"The poor don't have enough income to save, and can't help going into debt to the rich. Debt is caused by inequality".
That statement is wrong on many levels. It's wrong theoretically. It's wrong empirically. But most of all, it's wrong because it might make inequality worse. It's the soft bigotry of low expectations. Providence is especially important to the poor. Saying that the poor can't help but be improvident is the last thing they need to hear.
(This post will piss some people off. "Nick's blaming the poor; of course they can't help either their poverty or their lack of saving!")
If we want a policy that will promote equality of income we should do it because it's a good policy in its own right; not because of some spurious argument about reducing debt. And the sort of policy that would help attain that objective in the long run is one which encourages a higher savings rate by the poor than by the rich. For example: a policy that increased the after-tax rate of return on savings for the poor, relative to the rich. Canada's Tax Free Savings Account (everybody is allowed to save $5,000 per year tax-free) might be such a policy.
Let's start with theory.
A lot of debt is used to finance investment. In physical capital, houses, education, etc. But let's set that aside, because it's not what I am talking about here. I am talking about the distribution across the population of consumption and savings, not investment. Whether those savings are lent to others or used to finance one's own investment is a separate question.
Economic theory of the consumption/saving decision is based on intertemporal utility maximisation. Milton Friedman's Permanent Income Hypothesis is a simplified version of this. If you consume less today you can consume more tomorrow. You compare the marginal utility of present consumption to the marginal utility of future consumption. You compare your personal subjective rate of time preference (your degree of patience or subjective discount rate) to the market rate of interest at which you can borrow or lend.
This theory says that people who have a low rate of time preference (who are more patient) will tend to save, while those who have a high rate of time preference will dissave (have negative saving).
This theory says that people who have temporarily high income will tend to save, while those who have temporarily low income will dissave. Because if they didn't, and just consumed their current income every period, their marginal utility of consumption in good times would be lower than their marginal utility of consumption in bad times. We save and dissave to smooth consumption over time.
This theory does not say that people who have permanently high income will tend to save, while those who have permanently low income will tend to dissave. Consumption depends on permanent income. But the proportion of your permanent income you consume (and hence the proportion you save) need have no relation with the level of your permanent income. Depending on the particular utility function, the relation could go either way. If the intertemporal preferences simply scale up (which is the standard assumption), then consumption and savings scale up with permanent income, and the savings rate (the percentage of income saved) is independent of permanent income.
Start in one equilibrium. Double both income and consumption both today and tomorrow. If the marginal utility of consumption falls by the same percentage both today and tomorrow when consumption doubles (which it must for example if today's and tomorrow's consumption are equal), then you are still in equilibrium. If the ratio of today's to tomorrow's marginal utility of consumption stays the same, then everything scales, and you save the same fraction of your income regardless of whether income is permanently high or permanently low.
Sure, the poor really need to consume today. But they really need to consume tomorrow too. So their need to save is as strong as the rich.
1. Inequality in permanent income will not affect the level of debt.
2. Inequality of transitory income will affect the level of debt. Those having temporarily low income today will borrow from those with temporarily high income today. And will repay the loans in future when the transitory shock reverses. (And it must reverse, because it wouldn't be transitory if it didn't.)
3. Inequality of rates of time preference will affect the level of debt. Those with high rates of time preference will borrow from those with low rates of time preference, until they are credit constrained and cannot borrow more.
That third inequality is what is driving debt in the Gauti Eggertsson and Paul Krugman paper (pdf). Debt is caused by inequality of patience, not inequality of income.
The second and third inequalities are what are driving debt in Matteo Iacoviello's paper (pdf) (HT goldilocksisableachblond). Despite what it says in the abstract of that paper, it is not income inequality driving debt in his model. Debt is not caused by some people being permanently rich and others being permanently poor. Debt is caused by fluctuations of income over time, where one person's fluctuations are imperfectly correlated with others' fluctuations.
A rich or poor person, having a bad year, will borrow from a poor or rich person, having a good year. An impatient person will borrow from a patient person.
Being poor means having low permanent income. Being rich means having high permanent income. Debt is not caused by inequality in permanent income. Debt is not caused by inequality between rich and poor.
The only way in which a change in permanent income can cause a change in savings is if it causes a change in the pattern of transitory income. For example, as people have become richer over time, the wealth effect on labour supply means they spend a smaller fraction of their lifetimes working, and retire well before dying. Retirement is a time of negative transitory income (current income is below permanent income). So people save for their retirement. And the longer their retirement, the greater the percentage of their income they will save while working.
Here's the nightmare scenario of standard theory (thanks commenter Greg). Take a very simple model with infinitely-lived agents and no investment. Assume all agents have an exogenous flow of income that is constant over time. Assume all agents are identical, except some have low and some have high discount rates. The equilibrium rate of interest will be between the high and low discount rates. The impatient borrow from the patient, for consumption loans. The impatient will initially consume more than their income, and the patient will initially consume less than their income. But over time, the consumption of the impatient will fall and asymptote towards zero (or starvation-level). And the consumption of the patient will rise and asymptote towards their consuming all the labour income of both sets of agents. Debt, and inequality of wealth, rise inexorably over time.
Transfers from rich to poor (i.e. from patient savers to impatient dissavers) will not solve this problem. All they do is reduce the after-tax rate of return to both sets of agents, by an equal amount. The implied tax rate on saving increases the rate of interest, and the patient still save more than the impatient, net of taxes and transfers. It only works if people don't see it coming. But of course they will.
A policy that would help solve this problem is one that gives the poor a greater after-tax return on saving than the rich. That works in two ways. First, it gives those with low savings a greater incentive to save than those with high savings. Second, it means that a given level of saving will accumulate faster if the stock of savings is low than if it is high. One way to implement such a policy would be to put a limit on the amount of saving that could accumulate tax-free. I think that Canada's Tax Free Savings Accounts might do this. They let every person save $5,000 per year without paying tax on the interest earned.
That's what standard theory says.
Does that standard theory make sense? Well, OK, if you are in danger of starvation today it doesn't. Because if you don't consume today the marginal utility of your future consumption is irrelevant. But our ancestors, whose saving and investment created the income we have today, and who were much poorer than we are today, would laugh at us if we gave this excuse for not saving. (Mine, I think, would have been more disgusted than amused).
Does it make sense empirically? Does it fit the facts? I don't know for sure. But the opposite theory, which says that the rich save and the poor dissave, is contradicted by some widely known facts. And big facts at that.
Our grandparents, and great grandparents, despite being massively poorer than us, saved. That's how we have the capital and technology that we have today, that makes us so much richer than them. Real interest rates have not been massively declining, and savings rates have not been massively rising, over the last 200 years as our incomes have massively risen.
China is still much poorer than the rich countries, and yet has a much higher saving rate.
And it's no good just looking at a cross-section of people today and seeing if the savings rate rises with income. Current income is the sum of permanent income plus transitory income. And theory says that transitory income will be saved.
Moreover, current income will be correlated with patience. This is not to say that the poor are impatient. But it is to say that the impatient will tend to become poor. Because the impatient will save and invest less.
The casual assertion that the poor can't afford to save is what bugs me. It bugs me because it ignores theory. It bugs me because it ignores the evidence of our grandparents. But mostly it bugs me because it sends the wrong message.
I understand this only through vague ancestral memories. In the rest of this post I'm talking myth, not history. (I am bad at history).
It doesn't matter that much if rich dissolute celebrities blow their wealth by consuming the lot. (Except they set a bad example for those who can't afford to blow what little wealth they have). In the past, similar rich dissolute aristocrats were the celebrities of the day, and many set a bad example too. But opposing that example was a cultural movement (centred around a religious movement) which promoted a very different set of virtues, and especially for the poor.
Father said that Grandfather paid the farm men's wages on Saturday, to be met by some of their wives on Monday, asking for an advance on next week's wages, because their husbands had already spent the lot on drink. And how the village was split between Tory/Church of England/drinkers and Liberal/Non-Conformist/abstainers.
Commenter Determinant tells me it all changed in the 1930's, for the United Church in Canada anyway, when they shifted from promoting the old virtues towards something more like socialism. I think that was a dead end.
Nowadays the alliances seem to have shifted. The old virtues would now be seen as cultural conservatism, and are more associated with the right than the left of the political spectrum. Which is a pity. It's the poor that need them most.
(This post is not as well argued and evidenced as I want it to be. But I'm aware of the limits of my comparative advantage, so I'm going to stop here and post it as is. And give Frances something to respond to.)
Worthwhile Canadian Initiative 
Um the abstinence theory is dead. Nobody uses it. The math is motivated by other interesting roundabouts but abstinence is dead as a theory of capital and interest and no one is using thrift as an explanation of the origins or development of capitalism. And that was not just a function of invective from Marx but it is fun that you caught the reference: odd to be at sea in a system of negative dialectics eh! Although I have always harboured a belief that the roundabouts were really just a saving move for the older doctrines so maybe you are right nothing much changes in the face of withering attacks. Outside of war or revolution that is.
On the grandparents the point is that that way of life is closed-off on legal, technological and economic grounds for most of us: the frontier is gone and urbanization and the intensification of the social division of labour mean that, as you would acknowledge, it does not make sense to try to do everything yourself if you have access to paid labour markets and if you do not, you do not have access to credit or its alternative going back to the land. To put it in Steinbeck’s terms: No Lennie we can’t live off the land in Toronto. There is no analogue. The question over credit is a question over to what ends debt is put. Clearly student loans for the poor or start up grants for poor yet nonetheless entrepreneurial spirits are a good idea. Credit for teenagers from poor families to have cell phones less so. Unless of course they are prostitutes or drug dealers but then that is just case of the latter above:). oh shit that just gave me an idea for a Modest Proposal.
At the risk of committing an argument from incredulity, moral incontinence as the origin of economic class? Really?
This is why the United Church of Canada, at least, abandoned the theology of Moral Continence (to borrow Mandos’ expression) in the 1930’s. In fact I don’t know of Canadian church that makes an issue out of that. If they believe it, they don’t scream it, or even talk loudly about it.
Mandos: I feel I am arguing with Nigel Tufnel.
Travis: “Um the abstinence theory is dead. Nobody uses it. The math is motivated by other interesting roundabouts but abstinence is dead as a theory of capital and interest and no one is using thrift as an explanation of the origins or development of capitalism.”
Capitalism no. Capital yes. Nobody uses the words “thrift”, and especially “abstinence”. Nobody uses words at all any more. At least, not words anyone else would recognise. My guess is that people working on long run growth theory would look at you blankly if you asked them if their model of capital accumulation was based on “abstinence”. And they would be very unlikely to get the reference.
I had to look that one up since I never actually saw This is Spinal Tap. My tolerance for rock movies, including mockumentaries, is pretty low.
You referring to my tendency to quadruple-post? I have chronic esprit de l’escalier.
Mandos: This is really worth seeing. The “goes up to 11” bit at the end
I had to look up “esprit de l’escalier.” Will have to try to remember that one.
It was a bit funny but I mostly don’t get it—I mean, that’s how I feel about economists (as a group)…
Are there really people saying “inequality causes debt”? I think the issues and claims are a bit more subtle than that.
Debt is driven by valuation, not income smoothing. From Z.1, consumer credit outstanding was 2.5 Trillion, out of about 35 Trillion in non-financial debt outstanding. The other 32.5 Trillion of debt had nothing to with anyone’s intertemporal substitution problem.
When you borrow to buy a house, you are neither saving nor dissaving, and PIH doesn’t have anything to say about how much you borrow, and suffers from the same valuation problem as the person buying the house.
Perhaps from a “moral” or “debt is bad” sense, you can argue that someone borrowing to buy a house is being imprudent, and they should save to buy the house instead.
But from a logical or accounting sense, capital transactions are neither saving nor dissaving, and balance sheet expansion for the purpose of acquiring real assets (e.g. 90% of non-financial balance sheet expansion) has nothing to do with instant gratification.
Regardless of what a household’s time preference happens to be, if they believe a house will appreciate, then they will buy the house now. They are not going to save to buy the house for more in the future.
Similarly, you cannot argue that income inequality has anything to do with prudence or imprudence. You can argue that wealth inequality does, but you still need an explanation for the growing income inequality.
When people make valuation errors and borrow to bid up the price of the in-place capital, that does increase the incomes of others and it contributes to increased savings. This is where the inequality issues kick in. If everyone in the economy owned a house worth X, with X of debt owed, and if everyone bid up the house of their neighbors, borrowing 2X to buy their neighbor’s house, and selling their own house for 2X as well, then everyone’s income in that period would increase exactly by X. At that point, you can argue that some of them — the more imprudent ones — would consume more, while others would save more, but still there would be no change in income distribution.
On the other hand, what you see is different — not everyone selling their house to each other at the same time, but one person buying the house, followed by 2, followed by 4, etc., in a pyramid-type manner, in which some people’s net-worth goes up by more than others, due to issues of market timing, access to credit, etc.
Sam Zell sells equity properties for 39 Billion in 2007 to Blackstone. Right at the peak. Sam’s net worth goes up by, say, 1 Billion, but Blackstone does not dissave by 1 billion, as its net worth is unchanged. And this is not evenly distributed across the board.
As Sam was building his real estate empire, he borrowed to buy assets in a period of time in which they were secularly increasing in value and interest rates were in a secular decline. This meant that just as time passed, he gained equity in the property, which was rolled over as collateral to secure additional loans to buy additional properties. On the residential side, he also made a lot of money by kicking out low income tenants, and renovating the residential units, making the neighborhood more desirable, thereby increasing the property values and pushing the former tenants into other neighborhoods (decreasing their property values).
For Sam to save the billion required “entrepreneurial spirit”, access to cheap credit, weak or disorganized home-owners associations, excellent legal help, good market timing, a generous tax code, and a long of list of other qualities and circumstances.
But thrift appears nowhere on that list.
Neither does any sort of marginal value product argument.
What you are talking about just isn’t relevant to what has been happening here.
Debt is growth is about asset valuation, not thrift.
Savings is the primarily the result of debt growth, the distribution of savings is primarily about power.
Within that broad context, there may be minor variations due idiosyncratic tendencies. Perhaps one person saves a few thousand more than someone else due to increased thriftiness, but whether they earn a hundred thousand more than someone else is more a matter of power relations and debt growth than prudence or imprudence. Prudence isn’t important at the macro scale.
I’ve had a sudden attack of “esprit de l’escalier”!
Kaleberg: “Clearly the author has met more Martians than Americans making the median income or less. Arguing that the poor, which in economics circles these days means 80-90% of all Americans, just aren’t saving enough ignores simple reality. Sure, you can live on sorghum boiled in water, or bread, weak tea and treacle,…”
Who the hell are you to assume I am talking about Americans? Jeez! America is not the only country in the world. It is not the only country with poor. It is not the only country with debt.
Ever look at the title of this blog? No. You wandered over the border without ever realising there is a world outside the US.
But, as a matter of fact, I have met loads of Americans earning the median income or less. (And no, “median or less” does not mean 80-90% of the population; it means 50%). I once lived with them for a year. I have probably travelled across more US states than most Americans, for that matter. And when I went to America I was stunned by the quality and variety and cheapness of the food. And, on much less than the median US income, ate better than I had ever eaten in my life. And better than I did again for a long time.
Careful Nick, your sup/inf complex is showing. mmm ihop. Anyway,
I just want to say I’m having a fantastic time still looking through different denominations. Christian reconstructionist, independent babtist, presbyterian etc, basically the reformed denominations and babtist, mennonites, or everything non RC/Anglican. I wonder if there was an Anglican migration north, during the American Revolution, wiki says yes. No wonder the Kennedy Catholic thing was a big deal.
Probably right. Nobody cares about hammers and nails any more. But that is cold comfort to all those who would take shelter under Popper. Not the first time bad Voodoo drove out the good.
It is odd though that you should take such a moralistic (genetic?) tone with respect to the poor. in fact it is od dthat on the hand you laud private markets but on the other give no consideration to the degree to which we are all bombarded by the image industry to consume. So what you are really demanding is that poor are less susceptible to the push to conspicuous consumption than the rest. That sir is soft bigotry. But even so you have not demonstrated that such superior character would be meaningfully rewarded in terms of a change in station. As you have it, if they could achieve this moral superiority they could improve themselves that they can’t is evidence they deserve their station?
Ok do the run. Min wage with 10% savings. How many years of frugality is required for a game changer?
Who knew Kalenberg would get your heart pounding. I am starting think this income wealth inequality thing is really not your shtick.
And by reformed, I mean Calvinist, still looking for Lutherans swedes etc. Got something. comparing the three.
Determinant, yep on the Tyndale.
Any theory of poverty that does not even mention behavioral traits like intelligence, conscientiousness and time-preference is worthless (talking about the comments, not your post). Yeah yeah, heartless rightwing stuff. Whatever, if it explains something, its useful and needs to be part of the conversation, whether its heartless rightwing stuff or mushy leftwing stuff.
Some basics
People are different! Hey! Why is this ignored? Intelligence, conscientiousness, and time-preference are all randomly distributed. Yes, luck is also randomly distributed and its a good point that left wingers mention, but you cant ignore how different people are in their abilities and character. The two – luck + human capital must be combined for any satisfying explanation.
And yes, institutions like the old time church can help by using social pressure to dissuade behaviors not in the long-term interest of the person.
Yes, but people are different in their abilities and character to a great extent due to their environment, which is shaped by inequality and the values implicit in inequality.
Eventually “old time church” becomes co-opted by the rich and powerful…
Nick,
There’s a IMF working paper dealing with the same problems:
Inequality, Leverage and Crises Michael – Kumhof and Romain Rancière
Click to access wp10268.pdf
abstract:
The paper studies how high leverage and crises can arise as a result of changes in the income distribution. Empirically, the periods 1920-1929 and 1983-2008 both exhibited a large increase in the income share of the rich, a large increase in leverage for the remainder, and an eventual financial and real crisis. The paper presents a theoretical model where these features arise endogenously as a result of a shift in bargaining powers over incomes. A financial crisis can reduce leverage if it is very large and not accompanied by a real contraction. But restoration of the lower income group’s bargaining power is more effective.
Sounds a little marxist to me.
Nick: OK I get your point. The short term data is always going to show something like a + bY. But:
http://www.dartmouth.edu/~jskinner/documents/DynanKEDotheRich.pdf
Do the Rich Save More?
Karen E. Dynan
Federal Reserve Board
Jonathan Skinner
Dartmouth College and National Bureau of Economic Research
Stephen P. Zeldes
Columbia University and National Bureau of Economic Research
The question of whether higher–lifetime income households save a
larger fraction of their income was the subject of much debate in the
1950s and 1960s, and while not resolved, it remains central to the
evaluation of tax and macroeconomic policies. We resolve this longstanding
question using new empirical methods applied to the Panel
Study of Income Dynamics, the Survey of Consumer Finances, and
the Consumer Expenditure Survey. We find a strong positive relationship
between saving rates and lifetime income and a weaker but
still positive relationship between the marginal propensity to save and
lifetime income. There is little support for theories that seek to explain
these positive correlations by relying solely on time preference rates,
398 journal of political economy
nonhomothetic preferences, or variations in Social Security benefits.
There is more support for models emphasizing uncertainty with respect
to income and health expenses, bequest motives, and asset-based
means testing or behavioral factors causing minimal saving rates
among low-income households.
Contemplationist has a point, but then the issue is how the rest of us decide to treat the poor. Do we assure them some minimum standard, or not?
My concern is the increase, in the last 30 years, of income inequality. This is the chart that concerns me:
http://paul.kedrosky.com/archives/2009/03/us_total_credit.html
I cannot believe that the situation for the poor is the same now as it was in the 1960’s. Somebody is servicing that debt, and it is not the rich. Somebody is collecting on that debt. And it is not the poor. I don’t know what the graph is for Canada, but I don’t think it’s very different.
(Sorry, Nick, I can’t get these links to work. I don’t know what the problem is.)
Nick Rowe
“Second off, the permanent income hypothesis does say that saving is a constant proportion (approximately) of permanent income, and a constant proportion of transitory income. Just that those proportions are very different. 100% of transitory income, and closer to 0% of permanent income (depending on the interest rate and rate of time preference).”
Maybe the permanent income hypothesis says that, but then it can’t explain how wealth is even more skewed than income (unless you play silly games with the definition of transitory income).
I suppose besides playing silly games with the definition of permanent and transitory income, you could play silly games with “consumption”.
P.S. I don’t necessarily blame Friedman for this. When he was writing, marginal tax rates on the rich were much higher.
Edeast: “Careful Nick, your sup/inf complex is showing. mmm ihop. Anyway,”
You lost me there. But it felt good to wrap myself in the flag for once. (Actually, I’m pro-American, and not the Canadian nationalist sort, even though I still think their rebellion was a mistake, and the root source of many ills ;-). They only really rebelled anyway because they didn’t like Quebec staying French and Catholic. Look it up!)
Travis: “It is odd though that you should take such a moralistic (genetic?) tone with respect to the poor.”
Yes, it feels odd to me too. But my beef is not with the morals of the poor, but with those who would undermine their morals by saying they can’t help it. That’s what’s immoral. And a lot of lefties here (not you, because you are a hard-lefty) are going bat-shit crazy at my accusation. And can only do a knee-jerk response from their hind-brains, by reading me as worshipping all the demons in their demonology, and disrespecting all their sacred cows.
The funniest thing is, Guerilla economist (see comment above) actually has a critique that makes a serious dent in my argument. And they have all ignored it. They just keep on repeating “But the poor can’t afford to save!” in outraged tones, ignoring my argument altogether.
“So what you are really demanding is that poor are less susceptible to the push to conspicuous consumption than the rest.”
No. Though it would be nice if they were. Because the same amount of susceptibility is more harmful to them.
Contemplationist is right, of course. Though seeing the knee-jerk reactions of some lefties to this post, which mentions none of that stuff, makes me wonder how they would react. But this post is not about the causes of poverty. It’s about what determines saving, and the effect of income on saving.
Rafael: It might not be Marxist. Depends on the theoretical model. My guess is that it’s the same mechanism as in the Iacoviello paper I cited. It’s probably transitory income, rather than true inequality. I would read it, but have to sort out too many people here.
Greg: “There is more support for models emphasizing uncertainty with respect to income and health expenses, bequest motives, and asset-based
means testing or behavioral factors causing minimal saving rates
among low-income households.”
The “bequest motive” is at the root of Guerilla Economist’s critique. The “asset backed means testing” is what I was talking about above, it’s what gives the poor a lower after tax rate of return on savings than the rich. It’s precisely the sort of perverse government policy that makes the problem worse, by discouraging saving by the poor. To which the left (OK, some on the left) add their patronising excuses.
“Contemplationist has a point, but then the issue is how the rest of us decide to treat the poor. Do we assure them some minimum standard, or not?”
Simple. We do. Assume poverty is 100% determined by genetics. There’s a little strand of DNA that determines your relative income. Now assume instead that poverty is 100% determined by luck. It’s who you happen to meet at the right time in the right place. What’s the difference?
RSJ: “Are there really people saying “inequality causes debt”? I think the issues and claims are a bit more subtle than that.”
Well, all the people mad at me here seem to be saying that.
But you are right, most debt is the result of investment decisions, not saving/dissaving. But I did say at the beginning of the post I was setting that aside, so I could concentrate on the saving/dissaving question.
Reason: “Maybe the permanent income hypothesis says that, but then it can’t explain how wealth is even more skewed than income (unless you play silly games with the definition of transitory income).”
Wow, that was a softball. Take a simple lifecycle model, which is a variant/application of the PIH, and you will get that. Non-human wealth rises from zero to a peak when you retire, and down to zero again when you die.
In fact, I’m trying to think of an example where the PIH does not have that property, and can’t think of one yet.
Oh, yes I can. People live forever, and half earn $100 in even years and $0 in odd years, while the other half it’s the opposite. 0% interest. So half will have $50 in wealth at the beginning of each year, and the other half -$50. Well, it almost works.
“Non-human wealth rises from zero to a peak when you retire, and down to zero again when you die.”
Well no it doesn’t (some people inherest and some people bequest). But this is not the point is it. The same is true I’m CERTAIN for a cross section of the population of a given age (say 55).
Oops
inherit some how become inherest (when mated with bequest it seems).
Nick I see you and Contemplationist are out to prove my point. There are some very negative effects of being considered poor both to one’s self image and motivation and to the image one is perceived with by others, and both of those perceptions have real long term effects on an individual’s earning power. There is a minimum level of visible consumption that is required to earn the ‘Not a Loser’ badge.*
That level can change with both the level of visibility of everyone in society’s consumption(think clothes brands here for example) and the social norms about the level of income as revealed by one’s consumption to meet the minimum standards.
But for some reason, without any apparent empirical evidence, you seem determined to claim the PIH intercept goes through zero. Following George Akerlof’s ‘Identity Economics’ I suspect that most people have a self identity in mind that informs a minimum spending level to live up to it, just that the middle classes and wealthier have more freedom in choosing what self identity to pursue. I don’t actually think I have much of a problem with your policy recommendations, but you seem to be coming from the perspective of a cranky old guy that fixes his own Dodge Dart or whatever and can’t understand why everyone doesn’t self identify the same way. That’s not necessarily a perfect starting place for good social science.
* A US TV character last week made the joke that “Capitalism is God’s way of Determining who is smart and who is poor.” Funny but, undoubtedly a bit less so if one is one of God’s Dummies.
Nick,
I’m not even sure your example has the property (wealth being more skewed than income) that you think it does. If all start from 0 and save at the same rate, then sure some rich will have lots of wealth, but some rich will have harly any wealth, and some poor will have some wealth. How does it help your argument exactly?
To avoid confusion by rich and poor above I mean high permanant income and low permanent income. I understand the RANGE from high to low in wealth will be greater than the range of income – if the rate of saving is high enough (10% will do, 5% barely). But the ratio of total savings would then still be proportional to concentration of total permanent income, independent of permanent income. But we don’t see that do we?
Doing some rough calculations based on wikipedia figures for concentration of wealth and income, I get that the top 20% of households by income have approx 50% of the income and 80% of the wealth. Of course permanent income and household are imperfect substitutes because income changes with age. But wealth distribution by age is nowhere near so skewed.
I will admit that the existance of social security biases the figures because expected income from social security could be considered part of household wealth and isn’t measured as such.
Nick,
The objection sounds like a mantra to you because you’re starting (as economists usually do) from a different perspective on economic justice. I happen to think that people’s basic well-being shouldn’t be dependent on small variations in their level of moral continence, and that their basic well-being should include a reasonably large share of the convenience of modern life. From that perspective, the discussion of whether or not “inequality causes debt” contains dangerous presuppositions to me; it is appropriate to compensate for the predilection not to save.
This is the usual problem in discussions between mainstream economists and the present-day left: the former never seem to understand that some of what they think of as means are actually ends for the latter.
Still reading. Too tired to comment much.
Nick: It’s a reference to the wikileaks, paroxisms of moral outrage vs inferiority complex, Andrew Coyne’s interpretation. I was agreeing about the food. And I get what you are saying, I think most anglophones are pro-America, it’s just that francophones are such strong critics. But I suppose the converse is also true concerning the monarchy.
For 3 years I was educated with a southern US curriculum so I really get the bible belt. And I’d say that I’m more pro-revolution than you. However the reflexive nationalists on comment boards make me wince, not you, more the health-care hockey pointlessness, this image captures how I define Canada, and what I’m proud of. Sort of jingoistic altruists or something.
My grandparents saved of their higly transitory income in the 30’s. Did it make any difference short term? Maybe they could buy one more loaf of bread tomorrrow if the starved even more today. Long-term? Could not afford a house anyway.What saved them what the pst-war expansion.
Toda’s poor? Can they save enough for the down payment on a house that the middle class is increasingly unable to afford? To pay for a university education ? Try to get a job at a bank with your Hochelaga-Maisonneuve accent.
The Chinese save, like the Japanese and the Koreans did earlier. Growth is so fast you can’t adjust your calculation of permanent income. It all looks transitory and your children will adjust their consumption pattern later. Growth leads to savings not the reverse. And it explains why poor but growing countries can save more than rich but stable countries.
For a look at the life of the truly poor, watch the series “Les naufragés des villes” on RDI. In french. Do your bit for national unity…
And even then , it is a fake reality. The middle and upper income volunteers know it is just a show lasting two months after which they go back to paradise. Yesterday,after the first installment (day)they were already out of pocket.
Francos more critical of the Americans? Certainly not. The lower class certainly have what we call an admiring “Elvis Gratton ” view. The better educated has the same ( but no more) critical view as other canadians and europeans of the same background. We fought the Americans in 1775 and 1812 because it would have meant even less rights than under the Brits. Other than that , if the U.S. army were to invade Toronto, what could we do? Life is tough isn’it?
I meant francos critical of us anglos, and any imperialistic, or anglosphere ambitions(Boer war, conscription etc) and free market calvinist type policy. While they are also critical of our monarchist childishness and admire the US.
Perhaps I am naive but if we had two income earners one with an income of $15000 per year and the other with an income of $150000.00 per year and both decided that they would save 10% of their wages each pay period would it not be much easier for the wealthier to do so, with much less sacrifice and with a much greater confidence that he would enjoy the benefit of his thrift?
The person with a $15000 income would save a mere 1500 a year, his best option for investment would likely be a Certificate of Deposit with a 1.5% annual return which he could purchase once he had $1000 or more, until then he would likely leave the money in a zero interest checking account not having a sufficient balance to obtain a .25% per annum savings account. About 90% of his remaining income would be necessary for food, shelter, clothing and transportation, the remaining 10% would have to cover all other expenses and any emergencies that might arise. If his 10 year old car developed a mechanical problem, or his rented apartment required plumbing repairs not covered by his lease he would either have to dip into his savings, unlikely to cover his emergency needs, or go into debt. With such a modest income and no valuable assets to pledge as security he could at best hope to borrow from a payday lender with a 200%-950% per annum interest rate or to charge it to a credit card with a 25% per annum interest rate. If these extraordinary expenses were not incurred he would effectively give up his income as without regular bathing or reliable transportation he would lose his job. Under these circumstances how much more valuable to him is dollar 261 of his weekly income if consumed than it would be if it were saved?
The person with a $150000 income would save $15000 over a year, he could easily invest in a stock market index fund with a historic return of 11% or better, even with a safer portfolio he could anticipate a return 6-8% a year with some confidence. Perhaps 40-50% of his remaining monthly income would be required to pay for his shelter, food, clothing and transportation, if he really liked to live beyond his means he might choose to devote 60-70% to such necessities with a comfortable margin for other expenditures. His 3 year old car probably won’t have too many problems over the course of the year, but if it does he can replace it with a new one without increasing the amount he has to pay for transportation each month significantly. Owning his home does leave him stuck with all required maintenance and repairs, but even if he has a large unexpected expense he can borrow against his home equity at no worse than 4-6% per annum or else he’ll have plenty of time to make up the difference from his future income if he does have to tap his savings to pay for such an emergency. How much less valuable to him is dollar 2597 of his weekly income if consumed than if saved?
It seems to me that each percent of income saved by a low income person both costs him more and benefits him less, and that those benefits are much less certain to be realized, than the same percentage of income saved by a high income person.
Nick,
“Well, all the people mad at me here seem to be saying that.”
No, I don’t think they are criticizing you for that, but rather for making these types of moral or character arguments to address what is basically an institutional or structural failure. There is just a long history of economics doing this — e.g. “voluntary unemployment” being the excuse for the 20-40% unemployment rates typical in the non-agricultural sector during the 19th century.
And the economists respond with talk of impatience, people not wanting to work, etc.
Then suddenly we adopted demand management policies and the unemployment rate dropped in half.
Everyone became more hard-working, more prudent?
Did everyone become impatient in the 1990s, or was there an asset valuation problem?
These are structural problems, institutional problems, not character problems; Despite the premise of the Krugman/Gauti paper, debt is not the impatient borrowing from the patient, it is investors valuing the in-place assets as delivering a greater cash-flow, with new money being created as a result, and the new money is distributed disproportionally to the wealthy. Here is a clear connection between debt growth and income inequality not relying on character issues at all.
Nick,
Hard-lefty? Do not get me wrong I like it but…
I will give give you a personal anecdote. Back in my bachelor of arts days I was driving down the road with a hard-nosed blaster (coal miner) who lost his fingers on one hand when the descending cage cut them off (always keep your hands inside the cage) and a pan handler walked up begging for money. He told the guy to fk right-off. I said WTF you are a socialist you can’t talk to the poor like that. And he replied “we live in one of the richest cities in NA and thus in the world he should either get organized or just steal what he needs from the rich.” To which he added: “being poor is no excuse to accept your poverty.”
Often Nietzsche goes further than Marx. Me I keep both close even though each unsettles the other.
“Well, OK, if you are in danger of starvation today it doesn’t. Because if you don’t consume today the marginal utility of your future consumption is irrelevant.”
Yep. We actually do have poor people in the US today who are in this position; who are forced to go into debt due to danger of death right here, right now.
In fact, medically-induced bankruptcy is the chief cause of bankruptcy in the US. You can be sure people are not doing this unless their lives are at risk.
Even short of that, there are masses of people who are not earning a “living wage” are in the position of being forced to either take on debt or steal money. Our welfare system really has been ground up that bad. Debt is a lower-risk strategy.
Accordingly, your analysis is simply…. wrong. By “the poor” you seem to mean “the moderately poor”, not “the dirt poor”.
This book may be of interest:
The Persistence of Poverty
Why the Economics of the Well-Off Can’t Help the Poor
I think like Jaques Giguere. I think what he says is just about right.
Nick, I think you might profit by reading the Kumhof and Rancière paper. Maxine Udall’s summary was pithier than the paper abstract (http://www.maxineudall.com/2010/12/company-store-redux.html):
“In Kumhof and Ranciere’s model, increasing concentration of wealth in a small “investor” class leads to higher demand for investment assets, such as securitized pools of loans made to wage earners who must borrow to maintain consumption as their real income declines.”
At a point in time, you could read it as a transitory income effect, but the model has a positive feedback whereby the equilibrium is endogenously shifted. So Marxist then, I suppose.
But note that this model fits certain facts about the sub-prime meltdown, explained in the Levitin & Wachter paper: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1669401. The volume of sub-prime mortgage issuance increased even as spreads narrowed, implying an outward shift in the mortgage supply curve. But of course, mortgage supply is the same as investment demand.
Phil: Thanks. I just read (skimmed) it.
Essentially, it’s a variant on the model I sketched above, in the “nightmare scenario”. Here’s a massively simplified version: some people are more patient than others. Call the patient people “capitalists” and the impatient people “workers”. (See, they are the ones assuming poor workers are improvident!). Over time the workers will slowly go into debt to the capitalists. If there’s an exogenous shift in the distribution of permanent income from workers to capitalists, the real rate of interest will increase, and this process will happen quicker.
The only real difference between their model and my model (apart from their assumption that it’s the workers who are impatient) is that they give the capitalists weird preferences. Capitalists do not save for future consumption. Capitalists are Scrooges, who save for savings sake. This means that my nightmare scenario may or may not happen, depending on the distribution of permanent income.
If I had started out my blog post here by saying “Let’s face it guys, the poor are simply less provident than the rich, because poor and rich have different innate preferences”, people would have dumped all over me for making that assumption. But if you make that exact same assumption, and use it to say that inequality is a bad thing, all the lefties would be happy! It’s all in the framing.
I dunno … I’m very leftie (at least where poverty is concerned) and I have no problem saying the poor are improvident compared to the rich. It follows from the definition of poor. Kinda hard to save for tomorrow when you don’t have enough today. For the most part, I think the different preferences are a consequence of the poverty, not its cause.
Well said, Patrick!
Again, I refer you (all) to the book (review) I linked to above. An academic work well worth reading in my opinion.
Another review by Tyler Cowen
Patrick That’s not different innate preferences. That paper is talking about different innate preferences.
Nick,
No time for a proper answer now either because I’ve got a godverdomme assignment to write. But quickly,
I think you’ve misunderstood me. I wasn’t bringing up cardinalism because I think that the distinction between cardinal and ordinal utility relates directly to the issue of interpersonal comparisons of utility. It doesn’t—it’s impossible in either case.
The fact that it’s impossible is (close to) what I was trying to get at. The cardinalists were generally more bothered about this than their ordinalist successors. You can see this in the development of neoclassical price index theory. The cardinal-ordinal utility distinction and noncomparability are distinct conceptually but historically the two arrived in the same box, as it were. Perhaps ordinality was a palliative for noncomparability—just define the problem out of existence.
Here’s what one randomly selected textbook says about the issue, in a section entitled “The impossibility of comparing utility between persons”:
“The problems in measuring consumer surplus which we have discussed so far have all been concerned with the ambiguity of this concept when analysing the individual consumer’s situation. We have, however, seen that we may produce an apparently unambiguous monetary measure of an individual’s satisfaction from consuming a particular good if we make the special assumptions set out in the two previous sections of this chapter [total utility is independent from the amount consumed, and constant marginal utility—the subject is Marshallian demand theory and consumer choice]. It must be noted, however, that even making these assumptions provides no basis in economic theory for adding these measures of satisfaction over individuals to produce some global measure of the gain to a community from consuming a particular good. Even if we are willing to postulate the existence of a cardinal utility function for each member of the community, there is no basis for comparing these functions between people and hence no way of adding them up. A pound’s worth of satisfaction to one person and a pound’s worth of satisfaction to another may or may not be the same amount of satisfaction. There is no way of knowing.”
You’re claiming that poor people don’t go into debt because they are poor; they go into debt because they have a high rate of time preference. And you’re claiming that over time, people who have a high rate of time preference become poor. That is, poor people don’t go into debt because they are poor; they are poor because they go into debt.
Well and good. But can you justify your assumptions? They are very restrictive.
Let ‘s say, arguendo, that you can. What are we left with? We know that people go into debt because they have a high rate of time preference. In other words, people go into debt because they are the kinds of people who go into debt, and this property is independent of income (by assumption). So we don’t really know anything. On this basis, you offer some advice: Poor people should be less impatient, and save more—then they will be less poor. No doubt Marx is spinning in his grave. I don’t care about Marx, and your policy prescription seems reasonable, but the inanity of that statement annoys me.
I dunno, this just doesn’t seem like a very fruitful way to proceed. Perhaps I’m missing the larger picture…
Framing always has an effect on us poor, frail mortals. But I think you are attributing too much to framing in this case.
As I read you, “innate” preferences are essentially metaphysical, rather than observable. It is logically possible for rich and poor to have the same innate preferences but markedly different observable ones. This could happen if, say, rank in savings were associated with status, but status had some non-linear intrinsic value. In that case, people would not in fact save for the sake of future expenditure but for status. Everyone would have the same innate propensity to save conditioned on an available amount to save, but they would not have the same empirical propensity to save, given heterogeneous incomes.
Or you could make up some other story. The heart of the matter is that your assumptions about why people save and their propensities to do so are exactly that. The empirical support for them is at best ambiguous. In that respect, your model is just as weird as the alternatives.
vimothy: “You’re claiming that poor people don’t go into debt because they are poor; they go into debt because they have a high rate of time preference.”
No. That’s not what I am claiming. I see no reason why the poor should have a lower or higher rate of time preference, or be more or less likely to go into debt. It’s everyone else who is claiming that the poor will be more likely to go into debt. Not me.
(Those who do have a high rate of time preference, and who go into debt because of that, will, of course, tend to become poor over time. But there are plenty of other reasons why people should end up poor, of course.)
Phil: this is not metaphysical. This is about how people will behave in different circumstances.
Here is my basic assumption: everybody has the same preferences (until shown otherwise). If you took a poor person and gave them a rich person’s (permanent) income, they would consume and save like a rich person, and vice versa. Everything scales.
But that paper you linked to makes a very different assumption. It says that if you took a poor worker, and gave them a rich person’s income, they would behave very differently from a rich person. Look at the paper! The workers and “investors” have totally different utility functions! They are a different species! Given the exact same opportunities, they will behave in totally different ways!