Living Economics

Income Lotteries
Income distribution may be more unequal while average income is increasing.

When Bill Gates walks into a working-class bar, the "average guy" in the bar instantly becomes a millionaire. But the workers are no richer than before. As long as the top incomes continue to rise, the average income will rise too. In fact, when most of the income growth is concentrated at the top, the median income can fall while the average income rises. In income distribution, it is the median income that divides the income recipients into 2 equal halves that matters.

In the U.S., there has been a tendency for the median income and average income to drift apart. Specifically, the average per capita GDP has increased by 53% from 1980 to 2002, while the median income per family has increased by only 20% in the same period. That means more of the income growth has been concentrated at the top.

If you could choose between country A where the average per capita income is the highest and country B where the median income is the highest and your income is randomly assigned, which country would you rather live in? A risk-averse1 person would choose country B in this income lottery.

But if your income is not randomly assigned and you have some idea which side of the median income you are more likely to end up with, you are more likely to choose country A. In this country, public education may be crumbling, jobs may be insecure, street crimes may be endemic, and 20% of the population may have little access to basic health care. But when you make it to the top, you are king of your own domain. You can buy your way out of these social ills.

Some economists see income inequality as a sports tournament where the high top prizes serve to bring out the best from the fittest, and the pursuit of income equality through income redistribution as a dead-end strategy destined to be swept away by competitive globalization. But others question the ultimate moral purposes of income growth if its fruits are not more evenly shared and whether unfettered market competition is the best way to grow income.

Note:
  1. The tendency to choose a sure thing over a gamble with equal expected value.
  2. The tendency to choose a sure thing over a gamble with equal expected value.
References:
  • Delong, J.B. “Growth is good.” Harvard Magazine. January/February 2006.
  • Friedman, M. F. The Moral Consequences of Economic Growth. Knopf, 2005.
  • Stiglitz, J. “The ethical economist.” Foreign Affairs, November/December 2005.
  • U. S. Census Bureau. Mini Historical Statistics.
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