Monday, February 05, 2007

The Best Argumentation About Income Equality I've Seen Yet

Alan Reynolds of Cato has pretty much blown the leftists' argument about income inequality out of the water with his book, "Income and Wealth," and his Cato piece. He decomposes their statistical base and proves pretty much without a doubt that the income inequality "proof" just doesn't exist.

tall&short
[Thanks to usgtf.com for the image.]

But I like the approach of Tim Worstall much better.

This Englishman writes for Tech Central Station and maintains a blog with a style that is very much after my own heart, i.e. he injects everything with a potent mix of common sense and a sense of humor. The cocktail is devastating and insightful.

His latest article at TCS on the subject of income inequality parallels my sentiments exactly. Unlike Alan Reynolds, whom I respect and admire also for his diligent research and pointed wit, Tim does not try to puff up the free market case by proving that there is no income inequality. Tim knows, as we all know, that statistics are a dish that can be eaten hot or cold.

Everyone dislikes the idea of his own relative purchasing power diminishing; but let's just go along with the hypothesis, i.e. that there is increasing income disparity in the US. From the point of view of a scientific economist (as contrasted to someone like Paul Krugman, who seems to have lost his white coat somewhere along the way), an equitable study of market phenomena requires an objective mind. After all, economists are not in the business of making value judgments about economic phenomena; they're just supposed to study the mechanics of them. (See my earlier post on this subject.) They merely describe market relationships and leave the politicking to the politicians.

So Tim takes the position that there may indeed be some income equality happening in the advanced economies, and that it is pointless to flood the airwaves and printed pages with numbers in an effort to prove or disprove it. He explains that there already exists a model in economics -- in fact one that exists since 1941 -- that predicted such inequities of income, and it is called the Stolper-Samuelson Theorem.

This model says, as Tim puts it, "[Globalization] will lower wages in the US and raise corporate profits (more precisely, returns to capital)." This does describe exactly what we lay people think we are observing in the US today.

But, you say, this just proves that globalization is a bad thing. Well, not exactly. There is another side to the Stolper-Samuelson Theorem, pointed out by Paul Ormerod and Xavier Sala i Martin, and cited by Tim in this way:

"Globalization is raising the incomes of the workers in the poor countries (over and above what is happening as the countries develop) because of the trade off inherent in the model."

This again is also what seems to be happening today. Poorer countries are seeing their people's standard of living rising.

Perhaps the theorem is true, and the cost of this rise is the relative (and Tim emphasizes "relative") increase in the growing disparity between the wages of the rich and those on the bottom rungs of the wealthier nations.

The word "relative" is crucial here. Tim steps out of his scientific skin for a moment and permits himself to express his own human value judgment. I can't say it better than he does:

"Those poor who are getting richer in other countries are not moving from one level of luxury to a slightly higher one. They are moving from destitution, from not knowing where the next meal is coming from, to something close to a middle class income. They are doing this in their hundreds of millions, across the globe, and that has to be a good thing."

At the same time, those in the US who are feeling a slight pinch in their purchasing power are having to forego a second house, a third car, and the latest flat screen. They've already got the two cars, the cell phones, three TVs, a very comfortable living space, and a job, for the most part (at least 95.5% of the work force), and I'm talking about those people described as poor in the US statistics, i.e. under the poverty level. Anyone above that limit probably has the flat screen already, and they're probably only complaining because they can't meet the payments on the vacation condo since the adjustable rate mortgage went up. Maybe they've had to change their vacation plans and make a reservation in a three-star hotel in Hawaii instead of the five-star they would have preferred.

There is only one thing that Tim doesn't mention, and I will bring it up because I am not a scientist and I can say whatever my unscientific little heart desires on this blog. I think there is another factor contributing to this income disparity, and it is the ballooning of global liquidity that we also think we perceive today ("we" being some economists, other bloggers, and myself.) See my article at Prudent Bear, republished here, for a detailed discussion of my vision of this phenomenon. (The article is entitled "If these are bubbles, where is all that hot-air money coming from?" Go to the December archives.)

In short, I believe we are experiencing inflation of the US dollar and of other currencies like the yen that are invested in US dollar instruments, and that this excess credit has risen to the top without passing through the middle and lower classes and without showing up in the CPI.

So as of today, thanks to Tim, I believe there are two factors at work here, first the Stolper-Samuelson Theorem with the Ormerod and Sala i Martin aftereffect, and second, "inflationary" (although not perceived as such) and therefore excessive global liquidity.

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