Wealth, income, (in)equality

If you have some Facebook or Twitter friends who study social sciences, chances are you have seen a certain video on “Wealth inequality in America” already: Which percentiles of the population own which share of wealth?

wealth-1

I have two problems with this six-minute clip. First, it does not sufficiently explain the underlying data: The poll results are not as clear as it seems, and the video lacks comparisons to other countries. Second, more importantly, the clip fails to acknowledge that wealth is almost per definition distributed in a highly unequal way.

1. So where do those graphs come from?

Let’s take a look at the data from the video in comparison to other economies. Here it is important to differentiate wealth (the stock of assets) from income (the flow). Hardly anyone has no income at all, but a lot of people are unable to save anything at the end of the month – so the distribution of wealth tends to be even more unequal (see wealth concentration). The upper graph shows exactly that for the U.S.: A few people at the top own a lot.

Check out the lower bar in comparison, the one where the top 20% own roughly four times as much as the bottom 20%. Like most of the stuff in the video, it is taken from a 2011 Norton/Ariely paper. Their footnote #2 contains a surprise:

We used Sweden’s income rather than wealth distribution [as one of three options when asking people how wealth should be distributed] because it provided a clearer contrast to the other two wealth distribution examples; although more equal than the United States’ wealth distribution, Sweden’s wealth distribution is still extremely top heavy. (Norton & Ariely 2011, emphasis and text in brackets added)

So the example distribution offered to the participants in the Norton/Ariely study wasn’t a real-world example of a wealth distribution – it was an income distribution! (I’m not the first to notice that, of course.)

This is not to somehow normatively defend the huge inequalities in the U.S. – it’s just that we should not compare apples to oranges. Look at the data on wealth distribution for some OECD countries (from Fredrikson 2012):

    The top 3 colors here taken together equal the top 20% from the video. Also note that this graph conflates the whole lower half in the dark blue area!
The top 3 colors here taken together equal the top 20% from the video. Also note that this graph conflates the whole lower half in the dark blue area!

OK, so in the U.S. the notorious top 1% owns a bigger share than elsewhere. But even in Sweden, where income is distributed more evenly than in the U.S., half of the people don’t seem to own anything. How come?

Well, turns out it’s complicated. A lot of people are in debt in Sweden, so they have negative net assets. Another thing to consider is home ownership. The “better”-looking data for Italy might be due to higher house prices, while in Sweden and Germany the less well-off tend to rent apartments. I’ll not even try to cover demographics and other factors here – see the OECD paper for details, or earlier discussions of the Norton/Ariely paper.

2. How could / should wealth be distributed?

For very good reasons, modern societies opt to have regulation and taxation that redistribute income and wealth. The idea, obviously, is to have everyone pay their share for the public according to their abilities. So in terms of income and wealth distributions as discussed above, you want solid absolute values for the people at the low margin and aim for smoothly rising values along the percentiles.

Political institutions play the crucial role in that direction: Using the terminology of Acemoglu and Robinson (“Why Nations Fail”), inclusive political and economic systems allow all of the population to participate. The extractive model, where tiny elites exploit the vast majority, has thankfully gone out of style.

Under no circumstance, however, will a system that allocates wealth through markets produce a distribution where the richest group “only” owns a low-digit multiple of the poorest. (The distribution implied in the third row of the video.)

That’s because income and wealth work in a different way than variables such as height. In the words of Nassim Taleb, they are scalable and thus belong to “Extremistan”, where we should think in terms of Pareto distributions. One adult person being twice as tall as another is extremely unlikely, but the distribution of wealth or income easily allows for much bigger deviations (N. N. Taleb, The Black Swan, pp. 234-235).

wealth-2

So some of the outrage in the video – “the top 1% doesn’t even fit in the scale anymore!” – is misdirected, unless you reject practically all forms of capitalism.

Think about it: Logically, if you wanted the well-off people to own only five times as much as the poorest, you’d first have to take their houses away (or give everybody one), and then keep taking almost every cent they have left after paying everyday expenses. Otherwise, people with cash left at the end of the month will inevitably end up with much bigger savings than unskilled workers (or households consisting of young academics still looking for a permanent job, for that matter).

Thus, for the majority of the political spectrum, the sensible goal should be a distribution where the absolute levels of wealth (and income) are decently high across the board. But getting too agitated about the relative extremes at the top is not a useful priority.

In other words: Don’t freak out about the way Pareto distributions look.

3. OK, “don’t freak out”. Now what?

Of course things are much more complex than the clip suggests. But the video does not only simplify, it also pretty much misses the point. In my opinion, we should try to moderate the trend towards ever more concentration of wealth at the top, and more importantly ensure that everybody has an income high enough to allow for savings. That is a worthwhile political priority. Instead people discuss caps on CEO compensation (in Switzerland, of all places) and bankers’ bonuses…

We should argue about the appropriate levels of taxes on income, capital gains, assets and inheritances. There is a good case for closing loopholes and raising tax rates, given that the inequalities discussed above seem to increase in recent years (see the OECD paper again). Taxation can serve to smoothen differences in wealth and income, and to ensure a solid base for everyone in absolute terms.

7 thoughts on “Wealth, income, (in)equality

  1. Some good points, but you should make your own normative starting points clearer.
    – The video didn’t intend to prove a point comparing the US to other countries so arguing the need it misses the point. There’s a deeper problem here with comparativists that want to engage in more and more data comparison between countries while losing sight of the bigger picture. You should criticize arguments for what they try to do, not what you want them to try to do.
    -It’s nice to bring in Taleb, but man, you’re engaging in more normative thinking here that you make explicit – “But getting too agitated about the relative extremes at the top is not a useful priority.” You kinda need a broader framework to argue that. To some degree I agree that “capitalism always looks like this” – but then, our legal/political/economic institutions are held captive by these capitalist interests at the same time: Why the hell are there next to no taxes on capital gains while normal income gets the shit taxed out of? Put differently: You pretend that there is a social scientific law in which some activities are necessarily “scalable” – but whether or not there are Pareto distributions can and is regulated by man-made institutions (or lack of).

    1. Hi Peter, thanks for your comments! I completely agree on your worries about state capture. There are all sorts of problems with the developments the video describes! I just think it doesn’t do a very good job of making those points.

      Taxation is the crucial thing here, and neither the person who made the video nor I seem very qualified to make substantively clever statements in that regard. Someone on Facebook pointed me to this TED Talk http://www.youtube.com/watch?v=iIhOXCgSunc – but of course there is controversy about that as well… http://www.forbes.com/sites/timworstall/2012/05/19/the-ignorance-of-nick-hanauers-ted-speech/

      Finally, on the comparison: the problem is that Norton and Ariely seem to imply a comparison with their pseudo-Sweden…

    2. Yes, I totally agree. I had planned to write a response to Mathis’s post but now maybe I don’t need to…

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