Monday, April 25, 2011

1979-2007: Rich Got Richer, Poor Got Richer


WASHINGTON – "Today, the Employment Policies Institute (EPI) announced the publication of new research by economists Dr. Richard V. Burkhauser of Cornell University, Dr. Jeff Larrimore of the Joint Committee on Taxation and Dr. Kosali Simon of Indiana University, the results of which appear in the most recent issue of the Journal of Policy Analysis and Management (link fixed).

In his recent speech on deficit reduction, President Obama defended his support of higher taxes on wealthy Americans by echoing a widely-held view that the rich are getting richer while the poor and middle class are falling behind. But Burkhauser et al. find that this popular notion is mistaken; in reality, growth in after-tax household income has been substantial across the entire income distribution over the last thirty years (see table above).

“By leaving out additional sources of income – like fringe benefits or employer-provided health insurance – past studies have dramatically understated American households’ access to after-tax resources.” said Dr. Burkhauser. “What we found is that the rich did get richer over the last 30 years, but so did the middle class, the working class and the poorest.”

By taking into account previously unmeasured shifts in household size and the tax units in them, the taxes and transfers of government, and the increasing importance of fringe benefits, the research shows a picture of growth that spans all income groups.

Burkhauser continued: “For instance, the conventional wisdom holds that the poorest households saw their income shrink by a third over the last three decades. But accounting for income transfers and the value of fringe benefits, this research shows that the bottom 20 percent of households actually experienced after-tax income growth of more than 26 percent.”

Burkhauser concluded: “This isn’t a zero sum game, where one group wins at the expense of others. The growth in productivity of Americans in the top twenty percent of tax units increased the size of the economic pie sufficiently to register major gains across the entire distribution of after-tax income.”


67 Comments:

At 4/25/2011 2:56 PM, Blogger Bret said...

Neither link takes me anywhere useful.

I'm quite curious (and skeptical) regarding how "taking into account previously unmeasured shifts in household size..." makes this (apparently) substantial difference.

 
At 4/25/2011 3:16 PM, Blogger Rand said...

As long as you define "the poor" as the lowest quintile of households by income, the percentage of "poor" households will always be 20%.

Households are called "poor" in the United States when they would be middle class in other parts of the world.

It brings to mind the comment from the Indian (South Asian) fellow who said that he wanted to visit The United States so that he could meet poor people who suffered from obesity.

 
At 4/25/2011 3:37 PM, Blogger Mark J. Perry said...

Bret: Average household size has decreased consistently over time, so that even if real median household income was flat over time, the income per household member could be going up.

 
At 4/25/2011 3:52 PM, Blogger Seth said...

So trickle-down economics works?

 
At 4/25/2011 4:01 PM, Blogger Bret said...

The quote I'm questioning is: “For instance, the conventional wisdom holds that the poorest households saw their income shrink by a third over the last three decades. But accounting for income transfers and the value of fringe benefits, this research shows that the bottom 20 percent of households actually experienced after-tax income growth of more than 26 percent.”

The quote isn't that the poorest household members are better off, but that households as a whole have seen income growth.

In either case, it's not necessarily cause for celebration. To illustrate, compare a 5 person family with a single bread winner making $50K with a 2 person husband and wife team making $30K each. That's 20% higher for the household, but are they really better off given that the hourly wage of the latter pair is only 60% of the former. In other words, being "better off" because the family works far more hours isn't really better off.

Worse, if it's by household member, compare the $50K single breadwinner 5 person family to a single member household where the person makes $12K. Still a 20% increase per person, but it's hard to say the $12K person is better off. He can't afford a family.

So if becoming "better off" means foregoing a family because you can't afford it, then that's a rather different definition of "better off" than I would use.

That's why a link to the actual study would be useful if anyone can find it.

 
At 4/25/2011 4:31 PM, Blogger Benjamin said...

Interesting.

But this post also suggests that without government transfer prgrams, in-kind or otherwise, the poor would be worse off.

That is better than I thought. I assumed all government programs were crap.

 
At 4/25/2011 7:20 PM, Blogger Benjamin said...

Don't try to be an entrepreneur in Los Angeles.

http://thesource.metro.net/2011/04/25/sheriffs-deputies-crack-down-on-illegal-vending-on-blue-and-green-lines/

 
At 4/25/2011 8:20 PM, Blogger kleht said...

I was wondering how the lower income folks could be losing and not gaining over the past 30 years or so. It did not make any sense.

Having said that, though, there is a world of a difference between the poor gaining 24% from a low base and the rich gaining 52% from a much higher base.

 
At 4/25/2011 8:43 PM, Blogger Methinks said...

there is a world of a difference between the poor gaining 24% from a low base and the rich gaining 52% from a much higher base.

That world is called “taking more risks” (risk and reward are inexorably linked) and forgoing current income and pleasure to obtain a higher education (the high returns on which are well documented).

Of course, if you aren’t particularly keen on taking risks and have a love of leisure time (nothing wrong with that), you’re free to settle into the very comfortable life of the American middle class. A middle class whose material wealth can only be dreamed of by upper classes in most of the rest of the world.

Much of the bottom quintile consists of new immigrants who have imported their poverty with them. They rarely remain in the bottom quintile, but they are usually replaced (and, hopefully, always will be) by new impoverished immigrants.

In this country, more than any other, people can achieve whatever they want and that fact is taken for granted here. But, take it from this immigrant: it is rare anywhere else in the world.

Or would you prefer social democracies where the top quintile lives a life materially poorer than the fourth quintile in the United States and the rich are a politically connected class whose access and favours are not easily recorded on a ledger, but to which the ordinary citizen can never hope to gain access. In those stagnant social democracies the average citizen can never hope to rise above his small life on his merit.

 
At 4/25/2011 10:14 PM, Blogger PeakTrader said...

Who are these bottom 20%?

Warren Buffett, who pays himself $1 a year?

Someone with over $1 million in net wealth (e.g. home equity, jewelry, paintings, etc.) who receives $1,200 a month in Social Security, has the mortgage paid-off, and doesn't work?

Someone who receives $2,000 a month in royalties from an oil well and doesn't work?

A poor immigrant who doesn't speak english working part-time in a restaurant?

A student finishing up a Ph.D or a law degree, who works part-time?

An unemployed state worker or military vet who retired with a $2,000 a month pension at 38?

A poor immigrant with five children earning $2,000 a month?

A drug addict receiving $1,000 a month in disability (and much more in non-cash benefits)?

 
At 4/25/2011 11:32 PM, Blogger PeakTrader said...

Typically, within five years working for a "greedy capitalist," income can increase 50% (from raises, promotions, bonuses, etc.), and benefits can be substantial (e.g. medical, dental, retirement, vacation, etc.).

 
At 4/26/2011 8:35 AM, Blogger Roger said...

These statistics severely understate the actual gains to actual families starting in 1979. The data shows that the poorest quintile have increased the most in absolute dollars. See this link by Steve Horowitz on the trends from '79 to '91:

http://www.google.com/url?sa=t&source=web&cd=1&ved=0CBkQFjAA&url=http%3A%2F%2Fwww.youtube.com%2Fwatch%3Fv%3Dn62E4hB1uU8&ei=Zse2Te_xPOyD0QG798H4Dw&usg=AFQjCNGRX45ac32KL-ujoRQ7ms1f38qlWw&sig2=CWe1EcI8a4LCCpLnvpZK6w


The poorest quintile tend to be the youngest quintile or those newest immigrants. Over time, they tend to move up. The lower the starting quintile, the higher the relative and absolute increase over time. The data is crystal clear. Indeed only 14% of those poor in 1979 were still poor just 10 years later. I am a case in point.

I was at the bottom of the lowest quintile in 1979 (I bet I made 3 or 4 thousand that year) but by 2007 was near the top of the highest quintile. Now I am retired and somewhere in the 2nd or perhaps 3rd quintile.

When you understand that what is being displayed is akin to a stair case or escalator, it becomes clear that our initial biases on the data may be wrong. What we want is a steep incline which shows the rewards of our efforts over time.

 
At 4/26/2011 9:01 AM, Blogger morganovich said...

"But this post also suggests that without government transfer prgrams, in-kind or otherwise, the poor would be worse off. "

no it doesn't. where are you getting that?

much of this increase came from housing, benefits (often privately provided), taxes that disproportionately affect the rich, and household size. none of those have anything to do with government transfer programs. you are drawing a completely unsupported conclusion.

that said, i do wonder how much of this was housing driven by programs like the CRA. i also wonder how much lower quintile wealth was destroyed there when the program went bust. anecdotal, i can tell you that in places like oakland, this has been like a neutron bomb. lot's of VERY poor people wound up buying multiple houses and renting them out while running neg am loans and looking to flip. those people got utterly wiped out in yet another example of a well intentioned government program harming those it was intended to aid.

 
At 4/26/2011 9:16 AM, Blogger Hydra said...

If you risk $100 k and it is one eighth of what you have available, it is not the same risk as if it is everything you have.

More willing to assume risk often means more able to assume risk.

 
At 4/26/2011 9:56 AM, Blogger morganovich said...

"If you risk $100 k and it is one eighth of what you have available, it is not the same risk as if it is everything you have."

but this makes no difference in % terms.

if each risker gets a 10% return, the former only increases wealth by 1% while the latter 10%.

 
At 4/26/2011 9:58 AM, Blogger Che is dead said...

"More willing to assume risk often means more able to assume risk."

Really? Is a person more willing to accept risk when they have nothing to lose, or when they have everything to lose?

 
At 4/26/2011 10:24 AM, Blogger Hydra said...

Freedoms just another word for nothing left to lose, according to Janis Joplin.

I think you are making an argument that does not really apply. Sure, you do not want to back a rat into a corner, where he has nothing to lose. I don't think that extreme example often holds in the business world, although there are examples, like the Guy who was about to fold, and took his last payroll to Vegas, and won enough to get over the hump.

I sometimes make small business loans, and a big part of my decision depends on what my reserves are.

When I was hunting venture capital, one problem I found was that people with spare money to invest needed to do it right away, but it was always spare money. If they lost it, they would still be well off.

Psychologists tell us the fear of loss is more powerful than the satisfaction of gain, so it stands to reason the fear of losing everything is more powerfully than fear of losing 1%. Also with numerous 1% investments, you have less risk than an all or nothing player.

 
At 4/26/2011 10:25 AM, Blogger PeakTrader said...

Would you be more willing to risk $32,000 if the portfolio was $100,000 or $800,000?

Apr 26th Trading Log (Midday Update):

Current Trade: Bought 100 SPY Jun 135 puts at $32,000 [about 134 3/4]. I plan to buy 100 more puts at 2.80, or sell the puts at 4.00. Also, I plan to sell the C calls at 0.85.

My portfolio is about $780,000 including $675,000 in cash.

Calls Contracts

C Jan 4 2012 1,000

Puts Contracts

SPY Jun 135 100

Portfolio at $100,000 on Jul 1st, 2007. Portfolio stop loss raised to $500,000. Stop loss will be strictly enforced and extreme caution will be taken if triggered to avoid large losses and preserve capital in "irrational" market periods.

 
At 4/26/2011 10:38 AM, Blogger morganovich said...

hydra-

but none of that matters in terms of percentage gains.

if you are arguing that it's less stable to be poor, well, i think that that is obvious. it's always better to have reserves.

but it's also easier to get big % wins from small amounts.

a pay raise from 40k to 50k is a much bigger deal that a raise from 100k to 110 despite being the same dollar amount.

 
At 4/26/2011 10:41 AM, Blogger morganovich said...

hydra-

i think you will also find the most people become MORE not less risk averse as they get wealthy.

the first rule of being wealthy is stay that way. you no longer need to take the same risks. i see this all the time with investors who got rich by taking big risks but are no longer willing to do so.

consider sitting at a blackjack table. you might toss $100 around like it's no big deal and just enjoy the free drinks, but let's say you win a bunch and now it's $10k. you going to feel as cavalier about risking it?

 
At 4/26/2011 11:05 AM, Blogger Methinks said...

More willing to assume risk often means more able to assume risk.

Utter nonsense. Everyone has a different and highly subjective risk tolerance.

 
At 4/26/2011 11:11 AM, Blogger Hydra said...

"i think you will also find the most people become MORE not less risk averse as they get wealthy."

That has not been my experience. True, the goal is to stay wealthy, and you don't do that by that by having piles of money that is not growing as fast as inflation.

It is why poor people play the lottery: if they lose a dollar it won't break them, but they have a chance of winning big.

Rich people have hedge funds, where they can put a chunk of change that won't break them if they lose it, but stands a chance of winning big.

Neither of those examples suggests someone that is taking much of a risk.

 
At 4/26/2011 11:15 AM, Blogger Hydra said...

Utter nonsense. Everyone has a different and highly subjective risk tolerance.

===============================

Only partially true.

We know there are real patterns to risk tolerance, even theough they vary by individual, statistically the patterns predictable.

 
At 4/26/2011 11:28 AM, Blogger Hydra said...

consider sitting at a blackjack table. you might toss $100 around like it's no big deal and just enjoy the free drinks, but let's say you win a bunch and now it's $10k. you going to feel as cavalier about risking it?

=========================

That would never happen for me, I have no interest in it.


But aren't you making my point?

You toss around $100, and it is a small part of your wealth. You toss arount $10k an dit is no longer a small part of your wealth.

My argument is that you are more likely to toss around $100, when you have $10k than you are when you have only $100.

I am not arguing against the idea that you are as unlikely to bet all you your money if it is $10k, as you are if it is $100. As you point out, you might even be less likely, because the loss is more.

However, you now have the opportunity of betting $100, and only taking a 10% loss, an opportunity our friend with only $100 hasn't got.

To argue that the richer guy is "more willing to take risk" strikes me as disingenuous.

 
At 4/26/2011 11:33 AM, Blogger Hydra said...

a pay raise from 40k to 50k is a much bigger deal that a raise from 100k to 110 despite being the same dollar amount.

==========================

Isn't that my argument? A gain (or a loss) of $10k means less if you have more reserve. From the investment side, that means you will see the same $10k risk as less risky.

 
At 4/26/2011 11:44 AM, Blogger morganovich said...

no, it's the opposite of your augment because we are speaking in % terms.

the former is a 25% raise, the latter 10%.

if you look at the bell curve of incomes, it's much easier and more common to go from 40k to 50 than from 100 to 125.

i think you are missing the point. the same is true of the blackjack example. i have a good friend in the casino business. according to him, poor people bet far more of their wealth at the tables than rich ones. my point is that once you have money, you strive to keep it. your risk tolerance goes down because you have more to lose.

you seem to be arguing that the poor take more risks, but this is a reflection of risk appetite, not necessity. no one makes them take risk. they chose to do so.

 
At 4/26/2011 11:59 AM, Blogger Kevmaur said...

The title of this article is misleading. It should say "1979-2007: Rich Got Richer, Poor Got Richer Half as Fast".

And this is without the bill being paid. The question is, who will pay the bill, and what will this data look like afterwards? If the fed keeps printing, the middle class and lower will see these gains erased by inflation, while the uber-rich protect themselves by investing in hard assets.

 
At 4/26/2011 12:05 PM, Blogger Hydra said...

PT:

I'm not following your argument.

Are you saying that you are making a leveraged bet, such that if the leverage turns against you, you lose everything?

 
At 4/26/2011 12:11 PM, Blogger morganovich said...

kev-

that cuts both ways.

the lower income brackets get more of their income from wages. these go up with inflation. they also have less savings to erode from inflation and more debt which inflation erases.

those with large amounts of savings and little debt are the ones most harmed by inflation.

you can potentially hedge it, but in practice, it's not so easy.

you also tend to get much higher rates of inflation in high end goods than those at the bottom.

the 70's were a good time to be on indexed wages, but a terrible time to be an investor.

from 1970-80 the S+P went nowhere. bonds got massacred. but wages were up a great deal as were home prices which are a much bigger part of middle class than upper class wealth.

 
At 4/26/2011 12:15 PM, Blogger morganovich said...

hydra-

also consider:

if you make 50k and have 10k in savings, risking it all is only 20% of your annual income. if it blows up, you can make it back.

this is very different from making $500k and risking your $2 million in savings. you are not going to be able to make that back.

the ratio of savings to income is a key determinant of risk and risk appetite.

to risk your whole 10k in savings while earning 50 is very different from risking just half of your retirement nestegg when your income has ceased.

 
At 4/26/2011 12:21 PM, Blogger Walt G. said...

"poor people bet far more of their wealth at the tables than rich ones"

Is that because the poor are more willing to take risk or less likely to understand risk? Once you get past being born into money, what really separates the poor from the rich?

Personally, I don't gamble at casinos or buy lottery tickets except for occasional entertainment.

 
At 4/26/2011 12:21 PM, Blogger Hydra said...

you seem to be arguing that the poor take more risks,

============================

Just the opposite. I am arguing that the poor, in general, take fewer risks, precisely because ANY risk is a bigger slice of their wealth.

Their goal, same as for the rich, is not to be even WORSE off.

But, If I'm worth $10 million and I lose $100,000, from a PRACTICAL standpoint, I'm not any worse off. Like your pay raise example, it is down in the noise.

But the same investment would/could wipe a poor person out, so he does not make the investment, and stays poor.

People look at this and say, well, the rich create the bigger pie that makes the poor better off, because they are more willing to risk their capital.


What I'm syaing is that it is not that much of a risk for them, for the same reason a $10k raise is not as exciting a raise.


Or as someone said, the first million is hard work, the second is inevitable.



But, if you are changing the argument to say that the very wealthy are less likely than the poor to put EVERYTHNG on the table, than poor people, sure. In the first place the poor won't have much choice, given they are going to do something, it is goiing to take all they have got.

The rich have no reason to make such a radical bet, since they can place five such wagers, and still be rich if they lose all of them.

 
At 4/26/2011 12:25 PM, Blogger Hydra said...

"poor people bet far more of their wealth at the tables than rich ones"

Is that because the poor are more willing to take risk or less likely to understand risk?

============================

As I pointed out above, given that they are going to take a risk, it will ALWAYS be a bigger portion of their income.

But this is a gross generalization based on a self selected subset (poor gamblers). Considering all poor people, including those that don't bet, because they know the risk and cannot stand the loss, I doubt that you will find that what is suggested based on observation of gamblers is true for all poor people.

 
At 4/26/2011 12:36 PM, Blogger JohnnyL said...

This report is just B.S. like the CPI which excludes food and energy, the two things that we need every day. It is used by spin doctors to cloud the lies of free trade, the military and the declining value of the dollar and you, who endorse it, shows that you are a shill for the status quo.

 
At 4/26/2011 12:39 PM, Blogger Hydra said...

if you make 50k and have 10k in savings, risking it all is only 20% of your annual income. if it blows up, you can make it back.

this is very different from making $500k and risking your $2 million in savings. you are not going to be able to make that back.

===========================

Morganovich, I see that as really twisted thinking. Paarticularly thye point at the end where you intrduce a new variable, beig a fixed income.

First of all if you have $2 million in savings, what have you done with it that your income has ceased?

Second you compare a guy risking All $10K with a guy risking $2 million. Lets take the same two guys, looking at the same $10k investment (in a hot dog stand) with the same risks, and the same returns.

Third, if you make only $50k you really cannot make it back, because all your income is consumed. Even with no other income, if you have $2million to start with, you will get your $10k back faster, and if you don't, it hardly matters. It won't change your life style, so long as you don't make a stupid move like that every week.

 
At 4/26/2011 1:03 PM, Blogger Christine said...

Google EPI Employment Policies Institute and you find it is a front / shame non-profit started by, and housed in, a public relations firm for low wage industries.
They have been accused frequently of using misleading and manipulated data.
Having paid off 3 "intellects" with fancy degrees to pen this "study", they probably did the same to the author, who has his own fancy sheepskins and his head up his a$$

 
At 4/26/2011 1:11 PM, Blogger Ron H. said...

"It is why poor people play the lottery: if they lose a dollar it won't break them, but they have a chance of winning big."

The fact that poor people disproportionately play the lottery, arguably one of the worst bets one can make, works better as a explaination for their condition than it does as an example of risk tolerance.

In other words, by playing the lottery, poor people are demonstrating that they make poor choices, which may help explain why they are poor.

 
At 4/26/2011 1:25 PM, Blogger Methinks said...

Hydra,

I'm unaware of these statistics you speak of. I'm unaware of any statistics that show that entrepreneurs are mostly wealthy to begin with, for instance.

As an investor, I may lose the capital I invested. Typically, the entrepreneur loses his shirt. Big risk.

 
At 4/26/2011 1:55 PM, Blogger Ron H. said...

"We know there are real patterns to risk tolerance, even theough they vary by individual, statistically the patterns predictable."

Fascinating. do you have a reference for this?

"However, you now have the opportunity of betting $100, and only taking a 10% loss, an opportunity our friend with only $100 hasn't got."

Another fine example of your failure to understand percentages. Please ask someone to check your comments for math errors before you publish them.

"But aren't you making my point?"

No, he's not.

morganovich said this:

"i think you will also find the most people become MORE not less risk averse as they get wealthy."

Your response was:

"That has not been my experience."

Your argument has now become:

"To argue that the richer guy is "more willing to take risk" strikes me as disingenuous."

He's not arguing that at all. In fact, if you check your prior comments, I think you'll find you are now arguing against yourself.

Good work!

"But, if you are changing the argument to say that the very wealthy are less likely than the poor to put EVERYTHNG on the table, than poor people, sure."

The argument hasn't changed. See above starting with: 'morganovich said this." You have once more changed your position, and now appear to agree with him.

I'm fairly familiar this pattern, but someone not used to hydraspeak would surely be lost by now.

I think most just realize pretty quickly that you don't know what you are talking about, and quit responding to you.

 
At 4/26/2011 2:13 PM, Blogger Ron H. said...

"I am arguing that the poor, in general, take fewer risks, precisely because ANY risk is a bigger slice of their wealth."

Not in PERCENTAGE terms. Remember that you need help with that concept, and ask someone to check your comments for nonsense like the above.

"First of all if you have $2 million in savings, what have you done with it that your income has ceased?"

It doesn't matter what's been done with it in the past, the idea is that it will all be put at risk.

The "income has ceased" part just makes no sense. You'll need to explain what you are struggling to say.

You may to be trying to make the point that a person who risks less of their wealth - as a percentage - is risking less of their wealth.

Duh!! OK.

This may be confusing to people
who aren't questioning that obvious point, and can't figure out what else you might really mean.

 
At 4/26/2011 2:34 PM, Blogger Hydra said...

It doesn't matter what's been done with it in the past, the idea is that it will all be put at risk.

==============================

But the rich do not HAVE to put it all at risk. If that is the argument you are making, then it is 100% risk either way, and in that case the wealthy would be more conservative because it is more real dollars. You don;t invest percentaged.

I sometimes make small business loans. They are collateralized, but still, I cannot make the loan if it represents all that I have. When I do make the loans, I can do it because it is a small risk to me, not because I am more willing to take a risk.

Are we just talking different sides of the same coin?

 
At 4/26/2011 3:06 PM, Blogger Hydra said...

take fewer risks, precisely because ANY risk is a bigger slice of their wealth."

Not in PERCENTAGE terms. Remember that you need help with that concept,

=================================

You need help with percentages, not me.

I'm worth $500,000. I have an investment opprotunity that will cost me $20,000 and make 10% in a year.

Given that a 100% loss occurs, that is 4% of my net worth (and maybe a substantial amount of my free cash worth) I'm putting at risk.

If Im worth 5,000,000, it is four tenths of what I am worth. Same cash risk, same cash opportunity, but it is less as a percent of my holdings and much less as a percent of my fiancial wealth.

How do you figure it?

If you are comparing a $500,000 opportunity against a $5 million oppportunity, then it is 100% risk (as far as net worth is concerned) either way, but it isn't the same opportunity either, so there is no way to compare the risk/opportunity.

 
At 4/26/2011 3:22 PM, Blogger Hydra said...

You may to be trying to make the point that a person who risks less of their wealth - as a percentage - is risking less of their wealth.

===========================

No. I'm making the point that a $20,000 risk is a $20,000 risk. But what you are really risking is how you live. A rich person can lose $20,000, and sure enough he is out $20,000, but it may make an imperceptible difference in how he lives, where it would wipe out a poor person.

Reward on the other hand works the other way. Given that the investment is successful, it will be a bigger difference for the small guy than the big one, but it makes no difference if he cannot "afford" the risk to begin with. And here the abillity to afford the risk means how a loss would affect your life.


A person is given the choice between two scenarios, one with a guaranteed payoff and one without. In the guaranteed scenario, the person receives $50. In the uncertain scenario, a coin is flipped to decide whether the person receives $100 or nothing. The expected payoff for both scenarios is $50.


If you have nothing, I argue that you are more likely to take the $50, because it makes a substantial difference in your life. If you are worth a few million, I argue that you will be more willing to take the chance, precisesly because it makes no difference to you: there is essentially no risk.

 
At 4/26/2011 3:48 PM, Blogger Hydra said...

"We find that risk aversion is a decreasing function of endowment...."


"Individuals who are more likely to face income uncertainty or to become liquidity constrained exhibit a higher degree of absolute risk aversion....."



http://ideas.repec.org/p/red/sed004/525.html

 
At 4/26/2011 4:18 PM, Blogger morganovich said...

no hydra, you are now digging into minutia and losing the plot.

my point is that the ration of savings to income matters.

your point in having $2 million in savings and no income completely misses the point. if you take $2million and invest it in a start up, you will have no income. you may or may not get your money back. virtually no one who has just retired would make that bet with their whole nest egg.

i've run economic experiments on precisely this topic (as an undergrad).

people are much more likely to gamble money if payday is tomorrow rather than in 2 weeks.

they will also bet larger portions of savings/winnings.

people also bet more if payday is tomorrow than they do of a paycheck they just got today.

the expectation of future cash flows drives risk behavior. (though clearly not as the sole determinant)

and BTW, ron is correct, you have now contradicted yourself so many times that i cannot even tell which side of this you are on.

look, it's terribly simple.
if you have low savings relative to earnings, you tend to be more comfortable with risk. thus, you bet bigger.

if you have high savings relative to income you invest more conservatively.

can you seriously be disagreeing with that?

 
At 4/26/2011 4:18 PM, Blogger Hydra said...

"The narrowest definition of wealth excludes the value of houses, cars, and human capital, since these asset categories violate the assumptions of divisibility and liquidity which are inherent in the model. On the basis of this definition of wealth, they find evidence of decreasing relative risk aversion (DRRA), ie. individuals invest a larger proportion of their wealth in risky assets as wealth increases. When wealth is defined to include the value of houses, cars and human capital, they find evidence of constant relative risk aversion (CRRA). "



Which is pretty much what I suggested: if it affects how you live, people become more risk avaerse, As long as you hold that constant wealthy people are less risk averse.

Well, they are less risk averse, because there is little risk to them personally: the money they are investing is play money, not money they depend on to live.


Say I invest in the market and double my money. Then I take my original investment out. From that point forward, it is impossible for me to "lose money" in the market. From that point forward there is no risk to me, because I have protected my original wealth.

 
At 4/26/2011 4:30 PM, Blogger Ron H. said...

"You need help with percentages, not me."

LOL you're funny. You just proved my point in this, as well as your next comment.

"Are we just talking different sides of the same coin?"

No, "we" aren't, but you have taken both sides of the same argument.

First of all, you need to decide whether you think poor people, or rich people are more risk averse, and you need to stick with that one position. You have argued both positions in this thread, as I've already pointed out. You can't have it both ways. Reread your own comments if you doubt it.

Here we go, pay attention.

"I'm worth $500,000...invest $20,000...100% loss = 4% of net worth."

Is that correct so far? It's your statement, with some of the unnecessary words taken out. The math, what little there is of it, is correct. Good job so far!

"If Im worth 5,000,000, it [ $20k ] is four tenths [ of a percent ] of what I am worth. Same cash risk, same cash opportunity, but it is less as a percent of my holdings and much less as a percent of my fiancial wealth."

Wow, that sure sounds like what I said, doesn't it?

"You may to be trying to make the point that a person who risks less of their wealth - as a percentage - is risking less of their wealth."

"No. I'm making the point that a $20,000 risk is a $20,000 risk."

OK! $20k = $20k. So far, so good.

"But what you are really risking is how you live. A rich person can lose $20,000, and sure enough he is out $20,000, but it may make an imperceptible difference in how he lives, where it would wipe out a poor person."

Does this mean that $20k is a larger percentage of a poor person's wealth? If so, than the reverse must also be true, that $20 is a smaller percentage of a rich person's wealth, right?

Do you mean something about $20k being larger compared to a poor person's income, than it is compared to a rich person's income?

Well, duh, no argument their either, but you haven't said that.

I still believe you have some trouble with confusing income and wealth.

How many times do you intend to go in a circle with this? You should talk with someone who can explain it to you and create some small crack in your shell of ignorance. I'm not having any luck.

 
At 4/26/2011 4:39 PM, Blogger Hydra said...

look, it's terribly simple.
if you have low savings relative to earnings, you tend to be more comfortable with risk. thus, you bet bigger.

if you have high savings relative to income you invest more conservatively.

can you seriously be disagreeing with that?

=======================

Yes. I believe it is opposite of that, and it makes no difference whether you express the wealth that is at risk as capital or as income.


I don't know where the ratio of savings to income came into this.


Methinks argues that the rich enjoy more rewards because they take more risk. I argue that the rich exhibit decreased risk aversion, precisely because there is no real risk to them.

Some argue that the poor exhibit bad decision making by playing the lottery, and I don't disagree with that. However, If a lottery player is betting a small percentage of his wealth, how is his risk aversion any different from a wealthy person who bets an equivalent amount of his wealth on a wildcat well?

He knows about as much about the wildcatter as the lottery payer does: the % of time a payout is made.

In either case it is not enough of a relative loss to cause concern, or to engender the research required to make a better decision.

But the argument was whether the wealthy take more risk, and wealth usually means accumulated wealth. Introducing the ratio of income to wealth is an attempt to change the argument, but I don't think even that makes any difference in behavior.

 
At 4/26/2011 4:55 PM, Blogger Hydra said...

you need to decide whether you think poor people, or rich people are more risk averse

========================

I do not need to decide that. As I understand it the theory is that rich people are relatively less risk averse.

Like anything else there is some controversy on this point, but as I understand it, the theory has not been disproven, yet.

The rich take more risk (expend more money on investments) because they (correctly) percieve that there is none. And also because they have the money to do it with.

This corresponds to my observation of others, and to my own behavior over time. I can afford to take more cash dollar risk now, because it does not affect my base living standard: there is no risk to me in doing it.

The fact that the rich risk more in dollars has nothing to do with them being smarter or braver than poor people. Reduce them to being poor, and their behavior will revert, too.

When the economy tanked the wealth of rich people decreased and so did their willingness to invest, hence the slow recovery.

That said, there are individual risk seekers and risk avoiders, and that tendency is independent of wealth.

 
At 4/26/2011 4:58 PM, Blogger Hydra said...

Does this mean that $20k is a larger percentage of a poor person's wealth? If so, than the reverse must also be true, that $20 is a smaller percentage of a rich person's wealth, right?

Do you mean something about $20k being larger compared to a poor person's income, than it is compared to a rich person's income?

=========================

The original argument was about wealth, but studies suggests it makes no difference whether wealth is expressed as an endowment or an income stream.

 
At 4/26/2011 5:02 PM, Blogger Hydra said...

No, "we" aren't, but you have taken both sides of the same argument.

=======================

Well, yes. I argue that the rich invest more, or "take more risk", as it is called precisesly because there is no risk to them, or their lifestyle.

 
At 4/26/2011 5:10 PM, Blogger Hydra said...

Wow, that sure sounds like what I said, doesn't it?

=======================

No. actually. I argueed that any investment a poor person makes is a bigger slidce of their wealth than the same investment for a rich person, and you said not in percentage terms: her it is:


' "I am arguing that the poor, in general, take fewer risks, precisely because ANY risk is a bigger slice of their wealth."

Not in PERCENTAGE terms.'

How is a $20k risk not a bigger % of a poor pewrsons wealth that $20k of a wealthy persons?



Now, if you are arguing that the wealthy person invests more money than $20K, and therefore a bigger portion of his wealth you are no longer comparing the same investment opportunity.

 
At 4/26/2011 6:00 PM, Blogger Hydra said...

"The growth in productivity of Americans in the top twenty percent of tax units increased the size of the economic pie sufficiently to register major gains across the entire distribution of after-tax income.”

==================================

How does that happen, if the rich are, as you say, more risk averses and less prone to invest?

 
At 4/26/2011 6:17 PM, Blogger Ron H. said...

"The narrowest definition of wealth excludes the value of houses, cars, and human capital, since these asset categories violate the assumptions of divisibility and liquidity which are inherent in the model.

If divisibility & liquidity are required, I guess my ownership of the Empire State Building wouldn't count toward my wealth, as it's neither.

I don't have time to read a 71 page paper right now, but this appears to be a limited study, and it seems hard to generalize from it. The authors admit that "it's complicated". Couldn't you find something less obscure?

"Say I invest in the market and double my money. Then I take my original investment out. From that point forward, it is impossible for me to "lose money" in the market. From that point forward there is no risk to me, because I have protected my original wealth."

This says nothing about relative risk tolerance. Why did you write this?


"Yes. I believe it is opposite of that, and it makes no difference whether you express the wealth that is at risk as capital or as income."

Wait! Wait! I KNEW you were confusing income with wealth. Just listen to yourself! Income is NOT wealth.

"I don't know where the ratio of savings to income came into this."

It is this that causes you to miss the entire point. It is necessary to an understanding of relative risk tolerence. Without it, your comments wouldn't make sense.

OH! WAIT! ...

 
At 4/26/2011 6:24 PM, Blogger PeakTrader said...

Rich people know when to take a big risk.

When a great opportunity shows up, which is rare (i.e. when the odds are high to win), that's when to make a bold move.

 
At 4/26/2011 9:34 PM, Blogger VangelV said...

Here is another view.

A few excerpts:

There are currently 130.738 million payroll jobs in the U.S. (as of March 2011). There were 130.781 million payroll jobs in January 2000. So that is over eleven years with no increase in total payroll jobs.

And the median household income in constant dollars was $49,777 in 2009. That is barely above the $49,309 in 1997, and below the $51,100 in 1998. (Census data here in Excel).


So what we have is a small increase in the median wage if we rely on the CPI being accurate, which we know not to be true. Sorry Mark but we are a lot closer to a collapse in living standards than we are to a boom. The reason is the same as what we saw in Japan. The US has a balance sheet recession that cannot be solved by tinkering at the margins. What is needed is a liquidation of malinvestments and an outright default. Of course, given the political incentives what we are likely to get is more money printing and a hyperinflationary depression.

 
At 4/26/2011 10:28 PM, Blogger SBVOR said...

Hell, I reached the same conclusions as these economists last year by simply examining CBO data:

http://sbvor.blogspot.com/2010/10/why-progressive-lies-make-my-blood-boil.html

But, Dims just believe anything their lords and masters tell them. Dims never fact check anything.

 
At 4/27/2011 2:31 AM, Blogger PeakTrader said...

VangelV, when you include your limited data with other data, the U.S. economy produced and captured in the global economy more assets and goods with fewer inputs, time, and effort.

So, U.S. living standards in the 2000s (at least till 2007) improved at a faster rate than even in the 1990s.

A mild recession in 2008 or a V-shaped recovery from the severe recession were attainable with appropriate policies.

I've stated before:

The U.S. created 17.6 million jobs between 1993-98, and created only 3.7 million jobs between 2001-06. However, U.S. real GDP growth was only slightly higher from 1993-98 than from 2001-06. So, the U.S. became much more productive in the 2000s, i.e. using fewer inputs to produce more output.

The quick and massive U.S. Creative-Destruction process, generally between 2000-02, freed-up resources, e.g. labor, capital, raw materials, energy, etc. Freed-up capital was redeployed into firms that generated even more capital, including U.S. Agricultural and Industrial Revolution firms. Older U.S. firms gained greater market power, since they focused on higher quality "core" products, while offshoring less profitable goods to Third World countries for larger profits (rather than discontinue operations of those products).

Consequently, U.S. corporations generated double-digit profit growth for a record 20 consecutive quarters in the 2000s, which resulted in strong balance sheets. Much of the redeployed capital flowed into business start-ups, which helped keep the U.S. unemployment rate low. U.S. Information and Biotech Revolution firms continued to lead the rest of the world combined (in both revenues and profits) after the Creative-Destruction process.

The only way to move from one economic revolution into the next is through efficiencies, which free-up limited resources. It's all interrelated, and inevitable, which is why the U.S. leads the world in the Agricultural-Industrial-Information-Biotech Revolutions.

It's important to note that U.S. actual output has generally been below U.S. potential output throughout the 2000s. Export-led economies have been absorbing U.S. dollars to maintain acceptable levels of employment and output. Just like the volume of output in itself will cause declining prices and induce demand, the volume of capital will in itself cause interest rates to fall and induce demand. The gains of U.S. assets increased faster than the gains of U.S. liabilities. Similarly, the increases in U.S. output exceeded the rises in U.S. inflation, which induced demand and raised living standards.

Export-led economies needed to accept small gains of trade to spur export growth (which imply the U.S accepts large gains of trade). Also, while the U.S. dollar depreciated, export-led economies were required to accept even smaller gains of trade to maintain export-led growth.

The U.S. had abundant capital from foreign capital inflows and capital creation of U.S. firms. Much of that capital flowed into the U.S. housing market creating an oversupply of houses and causing a crisis, i.e. Americans who couldn't really afford to buy houses were able to buy them, and Americans who couldn't really afford to buy more expensive houses were able to buy them.

The U.S. economy can be viewed as a Black Hole attracting imports and capital. The U.S. is also attracting foreigners who own that capital, e.g. through the depreciated dollar, relatively lower prices, low interest rates, etc.

 
At 4/27/2011 2:56 AM, Blogger PeakTrader said...

U.S. dollars flowed to foreigners from up to $800 billion a year U.S. trade deficits.

Those dollars were redirected to the U.S. government, which decided to spend and reduce budget deficits rather than "refund" those dollars to U.S. producers and consumers.

 
At 4/27/2011 10:10 AM, Blogger Bill said...

Including "fringe benefits" in their calculations of the wealth of the poor is disingenuous.

For example, the "value" of employer-paid health benefits rose 220 percent from 1980 to 1992. However, this did not translate into a single additional dime of purchasing power for low-income families. In fact, it led to reduced wage increases and bonuses.

A little common sense would help these academics.

 
At 4/27/2011 11:53 AM, Blogger morganovich said...

"As I understand it the theory is that rich people are relatively less risk averse."

then your understanding is grievously flawed.

the opposite is true.

 
At 4/27/2011 11:53 AM, Blogger Walt G. said...

Bill,

Don't you end up with more purchasing power if you spend less on medical bills? It's always a balance of risk, reward, and utility. The people who make the best guess among those three choices of where to put their money often come out ahead.

 
At 4/27/2011 5:23 PM, Blogger Ron H. said...

Bill

"Including "fringe benefits" in their calculations of the wealth of the poor is disingenuous."

"Fringe benefits" are a form of income, not wealth, and should be included in calculations of income.

"For example, the "value" of employer-paid health benefits rose 220 percent from 1980 to 1992. However, this did not translate into a single additional dime of purchasing power for low-income families. In fact, it led to reduced wage increases and bonuses."

That's only a valid complaint if you believe that low income families place no value on health benefits, and if given a choice, would not purchase any.

Other items, paid by an employer for the benefit of the employee, that should also be considered income include: sick pay, vacation pay, holiday pay, 1/2 social security contribution, retirement pay, 401k contributions, unemployment insurance, workman's comp., tuition assistance, company paid education and training, paid maternity leave, etc., etc.

Notice how many of these aren't taxed as income to an employee.

If a person works as an independent contractor, they must consider that they will have to pay for any of these that they value, on their own, except the employer 1/2 SS contribution, which they WILL pay.

 
At 4/27/2011 7:17 PM, Blogger VangelV said...

then your understanding is grievously flawed.

the opposite is true.


Let us think about this for a while. You get rich by not being risk averse. Once you get rich the risks that are taken tend to decrease, which is why so many once-great companies fade from the scene over time. (Yes, I know that free markets tend to bring competitors and new ideas that bring down the established leaders over time. I only suggest that once success is achieved many of the players start playing it safe and that makes them poorer.)

The problem with the progressives is not that they will make the rich poorer. The rich have ways to protect their capital and will use those ways to do so. The problem is that the progressives make it far more difficult for poor risk takers to become rich enough to challenge the established players. This is why Europe is much more likely to have dominant companies stay dominant for decades while the US has a much higher turnover.

 
At 4/27/2011 10:59 PM, Blogger Ron H. said...

"Well, yes. I argue that the rich invest more, or "take more risk", as it is called precisesly because there is no risk to them, or their lifestyle."

You are a truly silly person. Is it the definition of the word "risk" that is tripping you up?

"Take more risk" means just that. If it isn't "risk", then they can't take more risk.

Slap yourself, then try that again.


"No. actually. I argueed that any investment a poor person makes is a bigger slidce of their wealth than the same investment for a rich person, and you said not in percentage terms: her it is:"

You seem to be struggling with the English language. I already know percentages cause you problems, maybe even the WORD percentages gives you trouble.


"' "I am arguing that the poor, in general, take fewer risks, precisely because ANY risk is a bigger slice of their wealth."

Not in PERCENTAGE terms.
"

A person risking half of a their wealth is the same level of risk for everyone...

Why am I wasting time on this? You just don't get it.

 
At 4/28/2011 7:17 AM, Blogger Walt G. said...

I think the word "risk" is being used in the past postings where utility would be a much better term. The utility function of money for someone with a lot of money and someone with little money is not the same just because the percentages are equal.

A millionaire who spends/risks half his money will probably still eat tomorrow while someone who only has a couple of dollars might not.

I find it difficult to generalize being risk averse from just making choices at the individual level. It seems to me that someone who makes good choices will come out ahead whether they are risk averse, risk prone, or even neutral. That might mean being risky at times and cautious at other times.

 
At 4/30/2011 12:10 PM, Blogger ahservant said...

One likely aspect of the "conventional wisdom" estimate of income in the lowest quintile is that government transfers and programs/benefits may discourage generating earned income in favor of receiving benefits and transfers. This could increase over time as government transfers and programs/benefits increase.
Kudos to the authors of this common sense analysis of the big picture in income gains by quintile.
Combined with upward (and downward) mobility within the quintiles shows the Horatio Alger story still exists in America.
The American public needs to be continually reminded of the benefits of our free market system, which the progressive left is actively seeking o dismantle.

 

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