probably lives in a far better neighborhood, has access to technological improvements like air conditioning, and while she may not be able to pay for college access for her kids fully out of pocket (assuming she has them), they still face better life prospects than they would have in the 50s. The correct question is not what is the difference between the middle class and rich today compared to the middle class and rich of yesteryear. The correct question is how much better is the life of the middle class today compared to the past, and how can we share some prosperity with people in the lowest income brackets.

Income inequality is still a big issue today, and we need better policies from various levels of government to address it. But to look merely at income differences, and not what incomes of various groups of people can buy them, misses the point and will lead us to the wrong policies.

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