One more thing on Cox and Alm

I always keep international economics in mind, so while reading for my earlier post, I took this interesting excerpt Cox and Alm's article. Their view for why consumption went up in past years is that prices have been falling. And why is that?

There are several reasons that the costs of goods have dropped so drastically, but perhaps the biggest is increased international trade. Imports lower prices directly. Cheaper inputs cut domestic companies’ costs. International competition forces producers everywhere to become more efficient and hold down prices. Nations do what they do best and trade for the rest.

Thus there is a certain perversity to suggestions that the proper reaction to a potential recession is to enact protectionist measures. While foreign competition may have eroded some American workers’ incomes, looking at consumption broadens our perspective. Simply put, the poor are less poor. Globalization extends and deepens a capitalist system that has for generations been lifting American living standards — for high-income households, of course, but for low-income ones as well.

By the way, if the theme interests you, I really recommend reading the whole thing.

Long live inequalities: The several gaps between rich and poor

Last week, Greg Mankiw quoted an article in The New York Times, by Cox and Alm, who report:

[I]f we compare the incomes of the top and bottom fifths, we see a ratio of 15 to 1. If we turn to consumption, the gap declines to around 4 to 1. [...]

Let’s take the adjustments one step further. Richer households are larger — an average of 3.1 people in the top fifth, compared with [...] 1.7 in the bottom fifth. If we look at consumption per person, the difference between the richest and poorest households falls to just 2.1 to 1.

The article touches on a very important issue, which is the way we measure inequality. This theme got special attention with Krugman's Conscience of a Liberal[1], where he "explains what can be done to narrow the wealth and income gap"[2]. The debate involves several aspects, such as its statistical measurement (see Mark Thoma’s “Increasing Inequality is Not a Statistical Illusion”) or, as the quoted NYT op-ed puts it, whether we should substitute consumption for income calculations.

The thing that troubles me, however, in all this wealth/income/consumption inequality debate, is very few people actually question its central assumption that inequality is bad! In that case, there’s another type of inequality we should really look into, because it could help explain some more of the above 2:1 proportion. Steven Landsburg provides an insight it for us:

In 1965, leisure was pretty much equally distributed across classes. People of the same age, sex, and family size tended to have about the same amount of leisure, regardless of their socioeconomic status. But since then, two things have happened. First, leisure (like income) has increased dramatically across the board. Second, though everyone's a winner, the biggest winners are at the bottom of the socioeconomic ladder. […]

[W]hen you compare modern Americans to their 1965 counterparts—people with the same family size, age, and education—the gains are still on the order of 4 to 8 hours a week, or something like seven extra weeks of leisure per year.

But not for everyone. About 10 percent of us are stuck in 1965, leisurewise. At the opposite extreme, 10 percent of us have gained a staggering 14 hours a week or more. (Once again, your gains are measured in comparison to a person who, in 1965, had the same characteristics that you have today.) By and large, the biggest leisure gains have gone precisely to those with the most stagnant incomes—that is, the least skilled and the least educated. And conversely, the smallest leisure gains have been concentrated among the most educated, the same group that's had the biggest gains in income.

Aguiar and Hurst can't explain fully that rising inequality, just as nobody can explain fully the rising inequality in income. But there are, I think, two important morals here.

First, man does not live by bread alone. Our happiness depends partly on our incomes, but also on the time we spend with our friends, our hobbies, and our favorite TV shows. So, it's a good exercise in perspective to remember that by and large, the big winners in the income derby have been the small winners in the leisure derby, and vice versa.

Second, a certain class of pundits and politicians are quick to see any increase in income inequality as a problem that needs fixing—usually through some form of redistributive taxation. Applying the same philosophy to leisure, you could conclude that something must be done to reverse the trends of the past 40 years—say, by rounding up all those folks with extra time on their hands and putting them to (unpaid) work in the kitchens of their "less fortunate" neighbors. If you think it's OK to redistribute income but repellent to redistribute leisure, you might want to ask yourself what—if anything—is the fundamental difference.

My moral here is: if we really want to end inequality, why not go all the way and adopt a totalitarian communist system? This reductio ad absurdum may seem odd, but it’s not the case that people are equal. Nor can we say for sure how they are different, but our ignorance should make us turn to a more merit-based system.

Such system would allow agents to make their own choices regarding the income they wish to work for, the wealth they aim at accumulating and how much leisure they are willing to give up for those. It’s not an easy choice: we all would like to consume more, accumulate money – be it for increasing consumption, leaving it for your kids or anything else – while having more free time.

This reminds me of a story about a very successful Brazilian investor. He and some friends were at a bar going through the financial reports of a firm, trying to find something to give an edge over the market. After hours of scrutinizing the books, they finally found what they were looking for and decided to celebrate. As they looked around looking for the waiter, they noticed the bar was empty. They had been working for hours, it was already evening (around 9pm to my recollection) and the place should be filled with people. This puzzled them until someone solved the mystery: it was New Year’s eve!

Of course the reporter interviewing him asked if he wasn’t upset about working so late during New Year’s eve, but no, he wasn’t. Now, how many people would be willing to work late on December 31st? Is it fair to infringe this person’s liberty by taxing him more than his co-worker who was enjoying his vacations instead of studying accounting books? I believe this answer involves not a subjective judgement, but can be answered by verifying which would yield more wealth to society.

The reality is we are constrained by time and some people are more productive, others are willing to work harder, while others would just like to earn their living and enjoy life. Why should we be opposed to a genius work-a-holic making millions of dollars, if he produces much more than that to society and few of us have that characteristic?

Let each person pick his own bundle of ability-effort-output and there shall be no (legitimate) envy. And inequality will undoubtedly be a good thing, for it will motivate harder work, simultaneously allowing more leisure.


Notes:

[1] For his summary of the theme and the book, you can check Krugman’s first blog post. There is also a highly controversial NYT review. You can also go straight for Mark Thoma’s comment on this, which gathers different sources.
[2] Quote from the book's back flap.

In Response to CITIZEN OF EUROPE: Do Central - Eastern European countries need their own Gordon Browns?

Jan Jablonski clashes with Citizen of Europe. The first blog debate starts!

The text makes two major points. Firstly, the fact that the UK stays outside the Eurozone allows it to make a necessary economic adjustment through currency depreciation rather than through “painful disinflation”. Secondly, as an opposite case, Spain didn’t have a freedom in altering the exchange rate, therefore the adjustment had to be done through prices and consequently affect employment. It actually all boils down to the question about whether it pays to join the Eurozone, as giving up the currency and monetary policy is the essence of a monetary union.

The discussion on this topic is already humongous starting from “the optimum currency area theory”. For the case of the UK the famous Five Economic Tests for assessing the UK's readiness to join the Eurozone can be mentioned. On the course of the discussion however, it does not become clear whether floating exchange rate regime helps dealing with shocks and adjustments or is in fact an another source of a shock. Additionally, Spain did not enjoy the benefits of having semi-world currency as the UK does (which brings substantial income), so giving up peseta was easier in that sense. Here:

“In Spain, the booming economy led to rising wages and, as a result, to a surging inflation. That in turn contributed to the loss of exports competitiveness and economic slowdown.”

The discussion is actually about business cycle. The supposition is that a proper monetary policy response would be the appropriate action. However, was a monetary policy in Spain an efficient tool in smoothing business cycle before joining the Eurozone? Maybe it was not? Maybe fiscal policy is actually a more efficient tool? Of course it is efficient only in case of a proper budget discipline, giving space for the automatic stabilizers to work.

Even if adopting euro was not really helpful to deal with the situation in Spain, is it also the case for EEC? The article is not really clear about how to relate the UK and Spanish example to the EEC, but certainly the first question to ask would be about business cycle synchronization. How much are the cycles of EEC synchronized with their biggest EU trading partners. Is it to the similar extent as in Spain? In case it is more synchronized, giving up monetary policy for European Central Bank would be less painful for the EEC than it was for Spain.

Author: Jan Jablonski, MSc, Economics International moderator