Why Inequality Matters

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In his most recent post, Matthew Kahn describes me as someone who believes that people want to keep up with the Joneses.  But I’ve never felt comfortable with that way of characterizing people’s concerns about relative income, because of its apparent implication that inequality wouldn’t matter if only people could learn to ignore negative emotions like envy and jealousy. Yet relative income matters for a host of reasons that have nothing to do with such emotions.  That’s because our ability to achieve important life goals often depends strongly on how much we spend in relative terms.

If you’re applying for a job, for example, you’re advised to look good when you go for your interview. But looking good is an inescapably relative concept. If other applicants spend more on clothing, your best bet may be to spend more as well, even though your likelihood of a callback won’t rise if all spend more.  Yet if others spend more and you don’t, your odds will fall.

Similarly, the relative amount you spend on housing affects your ability to send your children to good schools, because a good school is also an inherently relative concept. In almost every local environment, the good schools tend to be those located in more expensive neighborhoods. To send your children to one, you must outbid others for the relatively expensive housing in the neighborhoods they serve.

Failure to recognize the instrumental role of relative spending explains why many fail to recognize that rising income inequality has imposed large economic costs on middle-income families. The problem stems from a multi-step process that Adam Seth Levine, Oege Dijk, and I have called expenditure cascades. The first step occurs when people at the top spend more, which they’ve been doing simply because they have so much more money. When they build bigger mansions, they shift the frame of reference that shapes demands for those with slightly lower incomes, who travel in overlapping social circles.  The near rich respond by building bigger houses as well, which shifts the frame of reference for others just below them, and so on, all the way down the income ladder.

This cascade is the most parsimonious explanation for the striking fact that the median new single-family house in the United States, which stood at 1,570 square feet in 1970, had grown to more than 2,300 square feet by 2007.  That growth cannot be explained by growth in the median wage or median family income, which changed by much smaller amounts during those years.

What changed dramatically was the context in which the median family’s housing choice was made.  Any family that failed to rent or purchase a house near the median of its local price distribution would have had to send its children to below-average schools.  So a family that was determined not to see its children fall behind had little choice but to keep pace with what similarly situated families were spending on housing.

The figure at the top of this post (an updated version of one described in more detail here) shows how much more difficult keeping pace has become for the median family. Taking the implicit monthly cost of a house to be roughly one percent of its purchase price, it plots the number of hours each month the median earner would have needed to work to meet that cost during the last 60 years.  During the immediate postwar decades, when the income distribution was stable, the median burden of homeownership varied little, and was actually slightly lower in 1970 (41.5 monthly hours of work) than in 1950 (42.5 hours).  But as income inequality began rising sharply in the 1970s, the toil index rose in tandem. By 2010, the median worker had to work 82.9 hours a month—almost twice as many as in 1970—to put her family into a house of median price.

Housing is of course not the only expenditure that is sensitive to context.  Explosive income growth at the top has also spawned similar expenditure cascades for items such as clothing, gifts, birthday parties, and other celebrations to mark special occasions. In these domains as well, the median earner must now spend more than before or else endure significant adverse consequences of one kind or another.

Of course, Matthew Kahn would be correct to note that not all such spending has been purely wasteful.  Although the utility conferred by a diamond ring may depend largely on its relative size and quality, for example, even the lone resident of a desert island might take additional pleasure in the way an absolutely larger stone refracts the light. Yet surely much of the extra spending of recent years has been a relatively inefficient source of extra utility.  The average American wedding now costs almost $30,000, nearly twice as much as in 1990. Does anyone believe that the extra spending has made couples and their families any happier?

Higher outlays of this sort crowd out other forms of spending that would produce real improvements in the quality of life.  If houses grew less rapidly, for example, we could invest in mass transit systems that would yield shorter, less stressful, commutes that would free up more time to spend with friends and family.  Or we could support medical research and safety investments that would reduce premature death.  The list goes on.

Inequality apologists like to remind us that the poor now enjoy many conveniences that even the very rich didn’t enjoy earlier.  But saying that rising income inequality has imposed enormous costs on middle-income families is not the same as saying that such families were better off a century ago.  Absolute income also matters, and everyone is indeed better off in many ways because it is so much higher now than in the past.

Saying that inequality has been costly is also not the same as saying that the optimal amount of inequality is zero. Few people would work if everyone were guaranteed an equal share of the national income irrespective of effort, in which case we would all be poor in absolute terms.

Yet precisely because relative spending power is so important for instrumental reasons, even very small absolute income differentials are sufficient to stimulate high levels of effort. There is no credible evidence that national income would fall if income disparities were to shrink substantially from today’s levels, and there is actually considerable reason for believing that it would be higher.

Many of the substantial costs associated with high income disparities are thus completely gratuitous. When the wealthy all build bigger mansions and stage more elaborate parties, they succeed only in raising the bar that defines adequate.  The associated waste is all the more troubling because it would be easy to eliminate so much of it with some simple changes in tax policy.

Comments

    • Ken Rhodes says

      My wife and I are both 69 years old. We recently downsized from a very large house to a much smaller one, and the transition has been difficult. We had to give up some of our furniture, we had to consolidate our two office spaces, formerly in separate rooms, into a single room. I had to give up some of my bookshelves, which meant giving away many of my books. My wife loves to entertain, and I tolerate it. We still do that frequently, but with smaller numbers of guests now. We have much less storage space for the accumulation of a lifetime of stuff, much of which was unimportant, but which we nevertheless felt sad when we gave it away.

      Our new house is 2,600 square feet. We would have been terminally depressed if we had been forced to downsize to 2,000 sq ft. The size has nothing to do with competing with our neighbors, or trying to make sure of the quality of the neighborhood schools, or any other “external” reason. Extra size enhances our lives.

      I grew up in the 1950s in Baltimore. My parents bought the best house they could afford in a good neighborhood with good schools and a good peer group for themselves, me and my sister. Our house had three small bedrooms and one small bathroom upstairs, and a three small rooms (LR, DR, Kit) downstairs. It was adequate, but very tight. There is no doubt in my mind that if my dad had a higher income, he’d have bought a bigger house in the same neighborhood. Not because he would have been competing with anyone. But because then he and my mom would have had their own bathroom, and my sister and I could have each had a full-size dresser and a full-size bookshelf in our rooms, and … etc.

      I agree that this was a terrific blog post on important policy. But I wish Dr. Fank hadn’t picked the absolute worst possible strawman to illustrate his point.

      • Phil says

        My wife and I are both 43, with no kids, and we live in an 1,800 sq ft space and it’s plenty big. Perhaps a little too big. Anything more would be an inexcusable waste of resources.

      • Evan says

        “Absolute worst possible”?

        Your comment is largely opinion influenced by culture. There are other cultures in which one might live with more people in smaller spaces while simultaneously feeling fulfilled and content. Perhaps you and I would be more stressed living like that, but that doesn’t mean anything in an objective sense. I am not saying that you are wrong, merely illustrating that more space = life enhancement is a belief that you hold, not necessarily others.

        May love and happiness fill yours and your wife’s lives Ken.

  1. SamChevre says

    Taking the implicit monthly cost of a house to be roughly one percent of its purchase price,..

    This may be the best metric available, but it is not a good one for the purpose; as interest rates have fallen, and as fixed-rate durations have risen, the monthly cashflow required to pay for a house has fallen as the purchase price goes up.

    I agree that sending children to a good school (basically, a school where two married parents are normal and normative) has gotten more expensive. I agree that housing prices have gone up. I just don’t think that the metric used to demonstrate that works well. (Basically, all-adults-work-for-income families have a standing-up-in-your-seat effect.)

    • Ebenezer Scrooge says

      Sam,
      You made an interesting conjecture: “all-adults-work-for-income families have a standing-up-in-your-seat effect.” I think it is true, but your metaphor leaves something out: not everybody is the same height. Higher-income families benefit, as the second income–thanks to income inequality–can more than pay for the domestic services lost. The lost domestic services of the now-working high-income spouse are replaced with low-priced female labor. Lower-income families get hosed, since they can’t replace the domestic services.

      • SamChevre says

        That’s an interesting way to look at it.

        What I was noticing was that as long as the normal family had one earner, it took 40 hours a month to live in an average school district; now that the normal family has two earners, it takes 40 hours a month from each worker to live in an average school district.

  2. EB says

    Becauser the acceptability of a school has become so positional (it always was to some extent, but even more so since changes in pedagogy and special education practices have become relevant), parents do aim for higher-income districts. It’s interesting that there has not developed a market for small houses in generally wealthier districts. It’s a product that would be snapped up.

      • Brett Bellmore says

        An artifact of local government being funded by property taxes; They’re limited in how they can boost the tax level, but have a relatively free hand with zoning and building standards, so they use those to jack up the minimum price of house anybody is allowed to build.

        • Phil says

          My local government is funded by municipal income tax, as are, I believe, most municipalities in Cuyahoga County. Is this not common elsewhere?

        • Ken Rhodes says

          Absolutely right, which has driven new construction to be homogeneous by neighborhood.

          It wasn’t always so. My wife and I moved a very nice home in the Kings Grant neighborhood of Virginia Beach in 1976. The elementary school, middle school, and high school our kids all went to were terrific, which was a major factor in our decision. We had a big house (3,000 sq ft); we had four kids at home (along with a dog, a cat, and some occasional other small animals), and we liked our elbow room. Also, the neighborhood was beautiful, with many mature trees, well maintained yards, and friendly neighbors.

          But since this was an established neighborhood with homes dating back to the fifties, there were also smaller and less expensive homes that had the identical positional advantages. This personal experience is the reason for my reply above about Dr. Frank’s strawman, and that I think EB has overlooked exactly such a market in cities with some age on them.

    • Cranky Observer says

      Such houses exist (I’ve bought my fair share of them), but they require a lot of searching and effort to find – which families lower on the income chain often can’t do for reasons of time and/or cultural knowledge. It is hard to build more of them (as Mr. Bellmore noted), but another factor is that such houses also tend to appreciate over time. I was watching “16 Candles” the other night for the first time since the 80s and remarked to the Cranky Spouse that the ‘shack’ that Molly Ringwald’s character and her father lived in – presumably the servant’s area of that fictional North Shore Chicago suburb – would be worth 600k today.

      Cranky

  3. Brett Bellmore says

    That graph needs another line, showing the monthly effort to home school a child to standard equal to an average school. (With increasing productivity of educational software, it would be sloped down.) If the two lines cross, public schooling has ceased to make any economic sense.

      • Katja says

        Exactly. There’s the opportunity cost of at least a halftime job involved.

        Also, how many parents can effectively teach, say, AP/honors level math and physics, even with the support of homeschooling materials? How good is the average parent’s calculus?

        That’s not counting whether you actually think that homeschooling is a good idea for your child to begin with.

        • Brett Bellmore says

          (Checks to see that his memory of typing “average” is correct…)

          I presume that if centralized education becomes economically inefficient, this has consequences even if labor participation is ‘sticky’.

          And, conveniently, an ever larger portion of our workforce are employed part time, especially as Obamacare kicks in, and gives employers a strong incentive to reduce hours. Isn’t that handy?

          We’re seriously considering homeschooling in our home, it’s rather more sophisticated than you imagine, with different parents specializing in different subjects.

          • Ken Rhodes says

            Brett, you are such an outlier in the distribution of intellect and education that your personal capability can’t be relevant to this issue. Of course you and I could teach our kids A/P math and physics; calculus is “beginner math” to us. We’d probably do OK in English and History, too. The same goes for many of the regular participants here. But many of the poor schlubs who can’t afford to move to a better neighborhood don’t really have the luxury of that home-schooling choice. For the kids of undereducated parents, home schooling would create one more generation lapping the same track.

          • Brett Bellmore says

            (Checks yet again: Yes, I did type “average”.)

            Ok, then, let’s reason about my son: Started reading before 2, we expect to start him on multiplication and division before he reaches 5, he’s still getting a firm grip on subtraction. (Reversion to the mean? Not in this case!) Let’s say he continues in his dad’s footsteps, ends up doing orbital mechanics for fun while in Jr. High, and writing lesson plans for the physics instructor when in High school. Maybe he won’t be a slacker like dad, and ends up skipping a lot of grades, instead of coasting.

            And yet, even at this pace, he won’t be tackling any subjects the average person couldn’t teach before he’s 8, maybe even ten. 90% of K-12, 100% of what most people get out of it, is easily within the capacity of the average person, who graduated from K-12, to teach. Maybe staying one semester ahead, relearning what they’ve forgotten.

            And this neglects homeschooling circles, where several parents cooperate, each concentrating on a subject they’re particularly good at.

            So I think your concerns about the capacity of average folks to do home schooling, even if they have extraordinary offspring, is misplaced.

            Labor force participation is declining, part time employment rising, so the manpower is likely there in many families.

            But, mainly, my point is this: If the professional education establishment can’t manage to be more cost-effective than DIY schooling, how pathetic is that, even if a lot of people don’t have the time or inclination to do it themselves? It would be as though modern agriculture ended up being more expensive than backyard gardens.

            The education system is seriously screwed up, and in desperate need of being completely rethought. That’s my point.

          • says

            Brett forgets that the fundamental role of public education is the socialist redistribution of capital, such that no matter their family situation, all children receive an education. The problems in our education system revolve almost entirely around serving the needs of low capital populations who can’t educate their own kids. Again, the libertarian fails to appreciate the distribution of societal capital (human, economic, social) in society, assuming freedom that does not exist without government.

          • Brett Bellmore says

            No, Brett remembers that the purpose of public education is actually to give the state an extended opportunity to indoctrinate it’s citizens before they form any mental defenses.

          • Ken Rhodes says

            Hmmm … A [very slight] paraphrase of Brett’s comment:

            Brett remembers that the purpose of parenting is actually to give the parents an extended opportunity to indoctrinate their children before they form any mental defenses.

            On a more serious note … I don’t think that sort of cynicism is productive towards the goal that Brett and I and many others surely share, stated below:

            “The education system is seriously screwed up, and in desperate need of being completely rethought. That’s my point.”

          • says

            If homeschooling is so great, how come the richest people have ALWAYS paid others for the private schooling of their children.

            Simply put Brett, the benefit of homeschooling is far below the value of parents’ time.

  4. npm says

    I don’t think this takes away from the substance of your argument, which I agree with (and I recommend your book Falling Behind), but I’m not sure if the average NEW housing size is meaningful. It looks to me that annual housing starts average around 1-2 percent of the total number of households, so the growth in average size is much smaller than suggested by your stats.

  5. Colin says

    Why is a ‘good school’ an inherently relative concept? Are you saying there’s no way to improve the quality of schools or schooling across the board? Or do are you just considering education as a positional good, in the same category as the smart suit you wear to the job interview?

      • Colin says

        Yes, peer group is a huge factor for success at school. But the problems of children whose family environment etc leaves them ill-equipped to do well at school are a matter of absolute poverty rather than inequality per se, in that they wouldn’t learn any less at school directly as a result of the rich getting richer, or the most learned part of the population becoming more so.

        • Brett Bellmore says

          There are still stories of immigrant families living in abject poverty, while devoting every cent above bare survivial to raising themselves up. hmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmm.

        • Brett Bellmore says

          You might want to delete that comment my son messed with, it’s disturbing the formatting.

          I think the evidence is that it’s less a matter of poverty leaving people poorly equipped to help educate their children, as it is a matter of the sort of traits which leave you poorly equipped to help with your child’s education also leaving you more likely to be and stay poor.

          • Colin says

            ‘Poverty’ can be cultural as well as material. For instance in the mid-20th century, the UK received a large number of immigrants of Indian origin who had a disproportionately urban and middle-class background (often from Africa, where they were over-represented in the business community as a legacy of the British Empire). After a generation, that seems to have counted for a lot in terms of educational success, as compared to both immigrants from a subsistence farming background, and native Brits growing up in ‘sink estates’. Similarly, I’d expect the children of debt-laden adjunct professors in the US to do a lot better at school on average than the children of parents who dropped out of high school, even if their material circumstances are similar.

  6. RMerriam says

    Is not a big difference between the poor of a century ago and today not income but purchasing power? Or, if income levels were equivalent today’s poor can buy more because prices for many items have decreased.

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