The Mismeasure of Inequality

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Growing economic inequality is now becoming a premise of our political debates. Unfortunately, however, conventional government measures of inequality provide a misleading picture of comparative living standards in the modern world.

Most importantly, income inequality is not a good proxy for gauging the rise or decline of economic equality. To be sure, if income equality is to be used as a proxy, incomes have to be calculated accurately. For instance, incomes have to be calculated after tax rather than before tax. Moreover, government transfers have to be included. Finally, for most people income changes significantly over their lives. The amount earned over a lifetime seems more relevant than that earned from year to year. All these adjustments temper the inequality of earned income.

Consumption, however, provides a better measure of economic equality than income. Consumption is the ultimate objective of earning, as Adam Smith himself recognized. And, as I have discussed in a recent essay, Innovation and Inequality, the most important phenomenon for consumption in modern world is that economic value is now more and more created by information that arranges material rather than the material itself. As a result, we all can enjoy a higher level of consumption from the common pool of innovations that rapidly become inexpensive or even free. Income differentials are less important given that common pool.

To be concrete, compare our situation to that of the Middle Ages. At that time most of the value in almost all goods lay in the material, like real property or metals. If I owned the lands and materials, you did not. But today relatively little of the value of a new piece of technology such as a smart phone lies in its material parts. Its value lies in the innovative ideas that arrange its material and the network over which millions communicate. This value can be enjoyed by everyone who has a phone. To be sure, some innovations are patented, but patents do not last forever and when better inventions are patented for the same purpose the cost of accessing the previous patents rapidly declines.

One result of a more idea based economy is that innovations move much more rapidly down the income scale. It took a very long time for timepieces to be widely owned, decades for refrigerators to grace almost every household in the United States, but less than a decade for most people to own a smart phone in this country. That faster progression suggests that important aspects of consumption are more equal than ever.

Or consider the general effect of our less material world on relative equality. In the Middle Ages, a very wealthy noble would experience life completely differently from someone earning the median income. The most important vector of life would be material and the noble would live in opulence and the middle class person in comparative squalor. But today, both billionaires and the middle class have relatively equal access to wonders of the online world through the portal of the internet, where both spend an increasing portion of their time. This comparison captures an important underlying trend in our technologically driven society that is likely to accelerate.