Inequality: What If No One Has Any Idea What They’re Worried About?

Lots of economists are talking about a working paper that has just come out. Often these can be downloaded for free, but sometimes they are behind walls and cost money. SUU has no budget for this, so as I write this (June 5, 2013), I’m going from quotes rather than the whole paper.

The paper is by Gimpelson and Treisman and is called “Misperceiving Inequality”. What they did was go out and assess 1) whether peoples’ subjective perceptions of inequality matched up with objective measurements, and 2) which was more important for the political itch for income redistribution — subjective beliefs or objective measures.

So, what do people know?

Higher inequality is thought to increase demand for government income redistribution in democracies and to discourage democratization and promote class conflict and revolution in dictatorships. Most such arguments crucially assume that ordinary people know how high inequality is, how it has been changing, and where they fit in the income distribution. Using a variety of large, cross-national surveys, we show that, in recent years, ordinary people have had little idea about such things. What they think they know is often wrong. Widespread ignorance and misperceptions of inequality emerge robustly, regardless of the data source, operationalization, and method of measurement.

And, how is that related to policy pressures?

Moreover, we show that the perceived level of inequality—and not the actual level—correlates strongly with demand for redistribution and reported conflict between rich and poor. We suggest that most theories about political effects of inequality need to be either abandoned or reframed as theories about the effects of perceived inequality.

Those are quotes from the publicly available abstract. Bryan Caplan, writing at EconLog, has a university that actually supports professors reading new stuff that isn’t free. He quotes extensively from the article itself.

The actual poverty rate correlates only weakly with the reported degree of tension between rich and poor; but the perceived poverty rate is a strong predictor of such inter-class conflict.

Given 5 choices, could survey respondents identify the level of inequality in their own country?

Respondents turn out to be wrong about their country's income distribution most of the time. … Respondents worldwide were able to pick the "right" diagram only slightly more often than they would have done if choosing randomly.

Basically, perceptions of inequality are a multiple choice test on which respondents know so little they can’t even narrow down the choices to make a better guess.

But, inequality can follow a progression from more even to less even, so maybe respondents showed some inkling of what’s going on:

Were most people at least close? To check this, we examined what proportion of respondents were within one diagram of the correct one (for instance, if the correct diagram was B, we measured how often the respondents picked A, B, or C). With only five options to choose between, getting within one place of the correct option is not a very difficult task. … they were right 69 percent of the time, just one percentage point better than if they picked randomly.

So, perceptions are about as accurate as guessing the other player’s move in a game of rock-paper-scissors-lizard-spock.

It’s actually worse than that: quite a lot of the time peoples’ subjective perceptions of inequality are often negatively correlated with objective inequality. This is really bizarre: it’s like watching a game and thinking your teams’ turnovers are actually helping them win.

But, it’s even worse than that. No one thinks they’re rich themselves.

Owning two houses is usually a sign of wealth. … At most one in four respondents said that his or her family owned a second residence, and in all but three countries the frequency was less than one in six. Yet most such property owners did not consider themselves especially rich. On average, 60 percent of the secondary residence owners placed themselves in the bottom half of the income distribution. … Such anomalies were somewhat rarer in the developed countries. Still, in France, Italy, and Great Britain, 40 percent or more of second residence owners placed themselves in their country's bottom half.

I could actually put myself in that category. When I was a kid, my parents owned a second home at a summer resort. Now, this was mostly an income property that got rented out … but we spent 2 weeks there every summer too, plus innumerable warm weekends in the spring and fall when my parents worked hard on upkeep and repairs (albeit, in a pretty nice environment where they could relax quite a bit too). I never thought of myself as rich; heck, I still think of my upbringing as middle, or maybe even second quintile from the bottom. I must be some kind of idiot: I make far more money than my dad ever did, plus my wife works, and we’re nowhere near affording a second house.

But it gets even still worse. Check out this chart:

Actual objective improvements in inequality are towards the right, while subjective perceived improvements in inequality are going up. They’re not even positively correlated: when things actually get better people think they’re getting worse. This is like a Patriots fan being upset that they’ve just intercepted the Seahawks on the goal line at the end of Super Bowl XLVIII.

WTF?

And we base policy on this!

How’s This Expansion Doing?

I pulled an interesting graphic from an article about the weakness of the current expansion.

There’s a lot here, and not all of it is good (plus, no graphic designer would ever encourage using the vibrant colors). The colors are there to help the viewer keep track of years by going in a ROY G. BIV ordering, except with darker and lighter gray substituted for the R and the O, and with them totally ignoring indigo because … well … everyone else does, or something like that.

Anyway, what I really liked was the panel at the bottom left. This shows the cumulative real GDP growth after each trough since the late 1940’s.

One note of caution: the white area at the right of some of the bars shows all the growth for years past the 6th one. So, there’s only three expansions that went that long, but for each of them there was still significant growth … and under Clinton it was almost half of the growth from the expansion.

What’s the takeaway from that panel? First off, the partial rainbow of colors shows that this expansion is already longer than most of them. Second, the cumulative growth in this expansion is particularly weak: the expansions that weren’t as strong as this one were weak because they were already done by this point. Third, there really isn’t a sense that this expansion is weak because it was weak at one particular point. It’s been weak throughout.

And that’s an important point. I tend to be an apologist for the Obama record. It’s not great, but it’s on the low end of normal, and good enough to stay let’s wait and see. But a graph like this emphasizes my feeling that the longer we go with that story, the harder it becomes to rationalize. The pervasive weakness with each passing year suggests that there’s something holding the economy back over the medium term that just isn’t going away, and wasn’t there before Obama came along.

This is drawn from an article entitled “Economy Picks Up But Stays In It’s Rut” which appeared in the July 31 issue of The Wall Street Journal. The charts came from a companion piece entitled “Six Year Checkup”.

Prosperity

This map of the Legatum Prosperity Index gives a good summary of what macroeconomists mean when they talk about rich and poor countries, or developed and developing countries.

I believe this is for 2013 (or 2012): for later years I couldn’t find the map in a standalone form. You can go to prosperity.com where they have interactive versions if you want greater detail.

This hits the right notes though. The dark countries are rich and/or developed. This is the U.S. and Canada, western Europe, Australia and New Zealand, and Japan and South Korea. South Korea is the newest addition to the list. Singapore is probably on there, but too small to see. Taiwan should be on there, but China bullies them, lowering some scores. Israel would be on there, but gets marked down for safety and security due to terrorist threats and actions. They’ve put a couple of Persian Gulf countries in this group, which is OK, but I wonder if the whole society there feels like they’re living in a developed place. Lastly there’s Uruguay. This country is doing OK, but that shading is driven a lot by huge decreases in the enforcement of drug laws there over the last few years. I’m not against that, but I think it might be overrated. I think Chile is better developed top to bottom. Italy probably should be included in the dark blue group; this may be an effect of the poorer southern parts outweighing the richer northern parts.

The light blue is the countries that are doing pretty well. The orange countries, not so well. The red ones are doing poorly.

And don’t forget about the gray countries. They’re labeled as “No Data”. Typically this means they don’t collect or don’t report the data that underlies this index. Often, this is because of mismanagement: if you’re a kleptocrat, no one can tell what you stole if no one is measuring it. So some of these are places that just don’t cooperate with anyone (like North Korea and Cuba), kleptocracies (like Myanmar/Burma, or Turkmenistan), some are failed states (like Somalia and LIbya), some are too new (like South Sudan or Papua New Guinea), and some are still colonies (like Greenland, or Western Sahara).

N.B. There’s a statistical fact that you can’t rank, say, n items if you have less than n pieces of data. The most familiar example of this is college football rankings; who’s the best if South Florida beats Notre Dame, Notre Dame beats Michigan State, and Michigan State beats South Florida (this is the example that I found with many seconds of searching on the google, but it happens a lot). We also see this in things like U.S. News and World Report’s famous ranking of colleges. And we see it in things like this prosperity index. We work around that by assigning weights to the different components, and then taking a weighted average. The thing is, if a different person makes up the weights, it can yield a different ranking. Just keep in mind that you’re really looking for plausibility, rather than definitiveness. So, when I say Israel should be higher and Uruguay should be lower, that’s a personal opinion … but don’t presume that the numbers say that’s not correct just because we used one websites weights.

Recessions Are Uneven

This graphic is a little dated, but it illustrates a point I have to make every time we suffer through a new recession: business cycles are not geographically even.

I’m most interested in the top two panels. The top one shows a hallmark of the Great Recession of 2007-9. It was primarily two areas: 1) the west coast, and 2) a diagonal from the midwest down through Florida. That’s not to say that other areas weren’t hurting, but the 10% cutoff for shading emphasizes who was getting it the worst.

Flash forward five years, and there have been big improvements (it’s normal for it to take several years). The midwest and southeast are largely healed. The exception is the smaller urban areas in Illinois (think reruns of Roseanne to get a feel for those places). Illinois has been very badly run for decades, and this supports that. Most of the west coast is doing better too. The exception is the central valley of California, and this may be due to ongoing drought.

And, even when the economy is doing well, there are always pockets of poor performance: 1) south Texas is habitually weak, 2) I’m not sure what the problem is with that area of Arkansas, and 3) the shading in southern New Jersey is the collapse of the gaming industry their due to competition from other areas (you may have heard of Trump closing his casinos there).

You can read the whole thing, entitled “Help Wanted Signs Are Popping Up in U.S. Cities” in the April 28, 2014 issue of Bloomberg Businessweek.

Why Is Macro So Hard? What Passes for Expert Advice

How about a man who is taken seriously because of his economics credentials, who turns out to have made the whole thing up?

Yes, there may be a tendency for the American student do dismiss this big of news because it’s from Portugal.

But the big picture is that he said what people wanted to here … so they didn’t ask questions about whether he was qualified or not.

Mr Baptista da Silva's conversion into the latest must-interview figure on the media circuit began when he turned up last April at Lisbon's main philanthropic institution, the Academia do Bacalhau, with a large supply of business cards – which, it later turned out, bore false credentials – and an impressive-sounding dissertation entitled Growth, Inequality and Poverty. Looking Beyond Averages which, it also transpired, was "borrowed" from its writer, a World Bank employee, via the internet.

At the time, Mr Baptista da Silva also claimed to be a social economics professor at Milton College – a private university in Wisconsin, US, which actually closed in 1982 – and to be masterminding a UN research project into the effects of the recession on southern European countries. He even, some reports say, tried to pass himself off as a former adviser to Portugal's President, Joaio Sampaio, and the World Bank.

Blessed with such an impressive CV, Mr Baptista's subsequent criticisms of the Lisbon government's far-reaching austerity cuts, as well as dire warnings that the UN planned to take action against it, struck a deep chord with its financially beleaguered population.

According to the Spanish newspaper El País, his powerfully delivered comments at a debate at the International Club, a prestigious Lisbon cultural and social organisation last month, were greeted with thunderous applause and a part-standing ovation.

Now, here’s the part to pay attention to.

Portugal is one of the PIIGS: the Eurozone countries that got into really deep trouble in the Great Recession. Portugal followed directions from outside experts, instituted austerity programs, and is doing OK these days. Portugal is a poster child for what Greece should have done, but which it has gotten away with not doing … in 2010 … and again in 2012 … and a third time in 2015 … as the bailout money keeps rolling in.

This imposter did not take the pro-austerity side. Instead, he was taking the populist view, which I sometimes characterize as the spoiled teenager position, that Portugal is in trouble because it blew the last bag of money we gave it and so the only solution is to give it a new bag of money. Maybe even a nicer bag too.

I’m actually not necessarily against that position. Tough love is a difficult thing for anyone to pull off, or for recipients to accept. What I’m wholeheartedly against is people starting from the emotional position that they’re good, and therefore everyone else must be bad, and then gathering people through mood affiliation to hit the folks in the black hats up for more money.

Technorati Tags: portugal,economist,fake,resume,cv,why,macroeconomics,hard

The Sign Everyone Is Waiting For

The Obama expansion has been longer than average, but it’s also been weaker than average.

For most Americans, their last memory of an economy that really made everyone feel good was during Clinton’s second term. During those 16 quarters, the growth rate exceeded 1% (which annualizes out to about 4%) 7 out of 16 times, and the average over those 4 years was just a tad over 4% per year.

From the June 24 issue of The Wall Street Journal.

Why Institutions Matter

Serious economists talk a lot about institutions, and how they matter to well-being.

Not-so-serious economists — and in this group I’ll include politicians, bureaucrats, and most of the media and pundits — don’t talk about institutions much at all.

Why is that? What the heck are institutions? How could institutions make a difference to well-being? And how could some people “get it” while others do not?

Don Boudreaux has an absolutely stunning post at Café Hayek that may fill in some of the gaps in your thinking. I’m going to repost the entire thing here (sorry Don!).

Don’s post is a two-parter. You might find the first part a little boring and long-winded. Try not to. And I recommend re-reading it after you’ve read the second part, because it might make more sense then.

What Don is saying in the first part is that too many people, especially in positions of power, view well-being derived from economic outcomes as the result of solving some sort of engineering problem.

What the heck does he mean by that?

I’ll give you an example. Think of your smartphone, or the computer you use the most, or your home theatre system, or your car, or your filing or organizational system, or maybe your household’s financial situation and plan for the future. Got your example in mind? OK, then think of someone else managing their version of the same thing: their smartphone, their computer, their home theatre, car, their filing or organizational system, or their financial situation. And let’s think about those people: do you have friends that think if they just make one more tweak to that thing that their world will be all better?

My guess is that some of you are laughing to yourselves a little. Because we all know people like that. And I added the emphasis to “all” because I wanted you to think of that in the way that a parent might say it to a preschooler: “I’ll fix your boo-boo and make it all better”.

People who think this way (and we all do, just some to a greater extant than others)* are looking for an engineering solution to the problem: if we just keep tweaking it, eventually we’ll get it right.

And, unfortunately, many people double-down on that bit of bizarre human behavior by adding in some magical thinking. Something like, if I can just get my smartphone, or computer, or home theatre, or car, or filing system, or financial situation right, then everything else will fall into place. You know … people I find attractive will start finding me attractive first, and my dog will start listening to my commands, and their will always be a good parking spot when needed.

I’m not saying this is bad (and neither is Boudreaux). But we are saying that this is 1) very human, and 2) not always appropriate.

For example, football is the ultimate game for the engineering approach: endless drills on fixed patterns of play so that it will all work if everyone does their job at the same time. Except football teams can’t do that very successfully because there are always intangibles like team chemistry and home field advantage getting in the way. (WTF is home field advantage anyway? We all know it’s there, but WTF is it? Something in the water? No one knows … and that’s my point). So for a football coach, it’s very human to think that they can plan everything out, but not always appropriate to think that planning can produce the winning team they desire.

So, the first part of Boudreaux’s discussion is about what happens when people view the economy as an engineering problem:

Joan McDonald, a home-schooling mom, writes to ask if I can explain what we economists mean when we say that “institutions matter.”  I’ll give it a shot.

First of all, not all economists appreciate the role of institutions.  Economists who most ardently insist that institutions matter typical do so in order to counter the impression left by other economists – as well as by the many other people who are keen on guiding the economy less through market forces and more with central direction – that the economic problem is merely, or mainly, an engineering one.  Given all people’s tastes and preferences – given some known existing stock of capital, resources, and inventories – and given the current state of technology, the manner in which capital, resources (including labor), and inventories can be allocated in order to satisfy as many consumer desires as possible can be described mathematically.

Of course, the inconceivably immense number of such variables in reality means that no actual mathematical description – one with real quantities throughout – can in practice be written down.  What can be written down, though, is a description of the logic by which all the actual and given resources, inventories, and bits of capital must be allocated in order that the result is the satisfaction of as many as possible of the existing and given consumer preferences.

Such mathematical (or geographical, or even plain-word) depictions of the logic of ‘the economic problem’ makes this problem appear to be an engineering one.  Such depictions make central direction of the economy appear to be not only a plausible, but a preferred, method of ‘solving’ the economic problem.

Although there’s nothing inevitable in such engineering depictions of the economic problem that turns analysts’ attention from the role and reality of change, uncertainty, discovery, dispersed knowledge, and – most importantly – incentives, there seems to be something psychological in such depictions that has this attention-diverting effect on those who obsess over getting correct the formal mathematical description of the economic problem.

Those who ‘see’ the economic problem chiefly as an engineering challenge typically don’t think deeply enough about the available real-world conditions that can with the greatest likelihood of consistent success not only (1) approximate the best solution that can in principle be described mathematically with a set of given variables, but also (2) encourage and accommodate real and beneficial changes in the variables – changes such as occur, in the real world, in consumers’ preferences and in production techniques.  “Institutions” is the summary term for the set of real-world conditions that in fact govern how existing resources are allocated and the extent to which change is encouraged and accommodated.

Institutions can be “formal” – such as a particular government’s tax policy and occupational-licensing dictates.  Most institutions, however, are informal.  These are the rules of behavior that people generally obey even though these rules are not written down in the sovereign’s rule book and imposed formally.  They include the vast and intricate ‘constraints’ and expectations that are the evolved law and social customs and norms.  Some of these informal institutions reflect purely cultural happenstance (say, the fact that people today typically greet each other by shaking hands), while others reflect hard-wired human nature (such as the fact that each of us cares more about ourselves, our loved ones, and our friends than we care about strangers).

These formal and (mostly) informal ‘rules’ governing behavior combine with each other to influence the ways that each person in the multitudes of people in society act.  Some patterns of actions will produce ‘good’ overall economic outcomes; others will produce ‘bad’ overall economic outcomes – regardless of the formal details of the mathematical description of how resources can be ‘best’ allocated.  In other words, what actually happens in an economy is the consequence of institutions and not of the engineering problem that the economy faces.  The challenge – and it is a monumental one – is to get the institutions right; the challenge is not to describe in principle how best to allocate resources.  The latter task is child’s play in comparison to the former.

A good contemporary example of all this is Obamacare. A huge healthcare law about which the leader of the Democrats trying to pass it through Congress remarked “We have to pass the bill so you can find out what is in it.” That’s the engineering part. Now add a dash of magical thinking: we never passed this before because Republicans (who probably need to be wearing black hats in case people don’t get the message) wouldn’t let it pass, and Republicans continue to be the biggest threat to its success.

Of course, if you don’t like that example, we could use the 2003 invasion of Iraq and the plan for “nation building” put in place by the second Bush administration as the engineering solution. Then the magical thinking part is that the only way it could succeed was to keep the Democrats from getting elected and goofing it up.

But Boudreaux’s point is that this sort of thinking usually doesn’t work out well because institutions are more important to economics outcomes. Here’s the second part:

Pardon me if the above is unclear or too airy-fairy.  Let me end with a simple thought experiment.

Suppose that the rules of the economic ‘game’ are changed so that each household in America gets to spend, not the income that it earns, but only the income earned for it by some other household.  Each household is paired at random with another; no paired households know each other; they remain strangers to each other.  Let this be the only change in America’s institutions and economic landscape.

What do you predict will happen?  I predict that productive activity outside of each household will fall dramatically.  People will work fewer hours earning incomes at their jobs; they’ll invest far less in businesses and in financial markets; and they will display far lower levels of entrepreneurship in the market.  In turn, people over time will become much poorer materially.  People also will likely become less cosmopolitan as their engagement in commercial markets declines.  I predict also that there will be lower levels of formal schooling.

Note that in this hypothetical example the formal description of the ‘best’ way to ‘solve’ the economic problem isn’t changed.  People’s tastes and preferences are unchanged, and at the start of this social experiment America’s stock of resources, capital, and inventories is the same as it would have been had this social experiment not been launched.  Yet make this one change – which is an institutional and not an engineering one – and the economy’s performance changes greatly.

Of course, most institutional changes aren’t as dramatic as the one hypothesized here.  Therefore, the results of changes in institutions – good and bad – are more difficult to detect and to distinguish from other changes.  But even small changes institutions, we can be sure, affect the way the economy performs.

I think that example is almost perfect. What I would add is that the example needs to point out that while each family gets someone else’s production (because it’s transferable) they get to keep their own leisure (which isn’t). That’s really the key.

When we look around the world and try to explain why some regions are rich and others are not, capital accumulation and resources only go so far: the scale of differences in capital and resources needed to explain the differences we see in well-being is implausibly large, and growth models suggest those differences should disappear over the course of decades rather than centuries.

So that leaves us with technology, and to be sure there are large differences in technology between the rich and the poor. The thing is, there’s little that impedes the free flow of the “high tech” that we normally associate with technological advancement: your smartphone doesn’t cease to work when you cross a border, and so its value doesn’t change much either. If there aren’t actually large differences in technology between rich and poor, then those differences will hardly make a decent explanation for why we end up with differences in well-being.

Instead, we need to envision “low tech”. This is the sort of stuff that is a technology, in the sense that it doesn’t depreciate and it’s non-rivalrous. But, it stops or slows down when it needs to cross borders. The name we give to this is institutions: the ways of doing things that influence the efficient use of more capital by our labor to be more productive. That’s the thing that’s left to explain the big differences in well-being that we observe.

But people don’t like to talk about low tech institutions too much. They only change incrementally and slowly. Which means that a lot of times we’re stuck with them for the long haul. And because we’re stuck with them, we get attached to them as well. Think about how many people in human history have tried desperately to hold on to the institution of slavery, and yet it clearly doesn’t work as well as other economic systems.

But, because what I referred to at the top of the page as “non-serious economists” don’t talk about institutions enough, many people are flying blind when they try to figure out why the world’s economies are the way that they are.

* Just a note here about what college is supposed to do for you. I wasn’t sure if I should use “extent” or “extant” in that sentence. So I have this funny thing I do: I looked it up on The Google. You should get in the habit of doing this too; if you learn one thing in college that helps you in the real world, the willingness to ask about something you’re not sure of so that you do it right once instead of doing it twice might just be it. And if you’re curious, I was leaning 60/40 towards “extent”, and I was wrong. Good thing I checked.

Hiatus Over

You may have noticed I haven’t posted here for a few months. The hiatus is over.

The reason was that I was trying to develop a method for not just backing up this blog, but printing it in hard copy too. Not that I want to do that regularly, but I did need to figure it out to produce a single hard copy. Anyway, at over 800 pages, it’s done now.

Now, I can’t see a student being interested, since this is available for free, but if you really want a hard copy of the whole thing, or just a big chunk of it, let me know.

I have been drafting posts all summer long, so I’ll be posting rather heavily over the next several weeks.