Why don't we care about the poor?

Source: US Census Bureau, 2014.

Last week saw the release of the annual US poverty and income statistics.  On the face of it, they make for pretty terrible reading. The top fifth of the income distribution held nearly 50 per cent of all income, the bottom fifth just over 3 per cent (Figure 1b). If income was equally shared out across the population, the top fifth would only hold 20 per cent. A longer sweep of history shows how everyone except the top has lost out over the past 40 years, with only the income share of the top growing (Figure 1a).

It's a pretty lonely place down there at the bottom. 15 per cent of Americans are in poverty*. Many more are in near-poverty, struggling on the edge of hardship. Single mums and children fare the worst. Young children are five times as likely to be in poverty if they live in a family headed by a single mother compared to married parents. And despite a small tick down in poverty rates for children and those of Hispanic descent, poverty remains stubbornly high.

You'd be forgiven for blinking and missing this publication. The data are only published once a year and are already a year out of date. They don't move markets or grab headlines.  In fact, those that get most impassioned about the data are people already working at the coal face of poverty alleviation, who are able to demonstrate through statistics what they already know through experience.

Why don't these facts and figures about the harsh reality of life in America grab more attention?

Is it because the average person is also under pressure?  In 2013, the median household was 8% poorer than it was in 2007, just before the financial crisis began. That means that even though we might have made up for all the jobs that we shed in the Great Recession, we haven't made up for all the money we lost.  If the average family is worse-off, and are themselves struggling to stay afloat, they probably don't have the time, or money, to worry about the very poor.

Or is it because poverty's very existence goes against the ideal of the American dream? That if we really believe what they show, then we have to accept that opportunity is not equal for all. That hard work and determination alone are not enough to move out of hardship. By accepting poverty, we accept that there are barriers in-built into our institutional architecture that mean non-Whites are more likely to be born into poverty, live in a deprived area, eat poor-quality food, attend poor-quality schools, drop out of college (if indeed they apply), hold a minimum wage job, not have access to childcare, suffer from poor health outcomes and die early.

Perhaps these reasons are two sides of the same policy coin. If ordinary people are struggling to stay afloat, and those at the very bottom are sinking, then only active government policy can generate a tide that will lift all boats. An increase in the minimum wage, for example, would benefit the majority of people living in poverty but it would also create a corresponding increase in pay further up to maintain pay differentials. A concerted effort to improve the quality of K-12 education would benefit those who in poverty who are most likely to fall behind, as well as creating positive spillovers to all students within that learning environment. Those in poverty may be in the minority but solutions to their problems would definitely benefit the majority.

*According to a more comprehensive measure, the supplementary poverty measure, poverty rates are higher still. The 2013 estimate will be published later this year.

Health-onomics

Source: CIA World Factbook (life expectancy) and
Wilkinson and Pickett, 2009 (income inequality) 

Higher inequality means poorer health outcomes. The US is a case in point. It has the highest level of income inequality in the industrialised world. And at birth, Americans can typically expect to live shorter lives - around 79 years compared to 82 years in Switzerland (Figure 1) and nearly 90 years in Monaco (not shown in Figure 1). So why is inequality associated with adverse health?

In health, it's all about hierarchies, whether by income, education, social status or race. Those higher up the hierarchy report more favourable health outcomes than those lower down. Even those at the very top report better health than people just a notch below them. There is a 'gradient' effect of your position in society on your health (Adler et al, 1994;  Marmot et al, 1991).

Towards the middle and top of the income distribution, this is attributed to a 'keeping up with the Jones'' mentality. People are under pressure to compete with each other in jobs, wealth and possessions. These behavioural factors cause stress and stress-related illness.    

Towards the bottom, this is attributed to the more straightforward relationship between absolute deprivation and health. Material factors matter. The conditions of modern-day poverty in the US - working two jobs to make ends meet, living in over-crowded accommodation, living in neighbourhoods with few healthy eating options, low probability of having health insurance - all contribute to poor health outcomes. This becomes self-reinforcing for today's working families. Those who suffer from poor health are less likely to be able to hold down a long-term job. It also impacts on tomorrow's workforce. Children born into deprivation are more likely to suffer short and long-term health problems like obesity and asthma.

Healthcare reform will go some way to fixing these problems for the poor and uninsured. By opening up the market for healthcare, expanding government-funded medical programs and subsidising insurance premiums, coverage has already ticked up. The hope is that as more people sign up for medical insurance, they will be able to access timely and cost-effective care [a future blog will provide critique of the US healthcare system].

But tackling the hierarchies that generate unequal health outcomes requires reform of a wider set of institutions. That is because health is simply a window into the world of inequality. We need to flatten structures elsewhere. That might be in our schools and universities, where we need to ensure equality of opportunity. That might also be in our workplaces, where we need to ensure fair pay and progression. That might be in our neighbourhoods, where we lean against the creation of wealthy and less wealthy clusters. All of these actions would help break down the hierarchies that create inequality. Fixing health is only the first step.

An economy that works together, stays together

Source: Steve Breen / Creators Syndicate

The US economy is experiencing its slowest recovery in 70 years. We just can’t seem to give the economy the kick-start it needs. Why? Because we are held back by inequality. Only by tackling inequality head-on can we secure the sustained economic recovery that we are looking for.

Inequality sends a signal about the economy’s potential to grow today. Income among the poorest can be stagnant if people have given up looking for a job because opportunities are so scarce. The recent fall in US unemployment masks record falls in the participation rate, the number of people actually looking for a job. Fewer people in the labour force leads to lower per head growth rates and lower social cohesion. We are wasting our best resource – people. 

Source: Chan Lowe / Tribute Content Agency

Inequality also matters for the economy’s growth potential tomorrow. Richer families can afford to spend more time with their children, investing in their learning and development. Poorer families, who are more likely to work longer hours in minimum wage jobs, simply don’t have the time. But if you think that talent is randomly distributed, then this means that many children's potential will be left untapped. These young people are also more likely to drop out of high school or college, either because of cost or because they simply don't believe that people like them can succeed. This impacts on their ability to secure a job and makes it more likely that they will also fall on hard times.  

What can be done? If inequality is defined as a gap, then let’s build bridges that enable people to close this divide. Raising the minimum wage would enable everyone to earn a basic income. On-the-job training would improve career progression and lifetime income for those in work, and back-to-work training would improve job prospects for those out of work. A more progressive tax and social security system would provide much-needed resources to low-income families to invest in themselves. 

None of these policies constitute a hand-out. Raising the wage, for example, would actually increase tax receipts and reduce welfare expenditure as fewer people require income support. All of these policies can help children as much as adults. For example, women who joined the workforce following welfare reform in the UK spent the extra income earned on books and activities for their children. And each one would increase the productive potential of the economy. An economy that can produce more is likely to grow.  

To tip or not to tip, that SHOULD BE the question

Tipped workers are more than twice as likely to be in poverty as the average worker. Yet tipping remains an accepted norm in America because people believe that tips reward hard work. Don't they? 

It turns out that tipping is only weakly correlated with good service. Michael Lynn has shown that it is more strongly associated with social norms and the appearance of the server themselves. White, 30-something, blonde, females receive the highest tips. Black people are less likely to both give and receive tips. So the likelihood of receiving a tip is more or less out of a server's hands, even though servers believe that better service is rewarded with higher tips. 

Tipping can also be confusing and uncomfortable. Tourists in America are often puzzled about how much to tip. Stories are told of patrons being chased out of restaurants by servers who were unsatisfied with their tip, claiming that they needed the money to survive. The obligation falls to the customer to pay the server enough.

Why are tips so important to the server? Because their base wage rate ($2.13 an hour, unchanged for 20 years) is set assuming that tips will be received. In theory, tipped workers should take home a minimum wage ($7.25) because employers are obliged to make up any difference between base wage plus tips and the minimum wage. In practice, the process appears complicated and reliant on employers acting promptly to pay the difference in the two, without error.

Source: Council of Economic Advisers available here.
Occupations shown are predominantly tipped.

But even the minimum wage ($7.25 an hour) is too low to meet a basic standard of living, as previous blogs have argued. So if a server wishes to earn above this level, the only way that they can do so is to earn tips to take their total wages over and above the minimum wage. But tips are irregular and never guaranteed. As a result, the median tipped wage ($10.64) is much lower than the median across all wages ($17.12) (Chart 1, left-hand diamonds). Tipping isn't working as a way to increase income. In poorer areas, where income of the clientele is itself low, tipped workers are even less likely to earn a decent amount.  

In addition, tipped jobs attract more women than men, exposing them to the irregularity of income streams that tipped work brings. Nearly three-quarters of tipped workers are women, even though they account for just under half of total employment (Chart 1, left-hand bars). Women may be attracted to these jobs because they offer flexible hours that allow them to work around childcare. But the low-paid nature of this work makes it more likely that women, particularly single mothers, will find themselves in poverty.

Given how inefficient, confusing and poverty-creating tipping can be, why not eliminate the practice altogether? Some restaurants have already instigated such a practice. Examples include increasing base salaries and making clear that tips are optional, or adding a service charge to all tables and taking the decision out of the customer's hands altogether. Bringing tipped workers onto the minimum wage would eliminate one obstacle in the path to ensuring better pay. The next would be to secure a substantial wage increase for all low-paid workers. In the meantime, customers can revert to tipping because they want to, not because they have to.  

The Robin Hood method of tax and redistribution

Source: Spark Studio via Getty Images

Robin Hood famously took from the rich to give (back) to the poor, to the despair of the Sheriff of Nottingham. But could taxing high-earners actually increase economic well-being and decrease income inequality simultaneously? Could Robin Hood have been right? 

Economic theory tells us that our appetite is satiable. The first slice of pizza when you’re hungry is delicious but the fourth just gives you a stomach ache. And so it is with money. The marginal utility of money – the additional “happiness” we feel from an extra $1 in our pockets – falls as the total amount of money we have rises. $1 to the richest person means much less than $1 to the poorest. In fact, a 2010 study by Daniel Kahneman and Angus Deaton estimated that the average person requires around $75,000 to be happy. Additional income does not add to their emotional well-being.

Economic theory also tells us that those on lower incomes spend more of every $1 they earn than the rich. Their marginal propensity to consume is higher. All families need to meet basic needs. But for the poor, this takes up a higher fraction (if not all) of their income. This drives demand for goods and services. The rich, meanwhile, have a higher propensity to save.

Combining these two observations implies that taxing those on the higher incomes – say above $75,000 – and redistributing to those on the lowest could actually improve overall well-being. If the evidence is to be believed, those on high incomes would not be made worse-off.  And those on the lowest incomes would be made better-off.  

How might this redistribution occur, in a way that does not disincentive those on low incomes from working? One way is to make use of the negative income tax built into our system. Everyone who works has a tax-free allowance, the amount they can earn before they start paying income tax. But many people are unable to work sufficient hours or earn enough to meet their income tax threshold, so part of their benefit is unused. An income transfer could address this gap provided the person is working (the Earned Income Tax Credit effectively does this in the US on a smaller scale).

Opponents of higher taxes argue that those with a higher propensity to earn will have a lower incentive to work or invest in high-return activities because any income would be taxed away. As a result, economic growth would slow and we would all be worse-off. But a report by the Congressional Research Service, which provides unbiased research for the US Congress, found that there is little evidence of a relationship between income tax and hours, savings or investment. Furthermore, the IMF has demonstrated that lower inequality achieved through redistribution can in most cases produce more stable, durable growth rates. That is likely to be because it enables more of the population to participate fully in society. And neither Robin Hood nor the Sheriff could have argued that stable and durable growth was a bad thing.*

Brazil's World Cup still half empty

Source:  Fédération Internationale de Football Association

As many on social media have pointed out, the World Cup 2014 emblem looked like a man hanging his head in shame (Figure 1).*

Not the shame that came from losing 7-1 to Germany (though that was pretty painful). The shame that came from knowing that hosting the World Cup reportedly cost the country $4.2 billion but more than half of Brazilians believed it would hurt the economy. That 50 per cent of Brazilians thought now was a bad time to find employment despite the government saying that the World Cup would create 710,000 jobs. That the number of poor people living in Brazil could have filled its World Cup stadiums 30 times over.**

After the dust settles, and the spotlight dims, the facts will re-emerge. The International Monetary Fund forecasts that the Brazilian economy will grow by 1.8 per cent this year, compared to a 10-year average of 3.5 per cent, because of weakness in manufacturing, consumer spending and export performance. Others are more bearish still. The central bank has raised interest rates in recent months, because of above-target inflation, leading to worries that economic growth will be choked off. Social discontent led to a number of high-profile protests in the months leading up to the World Cup.   

Brazil appears to have lost grip on the solid macroeconomic framework it established over the last decade. This platform generated high single-digit growth rates, funded active redistribution policies and contributed to a rapid fall in inequality. Between 2004 and 2012, poverty rates more than halved from 22 per cent to 9 per cent. Conditional cash transfer programs that provided monetary rewards in exchange for attendance at school and health centres improved outcomes for those on the lowest incomes. Between 1999 and 2009, the increase in per capita income of the poorest 10 per cent was nearly four times that of the richest 10 per cent. Out of a general rise in income, grew a substantial middle class.

This middle class is now demanding action. Brazil needs to take this opportunity to re-establish its credibility and tackle the hard problems that are preventing it from achieving sustainable and inclusive growth. It needs to push forward on much-needed reforms to infrastructure that would reduce local bottlenecks and improve the quality, not just quantity, of public education and healthcare. It needs to tackle wasteful corruption, which is estimated to cost between 1.4 and 2.3 per cent of GDP a year, and enables favours to the 'haves' at the expense of the 'have-nots'.         

Brazil will play host to the Olympics in Summer 2016. It is likely that between now and then we will see more protests from a discontented population. But, if the country undertakes substantive reform, we may also see a very different country when the spotlight returns.

* The green hands form the shape of a head, which is held in the yellow hand
** Author's calculation based on data from the World Bank and the Stadium Guide

Inequality: seed of the crisis, thorn in the recovery

The US economic recovery is being built on fragile foundations. The average consumer might be spending more but the extra money isn't coming from substantial wage growth. Consumption is being financed by running down savings and building up debt. Savings ratios are back to levels last seen on the eve of the 2008 financial crisis. The consumer debt ratio - debt payments (excluding housing) as a proportion of disposable income - is on the rise (Figure 1).

Source:  Federal Reserve Board

This pattern is not new or sustainable. In the years prior to the financial crisis, wages of low-income households in the US failed to keep up with rising living costs. In order to maintain spending, these households took on more debt. Meanwhile, incomes at the top grew rapidly. Rising income inequality created political pressure to encourage borrowing (particularly in housing) to maintain demand in the economy. Such action built on the underlying "fault line" that inequality represented rather than resolving it (Rajan, 2010).  

Borrowers bet on higher wages being just around the corner, which would allow them to continue to service their debt. In 1989, the US household debt-to-income ratio was around 60 per cent for the top 10 per cent and around 80 per cent for all other groups. In 2007, the ratio was around 80 per cent for the top 10 per cent and 250 per cent for the bottom fifth. But wages failed to keep up with growing debt burdens. Default rates picked up, the inequality fault line was exposed and the financial crisis ensued.    

Today, for expenditure to be affordable, wages need to rise in line with living costs. One way to do this is to mandate for above-inflation increases in the minimum wage, so that low-paid workers can catch up. In February, President Obama signed an Executive Order increasing the minimum wage for federal contract employees to $10.10 an hour. He also called on Congress to pass a similar proposition for all Americans (the current federal minimum wage is $7.25). Some jurisdictions have implemented or announced their own above-average increases, for example, San Francisco ($10.74) and Seattle ($15). The Center for Economic Policy and Research has demonstrated that if the minimum wage had kept up with labour productivity since 1960, then it would have reached $21.72 by 2012.* 

A reasonable increase in the minimum wage would have a positive impact on the individual and economy. According to the Congressional Budget Office (CBO), an increase in the federal minimum wage to $10.10 by 2016 would lift 900,000 individuals out of poverty. But it is not just those in poverty that benefit. All low-income, and some middle-income, households stand to gain. The CBO reports that the cost of expected job losses that would arise from a higher minimum wage to $10.10 would be more than offset by overall gains.** An increase in consumption that follows from a rise in wages would stimulate business investment. An increase in tax contributions from better-paid workers would improve the state and federal balance sheet.   

But in the medium-term, increasing the wage packet of low-income households does not fully tackle the problem. As a result of technological progress and cheaper labour overseas, many middle-skilled jobs in the US have been eliminated (see "An earthquake on inequality is coming").  What remains are low-skilled and high-skilled jobs.  This makes it very difficult for those at the bottom to progress up the income ladder. What is required to bridge this gap is investment into training and job creation. This would enable low-income individuals to secure decent progression, pay and improve job quality. In turn, this would make it more likely that they are able to participate in the recovery, and not be left behind... again.

* This isn't necessarily an argument for increasing the minimum wage to $21.72. But it does demonstrate nicely that much of the gain produced by ordinary workers in recent years has been channeled away, towards senior executives and capital-owners, contributing to rising income inequality.

** Seattle has agreed to raise its minimum wage gradually to $15 by 2021.  As the population of low-paid workers is fairly small in the city, the benefits may outweigh costs arising from unemployment and higher operating expenses.  But further evidence is required before coming to a definitive conclusion.

This post was updated on 12 June, to clarify developments in low, middle and high-skilled jobs in the US.

I want YOU for the U.S. dream

The beauty of the American Dream is that the accident of birth does not determine a child's life chances. Those born into a poor family can become rich. Those raised by parents without education can go to college. Those growing up in rented homes can become homeowners. The future is in one's own hands.

Source:  The Pew Charitable Trusts (2012)

But there is strong evidence that the American dream is, well, just that, a dream. Social mobility is low. Children born into the poorest quintile are more likely to earn below average incomes (Figure 1, left, shows that 70 per cent of Americans born into the bottom quintile will remain below the middle in adulthood). They are less likely to go on to higher education. They are less likely to own their own home.

How then do we tackle a problem that appears to be ingrained in our society? One excellent suggestion is for Congress to create an Office for Opportunity. Establishing such a Federal institution would protect social mobility from the waxing and waning of political attention. The Office would define and target a single measure or set of measures. These could cover early childhood development, K-12 and college results, labour market participation and / or family circumstances, to track progress over a lifetime. It would also publish commentary on how well the USA was doing against these measures.

But this might not be enough. The UK government has set up a similar body, the Social Mobility and Child Poverty Commission. The Commission sets out targets for, and reports on progress against, a set of indicators. The trouble is that the general public have little awareness of its existence and so do not protest when goals are not met. Few know that the UK government has also committed in legislation to eradicate child poverty by 2020. Fewer still know that because of severe cuts to social security, the number of children in poverty could rise to 5 million by that time. For this reason, Save the Children UK recently launched its campaign, "A Fair Start for Every Child", asking for specific measures to ensure that a child's birth does not determine its chance in life. (Disclosure:  I was the lead author on their report).

What is required is a society-wide strategy to hold governments to account on their commitments. Such an approach was taken with the Millennium Development Goals (MDGs), which were publicly agreed by participating members. Armed with the knowledge of what their government had promised, developing country citizens were empowered to push leaders to deliver on specific promises. Learning from this, the US government should publicly commit to a set of SMDGs (Social Mobility Development Goals). It should undertake an extensive public awareness campaign to garner action by civil society. This would also ensure that ruling parties are held to account by the public. Only by doing so can we get America moving and have a decent shot of turning the American dream into a reality.

An earthquake on inequality is coming….

In the debate about rising inequality, the behaviour of Chief Executive Officers (CEOs) has been cited as a major cause.  They are accused of putting short-term (shareholder) interests ahead of long-term (firm) interests.  Their actions are hardly surprising considering that CEO remuneration has historically been tied to short-term objectives such as annual shareholder returns.

But are politicians equally guilty of short-termism?  Consider that their time horizon is the electoral cycle.  Their objective is to be re-elected.  Their method is policies that target the median voter.  A problem that, until recently, affected only a minority, is unlikely to be adequately addressed by the political process.  Cue civil society.  Over the past few years, as a direct response to the discontent caused by rising inequality, we have seen the emergence of the Occupy movement, the UK Living Wage campaign and the Arab Spring. 

Grass-root movements have a long history of affecting change in the United States and beyond.  Giving women the right to vote in the UK, the campaign for equal rights in the US, the fall of the Berlin Wall in Germany.  Activists were drawn together by a shared set of principles, which helped spread their reach and eventually spurred national and global campaigns. 

But in generating a sufficient mass, they also drew the attention of political parties.  The slow rumblings of discontent transformed into substantive political pressure, that forced the hand of politicians into declaring an active policy response.  Such events mimic the “stick-slip” dynamics of an earthquake, where the forces below the earth’s surface eventually generate enough strength to push against the forces holding the plates together, to produce an earthquake (Jones and Baumgartner (2012)).  In this case, the political system with its procedures, rules and norms acts as a retarding friction against the public movements that generate information about pressing issues of the day that require action.

 

The rise of the Occupys, the election of Bill de Blasio to Mayor of New York on an agenda of tackling inequality, the rejection of the Conservative-led coalition in recent UK elections, all suggest that the time is ripe for a major political earthquake.  Yet, the world is still waiting for a major set of policies to resolutely tackle income inequality in the US and beyond.  In the language of our earthquake analogy, what further information is required to overcome such political frictions, taking into consideration the time horizon over which politicians operate? 

First, dispelling the myth that monetary and fiscal stimulus have put the economy on a path of stable, inclusive growth and that no further action is required.  In the US, the wealthiest one per cent captured 95 per cent of post-financial crisis growth between 2009 and 2012, while the bottom 90 per cent became poorer (Oxfam (2014)). The vulnerabilities that formed the basis of the 2008 financial crisis still exist and could generate another crisis in the near-term.  

 

Second, agreeing that reducing inequality can be growth enhancing, as the IMF has strongly argued.  Elections have been won and lost on the state of the economy.  The 2015 election in the UK and the 2016 Presidential election in the US will be no different.      

Third, an acceptance that, because of the nature of technological progress that is driving rising income inequality, for the first time, our children could be worse-off than us (Kotlikoff and Sachs (2012)).  This, unlike the first two, may fall outside of a politician's traditional time horizon, but is surely the strongest argument for action.