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Monday 3 August 2015

Income inequality charade

With a federal election imminent in Canada and presidential primaries looming in America, we are likely to read and hear a lot about the "scourge" of income inequality in the coming weeks and months. Income inequality and the growing gap between the rich and poor in our society is a common theme in politics these days as politicians from both sides of the ideological spectrum strive to demonstrate that they care more about poverty than their competitors.

The spectacle would be funny if it wasn’t so misguided.

It’s true that income inequality in our society exists, and that the spread between the highest and lowest incomes – that is to say income variance - has increased in recent years. Citing this as evidence of a growing gap between rich and poor, however, is the statistician’s equivalent of medical malpractice.

Jobs at the bottom rung of the income ladder are typically entry level jobs, often requiring few if any special skills or education. They’re the sort of job that you might take when you first begin working as a teenager. It may be helping out part time at the local grocery, or flipping burgers at the local McDonald’s.

Even if the job does require higher education or training, when you’re young and just starting out, what you earn will typically be at the low end of the pay-scale within that profession, or trade.

The question is not what rung on the income ladder you occupy at any particular point in time, it’s whether or not you’re climbing the ladder as you acquire more skills and experience. This is known as income mobility, and measuring it tells a very different story indeed.

According to US Treasury Department data – and I’m using these data because the alleged problem of income inequality is perceived to be more acute in America than anywhere else – the average earnings of taxpayers who were in the bottom 20 percent of income in 1996 rose 91 percent by 2005. In contrast to this, the average earnings of those who were in the top 20 percent of income in 1996 rose just 10 percent by 2005, while the average income of those who were in the top 5 percent in 1996 actually declined.

In other words, while the disparity between average incomes of statistical categories may have grown between 1996 and 2005, this does not, in fact, reflect the actual experience of real people. Those in the bottom 20 percent of earners in 1996 earned their way into higher categories over that 10 year period. For them, the gap between the average income of those in the highest category and their own, actually declined. What’s more – and this is important to understand - many of those who were in the highest category of earners in 1996 found themselves in a lower category by 2005, their places at or near the top taken by others who had been steadily and successfully climbing the income ladder.

There are, of course, individual exceptions to this, but they have little impact on the general pattern.

Similar difficulties arise when interpreting data on distribution of wealth. Changes in this distribution represent only the changes in average or aggregate net worth of statistical categories. They do not reflect the actual experience of real people who move into higher categories as they accumulate wealth over a period of time. People also drop into lower categories, including, as it happens, a higher proportion of those in the top tier.

None of this real-life experience is evident in the statistics cited by those calling for government intervention.

But even if people’s incomes and net worth were static, meaning that individuals never moved from lower to higher categories or vice-versa, the use of these data to measure relative wealth would still be problematic.

Consider, for instance, the case of a private entrepreneur who owns a manufacturing business Let’s say that he is a multimillionaire, but most or all of his wealth is in the value of the factory he owns, or the machinery in that factory, or the supplies on hand to make whatever is being made at the moment the accounting is done. What if he takes little or no salary while he struggles to make his business a success? Is he still rich? Most observers would say that he is, but those who rely on income to make that judgment – as those calling for intervention do – would not. Or rather, they would count this entrepreneur twice – once as poor because his income is at the bottom end of the earnings scale, and once as rich because of the high value of his net worth.

What about those who don’t work, living instead off of their accumulated savings, like retirees with a pension? These people may have no difficulty making ends meet despite having little or no actual earned income to report. Are they "rich" because of their relatively high net worth, or are they "poor" because of their low earned, taxable income? Or are they in fact both depending on what criteria you use? And how does this growing segment of the population impact the statistics on income inequality?

As you can see, the issue is far more complex than it is being portrayed by President Obama and his ideological compatriots, both inside and outside of the United States.

Another problem with using incomes or net worth to determine relative wealth is that neither take into account the large variance in purchasing power depending on geographic location.

Consider, for instance, the difference in the cost of housing in a large city like New York, Toronto, or London, and the cost of suburban housing, or housing in smaller towns and villages. A family of four with an annual income of $75,000 living in a small town might well be able to afford housing that is far beyond the reach of someone with ten times that income living alone in Manhattan. And while the net worth of a family that owns a house in New York may be higher than that of a family that owns a house in a small town – the size of the house and its adjacent property in that small town could easily be superior to that of the house and property in New York, regardless of the value of the asset.

The point is this: Relative wealth simply cannot be determined using statistics on income variance or net worth. Indeed, because true wealth is a function of standard of living, which is largely subjective – relative wealth cannot be quantified at all, and it’s a fraud to claim otherwise.

A century or so ago, only the very rich could afford a car. Only they could afford that new device called a telephone. The well off would dine at their exclusive restaurants; they would attend opera and theatre, send their children to good schools, and have access to world-class health care. They enjoyed the benefits of electricity, indoor plumbing, and care-free central heating – meaning that they could pay someone to look after feeding coal into the furnace. They alone lived in good quality houses, enjoyed good quality food, had an extensive wardrobe and could afford to have their hair and nails done on a regular basis.

Today, a century later, the rich – even the mega-rich - enjoy pretty much the same thing…and so does just about everyone else in our society. Today, whether we are rich, poor or somewhere in between, we all have access to all of the things the rich alone used to have, and more.

In short, the evidence is all around us, and it’s irrefutable. Yes, there is a gap between the so-called haves and have-nots in our society, between the rich and poor. But never in human history has that gap been smaller than it is today in all things important and trivial, and despite the periodic fits and starts inherent in a free society with a free economy, that gap, over time, continues to shrink.

Bill Gates might be able to buy the company that made the device you’re reading this on now, but rest assured, if he too is reading, it’s on a device not so different from yours. If unequal distribution of incomes and wealth – as measured in simple dollars - is the price we have pay for this kind of real, as opposed to statistical equality, then I for one say:  Vive le difference!