Can You Spot the Billionaire?
Income Inequality in America Is Irrelevant
A Canadian student once confessed to me the confusion and anger he suffers whenever any of his friends move to the United States. I asked him why he feels this way. He replied that he “could never live in a country with such a high Gini coefficient.”
The Gini coefficient is a measure of income inequality. The higher is a country’s Gini coefficient, the greater is the inequality of incomes earned in that country. It says nothing about people’s absolute material well-being or about mobility among income groups. It is merely a snapshot of current differences in people’s monetary incomes.
Recently I attended a seminar that prompted me to recall this Canadian’s remark, and to shake my head at its irrelevance.
At this seminar a George Mason University graduate student presented his research on economic development in the Philippines. In the audience were college professors, graduate students, and a bona fide American billionaire. At some point during the student’s presentation I realized that had I not been told that the billionaire (let’s call him Mr. Bucks) was, in fact, a billionaire, I would have had no inkling that a person of such enormous wealth sat in the room.
It’s not that Mr. Bucks was shabby or unkempt. On the contrary, he wore a nice suit and a nice watch, and had a nice haircut. The reason he was not distinguishable as a billionaire had nothing to do with his own appearance; it had everything to do with the appearance of the other 25 or so people in the room. Everyone was as well-dressed and groomed as he was.
Take the graduate student making the presentation. His suit, his watch, and his haircut were also nice. In fact, just looking at both men indicated no difference at all in the quality of their dress, jewelry, or grooming.
It’s true that Mr. Bucks likely paid much more for his clothing, jewelry, and grooming than the graduate student did, but such expense is barely visible to the naked eye. One way to detect the wealth differences would have been for me, say, to feel the weave of Mr. Bucks’s suit and compare it with that of the graduate student. Mr. Bucks’s suit probably would have felt finer.
Another way to detect wealth or income differences would be to rely on rather abstract knowledge. For example, had I examined Mr. Bucks’s wristwatch up close, I likely would have learned that it was a Patek Philippe or a Rolex. The graduate student, in contrast, probably wore a Timex or a Swatch. The only reason, however, that “Patek Philippe” and “Timex” provide information about the value of these items is that we know, mostly through advertising, that a Patek Philippe is very expensive and a Timex isn’t. A visitor from Mars could have drawn no such inference from the brand names on the watches; he would have simply noticed that both keep time with the same remarkable accuracy.
An even more abstract piece of knowledge could have been produced by my corralling one of the graduate students into doing a quick survey and using the findings to calculate the Gini coefficient for the occupants of the seminar room. It would have been large. Reading this Gini coefficient would then have revealed (to all who know about Gini coefficients) that the incomes earned by people in that seminar room were quite unequal.
But again, none of the very real differences in incomes that separated people in that room were visible.
Contrast this fact with life in countries less infused with capitalism. As I sat in the seminar room with Mr. Bucks and others, the graduate student presenting his research showed pictures that he took in the Philippines. One picture was of shanty homes built literally on garbage heaps. Other pictures were of the occupants of these homes, often standing beside other Filipinos who were a bit wealthier.
Vast Differences
The wealth differences separating these desperately poor garbage-heap dwellers from their more-fortunate countrymen were evident to the naked eye. These very poor Filipinos wore clothing that, even in a snapshot, was clearly inferior to the clothing worn by Filipinos of greater, if still modest, wealth.
And importantly, even Filipinos who enjoyed this modest wealth wore clothes that were noticeably cheaper than those worn by one of the wealthiest people in that country, Imelda Marcos. While in the Philippines, the graduate student met Mrs. Marcos and had his picture taken with her. Her dress would not have distinguished her on any American street, but it was visibly superior to that worn by any other Filipino who appeared in the pictures we saw at that seminar.
It’s when I noticed this fact that I scanned the room and realized that the wealth differences separating Mr. Bucks from everyone else (and separating us professors from the graduate students) were invisible. This fact about capitalist society is remarkable. Hefty differences in money income and wealth do exist in capitalist societies. But the consequences of this inequality on actual material standards of living are so small that they are largely invisible. For most of the features of our routine existence—our dress, personal cleanliness, and access to basic health care, such as vaccines, vision correction, pain relief, and first aid—almost everyone in capitalist society is equal. (I noticed that Mr. Bucks swallowed two Bayer aspirin just as the seminar began. Bayer is the brand I use when I have a headache.) The differences in these everyday aspects of life that do distinguish people of different wealth levels are minor and largely unobservable.
I don’t want to push this point too far. I’m certain that Mr. Bucks has several homes, each one far grander—and visibly so—than any place the typical American will ever live. I’m sure that he drives an automobile that is much nicer than most, and that he drinks finer wine and eats at fancier restaurants than do ordinary people. And Mr. Bucks never worries about how he’ll pay his bills if he loses his job.
But the fact remains that in many of the basic elements of life, nearly every American is as well off as Mr. Bucks. If wealth differences between billionaires and ordinary Americans are barely visible in the most routine aspects of daily life, then to suffer distress over a Gini coefficient is to unwisely elevate ethereal abstractions over palpable reality.
Comment by Bruce D\'Amrosio on 27 May 2009:
For me, the serious issue is not wealth inequality, but the potentially correlated opportunity inequality. Wealth inequality tends to be associated with rigid, plutocratic or oligarchic, political establishments focused on preserving the status quo, at least in the common mindset. And that is, in fact, a loss for all in the long run, including the wealthy.
Intuitions tend to be guided by \"usual\" correlates of the particular point at issue. Even if from a more rational perspective that is fallible reasoning, it seems to me an essentially cautious, justifiable, practice.
On the other hand, forced mediocrity (\"we\’re all above average, don\’t anyone try to stand out\") also squashes initiative and guarantees sub-optimal results for all. I believe only a tiny fraction of the companies that were founded in the last 25 years and grew to international prominence were founded in Europe/Canada combined, which I imagine has a comparable level of population, education, and financial resources to the US, but a much lower Gini coefficient
Again, just a correlate, but interesting.
Comment by pete on 27 May 2009:
maybe the wealth inequality was not apparent because everyone in the room comes from the upper half. Do you think the differences would have been so invisible if members of the bottom ten percent were in the room with mister top ten percent? Income inequality is not an issue for the middle class, just the upper and lower. You had no lower in your article, and so i take your point as null.
Comment by Mat on 27 May 2009:
Pete, but where isn’t that the case? And what is your solution? Tax the upper class to the point where they’re middle class and so are the poor? The real point is that the if quality of life of the lower class of countries with high Gini is much better than the quality of life in those countries with low Gini, who cares? The US’ Gini is 10 points higher than Benin’s, but are we going to argue where the quality of life is better?
I feel that these statistics are completely irrelevant and jealousy driven or maybe Marxist driven and this is coming from someone who is middle class.
Comment by Mark on 27 May 2009:
Pete,
I agree with you in that it is likely that the audience in the speech that Mr. Boudreaux attended probably did not equally represent all social classes.
For instance, there were probably very few from the immigrant class of what much of the unskilled labor sectors are made of. These immigrants probably make a much less than what most members of that audience make per year, or their parents.
But it is noteworthy to point out that these immigrants come here for a step up and for opportunity. An immigrant comes to America to earn an income he could not earn in the Philippines, Mexico, or wherever he may have come.
As Don points out, American society is less stratified than just about any other nation on earth. The immigrant working menial labor has chances to move up in america. His children have even better chances.
These opportunities do not exist for the immigrant class or their children in their native lands. that’s why they come here.
Comment by Thucydides on 27 May 2009:
The obsession with equality, very much a part of our culture, seems strange to anyone who thinks about it in an objective manner without prior commitment. Who cares if Bill Gates has more money than Warren Buffett, or that both of them have much more than the rest of us? How does their wealth adversely affect anyone?
It is reasonable to be concerned that some people do not have enough to lead reasonably decent lives; beyond that, why should anyone care? I presume this comes from economic ignorance, i.e., the zero sum thinking typical of primitive society, in which the fact that someone has something is assumed to be the reason someone else does not. Also, I believe rationalized envy is at work. Envy is such an ugly emotion that it has to be disguised as compassion. So you see this great concern about wealth, as opposed to a more realistic and rational concern about those who lack minimal resources for a decent life. To repeat, it is not difference (“gini coefficient”) that should be of concern.
Comment by Bill on 27 May 2009:
Here’s an interesting piece re income inequality vs. consumption inequality. http://mjperry.blogspot.com/2008/02/consumption-equality-7x-than-income.html
Comment by Sampath on 27 May 2009:
Yes, I think there should be another coefficient for “consumption inequality”, if that ca n be measured. The socialist and communist countries will win (?) hands down.
When economists “worry” about Gini coefficient , their main concern is of some countires where 30 to 40% of the populace have no second meal a day.This unfortuanetely is not addressed by any econiomist or politician anywhere in the world.
Comment by Dave on 27 May 2009:
So long as “Mr. Bucks” didn’t acquire his wealth by fraud, coercion, or unfair government policies, not only does it not bother me that he’s a billionaire, he most likely has enriched the lives of many along the way. Perhaps he invented some device or software that made workers more productive, or opened a chain of restaurants at which people enjoy eating, or built houses for people to live in. At any rate, he’s made his money by providing goods and services other people voluntarily chose to buy, and most likely some people who’ve worked with him or invested in him have made money as well on his ventures.
That he’s a billionaire makes no difference to me whether I make $25,000 a year, $100,000, or $1 million — despite the difference in “Gini factor”.
Prosperity does not come from government confiscated the property of one to give to another, it comes from voluntary exchange.
Comment by Ted on 28 May 2009:
Well said, Dave!
Our notions of wealth are left over from a time when the rich – the nobility – attained their wealth by confiscating it from the producers – the peasantry. In a capitalist democracy, however, those roles are exactly reversed: the wealthy ARE the producers, while the masses can vote to confiscate – or “redistribute” – the producers’ wealth.
Back when Robin Hood stole from the rich to give to the poor, what he was really doing was retrieving wealth from the taxers and returning it to the taxed. Times have changed, but our thinking hasn’t yet caught up.
Comment by Commodore on 28 May 2009:
“A visitor from Mars could have drawn no such inference from the brand names on the watches; he would have simply noticed that both keep time with the same remarkable accuracy.”
Actually, it’s worse than that. Since the Patek Phillipe or Rolex was would have been an automatic mechanical watch and the Timex or Swatch would have had a quartz movement, the Timex or Swatch would have likely been _more_ accurate than the expensive one.
Comment by Hunter on 28 May 2009:
Matt, ‘what is the solution?’ There is no ‘solution! The point of the article is simply that capitalism plays a part in a society’s evolution.
Personally, I find this article mostly irrelevant because it places ‘material value’ as a virtue, and makes no claim to debt, which I’m sure many of those ‘visually equal’ professors and students are in up to their eyeballs. ‘Debt spending’ is a big part of why many Americans live the lifestyle we do.
Comment by Charles N. Steele on 28 May 2009:
Great stuff, a particularly nice little analysis! Glad you just cited it on Cafe Hayek.
I’ve seen similar examples in Russia, Ukraine, China, and West Africa; I’d not want to be in the bottom half in those places.
Conversely, the lower middle class immigrant neighborhoods I lived in in NYC were well under the average, and the lifestyle was pretty comfortable, and I enjoyed it.
Comment by Kilgore Trout on 28 May 2009:
My understanding is that the discipline of economics intends to understand and explain (among other things) consumer behaviour. Instead, the article above argues that consumer behavour is irrational and hence, inferior to elegant economic models. Ivory tower indeed. For better or worse, real consumers care deeply about relative incomes and wealth levels, to argue otherwise is pure nonsense and raises the question of who exactly is being irrelevant here.
Comment by Wally on 28 May 2009:
Thucydides and Dave: spot-on.
But Trout, who was arguing that consumers don\’t care about relative incomes? I thought the article and the discussion thread were both pointing that too many people do care about the Gini coefficient (whether or not it\’s referred to as such) and commenting on the the wrong-headedness of this. These people should be less concerned with the wealth of others when that level of wealth/status/timepiece snaziness has no deleterious effect on anyone else. Had Mr. Bucks\’s wealth been produced by slaves or been stolen, or otherwise acquired in a socially unacceptable manner, I would agree that we should detest him and figure out some way to take this booty back from him to be redistributed, but even then only to those he caused to suffer.
Comment by pacific_waters on 28 May 2009:
Obviously the commenter doesn’t understand the coefficient and the various ways it can be interpreted. That is the danger of partial knowledge or as has been said “They know enough to be dangerous.” I suppose he/she could live in India or Pakistan or various sub saharan countries as well some fo the more prosperous Scandinavian or European countries. I am quite happy the graduate student wants to stay in Canada. We have more than enough redistributionists, than you very much.
Comment by tim on 28 May 2009:
Wouldn’t the graduate student be in the bottom 10% of income earners?
Comment by Alice Temnick on 28 May 2009:
I am grateful to live in a country where entrepreneurship is rewarded, where “Mr. Bucks” can prosper and where movement throughout the quintiles of our Lorenz Curve is dynamic.
Comment by Libertarian on 28 May 2009:
This reminds me of what Milton Friedman used to say……that the very rich always live well, it’s the middle class and the poor who benefit so much more from capitalism and free markets. A middle class denizen today in the U.S. has much more wealth, free time, fun, and toys than an average rich guy of a hundred years ago. The poor of socialist countries? Not much difference made in those hundred years.
Comment by Libertarian on 28 May 2009:
Frankly, I don’t understand how there can even be a serious disagreement on this issue. Other than feelings and gut instincts, where is there ANY evidence that a smaller Gini coefficient is better? I have a friend whom I once asked a long time ago, in college, if it was better to have half the people poor and half the people rich, or to have all the people poor. She thought only a moment before saying that having all the people poor was preferable. Now what is the reason for such an answer? An instinct for fairness, perhaps? It certainly isn’t reason! If anyone here agrees with her, please tell us why.
Comment by Susan Lee on 29 May 2009:
\"The Capitalist achievement does not typicaly consist in providing more silk stockings for Queens, but in bringing them within the reach of factory girls and in return for steadily decreasing amounts of effort.\"
Joseph Schumpeter
Comment by Catherine on 2 June 2009:
Libertarian: I have met many people making the same choice she made. What seems to be the main reasoning behind such an approach is that these people focus on equality as uniformity. For them equality in front of the law or equal opportunity are not enough because they feel that people are born different (meaning unequal) and that it is unfair.
Furthermore I guess from what I heard that envy is the other explanation. The idea that they could be in the bottom half is so upsetting to them that they consider perfect uniformity a better option. My sister once made an argument for government controlled monopoly because she could not stand the idea that some people could pay less than her for similar service (now she has changed but she was very serious at the time).
In addition by choosing poverty for all they appear to be willing to be poor themselves and therefore be compassionate.
This type of reaction is distressing but it does not seem that reasonable arguments are effective.
Comment by Ben on 27 June 2009:
Once people understand that income is earned and not distributed, many of these false worldviews will go away.
Comment by Sebastian Franck on 21 July 2009:
In 2005 the Danish Minister of Welfare (Social Minister), Eva Kjer Hansen, of the socalled Danish Libertarian Party, said in an interview that she did not value equality in itself and that the Danish society could use a little more inequality to the benefit of rich and poor alike. The uproar and outrage was deafening! Her boss, the prime minister, reprimanden her and said that “it is not government policy to heighten inequality in our society.” Every other party and most pundits distanced themselves and attacked her for being callous and cynical. Soon after she withdrew her statements. (http://www.berlingske.dk/article/20050921/danmark/109210798/ – Article in Danish!)
Now that’s what you get in the world’s most equal society if you utter a view like this.
Btw – the Danish Gini-coefficient was 24,7 (USA: 40,8) in 2006 and average GDP per citizen was 35,125 PPP USD (USA: 43,968 PPP USD). I wouldn’t mind a slightly different tradeoff than that, myself.
Comment by erp on 21 July 2009:
Real life example of why we may be wrong about material things not mattering.
A relative from a Soviet bloc country emigrated to New York about 25 years ago. He was a Moscow educated urologist — chief of staff of a large hospital. Here he had low level job in a hospital and lived in a working class apartment in Brooklyn. Yet he was the most upbeat person I’d every talked to.
He was fascinated with everything. He couldn’t believe that everybody could afford to have cars, appliances, nice clothes, etc. Everybody in his country thought the American life style they saw on television and in the movies was propaganda and that we really weren’t better off than they.
When I said I was sorry he didn’t live in a nicer neighborhood, he said with great emotion, that I didn’t understand. His apartment was like a palace compared to his apartment in his home country where everything was dirty and dreary and all the people were hopeless.
You know, the kind of place where the Canadian student quoted in the first paragraph would have been delighted with the Gini coefficient.
Comment by Milton Recht on 21 July 2009:
Unfortunately, most people who recite Gini coefficients do not understand the peculiarities and limitations of using it in international comparisons, especially for a geographically large country like the US with a diverse population and economic opportunities.
In The US, there are large regional cost of living differences. For example, the cost of living in San Francisco is much higher than living in Des Moines. Local wages reflect these regional variations and cause the Gini coefficient to rise. In both cities, residents may have an equal standard of living and the Gini in each city could be low, but produce a higher Gini when the two populations are combined. EU countries are much smaller and have a much lower regional cost of living variation than the US. The Gini for the entire EU, without making adjustments for other problems discussed below, gets much closer to the US Gini. I believe .37 for the entire EU versus .46 for the US. It would be even closer if the adjustments discussed below were made.
Since Gini coefficients are computed using income at a point in time and not lifetime income, countries, like the US, with a higher number of new entrants into the workforce, due to immigrants, graduating students, mothers returning to the workforce, etc., will produce a higher Gini. A higher replacement birth rate, such as in the US versus some EU countries, raises the Gini number.
Likewise, there will be a higher Gini, if there are more opportunities to increase one\’s income over one\’s lifetime in a country, such as in the US, through business ownership, additional education, job promotions, experience, etc.
Investment income is not included in international Gini numbers. Retirees and others using investment income, make the Gini look higher in their countries. In countries with greater reliance on government retirement pensions, the Gini will be lower, especially if the government funds are counted as income.
Some countries count government transfers and benefits as income, e.g. France. However, the US does not. Also, some countries give money as benefits, which count as income, while other countries give goods or vouchers (food stamps, etc.), which do not count as income. The US Gini is higher than in EU and other countries that count their government programs as income or give cash.
The number of income data points influences the Gini coefficient. A country that measures its income distributions at quintiles (every 20 percent) will likely produce a different Gini number usually lower) than if it measured its income distribution at every 5 percent level.
Similarly, household Gini is lower than individual Gini in a country. Gini depends on whether one looks at household versus individual income.
The most troubling aspect of the Gini coefficient is that it makes the natural distribution of income and wealth in a country look bad. Income, wealth and many other of life\’s happenings follow a power law distribution. It is called a Pareto Distribution after his economic observations of this distribution.
It is more commonly known as the 80-20 or 70-30 rule. Many things in life approximate this type of distribution. Twenty percent of criminals cause eighty percent of crimes; twenty percent of drivers cause eighty percent of accidents; people wear twenty percent of their clothes eighty percent of the time; twenty percent of a company\’s customers account for eighty percent of sales, etc.
Income and wealth naturally follow an 80-20 rule. Twenty percent of people produce 80 percent of the income and wealth in a country. In a capitalistic society, with few limitations on individual advancement, education and entrepreneurship, income will follow an approximate 80-20 rule or Pareto distribution.
Economically free countries naturally will approximate the 80-20 rule and will produce a higher Gini coefficient than countries that restrict and limit economic advancement and entrepreneurship. A typical power law (Pareto distribution) for 80-20 percent income in a country will produce a Gini that seems high, about .35 to .5 than in countries that limit advancement and business opportunities.