Putting Income Inequality in Perspective

The conventional narrative about income inequality goes something like this: “Since the 1970s, the average income of the richest 1% has doubled, while the average income of the poorest 20% hasn’t increased at all.”

Such statements lead to claims that economic inequality is rising. But the statistics about income inequality — much like the narratives that accompany them — are deceptive.

First, comparing the relative performances of different income brackets over time is misleading. Folks like Ezra Klein try to spark outrage by claiming that “64% of all income growth since 1979 has gone to the top 10%” — as if the top 10% of the income distribution has contained the exact same people for the past three decades.

In reality, people do not stay in the same income brackets forever — the majority advance from low to high brackets over time. Pundits like Klein exaggerate income inequality by ignoring the fact that today’s “top 10%” contains people who ranked in lower brackets years ago. Economist Thomas Garrett points out that this is like “comparing apples to oranges ... it means comparing the incomes of different people at different stages in their earnings profile.”

Longitudinal studies, which track the economic progress of households over many years, are more relevant. According to the U.S. Treasury, “58% of the households that were in the lowest income quintile in 1996 moved to a higher income quintile by 2005.” A similar Pew study found that 71% of those born into the bottom half of the income distribution improved their rankings relative to their parents — with 45% rising at least 20 income percentiles above their parents’ position.

The old adage that “the rich keep getting richer” doesn’t hold up either. Some 57% of the households that ranked in the top 1% in 1996 had fallen out of that category by 2005 — while close to half of the top 5% also dropped to lower levels. It seems ironic, then, that Klein’s aforementioned post is titled, “The Rich Getting Richer in One Chart.” Perhaps he should add a second chart which shows half of them getting poorer, too.  

Of course, measuring economic well-being solely by income doesn’t make sense anyways. After all, you can’t eat or wear your income. Consumption is a much better metric for material well-being. To truly evaluate economic inequality, we must examine how the price and quality of goods consumed by the poor has changed over time compared with those consumed by the rich.

Economists at the University of Chicago recently found that the prices of goods consumed by poor households have been decreasing dramatically, stating that “measured against the prices of products that poorer consumers actually buy, their “real” incomes have been rising steadily ... changing our view of how progress has been distributed in recent decades substantially.” This decline in prices “offsets almost all the rise in inequality measured by official statistics [from 1994 to 2005].”

The products that poor consumers buy — typically necessities — have fallen in price faster than the products that rich consumers buy. This reduction in consumption inequality means that the material well-being of poorer households has grown closer to that of their richer counterparts.

This principle is not limited to necessities. Economist Michael Cox points out that products such as cell phones have become affordable to consumers of all income levels, largely thanks to income inequality. The first cell phones cost about $8,500, and of course, only the rich bought them. But the revenues that firms earned by selling cell phones to the rich funded innovation and research, which in turn made cell phones more affordable.

Today, an iPhone costs $50, and more than half of poor households own a cell phone. Televisions, air conditioning, and automobiles — once reserved for only the rich — are now owned by the vast majority of poor households. Without rich consumers, who purchased these products when they were new and expensive, we wouldn’t have many of the comforts that even the poor are accustomed to today.

These gains are meaningful. Economist Justin Wolfers reports that “inequality in happiness (between rich and poor Americans) has fallen substantially since the 1970s” — despite growing income inequality. Similar studies concur that “increasing income inequality can go together with decreasing inequality in happiness.” Perhaps income inequality doesn’t tell the whole story.

This isn’t to say that economic inequality is non-existent. But in states that have lower government spending, less redistribution of income, and fewer labor regulations, the incomes of the poorest families grow at a higher rate than the incomes of the wealthiest families. At the international level, similar studies show that more economically free countries have less inequality and higher living standards. Rather than redistributing income, those who wish to help the poor should embrace what really works — economic freedom.

Photo Credit: faceless b