Your Neighbor's Fancy Car Should Make You Feel Better About Income Inequality
Today while I was out running errands in my 5-year-old Honda Accord, I passed a Tesla. If I were a different kind of guy, seeing Elon Musk's latest creation whisk past me as I trundled along in my middleclassmobile might have inspired a sense of personal envy, or even some worry about the social implications of inequality in America.
But I'm an economist. And let's face it: In practical terms, the difference between a $200,000 Tesla and my last car, a beat-up minivan worth $2,000 at trade-in, is not all that large. They're both safe forms of transportation that get you from point A to point B and, given legal limits and the reality of suburban traffic, most of the time they're driven at roughly the same speeds.
In that sense, measures of income inequality overstate the differences within a developed country like the United States. The products available to the masses are, in many cases, nearly as good as those available only to the elite. Your garbageman's old Timex and your podiatrist's brand new Rolex serve almost precisely the same function.
It wasn't always so. A century ago, a hungry rich person had access to significantly more food and more choices than a poor one. Yet even bluebloods would have been able to get their hands on less variety and quality than one now finds at an average Midwestern all-you-can-eat buffet. When Herbert Hoover promised "a chicken in every pot" in the election of 1928, it was the sort of pledge that no one expected a politician to actually keep. Today, each American consumes an average of 27 chickens a year, and obesity is a bigger problem than hunger.
The chasm between the very rich and the median citizen yawns wider the further back you look. Three centuries ago, an aristocrat riding in a cushioned carriage would have looked down at a peasant trudging barefoot through the muck—a much more substantial difference than the Honda-Tesla gap today.
So why the 21st century panic about the gap between the rich and poor? At first glance, the numbers do look damning. Median family income has grown by about 20 percent since the 1970s, while income for those in the top 5 percent of households has grown by 75 percent or more, according to the Center for Budget and Policy Priorities. Economists Thomas Piketty and Emmanuel Saez looked at IRS data and concluded that the share of total pre-tax, pre-transfer income going to the top 1 percent has risen to levels not seen since the 1920s. That suggests an increase, not a decrease, in inequality.
But appearances can be deceiving. As the Brookings economist Gary Burtless has pointed out, if you account for transfers such as government housing assistance and employer-provided health insurance, "Americans in the bottom one-fifth of the distribution saw their real net incomes climb by almost 50 percent" since the late 1970s, while "those in the middle fifth of the distribution saw their incomes grow 36 percent." It's worth remembering that anytime someone says the gap between rich and poor is increasing, what he usually means is that rich people are getting richer faster than poor people are getting richer—not that any group is becoming worse off overall.
In their own perverse way, by throwing fistfuls of money at truly scarce resources, the social climbers, status seekers, and strivers are doing their part to rectify those income equality numbers that have everyone running scared.
Meanwhile, the difference between the lived experiences of Americans at different income levels has actually been decreasing. Changes in the quality of goods consumed by almost everyone mean we're a whole lot more equal than the data superficially suggest.
What's more, the same behavior that sparks personal envy and political angst—splashing out on fancy apartments, rare jewels, and other truly scarce goods—may actually be a sign of the closing gap between rich and poor in practical terms. When everyone is wealthier, it becomes harder to demonstrate differences in wealth.
Better Off Economic growth and the technological developments it fuels have been spectacularly effective at making incredible products cheap enough to be attainable for most families. As a result, Americans can routinely enjoy luxuries of the sort they once might have assumed they'd have to win the lottery to afford. The big-screen TV that a super-wealthy denizen of Beverly Hills might have bragged about 30 years ago can't be given away today on Craigslist; a low-end Android smartphone boasts many times more computing power than the best supercomputers available only to scientists in 1985. And while many Americans may never make it to Africa, considering the wealth of programming available from places like the National Geographic channel and Netflix, they hardly need to.
If you suddenly became a multi-millionaire, what would you do with the money? Hire a chauffeur? Eat better food? Wear custom-designed clothes? Many of those very outcomes could soon be available to us all, assuming robust enough economic and technological advancement.
Imagine a world where self-driving luxury cars cost so little that the average family thinks it's normal to buy a new one every year, where fast-casual joints sell the equivalent of cuisine now served only at five-star restaurants, and where bespoke suits are computer-fitted and delivered by drone for the cost of a cheap three-pack of T-shirts today. What's crazy about these possibilities is that they're just that: possible.
Economic growth and technological development can do much to change your material standard of living, and they have done much to reduce the disparities in people's material well-being in the developed world. The result is something that looks not like you coming into millions overnight but like almost everyone coming into millions.
But if that's so, why do so many Americans feel that they're just getting by?
Hard to Find Good Help These Days As people find they can afford more and better goods and services, their expectations rise. Think about how you'd feel if someone dropped that 30-year-old big-screen TV on your doorstep. Less than grateful, I'm betting.
But there is one class of commodities that does not become more attainable: the kind that can't be reproduced infinitely, no matter the technology. Unlike cars and food and clothing, which become cheaper to make over time, these truly scarce items rise in price as more and more consumers become wealthy enough to covet and compete over them.
The most obvious example is human labor. As society gets richer, people's time and energy get more expensive. Robots can substitute for some of this, but—barring perfect humanoid machines—any product that requires individual human beings, especially skilled human beings, will go up in price relative to ordinary goods.
This phenomenon is so common and predictable it even has a name: the servant problem. People in newly prosperous developing countries often complain of not being able to find good household help. There was a time when middle-class families, who might have struggled to pay for international flights or new electronics, were nonetheless accustomed to having cooks, maids, nannies, and the like take care of much of their domestic work. As the average citizen's income and purchasing power grew, a new world of products opened up. Yet domestic services once taken for granted moved further from the ordinary worker's reach.
In the cold light of day, few rational people would trade away the fruits of economic and technological advancement, from modern medicine to air conditioning to YouTube, merely to have someone to do their laundry. But that doesn't mean we don't still look wistfully, maybe resentfully, at elites who seem to have it all, including a live-in housekeeper now estimated to cost north of $35,000 per year.
Give Me Park Avenue A small apartment in New York City cost the equivalent of $530 a month in today's dollars in the period right after World War II. Now the median rent there is nearly $3,000. The median price of a U.S. home was $71,314 in current dollars in 1950; it's almost $300,000 today.
Of course, in 1950 the average home was under 1,000 square feet, and it featured just two bedrooms and one bath. The typical new home today is closer to 2,500 square feet, s
its on two stories, and has three bedrooms and two-and-a-half baths. When what was once luxurious starts to be viewed as necessary, or at least normal, it's hard to know who to be jealous of or why.
In the D.C. area, where I live, it's easy to see that what we call housing costs are really a product of two very different attributes: the price of materials and the price of good location. A three-bedroom rowhouse in the Georgetown neighborhood, with its cobblestone streets, shaded parks, and high-end shopping, can easily run over a million dollars. A couple of hours to the west in rural Virginia, you can get a 3,500-square-foot McMansion with four bedrooms, five baths, and many custom features for $400,000 or less. But you have to be willing to live in an isolated location, often with poor access to developed infrastructure. At the very least, you're in for a long commute to downtown Washington, where most of the jobs are.
Or compare San Francisco and Phoenix. Both are prosperous—Phoenix is hardly a rust-belt straggler—but the price of the median home in the latter place went from a nominal cost of under $100,000 in 1989 to about $200,000 by 2014. In San Francisco, no doubt fueled by the growth of Silicon Valley over the same period, the median home price went from around $200,000 to nearly $800,000.
These places' very different experiences are not fully captured by national inflation measures. Housing costs are rising much more quickly in certain areas than everything else, including wages. So someone who started out in a modest one-bedroom flat in San Francisco might well have seen his or her income increase faster than the national average and still be unable to upgrade to a two- or three-bedroom place in a comparable location.
To understand why that might be, look at the two cities' natural environments. Phoenix is in the desert, a.k.a. prime construction terrain. San Francisco is surrounded on three sides by water. This makes it much harder to add new units to the housing stock in the latter place—where would you build them?—even as demand skyrockets. And geography isn't the only issue: San Francisco has stricter land use controls, making it difficult to develop high-density, high-rise buildings.
Living quarters in San Francisco are scarce in a way they aren't in other places. And in a society growing wealthier, truly scarce items become ever more expensive.
Location, Location, Location Location is what the economist Fred Hirsch described as a positional good—something whose value depends on how many people desire it and on its standing relative to other goods. When a lot of people want to live somewhere and they have a lot of resources at their disposal, it becomes much more expensive to beat out your competitors.
The higher the rate of economic growth—and the better we get at satisfying the average person's material demands—the harder it will be to obtain elite, positional goods. If we're wealthy enough as a country, everyone can drive a Tesla. But only one person can live in the best Manhattan penthouse.
This isn't just a matter of status; positional competition affects even people who aren't bothered by social standing. While you can certainly get more for your money in remote rural Virginia than downtown D.C., if the time spent commuting to work eats into your ability to have dinner with your spouse or put your kids to bed, the trade-off might not be worth it.
Or consider the safety and quality of schools. As a 2016 Washington Post article put it, "The one thing rich parents do for their kids that makes all the difference" is to buy "pricey homes in nice neighborhoods with good school districts." Actual educational opportunities probably differ very little between public schools in solidly middle-class areas and public schools in 1-percenter enclaves. But to the extent that a child's classmates affect his or her outcomes, well-off families may feel they're in a "red-queen's race": They have to run harder as they get richer just to stay in place. Inevitably, this widens the perception of inequality, even if it doesn't make anyone worse off in absolute terms.
Where status combines with social externalities, the effects are multiplied. Most state universities today are staffed with top researchers with Ph.D.s and boast critical facilities such as libraries that put most of modern learning within reach of good students of modest means. And thanks to the internet, a lot of lectures can be heard at a nominal cost from the comfort of your living room. Yet even as it's gotten easier for self-motivated people to learn as much as they want from anywhere in the country, demand for admission to the few dozen top-ranked universities has only grown.
The prices have escalated too. Tuition for one year at Harvard cost just $600 in 1950, or about $6,000 in today's money. By 2016–17, the cost was $43,280, not including fees or room and board. That's more than a sevenfold increase. (Tuition and fees at four-year public universities also increased, from $2,600 in 2016 dollars per year in 1976–77 to $9,650 per year today.) But the real wonder is that their prices aren't even higher. Is there any doubt that if the 10 best private universities chose to raise tuition to $100,000 a year, there would still be enormous competition to enter?
Top colleges are desirable for two reasons. First, because they have the top students, so the benefits of attending go beyond what can be learned at home and encompass all the advantages of academic networking and high-level peer pressure. But second, because the very best spots are scarce—there can, by definition, be only 10 top-10 schools. Access to them, like access to the nicest housing locations, is a positional good. Technology can't make more of it.
Tax the Rich The good news is that humans in the developed world are in real terms more equal than ever before. In addition, as increased competition makes positional goods more expensive, the richest subset of the population—people who would have gotten the best of the best anyway—will have to part with more money in order to enjoy them. This creates a built-in disincentive to worry too much about status.
Those who choose to live in expensive areas simply because they prefer the cachet, even though a sober-minded analysis would show they could live better if they decamped to somewhere less fashionable, are taxing themselves. A person who could work less and earn less while living just as well in Phoenix, but who chooses to put in longer hours so he can afford to be in San Francisco, is in effect toiling for the privilege of his pricey zip code. In their own perverse way, by throwing fistfuls of money at truly scarce resources, the social climbers, status seekers, and strivers are doing their part to rectify those income equality numbers that have everyone running scared.
On the other hand, even in the most utopian science fiction vision, it's impossible to eliminate scarcity. One can imagine a scenario where material inequality is almost entirely abolished. But the inequalities that remained would be just as intractable as ever. In fact, since they would be the only differences left, whatever method was used to allocate the choicest piece of real estate, the experimental prototype, or the spot at an elite school would likely seem even more galling than before. While life is getting better for almost everyone, conflict over who gets what isn't going anywhere.