Friday, October 22, 2010

Why Income Matters

Why Income Matters

I'm a little bored at the moment. How about another post on income inequality to liven things up? That should bring the page views pouring in, shouldn't it?

I'm going to start by reporting on Will Wilkinson's emotional state: he's sad. He's been trying to explain the idea that there can be different inflation rates for different groups of people, but it's a complicated concept and hard to get across. However, he thinks it's an important part of the inequality argument, and that's the part I want to address.

So here's the simple version. Suppose that rich people tend to consume lots of Porsches and tins of Beluga caviar, while poor people tend to consume lots of Chevrolets and hot dogs. Now suppose that over the past decade the price of Porsches and caviar has gone up 20% while the price of Chevrolets and hot dogs has stayed the same.

Got that? Now suppose you read that the incomes of the poor had been flat during the aughts while the incomes of the rich had gone up 20%. You would be outraged. The rich are getting richer while the poor are stagnating! Inequality is rising! When will it ever stop?

And people are consuming the exact same number of BMWs and tins of caviar as they did ten years ago and poor people are consuming the exact same number of Chevrolets and hot dogs. Looking at income is misleading. Both groups are doing about the same.

Now, measuring inflation is hard enough already, and the measurement problems associated with trying to figure out separate inflation rates for rich and poor are convoluted enough to make grown econometricians cry. What's more, you can't just assume that everyone is buying the same stuff today that they bought in the past. Maybe purchasing patterns have changed over time in response to different growth rates in wages. It's a tough nut to crack.

In theory, though, it's a legitimate topic of research if you're interested in understanding the lived experience of different groups. You also need to consider government transfers, tax rates, household compositions, number of hours worked, and lots of other things. It's a fertile field of study.

As it happens, though, it's not the topic I'm usually interested in. The topic that's my normal preoccupation is understanding how the private economy works. That is, how does the private economy reward various groups of people? How has this changed over time? Why has it changed over time? Is it healthy? Can it last?

This second question is purely one of income and wealth distribution. I just want to know how money flows to different classes of people. Because while it's reasonable to ...

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