You Are What You Spend

New York Times: You Are What You Spend (HT: Greg Mankiw)

This is an outstanding article by two Federal Reserve Economists about standards of living at various quintiles.

The bottom fifth earned just $9,974, but spent nearly twice that — an average of $18,153 a year. How is that possible? A look at the far right-hand column of the consumption chart, labeled “financial flows,” shows why: those lower-income families have access to various sources of spending money that doesn’t fall under taxable income. These sources include portions of sales of property like homes and cars and securities that are not subject to capital gains taxes, insurance policies redeemed, or the drawing down of bank accounts. While some of these families are mired in poverty, many (the exact proportion is unclear) are headed by retirees and those temporarily between jobs, and thus their low income total doesn’t accurately reflect their long-term financial status.

So, bearing this in mind, if we compare the incomes of the top and bottom fifths, we see a ratio of 15 to 1. If we turn to consumption, the gap declines to around 4 to 1. A similar narrowing takes place throughout all levels of income distribution. The middle 20 percent of families had incomes more than four times the bottom fifth. Yet their edge in consumption fell to about 2 to 1.

Let’s take the adjustments one step further. Richer households are larger — an average of 3.1 people in the top fifth, compared with 2.5 people in the middle fifth and 1.7 in the bottom fifth. If we look at consumption per person, the difference between the richest and poorest households falls to just 2.1 to 1. The average person in the middle fifth consumes just 29 percent more than someone living in a bottom-fifth household.

To understand why consumption is a better guideline of economic prosperity than income, it helps to consider how our lives have changed. Nearly all American families now have refrigerators, stoves, color TVs, telephones and radios. Air-conditioners, cars, VCRs or DVD players, microwave ovens, washing machines, clothes dryers and cellphones have reached more than 80 percent of households.

As the second chart, on the spread of consumption, shows, this wasn’t always so. The conveniences we take for granted today usually began as niche products only a few wealthy families could afford. In time, ownership spread through the levels of income distribution as rising wages and falling prices made them affordable in the currency that matters most — the amount of time one had to put in at work to gain the necessary purchasing power.

At the average wage, a VCR fell from 365 hours in 1972 to a mere two hours today. A cellphone dropped from 456 hours in 1984 to four hours. A personal computer, jazzed up with thousands of times the computing power of the 1984 I.B.M., declined from 435 hours to 25 hours. Even cars are taking a smaller toll on our bank accounts: in the past decade, the work-time price of a mid-size Ford sedan declined by 6 percent.

There are several reasons that the costs of goods have dropped so drastically, but perhaps the biggest is increased international trade. ....

The article also contained this fascinating graphic below:

Comments

[brad wright]

Wow, this really gets home how much "stuff" we all have--both the wealthy & poor.

[Michael W. Kruse]

I agree. And the charts are some of the most effective communicators of this reality that I've ever seen.

[Steve Roth]

If inequality leads to faster growth, so everyone's better off long-term, then--arguably--it doesn't matter. Wealth has (by far) the highest inequality. So, does wealth inequality create economic prosperity? Over the long term, apparently not:

http://trueconservative.typepad.com/trueconservative/2008/02/wealth-equality.html

[Michael W. Kruse]

Steve, thanks for the link to you blog.

I don't think wealth inequality alone can be the cause of prosperity. Instead, I'd characterize it this way. Historically we've had considerable equality in wealth among the masses with a tiny sliver of folks holding most of the wealth. There was virtually no economic status mobility. In developed nations we have more of bell-shaped curve in distribution. Less equal distribution but with radically more mobility at all levels of economic status. That economic freedom and mobility is what inspires and rewards innovation, thus generating robust economic growth.

As Winston Churchill said, “The inherent vice of Capitalism is the unequal sharing of blessings; the inherent virtue of Socialism is the equal sharing of miseries.” :)

BTW, I love the premise of your blog site. Thanks for stopping by.

[Steve Roth]

Hi Michael:

Thanks to you too.

>I don't think wealth inequality alone can be the cause of prosperity.

No of course not. Just one of a zillion factors. While I show a correlation (long-term but not short-termm), the causation could arguably go either way. Or both.

A recent study mentioned in the economist, btw (sorry, to busy right now to look it up) found that generation to generation (which avoids the issue of who earns what at different ages), scandanavian countries have more upward mobility than the U.S. A poor person in Finland has a higher chance of kids being in a higher quintile.

Glad you like the "conservative" thing. One of those things one wants to get off one's chest... And thanks for the Churchill quote! One I hadn't heard.

Steve