Notes on Economic Inequality – Robert Murphy

By Robert Murphy – Contributor –

Fueled by the commercial success of Thomas Piketty’s Capital in the Twenty-First Century (see my scathing review), bloggers and pundits are discussing the age-old question of economic inequality. This debate is littered with confusing statistics and flat-out falsehoods, so in the present post I wanted to inoculate readers against these rhetorical sleights of hand.

First of all, there’s a distinction between income and wealth. The top 1% of income earners aren’t necessarily the same group of people as the wealthiest 1%. For example, imagine a small hedge fund manager in his 30s who has a great year, pulling in $20 million in income, even though his net worth is only $5 million. But meanwhile there’s an heiress to a family fortune who owns $500 million worth of property, even though she only earns $1 million in reported income that year. These people would be ranked differently in percentile groups, depending on whether we’re talking income vs. wealth.

This isn’t just a pedantic distinction. In the real world, it’s entirely possible that income inequality in the United States has sharply increased since the early 1980s while wealth inequality has not. So when people (such as Paul Krugman) try to defend claims about rising concentrations of wealth using empirical evidence based on income, it’s a dubious procedure.

Another important point to keep in mind in that income and wealth are created, not distributed. People will often make claims along the lines of “the top 1% appropriated x% of the income gains over the last two decades.” That makes it sound as if there’s a fixed pie of income (or wealth), and so if a rich person makes more, it means a poor person makes less. In general that’s not true. Innovators like Steve Jobs didn’t become billionaires by stealing wealth away from everybody else; no, they created it.

Now it’s true, of course there are many rich people who got their wealth through insidious means, such as using government privileges to knock down competitors or to get funding from taxpayers. Even so, it’s worth pointing out that in a market economy a person gains wealth only by pleasing customers. When talking about inequality, we shouldn’t use language and statistics that load the deck to automatically rule out the possibility of genuinely providing useful items for the masses.

Another crucial point is that the usual statistics about the “gains of the top 1%” hide the mobility of people within these percentage rankings. Let me give an exaggerated example just to make the point: Suppose the today’s poorest 1% suddenly earn $1 billion each next year. Furthermore, suppose everybody else earns the same amount next year, as they earned this year. In this contrived scenario, the standard statistics would show that “the top 1% absorbed 100% of the income gains in 2015, while the bottom 99% saw zero income growth.”

Does the reader see how perverse that is? The most egalitarian outcome imaginable—where the bottom 1% zoom to the top and push everybody else down a percentage point in the rankings—would actually show up as the least egalitarian outcome, the way these statistics are normally reported. To repeat, the reason this happens is that the claims about “the top 1% did such-and-such while the bottom 99% did so-and-so” lead one to believe that this is a static group of people, when in fact the membership in the “top 1%” can change over time.

Most people will see their incomes rise over the course of their life, as they gain work skills and build up assets (which generate an income to supplement their wage or salary income). Then they’ll retire and their income will decline. Thus each person will move through different “top x%” rankings during his or her life. Such normal, life-cycle mobility is part of what shows up in the aggregate rankings (though of course it’s not the only thing driving the results).

As a final note of caution, I urge readers not to trust academics like Paul Krugman who confidently assert that “all the evidence” comes down on one side of an issue. In the case of trends in U.S. wealth inequality, the data are decidedly mixed, as Scott Winship explains in this essay. Indeed, just to show how slippery Krugman is on this stuff, here’s a Twitter exchange from an academic who points out that Krugman is falsely attributing views to the academic’s research.

In the grand scheme, I am not concerned with economic inequality as a general rule. If someone gains wealth by stealing it from others (which happens very often through the use of government leverage), then of course I oppose that, because stealing is wrong. But if somebody gets rich by coming up with a new product or service that others want, then that’s nothing to lament. Yet even if one does care about economic inequality, we should be very careful when parsing the statistics thrown around in the current debate, because they can be very misleading.



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