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Income inequality

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Income inequality

There is a great debate in the US about the “great divergence”. According to Tim Noah, who recently wrote a series of articles in Slate:

“During the 20th century, the United States experienced two major trends in income distribution. The first termed the “Great Compression” by economists Claudia Goldin of Harvard and Robert Margo of Boston University, was egalitarian. From 1940 to 1973, incomes became more equal. The share taken by the very richest Americans (i.e. the top 1 percent and the top 0.1 percent) shrank. The second trend, termed the “Great Divergence” by economist Paul Krugman of Princeton, was inegalitarian. From 1979 to the present, incomes have become less equal. The share taken by the very richest Americans increased.”

So what if there has been this “great divergence”?

If we were to organize a game of chance, where only luck matters (in each play of the game a number is randomly selected and the one person with that number takes the prize), and where everyone (let’s say 100,000 people with each person given a unique number) starts with the same amount of money ($1,000) and bets $50 in each game, we would find that after a period of time, many of the original participants would have lost their money and a small number of the remaining would have large winnings ($1 million or more in this game). Eventually, one or two people would win all of the money. Increasing income or wealth inequality would be the result solely of luck.

If we change the nature of the game to allow for a role for talent, and we assume that talent is normally distributed (a small number have exceptional talents, a small number have very little, and the vast majority are concentrated around the average), inequality would grow more rapidly than in the simple game of chance. Thus, income or wealth inequality should not be surprising!

If we continue to introduce new people continuously into this game, each one with different talents, and possibly assume that over time talent does degenerate, income inequality would persist, sometimes increasing (the great divergence), sometimes decreasing (the great compression); but the composition of the very rich should change over time. Many of the wealthiest and/or highest paid individuals today likely were not among the wealthiest 20 or 30 years ago.

If we were to examine income distribution in the US using longitudinal data (i.e. following the same sample of individuals or families over time), we likely would find a high degree of income inequality at every point in time, but continuous change in the membership of the very rich, the near rich, the middle class and the poor. Individuals and families might not necessarily remain in the same income class over time (my family provides an excellent example). Some might move up, others down. Remember the classic line: from rags to riches to rags in three generations. (Many athletes have been able to compress this into 15 to 20 years of their lifetimes.)

Thus, as long as the income distribution is fluid and not stagnant and dependent on one’s lineage or contacts, is there a problem?

Extreme inequality is most likely to be a problem in the following two cases. If there is an extreme bipolar distribution, with a very small number of very rich people (5% or less of the total population), and an overwhelming number of very poor people (90% or more), the economy is likely to be stagnant. The very rich would have to control government and the military to keep the poor from rising up.

If there is a middle class between these two extremes, but people are stuck in their respective classes or castes, the economy also is likely to be stagnant. Aristocracy, or kleptocracy as in the case of many third world countries, would best describe this case. There is no role for meritocracy, risk taking and innovation.

The US model does not fit either of these. While it might not be a pure meritocracy, the US is likely as close to one as we are might find throughout history. Everyone has a chance to move ahead, albeit some are better positioned than others. Therefore, before US politicians rush out and blindly introduce policies to try to reverse the “great divergence”, they should first ask whether there are opportunities for people to move ahead.

A fluid income distribution is healthy and positive for a country and its economy.

The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of  Public and International Affairs.


1 Comment

  1. Fred Lazar September 22, 2010

    Good questions. One I guess is the culture of poverty. Children are influenced by what they around them. So many have little future before they even reach their teens. Communities and families have to take more responsibilities and have to point to different role models. This would be a starting point, but a very difficult one to deal with. Perhaps reforming the education system to use existing technology and make it more interesting and useful for young people. Technology has progressed dramatically, yet the way we educate young people has not kept up. Stronger income support systems so that the poor do not have to worry about survival or health problems impovershing them forever. Maybe outreach programs to show young people the opportunities that currently exist and the requirements to exploit them. There undoubtedly are many other possible policy initiatives, but one must always remember that talent differences do exist and as a result income differences also will continue to exist.

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