Saturday, January 24, 2015

Repeat after me: Wealth is not income and income is not consumption

            The recently published Oxfam report on the distribution of net wealth in the world, released  to coincide with the Davos meetings and showing that the global top 1% own almost one-half of world’s wealth, has generated lots of discussion. Some of it  reflects the misunderstanding of what distribution of wealth is, and it is on that specific critique that I would like to focus.

            The critique started by Felix Salmon (and continued by The Economist). Salmon in his piece entitled “Oxfam’s misleading wealth statistics” noticed in the Oxfam report (and in the report on which Oxfam study is based, Credit Suisse Global Wealth Report for 2014) that among the bottom decile  of adults, that is, among those with zero net wealth, there are about 40 million Americans and more than 50 million Europeans. That came as a shock: how can almost 100 million people from the rich world be among the poorest people on earth? (Other 80+% of the people in the bottom decile are from Africa, India, Latin America and Asia, as shown here in the graph from Credit Suisse report.)

            Salmon and others are perhaps not aware that, from the works published by Ed Wolff during the last 20 years and based on US Survey of Consumer Finances, we have known for years (see the graph below) that up to about one-fifth of American households have zero net wealth. When you exclude housing, the percentage of those with zero or negative net worth comes close to 30. How is net wealth defined? It is the sum of housing, cash, checking and savings deposits, financial assets such as stocks and bonds, and current cash value of life insurance and pension plans minus all liabilities (mortgages, loans). Most of the poor and the middle class have almost no financial assets, but their main assets is the homes they “own”.  “Own” here comes between the quotes because a large chunk, and at times (as when hosing prices go down) more than 100% of the value of one’s home may be owned by a bank. A person has then a negative housing wealth. Add to that car loans, school loans, credit card loans, and you can see how a large chunk of American households may have negative or zero wealth, and how in the wake of the recent recession that percentage increased by about 3 points (or about 10 million individuals). 

From Ed Wolff’s slides “Household Wealth Trends in the US, 1962-2013: What Happened over the Great Recession?” presented at CUNY Graduate center, October 7, 2014. 

            Among the advanced economies, wealth-poverty is not limited to the United States. In Germany  27% of households (as of 2013) have negative or zero net wealth (paper by Markus Grabka and Christian Westermeier). So these people would be also included among the wealth-poorest people in the world. 

            Is this an anomaly? Does it make the study of wealth inequality meaningless?  According to the critics of the Oxfam report it does, because the wealth-poor people from the rich countries do not necessarily lead a life of poverty. Thanks to deep financial systems that exist in rich countries they can borrow and keep their consumption relatively high all the while driving their net wealth down to zero. In effect, borrowing is simultaneously a way to keep consumption high (above your income which may be also high by global standards) and driving your net wealth down to zero. Thus, we have people who are absolutely poor by wealth standards while their income or consumption  may place them around the 60th, 70th or even higher global percentile.

            But the “anomaly” is solely in the minds of the critics. Distribution of net wealth is not the same thing as distribution of consumption or income. Each of these aggregates has its own uses. If one wants to look at people whose real consumption is minimal, who live at the edge of subsistence, one should look at the global distribution of consumption with its famous poverty line of $1 (now $1.25) international dollars per capita per day. This is what the World Bank has been doing since 1990. There are no people from the rich countries among the consumption-poor. Even the poorest people from the advanced economies have a much higher level of consumption (at least around $12-$15 international dollars per day).

            It is a wrong belief that there should be one and only one measure that would give us the answer who is poor and who is rich. The three welfare aggregates (wealth, income and consumption) are related but they are not the same. (And I leave out other “details” like the distinction between net income, that is, after-fisc income, and market income or income before any government transfers and taxes.) There are people who are poor or middle class according to one measure but rich according to another. Wealth is not income nor is income consumption. 

            Depending on what we want to study, we may focus on one or another aggregate. If standard of living is our concern, consumption is probably the best measure; it is also probably the best measure for long-term (lifetime) income. But if our interest is to look at the potential consumption that one can afford without reducing her assets, then income is a better measure. One may consider a decision to save out of a high income, and thus to choose to have a relatively low consumption, as not different from a decision to use one’s income to buy restaurant meals instead of a car. It is just a decision of what to do, or not to do, with your income that only the income-rich have the luxury to make. They can choose; others cannot. 

            But note also that there may be reverse cases, people with zero income whose consumption is relatively high (e.g., those who, after working for  several years and saving money, might take a couple of years off to go back go school). Or, as mentioned before, there may be people with reasonably high both income and consumption, and yet zero net wealth. You may even find people with very high net wealth and huge negative incomes, as happened in 2007 when the stock market crashed, and some billionaires lost millions of dollars. By the income metric, they were the poorest people on the planet that year. Is it wrong? Is it sully? Does it mean that we should not study income or consumption or wealth distributions? Not at all: we need them all but we need to know what the numbers we get mean.

            There are very good reasons to study distribution of net wealth, globally and within countries. Even for those people in the rich world who are “anomalously” placed among the wealth-poor and who may lead nice lives despite owning nothing, a shock in the form of a medical emergency (unless there is public health care), or loss of job may have catastrophic consequences. There is just no wealth to fall back on to tide you over the bad times. A decline in the value of the main asset (housing) had similar consequences for many people in the US during the recent crisis. Finally, wealth, especially when we look at the rich, is the source of both economic and political power. It is not people who are running huge, and hard to repay, credit card debts, who are likely to be "players" by contributing to the political campaigns, influencing policy and setting legislative agenda. It is the global top 1% who own half of world's wealth, or within the United States, the top 1% who own about 35% of net wealth, who wield political influence.

            To conclude: one has to be aware of what each measures does and what your objective is, before your decide that just because your think that the measure should show something it does not, you declare it a “silly” or “pointless exercise.”

NB. The Oxfam report is based on Credit Suisse 2014 report on global distribution of wealth. Credit Suisse reports in turn are based on the seminal work done by Jim Davies, Susanna Sandström, Tony Shorrocks and Ed Wolff on global distribution of wealth published in 2011. The global distribution data are pieced together from countries Household Balance sheets, wealth surveys, and finally, if data are  missing, through a regression-based relationship between income and wealth inequality. Luckily, however, actual data do exist for the main countries, US, China, most of Western Europe, India, Brazil and Russia. This, while global wealth data are even more difficult to put together than income or consumption data, and are subject to an even greater  margin of error, this work is the best estimate of global wealth inequality that we have.

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