Economic alarmists tell tall tales of a rigged economy

In a recent article in Scientific American, “The American Economy is Rigged,” Nobel laureate economist Joseph Stiglitz paints a gloomy picture of the U.S. economy and the American Dream over the last 40 years and then some: 

"Whereas the income share of the top 0.1 percent has more than quadrupled and that of the top 1 percent has almost doubled, that of the bottom 90 percent has declined. Wages at the bottom, adjusted for inflation, are about the same as they were some 60 years ago!"

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The implication is that while the rich have gotten richer, the rest of us are treading water or falling behind. Stiglitz blames these outcomes on bad economic policy.

This depressing view of recent decades has become received wisdom. Journalists and pundits regularly cite these kinds of pessimistic claims and conclude that the American economy is broken and the American Dream is dead.

But are these claims true? 

Stiglitz has the numbers to make his case, but he only shares numbers that reinforce his narrative. Even those numbers can be hard to interpret accurately. Yes, the gap between the rich and everyone else has been growing. But that can mean one of two things:

It can mean that the people who were rich in the past got even richer. Or it could just mean that the rich today are richer than the rich of the past.

Those sound like the same thing but they aren’t. In the first case, the rich are a group unto themselves, hoarding all the gains and sharing them with no one. But “the rich” is not a closed group.

Sociologists Mark Rank and Thomas Hirshl find that by age 60, 70 percent of Americans will have spent at least a year in the top 20 percent. Eleven percent will have spent at least a year in top 1 percent.

LeBron James grew up poor and now makes more money than Magic Johnson did in the 1980s. As basketball has become a global sport, the gains from being good at basketball have gotten larger than they were in the past.

There’s nothing sinister about this. It simply reflects the ability of LeBron James to delight more people with his artistry than Magic Johnson could in a world without the internet and global interest in basketball.

The change in salaries doesn’t capture what happened to the basketball players of the past. It tells you how much more today’s players make than yesterday’s.

Stiglitz argues that these success stories are celebrated because they are so rare. But the gloomy numbers he cites and those cited by his fellow alarmists depend on the assumptions that are made.

How should you measure inflation? Should you correct for demographic changes? Include fringe benefits? How should income be defined? Who should be in the sample? Choosing different answers to these questions leads to very different conclusions.

A recent study by Piketty, Saez, and Zucman, for example, finds that after correcting for inflation, the bottom half of the income distribution had a total gain in pre-tax income of 1 percent between 1980 and 2014. That may as well be zero. The economy is broken! 

At the other end of the assumption spectrum, a recent Congressional Budget Office analysis finds that over the same time period, median household income actually grew by 37 percent before taxes and transfers. A rising tide lifts all boats! Include taxes and transfers and the growth is 57 percent. Maybe the economy and public policy are not so rigged after all.

The gloomiest studies take a snapshot of the income distribution at a point in time and compare to one in the past. But the people in the snapshots are not the same. To really understand who benefits from economic growth, you need to follow the same people over time.

I summarize a number of these studies in a recent essay, “Do the Rich Capture All the Gains from Economic Growth?” Studies that follow the same people over time find the poor and the middle class have an easier time outdoing their parents and in many of the studies, the increases in income of the poor and the middle class exceed those of the rich. 

The pessimists explain this as simply what is called regression to the mean: If your parents are poor, it may be partly because of bad luck. Your luck is likely to be average so you will outdo them economically. But the point is that the children of the poor do get ahead and by a substantial amount relative to their parents. There’s improvement not stagnation.

While the children of the rich struggle to exceed the income of their parents, it’s true that they still do quite well. One way to summarize the complexity of the distribution of income over time is that there is a decent amount of absolute mobility but perhaps not as much relative mobility as we’d desire. It is still easy to get ahead in America but not so easy to get ahead of others.

None of this means that the status quo of public policy is acceptable. We should end the coddling of rich investment bankers, sugar farmers and others who use the political process to line their pockets with money from the rest of us.

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We should get rid of the barriers such as occupational licensing that make it hard for the poor to rise. Most of all we need an education system that serves all children and not just those in wealthy suburbs. 

But if Stiglitz is right and the system is rigged, if only the fattest of the fat cats are getting ahead, then the system needs more than an improvement here and there — people should be on the barricades pushing for a revolution. So it shouldn’t surprise us that as economists have relentlessly argued that the system is broken, the political cures on the table have become increasingly radical. We are playing with fire.

Ignoring the nuance that underlies the numbers is bad science, and it’s bad public policy.

Russ Roberts is the John and Jean De Nault research fellow at Stanford University’s Hoover Institution. He is the host of "EconTalk," a podcast, and with John Papola, is the creator of the Keynes-Hayek rap videos. His animated videos on the challenges of measuring economic progress, "The Numbers Game," can be found at PolicyEd.edu