Bookblogging: The failure of trickle down

Another section of my book-in-progress, looking at the failure of the trickle-down hypothesis. Comments and criticism welcome as always.

Failure

Although the trickle-down hypothesis never had much in the way of supporting evidence, empirical testing was difficult because its proponents never specified the time period over which the benefits of growth were supposed to percolate through to the poor. But, just as the crises of the 1970s marked the end of the Bretton Woods era, the global financial crisis marks the end of the era of finance-driven market liberalism. To the extent that any assessment of the distributional effects of market liberal policies will ever be possible, it is possible now.

The trickle-down theory can be examined using the tools of econometrics. But, at least for the US, no such sophisticated analysis is required. The raw data on income distribution shows that households in the bottom half of the income distribution gained nothing from the decades of market liberalism. Although apologists for market liberalism have offered various arguments to suggest that the raw data gives the wrong impression, none of these arguments stand up to scrutiny. All the evidence supports the commonsense conclusion that policies designed to benefit the rich at the expense of the poor have done precisely that.

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The US since 1970

US experience during the decades of neoliberalism gives little support for this view. In the period since the economic crisis of the early 1970s, US GDP has grown solidy, if not as rapidly as during the Keynesian postwar boom. More relevantly to the trickle-down hypothesis, the incomes and wealth of the richest Americans has grown spectacularly. Incomes at the 5th percentile of the income distribution doubled and those for the top 0.1 per cent quadrupled

By contrast, the gains to households in the middle of the income distribution have been much more modest. Between 1973 (the last year of the long postwar expansion) and 2008, median household income rose from $45 000 to just over $50 000, an annual rate of increase of 0.4 per cent.

For those at the bottom of the income distribution, there have been no gains at all. Real incomes for the lower half of the distribution have stagnated. The same picture emerges if we look at wages. Median earnings for full-time year-round male workers have not grown since 1974. For males with high school education or less, real wages have actually declined.

One result has been that the proportion of households living below the poverty line [1]<span class=”Apple-converted-space”> </span>, which declined drastically during the postwar Keynesian era has remained essentially static since 1970, falling in booms, but rising again in recessions.

The proportion of Americans below this fixed poverty line fell from 25 per cent in the late 1950s to 11 per cent in 1974. <a href=”http://www.census.gov/prod/2008pubs/p60-235.pdf”>Since then it has fluctuated, reaching 13.2 per cent in 2008</a>, a level that is certain to rise further as a result of the financial crisis and recession now taking place. Since the poverty line has remained unchanged, this means that the incomes accruing to the poorest 10 per cent of Americans have actually fallen over the last 30 years.

These outcomes are reflected in measures of the numbers of Americans who lack access to the basics of life: food, shelter and adequate medical care.

In 2008, 49.1 million Americans live in households classified as ‘food insecure’, meaning that they lacked access to enough food to fully meet basic needs at all times due to lack of financial resources. 17.3 million people lived in households that were considered to have “very low food security,” a USDA term (previously denominated “food insecure with hunger”) that means one or more people in the household were hungry over the course of the year because of the inability to afford enough food. This number had doubled since 2000, and has almost certainly increased further as a result of the recession. http://www.frac.org/html/hunger_in_the_us/hunger_index.html

The number of people without health insurance has risen steadily over the period of market liberalism, both in absolute terms and as a proportion of the population, reaching a peak of 46 million or 15 per cent of the population. Among the insured, an increasing proportion are reliant on government programs. The traditional model of employment-based private health insurance, which was developed as part of the New Deal, and covered most of the population during the Keynesian era, has been eroded to the point of collapse. At the time of writing, it remains to be seen whether Congress will pass legislation to extend health insurance to the entire population.

http://www.census.gov/hhes/www/hlthins/hlthin08.html

Homelessness is almost entirely a phenomenon of the era of market liberalism. During the decades of full employments, homelessness was confined to a tiny population of transients, mostly older males with mental health and substance abuse problems. In 2007, 1.6 million people spent time in homeless shelters, and about 40 per cent of the homeless population were families with children. And this was actually an improvement – homelessness is one of the few social problems where policy interventions have been sustained and at least partially successful in the US.

In summary, the experience of the US in the era of market liberalism has been as thorough a refutation of the trickle-down hypothesis as can reasonably be imagined. The well off have become better off, and the rich have become super-rich. But despite impressive technological progress (the most striking elements due, as we have seen, to the public and non-profit sectors) those in the middle of the income distributions have struggled to stay in place, and those at the bottom have actually become worse off in crucial respects.

Naturally, there have been plenty of attempts to deny the evidence presented above, or to argue that things are not as bad as they seem. Some of these attempts can be dismissed out of hand. Among the most popular and the silliest, is the observation that even the poor now have more access to consumer goods, such as televisions and refrigerators than they had in the past. For example, Cox and Alm in their book Myths of Rich and Poor observe that n spite of the rise in inequality a poor household in the 1990’s was more likely than an average household in the 1970’s to have a washing machine, clothes dryer, dishwasher, refrigerator, stove, color television, personal computer, or telephone. ”

The common feature of all the items listed in this quote is that their price has fallen dramatically relative to to the general price level. This means that even if incomes were exactly the same as in 1970 we would expect to see a big increase in consumption of these items. And, obviously, if these items have become relatively cheaper, others, such as health care have become relatively dearer. Unsurprisingly, we find that it is in access to health care E[2] that poor and middle class households have become worse off over time.

There are some adjustments that should be made to the data, and make the picture look a little better than suggested by the statistics quoted above.

Household size has decreased, mainly due to declining birth rates. The most appropriate measure of household size for the purpose of assessing living standards is the number of “equivalent adults” derived from a formula that takes account of the fact that children cost less to feed and clothe than adults and that two or more adults living together can do so more cheaply than adults in separate households.The average household contained 1.86 equivalent adults in 1974 and 1.68 equivalent adults in 2007 (my calculations on <a href=”http://www.census.gov/population/socdemo/hh-fam/hh6.xls”>US census data</a>). Income per equivalent adult rose at an annual rate of 0.7 per cent over this period.

In earnings terms, women have done a little better than men, with median earnings for full-time year-round workers rising by about 0.9 per year over this period.<span class=”Apple-converted-space”> </span> Relatedly, the main factors sustaining growth in incomes for American households outside the top 20 per cent has been an increase in the <a href=”http://www.frbsf.org/publications/economics/letter/2007/el2007-33.html”>labour force participation of women</a> and a decline in household savings. Over the period since 1999, consumption financed by borrowing against home equity has been the main factor offsetting stagnant or declining median household incomes.

Finally, until the 1990s, the consumer price index took inadequate account of changes in product quality, so the decline in real wages was overstated somewhat. The Boskin Commission introduced changes to the CPI which, not incidentally, reduced the cost of adjsuting Social Security and other welfare payments for inflation. So, while the stagnation of the 1970s and 1980s might be overstated, that of the 1990s and 2000s is not.

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The bankruptcy boom

The failure of the trickle-down approach has been even more severe in relation to consumer finance. The idea that increasing income inequality was unimportant when households could borrow to finance growing consumption was never defensible. The gap between income and consumption had to be filled by a massive increase in debt. With sufficiently optimistic assumptions about social mobility (that low-income households were in that state only temporarily) and asset appreciation (that the stagnation of median incomes would be offset by capital gains on houses and other investments)these increases in debt could be made to appear manageable, but once asset prices stopped rising they were shown to be unsustainable.

In the US context, these contradictions have been resolved for individual households by a massive increase in financial breakdowns. Until 2005, this mainly took the form of a steady increase in bankruptcy, to the point where, as John Edwards pointed out in 2003, Americans were <a href=”http://johnquiggin.com/index.php/archives/2003/11/26/bankruptcy-and-divorce/”>more likely to go bankrupt than to get divorced</a>. Restrictive reforms introduced at the behest of the credit card industry produced a dramatic drop in bankruptcy (in part, the lagged counterpart a massive upsurge in 2003 and 2004 as people rushed to get in under the old rules). From 2006, onwards, bankruptcy rates resumed their upward trend, reaching 1.1 million per year in 2008 and appearing likely to match or exceed pre-reform levels in 2009.

In normal times the failure of bankruptcy reform, and the renewed surge in bankruptcy would have been a major issue. But in the crisis of 2008 and 2009, the upward trend has been overshadowed by foreclosures on home mortgages. During the boom, when overstretched householders could normally sell at a profit and repay their debts, foreclosures were rare. From 2007 onwards, however, they increased dramatically, initially among low-income ‘subprime’ borrowers but spreading ever more broadly. <a href=”http://www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&amp;ItemID=5681&amp;accnt=64847″>2.3 million houses were affected by foreclosure action in 2008</a>. In hard-hit areas of California, more than 5 per cent of houses went into foreclosure in a single year.

The myth of trickle down was sustained, in large part, by the availability of easy credit. Now that the days of easy credit are gone, presumably for a long time to come, reality may reassert itself.

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Econometric studies

The relationship between inequality and economic growth has been the subject of a vast number of econometric studies, which have, as so often with econometric studies, yielded conflicting results. Early studies focused on the relationship between initial levels of inequality and subsequent levels of growth. These studies consistently found a negative relationship between inequality and growth. On the other hand, increases in inequality appeared to be favorable to growth.

It is perhaps, not surprising that the initial impact of an increase in inequality should be favorable to economic growth. For example, if tax rates on high-income earners are reduced, they are likely to spend less money and resources on low-productivity investments designed to minimise tax. More importantly, perhaps, in the late 20th century, growth in inequality was closely associated with financial deregulation and the growth of the financial sector. The short-term effects of financial deregulation have almost everywhere been favorable, while the negative consequences take years or even decades to manifest themselves. So, it is unsurprising to observe a positive correlation between changes in inequality and changes in economic growth rates in the short term and medium term.

It is only relatively recently that studies of this kind of explicitly examined the trickle-down hypothesis. Perhaps the most directly relevant work is that of Dan Andrews and Christopher Jencks of the Kennedy School of Government at ANU, and Andrew Leigh of the Australian National University who ask, and attempt to answer, the question ‘Do Rising Top Incomes Lift All Boats’. Andrews, Jencks and Leigh , find no systematic relationship between top income shares and economic growth in a panel of 12 developed nations observed for between 22 and 85 years between 1905 and 2000. After 1960, there is a small, but statistically significant relationship between changes in inequality and the rate of economic growth. However, the benefits to lower income groups flow through so slowly that, as income inequality increases, they may never catch up the ground they lose initially.

Andrews, Jencks and Leigh simulate some results for the US suggesting that even assuming that the increased inequality in the US after 1970 produced permanently higher economic growth, those outside the top 10 per cent of the income distribution would not have gained enough to offset their smaller share of total income over the 30 years to 2000.

And, as Andrews, Jencks and Leigh note the situation is much worse when the distribution of income within the bottom 90 per cent is considered. Households at or below the median income level (that is, those in the bottom half of the income distribution) have lost ground relative to those above the median, even as the population as a whole has lost ground relative to the top 10 per cent. And there is evidence to suggest significant adverse growth effects when inequality between the bottom and middle of the income distribution increases.

More importantly, the financial crisis, which was the inevitable result of the policies that generated the huge growth in US inequality, has wiped out years of income growth and asset accumulation for US households.

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Social mobility

The evidence that the United States, compared to other developed countries, is characterized by highly unequal economic outcomes, and that these outcomes have grown more unequal during the era of market liberalism is undeniable. Of course, that hasn’t stopped people denying it, especially when they are paid to do so, but at least such denials must be presented, in contrarian fashion, as showing that ‘everything you know about income inequality is wrong’. By contrast, the belief that this inequality is offset by high levels of social mobility is widely held in and outside the United States, and reflected in such epithets as ‘land of opportunity’.

In the late 19th century, the US was indeed a land of opportunity compared to the hierarchical societies of Europe, and many believe that this is still the case. But the evidence of international comparative studies is clear. Among the developed countries, the US has the lowest social mobility on nearly all measures, and the European social democracies the highest.

Ron Haskins and Isabel Sawhill of the Brookings Institution found 42% of American men with fathers in the bottom fifth of the income distribution remain there as compared to: Denmark, 25%; Sweden, 26%; Finland, 28%; Norway, 28%; and the United Kingdom, 30%. Other studies, using different measures of mobility, find the same outcome

Moreover, as market liberal policies have become entrenched, social mobility has declined. Not only have the well-off pulled away from the rest of the community in terms of income share, they have managed to pull up the ladder behind them, ensuring that their children have better life-chances than those born to poorer parents.

The evidence suggests that the distinction between equality of outcomes and equality of opportunity, a central theme in market liberal rhetoric, is inconsistent with empirical reality. More equal opportunities make for more equal outcomes, and vice versa.

It’s not hard to see why this should be so. The highly unequal outcomes of market liberal policies are often supposed to be offset by an education system available to all and by laws that prevent discrimination and encourage merit-based employment and promotion.

That might work for one generation, but in the second generation the rich parents will be looking to buy a headstart for their less-able children, for example by sending them to private schools where they will be coached in examination skills and equipped with an old school tie.

One generation more and the wealthy will be fighting to stop their tax dollars back from being wasted on public education systems from which they no longer benefit. Those who remain in the public system will lobby to get their own children into good public schools and ensure that these schools attract and retain the best teachers, benefit from fundraising activity and so on.

Education has traditionally been seen as the most promising route to upwards social mobility. But as inequality has increased, wealthy parents have sought, naturally enough, to secure the best educational outcomes for their children, most obviously through private schooling, expansion of which has been a central demand of market liberals. As a result, both the importance of ability as a determinant of educational attainment, and the importance of educational attainment as a source of social mobility have declined over time. A UK study found that ‘low ability children with high economic status’ (or, in more colloquial terms, the ‘dumb rich’) experienced the largest increases in educational attainment. This is reinforced, particularly in the US, by the increasing segregation of higher education on class lines.

The inequalities are even more evident in higher education. Thanks to scholarship programs, a handful of able students from poor backgrounds make it into Ivy League colleges like Harvard and Yale every year. But they are far outweighed by the mass of students from families in the top 10 per cent of the income distribution who have the financial resources to afford hefty fees the high quality high school education that gives them the grades needed for admission and the cultural capital required to navigate the complex admissions process. And of course, those with old money but less than stellar intellectual resources have their highly effective affirmative action program – the legacy admission system by which the children of alumni gain preferential admission. In the 1998 book The Shape of the River: Long-Term Consequences of Considering Race in College and University Admissions, authors William G. Bowen, former Princeton University president, and Derek Bok, former Harvard University president, found “the overall admission rate for legacies was almost twice that for all other candidates.” If inequality of outcomes is entrenched for a long period, it inexorably erodes equality of opportunity. Parents want the best for their children, and, in a highly unequal society, wealthy parents will always find a way to guarantee their children a substantial headstart.

While education is critical, high levels of inequality naturally perpetuate themselves through other, more subtle channels like health status. Barbara Ehrenreich’s Nickel and Dimed discusses the plight of the uninsured working poor in the United States. While the problem is worse in the US than elsewhere because of highly unequal access to health care, high levels of inequality produce unequal health outcomes even in countries with universal public systems. Children growing up with the poor health that is systematically associated with poverty can never be said to have a truly equal opportunity.

There are other factors at work. A widely dispersed income distribution means that a much bigger change in income is needed to move the same distance in the income distribution, say from the bottom quintile to the middle, or from the middle to the top. So, unequal outcomes represent a direct obstacle to social mobility.

Once you think about the many and various advantages of growing up rich rather than poor, it’s not at all surprising that widening the gap between the rich and the poor should also make it harder for the poor to become rich (or, for that matter, vice versa) so the evidence that, under market liberalism, social mobility is low and declining, should not surprise anyone. On the other hand, it is disappointing, if not surprising, that the myth of equal opportunity continues to be believed so many decades after it has ceased to have a basis in fact.

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The unhealthiness of hierarchies

Some of the most striking evidence against the trickle down hypotheses has come from studies of social outcomes such as health status, crime and social cohesion. Not surprisingly, the poor do worse on most such measures than the rich. More strikingly, though, a highly unequal society produces bad social outcomes even for those in higher income groups, who are better off, in purely monetary terns, than those with a similar relative position in more equal societies. Only for the very well-off do the direct benefits of higher income outweigh the adverse effects of living in an unequal society.

It is commonly thought that, while it is better to be at the top of the hierarchy than at the bottom, there are some offsetting disadvantages, particularly in relation to health. While the poor suffer from lack of access to good medical care and other problems, the rich are supposed to suffer from ‘diseases of affluence’ like heart disease, compounded by the stresses of life at the top. ‘Executive stress’ has become a cliché. So, to some extent there is thought to be a trade-off between health and wealth.

In place of this somewhat comforting picture, Michael Marmot has some disturbing news. People at the top of status hierarchies live longer and have better health than those at the bottom. This is true for a broad range of illnesses and causes of death. Moreover, the effect isn’t confined to the extremes of the distribution. At any point in a status hierarchy, people have, on average, better health than those a little below them and worse health than those a little above them.

Marmot’s work began with a study of British civil servants. The study population is interesting for two reasons. First, it excludes extremes of wealth and poverty. The civil service is not a road to riches, but even the lowest-ranking civil servants are not poor, on most understandings of the term. Second, the public service provides a clear-cut status hierarchy with very fine gradations.

Marmot’s study found, not surprisingly, that senior public servants, at the top of the status hierarchy, were healthier than those at the bottom. More strikingly, he found that, right through the hierarchy, relatively small differences in pay and status were associated with significant differences in life expectancy and other measures of health.

The same finding has been replicated across all sorts of different status hierarchies. As you move from the slums of South-East Washington DC to the leafy suburbs of Montgomery County, 20 miles away, life expectancy rises a year for every mile travelled. Among actors, Academy-award winners live, on average, four years longer than their Oscarless co-stars.

Along the way, Marmot demolishes the myth of executive stress. Despite their busy lives, Type A personalities and so on, senior managers are considerably less likely to die of heart attacks than the workers they order around. This is not a new finding, but the myth is sufficiently tenacious that Marmot needs to spend some time knocking it down yet again.

Marmot, along with others who have studied the problem, concludes that the crucial benefit of high-status positions is autonomy, that is, the amount of control people have over their own lives. Marmot’s analysis is not focused exclusively on autonomy. For example, he has a good discussion of social isolation and its relationship to social status. Nevertheless, his main point concerns autonomy, and this is by far the most interesting and novel feature of the book.

There is a complex web of relationships between health status autonomy, both self-perceived and measured by objective job characteristics. Low levels of autonomy are associated, not only with poorer access to health care, but with more of all the risk factors that contribute to poor health, from homicide to poor diet.

The centrality of autonomy is not, on reflection, all that surprising. Autonomy, or something like it, is at the root of many of the concerns commonly seen as part of notions like freedom, security and democratic participation. When we talk about a free society, for example, we usually have in mind a place in which people are free to pursue a wide range of projects. The distinction between negative and positive liberty, popularised by Berlin goes part of the way towards capturing this point, but a focus on autonomy does better.

The points are clearest in relation to employment. Early on, Marmot debunks the Marxian notion of exploitation (capitalists taking surplus value from workers) and says that what matters in Marx is alienation. He doesn’t develop this in detail, and the point is not new by any means, but he’s spot on here. It’s the fact that the boss is a boss, and not the fact that capitalists are extracting profit, that makes the employment relationship so troublesome. The more bossy the boss, the worse, as a rule is the job. This is why developments like managerialism, which celebrates the bossiness of bosses, have been met with such hostility.

So part of autonomy is not being bossed around. But like Berlin’s concept of ‘negative liberty’, this is only part of the story. Most of the time it’s better to be an employee with a boss than to sell your labour piecemeal on a market that fluctuates for reasons that are totally outside your control, understanding or prediction. This is where a concept of autonomy does better than liberty, negative or positive. To have autonomy, you must be operating in an environment that is reasonably predictable and amenable to your control.

Of course, the environment consists largely of other people. So one way of increasing your autonomy is by reducing that of other people, for example by moving up an existing hierarchy at their expense. Similarly when employers talk about increased flexibility in the workplace, they generally mean an increase in their control over when, where and how their employees do their job. Workers typically experience this as a loss of flexibility in their personal lives. In short, within a given social structure, autonomy is largely a zero-sum good.

But some social structures give more people more autonomy than others, and this is reflected both in average life expectancy and in the steepness or otherwise of status gradients in health. In general, higher levels of inequality on various dimensions are associated with lower average life expectancy and steeper status gradients.

In The Spirit Level, Richard Wilkinson and Kate Pickett build on Marmot’s work and other statistical evidence to produce a comprehensive case for the proposition that inequalities in income and status have far-reaching and damaging effects on a wide range of measures of social wellbeing, effects that are felt even by those who are relatively high in the income distributions.

Wilkinson and Pickett report two main types of statistical evidence. Following Marmot, they examine social gradients, that is, the relationship between individual outcomes and positions on the social ladder. Here there are two main results. First, in all countries, there is a strong relationship between social outcomes and social rank, much greater than can be explained by income differences alone. Second, greater inequality within a country is associated with a steeper social gradient.

Wilkinson and Pickett also report cross-section studies in which a number of countries, or other jurisdictions such as US states, are compared. The standard statistical approach here is regression analysis, in which differences in social outcomes such as life expectancy are statistically related to inequality levels, in a way that controls for other sources of variation, such as mean income levels. Among the outcome variables considered are measures of life expectancy and health status, crime and measures of ‘social capital’, such as trust.

The results are striking. Wilkinson and Pickett find a strong negative relationship between inequality and measures of social outcomes. The relationship is statistically significant, and undiminished by the inclusion of relevant control variables. [3]This result is, on the whole, unsurprising. If we consider the kinds of social relationships that contribute to hierarchical attitudes, stressful low-status jobs and so on, it seems unlikely that they will variations in income over the course of a few years, or even a few macroeconomic cycles. This is even more obvious in relation to the social outcomes such as life expectancy, it seems clear that they are the product of lifetime experience, rather than current income.

The United States is the obvious outlier in almost all studies of this kind. It is the wealthiest country in the world, the most unequal of the rich countries, and does poorly on a wide range of measures of social wellbeing, from life expectancy to serious crime and even on such objective measures as average height. In some cases, the poor performance primarily reflects the continuing black-white divide. In other cases, however, all but the very richest groups of Americans have worse average outcome than people with a comparable position in the income distribution in more equal countries, even though the average income of the non-Americans in these groups is much lower than that of the corresponding Americans.

Leigh, A. and Jencks, C. (2007), ‘Inequality and mortality: Long-run evidence from a panel of countries’, Journal of health economics, 26(1), 1-24.

Wilkinson, R. and Pickett, K. (2009) The Spirit Level: Why More Equal Societies Almost Always Do Better, Allen Lane, London.

[1] Unlike most developed countries, the US has a poverty line fixed in real terms, and based on an <a href=”http://www.census.gov/hhes/www/povmeas/papers/orshansky.html”>assessment of a poverty-line standard of living undertaken in 1963</a>.

[2] mergency health care remains generally accessible, and has benefitted from technical progress, which has contributed to declining mortality. But regular health care has become unaffordable for many, with the result that a wide variety of chronic conditions go untreated.

[3] Some other econometric adjustments, such as the inclusion of ‘fixed effects’ do weaken the findings. The interpretation of these adjustments remains controversial.