Saturday, April 2, 2011

Income inequality and the role of luck

In his recent visit to India Warren Buffet again referred to the role of the "ovarian lottery" in deciding life outcomes. He pointed to his luck in having been conceived in the womb of an American women, born male, and into a family which was infused with the values of capitalism.

In this context, Chris Dillow has an excellent post which highlights the role of plain good luck in income inequality. He points to a paper by Daniel D. Schnitzlein who compared the earnings of siblings and found that that share of inequality in permanent earnings that can be attributed to family and community factors shared by brothers are 20%, 43% and 45% for Denmark, Germany and US respectively.

Chris Dillow argues that while inequalities that are a result of the individuals' free choices about how hard to work, save and study are acceptable, that arising from the luck of what type of family we are born into is not acceptable. He advocates taxation of those excessively lucky to normalize incomes and remove the inequality arising from their disporportionate good luck.

However, if the objective is to reduce inequality, mere taxation will not help. I have blogged earlier about the work of Lane Kenworthy, who has examined the impact of various government policies on inequality across the developed countries. He has found that contrary to conventional wisdom with its emphasis on progressive taxation system, inequality reduction is achieved more by government transfers and better quality public services, both of which require higher quantity of taxes.

The over-sized role of the "ovarian lottery" in determining life-time incomes is validated empirically by the persistence of inter-generational earnings divisions between people at different levels in the income ladder. In this context, Markus Jäntti, Bernt Bratsberg et al write about the low social mobility in the US,

"Mobility is lower in the US than in the UK, where it is lower again compared to the Nordic countries. Persistence is greatest in the tails of the distributions and tends to be particularly high in the upper tails: though in the US this is reversed with a particularly high likelihood that sons of the poorest fathers will remain in the lowest earnings quintile. This is a challenge to the popular notion of 'American exceptionalism'. The US also differs from the Nordic countries in its very low likelihood that sons of the highest earners will show downward 'long-distance' mobility into the lowest earnings quintile."


Talking about inequality, Joseph Stiglitz has an excellent article in Vanity Fair, where he describes the American democracy as that "of the 1%, by the 1%, for the 1%"! He points to the extreme polarization of income levels in the US - the upper 1 percent of Americans are now taking in nearly a quarter of the nation’s income every year, while the top 1 percent control 40% of wealth.

1 comment:

sai prasad said...

I hope that this issue does not remain a nere sidelight. It makes interesting reading to compare countries with respect to the mobility of their citizenry across income levels. Most of these articles result in a sigh at the end of the read.

I feel that this issue needs to addressed in a concerted manner. Mobility, perceived or real, is essential to keep up the hopes of the youth of the country. A feeling of hope keeps them going for quite a while. A situation where there is little hope of improving their lot is likely to result in deep discontent against the system. This would lead to explosive situations like what we see in the middle east and in Telangana area presently.

"He has found that contrary to conventional wisdom with its emphasis on progressive taxation system, inequality reduction is achieved more by government transfers and better quality public services, both of which require higher quantity of taxes."

The solution appears very simple in its statement. However, to achieve optimum transfer of resources by government policy, is a policy challenge which has not been satisfactorily met in any country in recent times.

I also feel that these transfers are not likely to work if they they are standard formulae which have remained the same over a period of time.