The Mismeasure of Inequality

Growing economic inequality is now becoming a premise of our political debates. Unfortunately, however, conventional government measures of inequality provide a misleading picture of comparative living standards in the modern world.

Most importantly, income inequality is not a good proxy for gauging the rise or decline of economic equality. To be sure, if income equality is to be used as a proxy, incomes have to be calculated accurately. For instance, incomes have to be calculated after tax rather than before tax. Moreover, government transfers have to be included. Finally, for most people income changes significantly over their lives. The amount earned over a lifetime seems more relevant than that earned from year to year. All these adjustments temper the inequality of earned income.

Consumption, however, provides a better measure of economic equality than income. Consumption is the ultimate objective of earning, as Adam Smith himself recognized. And, as I have discussed in a recent essay, Innovation and Inequality, the most important phenomenon for consumption in modern world is that economic value is now more and more created by information that arranges material rather than the material itself. As a result, we all can enjoy a higher level of consumption from the common pool of innovations that rapidly become inexpensive or even free. Income differentials are less important given that common pool.

To be concrete, compare our situation to that of the Middle Ages. At that time most of the value in almost all goods lay in the material, like real property or metals. If I owned the lands and materials, you did not. But today relatively little of the value of a new piece of technology such as a smart phone lies in its material parts. Its value lies in the innovative ideas that arrange its material and the network over which millions communicate. This value can be enjoyed by everyone who has a phone. To be sure, some innovations are patented, but patents do not last forever and when better inventions are patented for the same purpose the cost of accessing the previous patents rapidly declines.

One result of a more idea based economy is that innovations move much more rapidly down the income scale. It took a very long time for timepieces to be widely owned, decades for refrigerators to grace almost every household in the United States, but less than a decade for most people to own a smart phone in this country. That faster progression suggests that important aspects of consumption are more equal than ever.

Or consider the general effect of our less material world on relative equality. In the Middle Ages, a very wealthy noble would experience life completely differently from someone earning the median income. The most important vector of life would be material and the noble would live in opulence and the middle class person in comparative squalor. But today, both billionaires and the middle class have relatively equal access to wonders of the online world through the portal of the internet, where both spend an increasing portion of their time. This comparison captures an important underlying trend in our technologically driven society that is likely to accelerate.

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on January 15, 2014 at 11:12:02 am

Income differentials are less important given that common pool....
At that time most of the value in almost all goods lay in the material, like real property or metals.

These two sentences illustrate a fundamental premise of the "inequality" issue that is deserving of some skepticism: that "inequality" is an objective concept, amenable to measurement and pliable to intervention. The key words from the quoted sentences are "important" and "value." These terms can refer either to subjective (e.g. important being synonymous with meaningful to someone) or objective (important meaning having a dominant influence on an objective metric). "Value" is inherently subjective.

Measures of inequality are simply methods that attempt to make subjective and transient concepts amenable to analysis, in the same way as linearizing non-linear functions, or digitizing continuous data. When something cannot be measured directly or easily, analysts search for surrogates (such as serum creatinine as a measure of kidney function), and this leads to the danger that the surrogate will itself be considered the important quantity. Often the surrogate can be manipulated independently of the real quantity of interest, (think of standardized test scores and the quality of education) creating its own type of mischief.

There is no doubt that income, or wealth or "stuff" are measurable surrogates for equality, susceptible to political exploitation and irresistible to demagogues. These surrogates are the ethereal obsessions of martinets and hustlers, of the chronically aggreived and perpetually resentful. It is beyond the power of government to prescribe what is important to someone, to mandate what will be meaningful to them, or what in life is most valuable.

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on January 15, 2014 at 12:05:29 pm

Yes, but as Hayek showed, "planners" must ultimately make these determinations if they are to achieve their goal of "social equality." thus, the surrogate mesasures become more real than the true measures, such as they are suscptible of apprehension and definition.

I suspect that will be next on the agenda.

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on January 15, 2014 at 19:20:18 pm

The whole concept of "too much" income inequality strikes me as completely absurd, as if there is some "ideal" level of inequality of income which is objectively determinable by the "experts" in Government, or that those selfsame "experts" can determine just who ought to occupy the spots at the top or the bottom of the spectrum. Let us assume, just for giggles and grins, that we currently have "too much" inequality of income. Just exactly how much is the gap going to be narrowed? Do we strive for absolute equality, where the homeless wino living on the street has exactly the same income as Bill Gates and Warren Buffet? I assume that can't be the case, so just how do we decide exactly what level of inequality we must strive for? And who shall we dispossess in order to redistribute income, ONLY corporate CEOs? Or maybe "overpaid" professional athletes, like Alex Rodriguez, Dwight Howard, Tiger Woods and LeBron James, each of whom earns a lot more than a great many CEOs? And what about Celebrities, like Oprah Winfrey, Martha Stewart, Matt Damon, Harrison Ford, and a large number of Hollywood A-Listers? And exactly how is that Government expropriation going to be distributed? Do I get a piece? Or only to the bottom 5%, 10%, or 20% of income brackets? Do we take into account assets or human capital? Does the recent College Graduate who remains unemployed get a cut because his income is still zero? Or only the chronically poor? The very notion that this is a problem which Government is competent to address is simply too inane to be taken seriously.

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Daniel Artz

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