Ezra Klein on Consumption, Debt, and Inequality

Ezra and I chatted a bit on Bloggingheads about the ideas in his post replying to a bit of my paper, but I had yet to read the post, my response was off-the-cuff, and I think I can do better.

So, I noted in my paper that nominal consumption inequality has increased much less than income inequality (and I go on to argue that real consumption inequality may have dropped). Ezra says:

You’d think the fact that our ears are still ringing from the deafening “pop!” of the consumption bubble would, in some way, impact this analysis. But it doesn’t. Nor does the word “debt.” But that’s how many households have kept their consumption high amid widespread wage stagnation.

Megan McArdle posted an excellent reply, for which I am grateful:

I think it’s easy to overstate the contribution of debt, for two reasons.  First, many of the discussions on consumption equality focus on the poor, who were still relatively credit constrained even at the height of the bubble.  And second, income inequality figures exclude both taxes and government benefits.  Things like the EITC and Section 8 vouchers really have made a quite substantial improvement in the ability of the poor to consume.

So I don’t think we actually know how much of a difference consumer credit made to equalizing consumption between rich and poor.  I suspect that the continued mechanization of formerly labor-intensive tasks has made a greater difference, but then you’d expect me to say that.  The data we want will not be available for several years, especially since period immediately following the financial crisis will be very atypical*, and therefore not useful in assessing the longer term trend.

Let me add that I don’t think pre-recession wage stagnation has been exactly widespread. It has been suprisingly focused on low-skill, male workers. Also, to be exactish, money wages can stagnate or fall while total compensation rises. And total labor-market compensation can stagnate or fall while total disposable income, including government transfers, increases. (Additionally, income from “informal” markets tends to be under-reported, but likely shows up in consumption surveys.) So, as Megan points out, a steady level of consumption for a household with stagnant wages (and no savings) needn’t imply increasing debt. That said, I suspect many lower-income households have over recent years increased their level of debt, and I suspect that this has played some small role in keeping consumption inequality in check. But we shouldn’t infer from the bust following the boom that this was mostly “bad” debt. I think improved access to formal credit markets has been a net plus for lower-income households. And even if some of this increase in debt took the form of sub-prime mortgages, not all of that turned out bad.

More to the point, the economy tanked due to a burst housing bubble. I agree that there was, in some relatively clear sense, overconsumption of houses–a good generally bought on credit. The reasons for this are many, but first among them is that the government, in many ways, rather encouraged house-buying. The economy-wide delusion about the long-term trend of housing prices seems to have been both a cause and effect of the bubble, as well as a cause of highly unrealistic individual/household estimates of wealth that could safely be borrowed against now. So, yeah, lots of people who wrongly thought they were house-rich ran up their credit cards. I think it’s safe to say that there was “too much” debt-financed consumption. But I would hazard to guess that, on the whole, this would tend to widen rather than narrow the income and consumption gaps. As I note in my latest column for The Week:

“High-income households are highly exposed to aggregate booms and busts,” report Northwestern University economists Jonathan A. Parker and Annette Vissing-Jorgensen in a recent National Bureau of Economic Research working paper. They estimate that our current bust is hitting the income and consumption of households in the top 20 percent of income earners significantly harder than the households in the 80 percent below. And the higher up the distribution you go, the harder the hit is likely to be.

That incomes at the top are now so sensitive to aggregate consumption (it didn’t use to be that way, Parker and VIssing-Jorgensen say) would seem to at least partly explain the coincidence of very high average debt-levels and high levels of inequality that Ezra emphasizes later in his post.

Folks were running up their credit cards because they thought they were house-rich. They thought they were house-rich because they were in the middle of a housing boom that made the current and future value of their houses look a lot higher than they really were. Those with compensation schemes highly sensitive to changes in aggregate demand–high income households–saw a disproportionate rise in already high income as consumption boomed. So income inquality went up. And now they same households have likely seen a rapid drop as consumption has fallen off a cliff. So income inequality went down. At least that’s part of the story. And it remains conjectural until the relevant stats finally roll it. (Also, I think it remains that the primary cause of rising income inequality has been the rise in returns to human capital investment [pdf], and that hasn’t gone anywhere.)

So, I think Ezra is probably right to suspect some kind of correlation between high levels of income inequality and high levels of average indebtedness. Both levels partially reflect the housing-bubble-driven boom in consumption. But I don’t think it would be right to imply (as Ezra seems to in his post) that the high level of inequality somehow independently contributed to the crash.

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26 thoughts on “Ezra Klein on Consumption, Debt, and Inequality

  1. Why are you having that discussion? What difference does it make whether inequality is increasing or decreasing. It it's increasisng, the Left will blame the Right, and,f it's decreasing, the Left will take the credit. So, what more could an economist say, and what more need be said than this: the market, always tending toward equilibrium, always tends toward the inequalities that would bring it about, and that any interventionist measures to reduce them, like any other interventionist measures, will have the opposite effect of what was intended, not reducing but increasing the inequalities and “social injustice.”

  2. I would add that it is self-defeating for free-marketeers to deny free market inequality or increasing inequality, for that tacity admits that there's something wrong with it, and, therefore, with the market itself, for inequality is essential to it.

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  14. “[T]he economy tanked due to a burst housing bubble.” Post hoc, ergo propter hoc? The cause of the economy's tanking is surely very, very complex, and I suspect that the decline in housing prices is, *at best*, an extremely minor component. (Admittedly, it's not clear what sort of *importance* a component from out of the entire causal welter must have to qualify it as *the cause.*)

  15. All you need to know is that such a thing is not possible in the free market, that there is nothing in it keeping buyers and sellers apart, for it is nothing but buyers and sellers. Get the “government” out of its way, and they will surely come together again. All they need is capital, and it is the great failure of the Keynesian Austrians to have endorsed the Keynesian bias for spending over saving.

  16. With income being such a poor predictor of welfare for the poor, is it also a poor indicator of welfare for the population as a whole? What do you think is the value of measures like GDP per capita, and if it's not very valuable, what measures can we use to figure out how well we're doing?

  17. To say that the housing bubble is the sole cause of the recession is probably overstating things. However, it is much more than an “extremely minor componenent.” The decline in the housing bubble is probably the primary cause of the investment bank failures, since they were heavily involved in securitizing subprime credit instruments. In addition, the decline in housing prices must have reduced aggregate demand to some degree, given that there are people who borrow against rising home prices via home equity loans. Were there other causes? Sure. But I think a strong case can be made that the housing bubble was the proximate cause.

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