The 1%: They’re at it again…


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One percent of Americans now earn a greater share of income than at any time since the 1920s, according to this article posted today. The top 1% of income earners, those who earned more than $394,000 last year, accounted for more than 19% of all income reported to the IRS, while the top 10%, or those who earned more than $114,000, accounted for more than 48% of all income.

I got upset when I read this article. I don’t think it’s fair. And I think something needs to change.

Specifically, I don’t think it’s fair to any of us that the standards of journalism have sunk so low that an AP reporter can get away with publishing a handful of numbers buried in a steaming pile of opinion and pass it off as “news”.

Nassim Taleb rants in his excellent book The Black Swan about how he does not read the news. He relies instead on prices to communicate what’s going on in the world, because prices are purely objective. He ridicules outlets like Bloomberg that try to explain price movements with a narrative that connects them to other events. No doubt you’ve seen the following occur: The market opens lower, and Bloomberg runs a headline “Stocks down on interest rate fears.” And then by lunchtime the market has rallied for some random reason, and Bloomberg changes the headline to “Stocks up on interest rate optimism.”

Of course investors don’t change their mind on interest rates between breakfast and lunch, unless Bernanke happened to make a statement to the press in the meantime. And Bloomberg certainly can’t tap into the thoughts of millions of market participants that quickly with any accuracy. These headlines are absolute rubbish, but we eat them up and come back for more. Taleb attributes this irrational behavior to what he calls the “narrative fallacy”, or our inability to look at facts without trying to come up with a story that ties them together. Everyone seems to want to find a narrative, and every narrative, no matter how far-fetched or even ridiculous it might be, will seem plausible to at least one person.

Let’s apply this lens to the AP article on income inequality. But before we do, I need to rant a bit myself:

I am frustrated with the lack of semantic precision found in most news articles about the economy, particularly the confounding of two concepts that are related but very different: Wealth and income. Too many reporters use these words interchangeably. This lack of discipline (together with lousy education, more on that later) is responsible for spreading a plague of economic and political confusion among the general public.

Wealth is a “stock” variable that describes what you have accumulated. It is expressed in units of money, like dollars. It is your net worth, i.e. the sum of your assets less the sum of your liabilities. It’s the value of your bank accounts, your property, your investments, etc. minus the value of all your debts. It’s the equity on your personal balance sheet. Ideally you want this number to be greater than zero.

Income is a “flow” variable that describes the rate at which you acquire wealth. It’s expressed in units of money per unit of time, like $20/hour or $114,000 per year. Generally speaking, you also want this number to be greater than zero.

But describing personal finance using these two variables is problematic for the popular discourse, because we find it convenient to distill reality, in all of its rich detail, down to a series of false dichotomies in order to simplify the talking points. For example, the terms rich and poor.

What does it mean to be rich? Does it mean high wealth, high income, or both? The answer to this question may seem irrelevant to many Americans considering our labor force participation rate of just 63.3%. There are an awful lot of people who would be happy if they were just a little better off than the status quo. But rich people have high wealth. There isn’t such an easy term for high-income people, so lazy reporters and politicians often call them rich as well. And while high income is correlated with high wealth, it doesn’t necessarily cause high wealth because one can always spend more than he earns.

Even with unambiguous definitions of wealth and income and our best efforts to avoid the narrative fallacy, income statistics can be hard to understand for a number of reasons. So lets go back and walk through that AP article.

We get off to an inauspicious start with the first sentence:

The gulf between the richest 1 percent and the rest of America is the widest it’s been since the Roaring ’20s.

The erroneous use of the word “richest” to describe the concept of income rather than wealth allows the author to foist another subtle lie upon us: That the top income-earners are an exclusive fraternity whose membership has not changed since the Roaring ’20s. You know, a cabal of old rich guys like Charles Montgomery Burns who’ve been waiting for this “Excellent!” opportunity to return to their pre-Depression glory days.

In fact, the composition of the 1% changes dramatically from year to year. In addition to the perennials like Bill Gates, Warren Buffet, and Mr. Burns, the 1% club includes transitory members like the salesperson who had a great year after spending the previous two living on her modest base salary while she built customer relationships in a new territory, and the farmer who had a bumper crop after getting wiped out by drought the previous year, and the entrepreneur who sold a business he had been running on a shoestring budget for several years without taking a salary himself.

These people and many others like them have a lot of lousy-to-mediocre years and a handful of great ones because they take big risks, and sometimes those bets pay off well.

The author continues:

In 2012, the incomes of the top 1 percent rose nearly 20 percent compared with a 1 percent increase for the remaining 99 percent.

The richest Americans were hit hard by the financial crisis. Their incomes fell more than 36 percent in the Great Recession of 2007-09 as stock prices plummeted. Incomes for the bottom 99 percent fell just 11.6 percent, according to the analysis.

But since the recession officially ended in June 2009, the top 1 percent have enjoyed the benefits of rising corporate profits and stock prices: 95 percent of the income gains reported since 2009 have gone to the top 1 percent.

That compares with a 45 percent share for the top 1 percent in the economic expansion of the 1990s and a 65 percent share from the expansion that followed the 2001 recession.

Again, the use of subtle language like “the incomes of the top 1 percent” implies that each member of last year’s top 1 percent got a 20% raise this year. Use of the singular, “the income of the top 1 percent,” would be factually and grammatically correct. We have no way of knowing the average increase for any individuals year-over-year.

The author repeats the same pattern of flawed reasoning and subtle linguistic hints throughout this section, attempting to construct a fictitious narrative of a typical 1%-er during and after the financial crisis using aggregate data, as if, say, the bearish money managers who did well during the crisis were the same people who profited from the market’s recovery in mid-to-late 2009. And to finish this exercise in fallacious reasoning the author compares these imaginary individuals with their younger imaginary selves from 2001 and even the 1990s, apparently to show that if there was such a person who was fortunate enough to have been a member of the 1% club for 23 straight years, he would have done exceptionally well this year by comparison with his measly-but-still-1% performances in past bull markets.

The author goes on to provide a couple of useful numbers that I already included in my introduction, and then comes the following important disclaimer:

The income figures include wages, pension payments, dividends and capital gains from the sale of stocks and other assets. They do not include so-called transfer payments from government programs such as unemployment benefits and Social Security.

In other words, they’ve assumed that the 37% of Americans who have given up looking for work have no income at all, even though we are supporting them with myriad entitlement programs. And these figures also include the 13% of Americans over the age of 65 who are living on Social Security, but we don’t count those payments as income, either. So fully 50% of the population, according to this study, effectively has zero income!

Might that little fact explain why this analysis found such a small increase in the income of this population since 2009? They’re not working!

And now, I present to you the narrative fallacy in all its glory:

The gap between rich and poor narrowed after World War II as unions negotiated better pay and benefits and as the government enacted a minimum wage and other policies to help the poor and middle class.

The top 1 percent’s share of income bottomed out at 7.7 percent in 1973 and has risen steadily since the early 1980s, according to the analysis.

Economists point to several reasons for widening income inequality. In some industries, U.S. workers now compete with low-wage labor in China and other developing countries. Clerical and call-center jobs have been outsourced to countries such as India and the Philippines.

Increasingly, technology is replacing workers in performing routine tasks. And union power has dwindled. The percentage of American workers represented by unions has dropped from 23.3 percent in 1983 to 12.5 percent last year, according to the Labor Department.

The changes have reduced costs for many employers. That is one reason corporate profits hit a record this year as a share of U.S. economic output, even though economic growth is sluggish and unemployment remains at a high 7.2 percent.

Every one of these statements is an opinion with enough facts sprinkled in to make the author sound credible. But there are numerous other plausible narratives that could explain how we got to where we are. Here’s my version:

The distribution of incomes narrowed after World War II as millions of employable men returned home to cities rather than their family farms, swelling the ranks of labor unions as they took private-sector manufacturing jobs that paid better than military service or manual labor on the farm because they created more economic value than these alternative uses for the same labor.

The trend toward urbanization and industrialization continued until the early 1970s, when increased manufacturing automation, information technology, liberalization of trade, and floating currencies forced manufacturing workers to begin competing against machines and cheap offshore labor.

Meanwhile, easy monetary policy began to inflate the prices of financial assets held disproportionately by wealthier Americans and eroded the purchasing power of the working classes due to a politically-rigged Consumer Price Index, which decline in household purchasing power coincided with the rise of feminism to encourage more women to join the workforce.

This increased the supply of labor but not the demand for the same, which further depressed wage growth, which made the two-income household a modern necessity and deprived children of many of the emotional benefits enjoyed by the previous generation, which in turn coincided with the dumbing-down of public education and ultimately condemned a huge segment of the rising generation to chronic under-achievement.

Which is how we arrived where we are today: Greater variance in household incomes than at any time recent memory, and no easy way to fix it.

Especially if we allow such lousy reporting to frame the problem inside a politically-convenient narrative that hints at “solutions”.

11 thoughts on “The 1%: They’re at it again…

  1. Like you, I find the whole concept of “income inequality” is so poorly reported that it drives me crazy. Then there’s the whole problem with the “household income” statistics. The average household in 2013 looks a lot different than the average household in 1950. And on and on it goes.

    The whole field of economics has become so politicized that it’s impossible to education the average American about simple concepts.

    1. Yes, great point! The popular narrative fails to account for the changing definition of a household. There’s also a huge discontinuity in the way AGI is computed, as the definition changed in the mid-1980s.

      Thanks for reading and for your insightful contribution.

  2. Reblogged this on Daily Plunge and commented:
    Income inequality is a topic that’s discussed constantly by people who are clueless about economics. The press makes things even worse. For those who are interested in this complex subject I encourage you to read this great article by Zach Mortensen.

  3. A story similar to this one is making the rounds today. The headline: “124 Brazilians are worth over a tenth of the country’s GDP”, seems to imply that 124 people make 10% of the income. But it’s comparing wealth and income again.

    This is tantamount to saying that I have driven 20 miles so far today, which is more than 30% of the speed limit on the freeway. Ridiculous.

    http://qz.com/123200/124-brazilians-are-worth-over-a-tenth-of-the-countrys-gdp/

  4. Great article. Your interpretation is insightful and grounded. Unfortunately, it’s a bit too boring and complex to make it into mainstream media.

    Quick question. I noticed the greatest peak in the graph occurred in 1928. What are some of the factors that contributed to that spike? Also, the spike occurred one year prior to the beginning of the great depression. Any causal correlation between the two?

    1. Thanks for reading and for your kind words.

      Good question about the peak variance in incomes prior to the great depression. I don’t think there is a causal relationship between the two, but I think they were both part of the natural business cycle precipitated by a magnificent expansion in credit.

      David Stockman’s recent book The Great Deformation explains this phenomenon in detail. I’ll paraphrase for now and may follow up with a more detailed post later:

      World War I caused a severe and prolonged shock to global agriculture markets as most production ceased in Europe. This collapse of supply increased crop prices, which made many farmers in the US quite wealthy. High crop prices drove up the value of farmland, which created an investment bubble not unlike the recent housing bubble, financed of course with a significant expansion in bank credit.

      Prices normalized when the war ended and European production slowly came back online. Lower prices meant that farmers could not afford the mortgage payments on the farms they bought at the peak. In addition, farmers had invested in tractors and other modern industrial farm machinery during the boom years, thereby increasing their capacity to grow crops, which created additional supply that further depressed crop prices as global supply recovered.

      So these shocks were amplified by a large expansion in bank credit, which created some really high incomes for people in the financial services business during the Roaring 20s. The accompanying stock market bubble was a symptom of the increase in prices that were amplified by an expansion of credit.

      And when those loans started going bad, the market crashed and banks started to fail. The depression was on.

      It’s interesting that the historical narrative most of us are taught in school blames the depression on speculation in the stock market and marks the 1929 crash as the start of the depression. But the seeds were sown (unfortunate pun) a decade and a half earlier in familiar form: Easy credit and bad loans.

  5. Your critique has one major flaw: It’s dependent on the presumption that the objective of today’s news media is to actually publish unbiased facts. That went out long before Monty Burns. ;-)

  6. Thanks for the reply! I took an Internet vacation for a while, but was excited to read your insight. I will definitely check out the book.

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