The Rising Inequality in Income and Wealth: Is It Happening and Why ?

"Have the rich have gotten richer and the poor poorer in the last twenty years?"

Question 1: Has income and wealth inequality worsened in the last 20 years in the U.S. as suggested by many studies ?

Question 2: Since greater inequality may not be so bad if there is a lot of class (income) mobility, what is the evidence on the degree of class mobility and its changes over time ?

Question 3: Have average and median real wages and household incomes declined in the last two decades ?

These three questions have been at the center of a raging policy debate in the US in the last few years on whether "the rich have gotten richer and the poor poorer". As the discussion below suggests, the two questions are related to each other but in a significant way quite different from each other. In fact, income and wealth inequality appears to have worsened (i.e. the relative incomes of rich and poor have diverged over the last two decades) regardless of the disputed issue of whether the absolute (average and median) incomes and wages have gone up or down.

To start the discussion, read the analysis of income inequality by Paul Krugman in the American Prospect. He presents systematic evidence on the widening income inequality in the U.S., discusses the evidence on the limited degree of income mobility and systematically refutes the arguments of those arguing that inequality has not increased.

High and increasing income inequality may not be considered as negative if there is a lot of class (income) mobility, i.e. if individuals in lower bracket of the income distribution have a high probability of moving over time to higher income brackets. That leaves open the empirical question of whether class mobility is high in the U.S. and whether it has increased or decreased over thelast two decades. For a recent summary of the evidence on income mobility read a Wall Street Journal article: in summary, income mobility is relatively low and has not increased over time. See also the above article by Krugman.

Next, read the recent study "Top Heavy" by NYU Professor Edward Wolff on "The Increasing Inequality in Wealth in America and What Can Be Done Abot It". Wolff reinforces the evidence presented by Krugman and suggests some policy proposal to reverse inequality.

Regarding the potential causes of the increased inequality, read the view of Robert Frank in "Talent and the Winner-Take-All Society" who offers an explanation of the widening inequality based on the idea of winner-take-all games.

For a recent acrimonious debate on income inequality, read the exchange on gold and income inequality betwen Krugman and Jude Wanniski (one of the intellectual fathers of supply-side economics): the original article of Krugman The spiral of inequality, the reply of Wanniski and the counter-reply of Krugman.

While the evidence in favor of rising income inequality appears to be overwhelming, there is parallel and more contorversial debate on whether (average and median) real wages and household incomes have been falling or not in the last couple of decades. Lawrence Mishel in Rising Tides, Sinking Wages offers a clear presentation of the popular view that not only income is more unequal, but that real wages have been falling during the last decade.

Such a view is controversial for a number of reasons. For a logical critique of arguments that average real wages must have fallen, see Krugman's recent debate on Slate with Galbraith.

On a related issue, the commission on CPI mismeasurement headed by the economist Michael Boskin presented the results of its report on December 5, 1996 and argued that the inflation rate is overestimated by about 1.5% per year. The results of the Boskin study (and those of Nakamura, a Philadelphia Fed economist) have important consequences for the estimates of real wage and income growth in the last two decades. They imply that previous studies suggesting a secular fall in median real wages might be incorrect: mismeasurement of CPI inflation has systematically biased downward estimates of real wages and earnings. For a summary of Nakamura's results see a recent NY Times article. See the related home pages on the controversies on CPI measurement and productivity growth for more deatils on these debates.

The Wall Street Journal editorial page, always wary of the view that "the rich have gotten richer and the poor poorer", seized upon the Boskin report and Nakamura study to argue (December 4, 1996) that the view that American workers have fared poorly for the last twenty years was wrong.

It is important to observe that, while the recent studies based on a correct measurement of inflation would suggest that average hourly earnings and median household incomes have increased rather than fallen in the last two decades, they do not refute the results about a worsening of income and income inequality: in fact, with the new CPI data real incomes are proportionally higher for every income group so that the the relative position and changes in the income distribution are not affected by the new CPI measurement. Moreover, with the new CPI data, the increase in real wealth of the wealthy is even more marked and the traditional results about a worsening of the wealth distribution remain unchallanged.

So a fair conclusion is probably that, while previous studies implied that real wages had fallen and income and wealth inequality had increased, the new measures of CPI imply only that real wages have increased while, at the same time, income and wealth inequality has increased as well. In other terms, the income boat might have risen for all rather than rising for some and falling for others but the relative increase has been significantly larger for high income groups.

Copyright: Nouriel Roubini, Stern School of Business, New York University, 1996.