Wednesday, January 24, 2007

The Two Measures of Wealth

There are two ways you can look at almost, if not, everything: absolutely and relatively. That is, you can talk about something in terms of how it is in and of itself or you can talk about something insofar as it relates to another thing. For instance, when describing someone, I can talk about their height either in terms of feet and inches (absolutely) or I can talk about their height insofar as it is more or less than someone else's (relatively).

This pair of perspectives also applies when talking about wealth (or standard of living, for that matter). We can talk about how well off someone is either absolutely or relative to someone else.

To illustrate, think of a young teenager who has spent his summer delivering newspaper and saved $250. During the same summer, the neighbors next door earned a total of $10,000. Thus, the neighbors earned 40 times as much as the boy. The boy spent his money on things like games, movies, etc. The following year, the boy spent the summer mowing lawns for neighbors (including the neighbors in questions) and, thus, saved up $500. His neighbors also did better, earning a total of $25,000, meaning that they earned 50 times as much as the boy. The boy, again, spent his money on things like games, movies, etc., but still had money left over when the summer was over since he had more to begin with.

Question: was the boy better or worse off in the second year? Well, it depends whether you consider absolute wealth as more important than relative wealth. That is, in absolute terms, the boy was much better off (100%, in fact) in the second year. (I'm glossing over the issue of inflation because, even if there were an unusually high inflation rate, the boy would still come out with somewhere north of 90% additional purchasing power.) On the other hand, if you care about relative wealth, than the boy was actually worse off the second year because his neighbors (those to whom we are comparing him) went from earning 40 times more than him to 50 times more than him. Thus, the boy was not "keeping up with the Joneses".

Question: Does it matter that someone else's earnings increased at a faster rate than the boys? Does this affect his purchasing power? No. The boy can still purchase much more than he could in the previous year regardless of the purchasing power of his neighbors (or employers).

To put it a different way, if someone were to ask the boy whether he would rather earn $500 while his neighbors earned $25,000 (a 50 fold difference) or earn $300 while his neighbors
earned $13,500, what do you think he would say? Of course, he would take the $500 since the ratio of how much the neighbors made to how much he made is irrelevant to him (except, perhaps, insofar as them earning more could lead to them paying him more for services rendered or giving him additional opportunities for work for which they would otherwise not have been willing to pay). Meaning, a wealth gap, might actually be an indicator of good economic prospects for him rather than an indicator of his economic demise.

The boy would simply not care that the "wealth gap" was widening between him and his neighbors. What is important to him is his own actual situation.

This issue of a "wealth gap" has come up in the politics recently, as TCS Daily points out. Apparently, Democrats are currently focusing on relative wealth, while President Bush is focusing on absolute wealth. I don't want to focus here on issues being disputed by the political parties because I don't want to become an apologist for either party. What I want to focus on is that some politicians are focusing on relative wealth, while others are focusing on absolute wealth. In case you haven't figured it out already, I think it is absolutely foolish to focus on relative wealth. When the standard of living and amount of disposable income for most of the population is at incredible highs, it seems to be a ridiculous, deceitful tactic to try to describe the middle class as dying out simply because a bunch of CEOs happen to be raking in enormous salaries, thus making the gap between their incomes and those of the average American wider.

The article is worth reading.

1 Comment:

Dane said...

Comparing the kid's $500 to his previous $250 tells us that his lot is improving, much as the kid who grows an inch in a year is taller. As far as your post goes, however, that inch might be normal, stunted, or part of a growth spurt.

So, I think we really have two different concerns going on here (maybe three):

When we're talking about the lot of a certain group of people, probably the most important "absolute" measure is whether they can live a humane life. Is the $250 or whatever sufficient, relative to the cost of basic goods (food, water, shelter, clothing, medicine), for them to live humanely?

Then, we have measuring whether their lot is improving, similar to checking whether a child is growing. This is the "absolute" improvement that you wrote about. In working toward a humane life, if such is currently not achieved, then this measure tells us whether we are getting closer (so long as inflation related to the cost of consumer goods is factored in). Otherwise, it just tells us if their lot is improving.

The "relative" improvement, however, tells us whether a class is improving at the same rate as another class. I don't find this to be absolutely foolish to consider. This doesn't mean that an increase in the "wealth gap" is wrong by definition, nor does it mean that the poor are getting poorer. It does indicate that the lower class is not growing at the same rate as the upper class. Is this stunted growth? Or is it good that the taller grow taller faster? This is probably worthy of a whole new post. What does the "wealth gap" really indicate, and how does that affect the common good?

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