More Research on the "Inequality Myth"

One of the more sophisticated arguments against free trade and other free market policies is that they exacerbate income inequality in the United States.  For example, here's Public Citizen in a 2008 anti-Bush/FTA screed:

U.S. median wages in inflation-controlled terms have scarcely risen in a generation, in no small part thanks to "labor arbitrage" between U.S. workers and low wage workers offshore, and the replacement of higher paying manufacturing jobs with lower paying service sector jobs....

[S]ome have suggested that technology – not trade deficits – are to blame for the job losses and stagnant real wages, meaning that policymakers should ignore trade and focus on making workers more computer literate. While more education and skills are certainly desirable, these are a separate concern.  For instance, college-educated workers have seen their wage growth stagnate in recent years, even in technologically sophisticated fields like engineering – the opposite of what you would expect if growing returns to skill were the main story. As well, a National Academies' study has found that employers will continue to demand mostly low skilled labor for the foreseeable future, projecting occupations like hospitality and restaurants as having the greatest demand in the coming decades. Thus, addressing the problems with the existing trade and investment rules, not only better educating American workers, will be an essential part of halting rising income inequality.

I've mentioned before that these criticisms are pretty misguided, most notably because (a) traditional measures of income inequality often focus on wages alone and neglect critical things like benefits and the ever-declining cost of basic necessities; and (b) recent work shows that trade actually decreases real income inequality by lowering prices for lower-end goods.  On this latter point, I've stated:

Beyond the obvious savings for basic household necessities (food, clothing, appliances, shelter, etc.) and the lower interest rates that it provides, free trade - particularly with low-cost countries like China - also has been shown to reduce real income inequality in the United States because the benefits of "cheap" imports are disproportionately enjoyed by lower income Americans. (Put simply, "rich" people don't shop at Wal-Mart, so they don't get as much benefit from free trade with China than do frequent Wal-Mart shoppers.)  Less real income disparity and more equal access to disrectionary goods and services means more social cohesion among America's rich, middle class and poor.

According to the Economist, new research supports both of these points and reinforces the notion that "income inequality" is mostly a myth and thus provides no grounds for the imposition of anti-market policies like protectionism:

In a recent paper weaving together several strands of new research, [Robert Gordon, an economist from Northwestern University] reports that improved use of income datasets "shows that there was no increase of inequality after 1993 in the bottom 99 percent of the population, and can be entirely explained by the behavior of income in the top 1 percent." So we are left needing an explanation for the rise of "the stinking rich"....  But when it comes to rising inequality, that's all there is to explain....

Mr Gordon's surprising conclusion is based upon recent studies showing that measured income inequality has been overstated due to inadequacies in traditional methods for constructing price indices and estimating real income. In the latest version of a much-discussed paper Christian Broda and John Romalis find that

the relative prices of low-quality products that are consumed disproportionately by low-income consumers have been falling over this period. This fact implies that measured against the prices of products that poorer consumers actually buy, their “real” incomes have been rising steadily. As a consequence, we find that around half of the increase in conventional inequality measures during 1994–2005 is the result of using the same price index for non-durable goods across different income groups.

Many popular narratives about inequality are grounded on the alleged fact that wages and incomes at the middle and bottom of the distribution have been stagnant for decades. It appears that this, too, may be an artefact of insufficiently sophisticated methods for building the price indices used to calculate rates of inflation. Using an updated price index, Christian Broda, Ephraim Leibtag, and David Weinstein find that

the real wages at the 10th percentile increased by 30 percent from 1979 to 2005. In other words, the real wages of low earners have not remained stagnant, as suggested by conventional measures, but actually have been rising on average by around 1 percent per year.

Surely there are intelligent objections to these studies. But taken together they are impressive and deserve careful consideration....

Please keep this research in mind the next time you hear someone breathlessly demanding the imposition of protectionist policies because they are "essential" to reversing American income inequality.  Either he's ignorant of the latest research, or he might just have other, less altruistic motives.