Monday, November 14, 2011

Is There Really US Income Inequality & What Exactly Would Be Its Impacts?

Some months ago, I had a discussion with a friend regarding income inequality. Being a systems engineering consultant primarily working with he military and its suppliers, he cited an author who claimed that significant income inequality had presaged the fall of great powers in the past.

Currently, the Occupy Wall Street crowd focus on income inequality, screaming about the "1%" versus the "99%."

Income inequality is often measured via some variant of the Herfindahl Index, described in that linked source as it applies to its original subject, market share concentration,

"It is defined as the sum of the squares of the market shares of the 50 largest firms (or summed over all the firms if there are fewer than 50) within the industry, where the market shares are expressed as fractions. The result is proportional to the average market share, weighted by market share. As such, it can range from 0 to 1.0, moving from a huge number of very small firms to a single monopolistic producer. Increases in the Herfindahl index generally indicate a decrease in competition and an increase of market power, whereas decreases indicate the opposite."

As applied to incomes, one simply substitutes that variable for market shares. The principle is the same.

However, regardless of how one measures income concentration, the question is the same: what exactly are the impacts of various levels of income equality or inequality?

I can't answer those questions, because I don't have primary research data to support any specific response. But the constant harping by many liberals on this question causes me to ask three more related ones:

1. What would be the empirical relationship, were we to have the data to assess it, between income concentration and periods of human innovation and growth in average standards of living?

2. What were US income concentrations in past eras? Particularly, for example, after the Revolutionary War, during the pre-Civil War era, then 1880s-1890s, and the early 20th century?

3. What are the percentages of various income levels that change to higher or lower levels through time?

Let's take the first question. What I'm attempting to get at is the phenomenon of capital accumulation and its effect on civilization. Whether it involves infrastructure such as roads, dams, water provision, sewage or art, such non-subsistence-level human activities require capital. And capital comes from savings, which is, definitionally, the positive difference between production and consumption.

If a society doesn't have capital accumulating, it's not going to advance on any significant dimension. Historically, unless you sign up for hereditary monarchies or feudalism, capitalism is the economic system which has done the best job combining merit-based wealth accumulation and the ability of a society to accumulate capital for which allow investments that, over time, improve general standards of living.

Specifically, in the US, I'd love to know the answer to the second question. Has the US experienced major changes in income concentrations over these eras? What do you think income concentration was like before the middle class ushered in by the Industrial Revolution?

Further, what does it say about US income concentration that Steve Jobs, Bill Gates and Mark Zuckerberg, none of whom apparently completed a four-year college degree, all became billionaires within the past two decades? And Larry Page and Sergey Brin, the co-founders of Google, did so within the past several years, though they finished college.

It appears that the potential for Americans to create wealth for themselves still exists. Perhaps not all are created equal and, thus, incomes won't ever be equal. Or perhaps some of the now-vocal 99% are simply lazy, or have made poor career choices.

Thirdly, from years in business, and my own proprietary equity research, I'm rather distrustful of simple static analyses. Simple static pictures of US income concentrations aren't as useful, informative or actionable as would be quintile-quintile migration tables for US incomes. Or any of several other ways of depicting the dynamics of US income concentration among specific groups of Americans.

What percent of the current top 5% of US income earners are children of similar income earners? How many years, on average, do people remain in a particular income strata?

The existence of Jobs, Gates, Zuckerberg, Page and Brin tell us that it's still quite possible in America to vault from median income to substantial wealth, even to the level of the top 1% of American incomes, in just a few short years.

So we know that US income mobility is still alive and well. And, really, that was one of the fundamental purposes of our nation's founding. You know, that old line,

", liberty and the pursuit of happiness...."

If, as I hypothesize, the early days or our Republic were marked by greater income concentration than that over which people currently Occupy parks in various US cities, perhaps they weren't all that discouraged. After all, having liberty was not a trivial thing. And still isn't.

And the pursuit of happiness was, for many homesteaders both before and after the Civil War, the ability to have and work their own farm or business, regardless of its economic prosperity.

It seems to me that we have far too little evidence of a problem with the dynamics of US income concentration at this time. There will always be a lower echelon of income earners. And, if I'm correct in my hypothesis about the early years of our nation, income disparities didn't prevent people from immigrating to America- it spurred it. As it has until very recently, when the economic growth of the nation began to slow.

How people got to an income level, and for how long, on average, people stay there, and how many rise, is of more interest in determining both if there is a problem in the US with income concentration, and what to do about it.

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