Saturday, August 22, 2009

Why care about inequality?

This is a follow-up post to a previous discussion about economic inequality.

Emmanuel Saez, the UC Berkeley economist, recently produced a fascinating chart on income distribution in the US, depicting the share of national income held by the top 10% of Americans over time:

As you can see, the top 10% of families accounted for roughly 50% of national income in 2007, a level not seen since the time of Jay Gatsby. Though this is only one of numerous measures of income inequality, it clearly shows that the distribution of income in America is more skewed now than at any point since before the Great Depression.

Why should we care about this? There are good economic reasons for discounting measures of inequality. First, economics is not, in general, a zero-sum game. We can all do better even if some gain more than others. And conversely, while some poor societies are highly equal, equal poverty is no great virtue.

Second, there are good reasons why some people make more than others. People who make great innovations (eg the founders of Google) or who have specialized skills (eg neurosurgeons) have every right to be compensated for what they do, since they provide value for society. Bill Gates is enormously wealthy, but he didn't get that way by stealing from others; he became wealthy by providing valuable products to society, making everyone better off (Vista notwithstanding). The carrot of great individual wealth has done much to improve human welfare.

However, there are equally good economic reasons to care about inequality. First, sometimes inequality does result from zero-sum interactions. As Harvard labor economist Larry Katz notes,
"Much of the growth of high-end incomes stemmed from market forces, like technological innovation... But a significant amount also stemmed from the wealthy’s newfound ability to win favorable government contracts, low tax rates and weak financial regulation".
If government is captured by narrow interests, then we are likely to see the growth of policies that privilege one group and do nothing to help (or sometimes even hurt) other groups. A less regressive tax code, for example, helps the wealthy but can hurt the poor.

We should also care about changes in inequality because it can indicate how well the economy is functioning for different groups in society. For this reason it is important to understand what is driving inequality. For example, Katz and co-author Claudia Goldin have argued that inequality has increased because of a decline in the relative supply of highly skilled workers. This suggests that increasing college enrollment (and completion rates) for lower-income groups would stem the growth in inequality and increase incomes for poorer Americans.

On the other hand, Arnold Kling and others have argued that inequality has been driven by changes in technology and the growth of "winner take all" markets, as well as changes in family structure. People today are more likely to marry someone of a similar economic and educational background than they were 50 years ago. This re-enforces inequality among now and in the future, as successful, highly educated parents are likely to have successful, highly educated children. If these are the causes, Kling argues, then there is little government policy to can do to stop them, since we are obviously not going to put restrictions on technological progress or prevent wealthy people from marrying each other.

Inequality is not something that the government can directly set, like interest rates or the budget deficit. It is the product, of complex economic, political and social forces. It is important to recognize that inequality has many causes and that by understanding those causes, we can understand fundamental structures in the economy. We should care about inequality because we should care about an economy that satisfies the needs of everyone in society. By understanding what causes inequality, we can better understand how to get there.

1 comment:

Gingi said...

Sounds like the primary reason that people like Larry Katz are concerned about inequality is because of corruption and potential wrongdoing by the wealthy elite, since, as the adage goes, money is power. Fair enough. But there is nothing else intrinsic that I find worrisome about this, as long as the Larry Page and Sergey Brin stories are far more commonplace than the Bernie Madoff stories. I'm not bothered that [many] people are [a lot] wealthier than I am. Nor should the poorest be. I do not believe that the rich have gotten rich at my expense.

I do agree with the intuition that economic inequality fosters innovations and programs, initiated by those above the poverty line, such as Bill Gates and his foundation, to provide economic opportunities to the poor.