AR Ward on income inequality

[mdegges]

“If you believe that when the rich get richer, the poor get poorer, then you believe that creating wealth causes poverty, and you’re an idiot.” -Michael Medved

The most common counter to this line is shock that someone could not believe in the ever growing gap between the rich and the poor, this was recently personified by author Tim Wise:

This misses the point of the statement. It is one thing to believe the gap between the rich and the poor is growing, and it is quite another to believe that when the rich get richer, as in whenever, as in it is the cause of, the poor getting poorer. And as the rest of the line goes, to believe this means you must believe creating wealth causes poverty.

In the mind of many leftists it is as if the rich become richer by stealing money from the poor. Sure, this may happen, especially in the form of government subsidies, but this is hardly an accurate generalization of how the rich become rich. Most of the time, individuals earn money because enough people willingly give it to them in an exchange they see as being worth it. Steve Jobs became rich by building a company that produces brilliant devices that people wanted to buy. Selling his product didn’t cause poverty, on the contrary, it was a blessing to thousands of employees, and millions of customers.

But what about the gap? Why is it growing? Part of the explanation only requires a basic understanding of math. This is another point Michael Medved makes. If a rich person goes from making $500,000 a year to making $550,000 a year, he or she has shown a 10 percent increase in income. If another person goes from making $25,000 a year to making $50,000 a year, he or she has shown a 100 percent increase in income. So even though the second person had an income that grew ten times greater, the gap between the two grew from $475,000 to $500,000. While the situation of these two people has been positive, by focusing on the increasing gap between them, one can make the situation sound negative.

This is partly why people can report that between the years of 1996 and 2005 the gap between the rich and the poor had grown, yet income for the bottom 20 percent increased by 91 percent during those years, according to the Treasury Department. Clearly the rich didn’t cause the bottom 20 percent to become poorer simply by increasing their incomes by even more money than they did.

The second part of the explanation is understanding the deceptive figures that are produced to expose the gap. This is a point made often by Thomas Sowell. Essentially the figures typically used to show the gap over time commit the fallacy of only looking at income brackets rather than real people. For example, lets say there are two people in a $25,000 and below income bracket, one making $25,000, and one making $10,000. The average for their income bracket is $17,500. But lets say the next year both people increase their income by $4,000. The person who made $25,000 is now making $29,000 and is now in a different income bracket altogether. So even though the other person went from making $10,000 a year to $14,000 a year, the average income for that bracket dropped from $17,500 to $14,000. A person only looking at income brackets, rather than the real people, can report an apparently worsening situation where the average income for the bottom group dropped.

Real people change income brackets, thus trivializing comparing income bracket based statistics. For example, 58 percent of those in the bottom income quintile in 1996 moved to a higher income group by 2005. Yes, people also move into lower income brackets but this is certainly true of the top 1 percent. Only 40 percent of those in the top 1 percent in 1996 were still in the top 1 percent in 2005. Only about 25 percent of the individuals in the top 1/100th percent in 1996 remained in the top 1/100th percent in 2005. This is why figures from the Census are often misleading. The IRS and Treasury Department have our Social Security numbers and track real people.

I’m not saying there aren’t people who are worse off now then they were five or ten years ago. There are plenty of people like that. I’m just saying that it generally isn’t a result of rich people becoming richer. If anything, it is the opposite. It would be easier to find a job if people wealthier than you had enough money to hire you, or invest in your business, or buy your products or services. In a subject as complex as economics its easy to superficially look over a figure and attribute it to whatever you like that also happened at the time, but you have to be able to explain basic principles underlying the connection. How does the rich becoming richer cause the poor to become poorer? How does creating wealth cause poverty? Can it be that people actually believe wealth is a zero-sum game? Although there are plenty of left leaning people who don’t buy into these things, its amazing how many leftists base their outlook of economics on some of the most foolish foundations.

- A.R. Ward

[link to original article - posted with permission]

Edited November 24, 2011 by Michele Degges

[softwareNerd]

Both points above are valid, though the first one (percent versus absolute numbers) may be a bit weak since most measures of income gaps are framed in terms of percentages.

The classical way of measuring income inequality is the "Gini index"). On one axis, you have all the people in the country: 0% to 100%, and on the other axis you have all the income as a percent (you could use some other number, like wealth, too). The 45% line represents the egalitarian's dream. So the deviation from that line is a measure of inequality (see linked Wiki article for details.). In Japan, the distribution of income is shockingly close to the egalitarian's dream when compared to a place like the U.S.A. Therefore, any intellectual argument that grants the premise that equality is a good thing, is going to have a hard time justifying the situation in the U.S.A.

I would guess that the opening of China and India helped to widen the gap in the U.S. (as measured by things like the Gini index). What you had was many millions of low-paid workers come onto the market in just a decade or two. This would naturally cause downward pressure on wages within certain occupations. The offset would come via the lower prices of stuff. However, in addition, many people in the U.S. were in positions where they were not passively being affected by the wage-pressure on one hand and the lowered prices on the other. They were also gaining from being part of the process that enabled the changes. If some people had to accept lower wages because of outsourcing, others people were helping organize the process.

[mdegges]

I would guess that the opening of China and India helped to widen the gap in the U.S. (as measured by things like the Gini index). What you had was many millions of low-paid workers come onto the market in just a decade or two. This would naturally cause downward pressure on wages within certain occupations. The offset would come via the lower prices of stuff. However, in addition, many people in the U.S. were in positions where they were not passively being affected by the wage-pressure on one hand and the lowered prices on the other. They were also gaining from being part of the process that enabled the changes. If some people had to accept lower wages because of outsourcing, others people were helping organize the process.

As in outsourcing? I agree! I would also think that there would be a wider gap between poor and rich during the transition phase from industrial USA to non industrial USA (fewer blue-collar jobs existed, but more white-collar jobs did). I haven't checked to see if there have been any studies done on this, but it would be interesting to see the effects of outsourcing in other countries vs the effects in our own (with inflation considered). Of course outsourcing is still used because it's successful and can generate a lot of money for white-collar workers in the US, but I'm not sure just how wide the gap became between the rich and poor. And in other countries, the flood of jobs must have been really great on the poor, but the wages are so low.. so I'm not sure how much of a difference that really made in their economies.

[softwareNerd]

Other than outsourcing, the other big force is technology. As factories get increasingly automated, it would appear that the lowest-skilled workers who do very mechanical tasks become of less economic value. With automation, one also has the effect of reduced costs-of-production, and therefore lower prices. So, the dual impacts on low-skilled workers are quite similar to outsourcing. Some economists blame automation/technology for the increase in inequality, others blame trade (here's a short summary). Either way, the impact has been much less than one might have speculated.

If I had to speculate, I'd guess that one reason the economic value of low-skilled workers has not dropped more is that the basic concept of lower-skilled workers is wishy-washy. A lot of white-collar office jobs simply take a bit of common sense, and no more common-sense than Rosy the riveter already had. So, if Rosy loses her job to a riveter-robot, and gets employed by a software firm it is not a stretch to think she'll be able to learn how to do office work for them, or even do their QA with very bare minimum training. (As a matter of tradition this might mean that Rosy needs a college degree, which in fact teaches her nothing about office-work or software-QA, but is her ticket to those positions.)

Economic theory tells us that workers are not paid on the basis of skill, as such, but on "marginal product" they produce. In other words, if you have an automated factory where a worker has to monitor a few simple processes and press a few buttons, he is probably doing less -- in terms of manual and brain work than a lathe-operator of yesteryear; yet, he is paid based on the marginal output that comes from employing him. Both technology and the outsourcing of currently "low-skilled" jobs causes our economy to shift to more capital intensive production, raising the wages of low-skilled workers.

And in other countries, the flood of jobs must have been really great on the poor, but the wages are so low.. so I'm not sure how much of a difference that really made in their economies.

For exporters, the impact has been great on the sectors most directly impacted. So, in China, if you were a worker in the right place where the export jobs were booming, you would have done extremely well. Then, that wealth attracts others, sees the model being copied elsewhere, and the wealth also filters through the economy as it is spent. People in China are significantly better off. They should hang a picture of Nixon instead of Mao in Tianamen Square! In India, the early exports were software, and wages for programmers shot up. They could spend like they'd never done before. Of course, this attracted more people to the profession. The next wave was call-centers, which was a boon for college-educated folk who could speak English decently and who lived in certain key cities. In both cases -- India and China -- the outsourcing was the start and it triggered an overall opening up of the economy, which had widespread impacts. In both cases, there are segments -- e.g. rural -- who are last to be impacted, but the overall increase in wealth is something that was unimaginable just two decades ago.

[brian0918]

Here's an interview segment where Thomas Sowell explains his problem with the income inequality argument, as mentioned in the original post:

Edited November 27, 2011 by brian0918

[mdegges]

Thanks for the link. It's funny, AR Ward also posted a Thomas Sowell clip on his blog which deals with some of those same points (equality, taxes, income, international economic gaps, etc). Here's a link to it on youtube:

[freestyle]

When there is growth, the "gap" gets bigger. Comparing the progress of the top achievers with people content to live off of what comes to them is non-sensical.

Notice that the gap between the slowest human runners and olympic record breaking sprinters keeps getting larger every time a record is broken.

In essence, this is a fraudulent stat that compares growth at the top with a baseline that includes a static population of non-movers.