Saturday, August 4, 2012

Income mobility for its own sake is good?

Tyler Cowen's defence of the case against income mobility has some very interesting arguments. He writes,
For a given level of income, if some are moving up others are moving down. Do you take theories of wage rigidity seriously? If so, you might favor less relative mobility, other things remaining equal. More upward — and thus downward — relative mobility probably means less aggregate happiness, due to habit formation and frame of reference effects.
Paul Krugman takes umbrage at this and accuses Tyler of promoting a form of class society. However, from behavioural economics point og view, Tyler is right. Researchers have shown that people generally suffer from loss-aversion bias - they are more motivated by avoiding a loss than acquiring a similarly sized gain.

Analyzing income mobility from this framework, it therefore follows that there is a net decrease in happiness with any changes in income levels. Those losing their income status suffer from a much greater loss than those benefiting from similar gains in income status. The economist would therefore argue that any income distribution is a Pareto optimum and any change in this would involve lowering aggregate happiness.

Tyler's central point is that at any particular income level, "there was no gain per se from having a higher rate of mobility churn, if not accompanied by higher standards of living". He also argues that the best way to ensure upward mobility is "to have a high rate of economic growth and spread across many income classes". In fact, he writes that if the general standard of living is rising, mobility takes care of itself over time. I have two issues here

1. Given the prevailing extremes in income distribution, even assuming stagnant incomes, there is a compelling in favor of higher mobility churn by itself. In the circumstances, a decrease in incomes at the top of the ladder (due to say, increase in taxation) generates limited marginal discontent. The magnitude of the loss aversion bias at the highest income levels is small, whereas the happiness from similarly sized gains at the bottom of the ladder are much higher.

2. Recent trends are ample proof of the fact that if the general standard of living rises, income mobility does not automatically take care of itself. Over the past quarter century, though standard of living has improved dramatically, income increases have been captured by those at the top of the income ladder.

Alex Tabbarok's defense of Tyler is not convincing. He picks up an simplified illustration which takes away from the complexity of income mobility in modern societies.

To repeat, given the high level of concentration of wealth at the top of the income ladder, any income mobility by way of shifts in the distribution of income, even at the same standard of living, generates beneficial effects.

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