Wednesday, October 19, 2011

Income Inequality Thought Experiment

Megan McArdle over at The Atlantic has a post which (as always) is thought provoking, but presents data which, once one has thought about it, is pretty obvious.

In economic downturns, such as the one we are in now, income inequality actually becomes less severe.  You can look at the handy charts she provides here, but I will describe a couple of things that are easy to see from the charts:

1.  You can see that in each recession and in the great depression, income inequality falls sharply.  The chart shows the share of total income earned by the top 1% of earners.

Why is it obvious that this would be so?  The income of top earners is tied to capital.  In good times, capital is in high demand and so interest is high.  Businesses are working at higher capacity and so the owners make a lot more profit.  Their fixed costs are what they always were;  The value of the land, machinery, buildings and so forth haven't changed.  They are selling more widgets and so they are using more materials and labor, but these are only a small portion of total costs. 

Workers also improve their income because of two factors:  First, there is more work to be done and so they may go from part time to full, or may gain some overtime hours.  Second, all the added work will create demand for more workers and this should drive up wage rates.

2. The second notable item from the chart is that, in spite of reduction in income disparity during recessions, there are trends which are easy to spot.  From around 1929 until around 1980 the trend was of declining income inequality, after that the trend is in the opposite direction.  I do not have any good hypothesis for why this should be so.

Here is the thought experiment part of the post:

I do not know if the relationship between economic prosperity and income disparity is something that anyone can do anything about.  If someone has ideas on that, I would be open to hearing them.  The thing is that for over 30 years, there has been a clear association between inequality and economic prosperity.  Given two choices which would you choose?

1.  The bottom two quintiles gain a real 10% in income  AND the top quintile doubles their income.


2.  The bottom two quintiles loose 10% of their income  AND the top quintile looses half of their income.

I would choose # 1. because everybody is better off than they otherwise would be.   I didn't want to overcomplicate things, but if you are wondering about the middle two quintiles--they gain or loose in the same direction as the others in their scenario, but by an intermediate amount.  I suspect that people of a more leftward inclination than me would choose # 2.  or would at least be tempted to choose it.

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