Saturday, August 11, 2012

Inequality and the Veil of Ignorance

Is the real level of inequality too high, too low, or just right? Traditional economics usually defines the ideal inequality from the perspective of economic efficiency: What level of inequality will motivate people to be the most productive and move up the wealth ladder? What level of inequality will allow those at the top to lift up society as a whole (say, by having the resources to invent new technologies)? What level of wealth will keep salaries low and competition high? Dan Ariely and Mike Norton, however, examine this question from a different perspective--that of regular (non-economist) people. They want to "examine inequality in terms of its effect on society as a whole, not just in terms of economic efficiency. After all, inequality is not just about economic efficiency. It's also about our day-to-day experience as citizens, the influence of envy, our social mobility, the importance of equal opportunity, our mutual dependency on each other, etc." 

DURHAM - The inequality of wealth and income in the U.S. has become an increasingly prevalent issue in recent years. One reason for this is that the visibility of this inequality has been increasing gradually for a long time--as society has become less segregated, people can now see more clearly how much other people make and consume. Owing to urban life and the media, our proximity to one another has decreased, making the disparity all too obvious. In addition to this general trend, the financial crisis, with all of its fall out, shined a spotlight on the salaries of bankers and financial workers relative to that of most Americans. And on top of these, and most recently, the upcoming presidential election has raised questions of social justice and income disparities, bringing the issues into focus even more.

It is relatively easy to think about inequality as being too great or too little in abstract terms, but ask yourself how much you really know about wealth distribution in the U.S. For example, imagine that we took all Americans and sorted them by wealth along a line with the poorest on the left and continuing as wealth increases until on the right we have the richest. Now, imagine that we divide them into five buckets with an equal number of citizens in each. The first bucket contains the poorest 20% of the population, the next contains the second wealthiest tier, and so on down to the wealthiest 20% (see Figure 1).

With this in mind, from the total pie of wealth (100%) what percent do you think the bottom 40% (that is, the first two buckets together) of Americans possess? And what about the top 20%? If you guessed around 9% for the bottom and 59% for the top, you're pretty much in line with the average response we got when we asked this question of thousands of Americans. 

The reality is quite different. Based on Wolff (2010), the bottom 40% of the population combined has only 0.3% of wealth while the top 20% possesses 84% (see Figure 2). These differences between levels of wealth in society comprise what's called the Gini coefficient, which is one way to quantify inequality.


We took a step back and examined social inequality based on the definition that the philosopher John Rawls gave in his book A Theory of Justice. In Rawls' terms, a society is just if a person understands all the conditions within that society and is willing to enter it in a random place (in terms of socio-economic status, gender, race, and so on). In terms of wealth, that means that people know everything about the wealth distribution and are willing to enter that society anywhere along the spectrum. They could be among the poorest or the richest, or anywhere in between. Rawls called this idea the "veil of ignorance" because the decision of whether to enter a particular society is disconnected from the particular knowledge that the individual has about the level of wealth that he or she will have after making the decision.

With this definition in mind, we did two things. First, we asked 5,522 people to create a distribution of wealth among the five buckets such that they themselves would be willing to enter that society at a random place. Their answers could range from a perfectly even distribution with 20% of wealth in each quintile to a fully biased distribution with 100% of wealth in one and 0% in the rest. 

We found that the ideal distribution described by this representative sample of Americans was dramatically more equal than exists anywhere in the world, with 32% of wealth belonging to the wealthiest quintile down to 11% by the poorest (see Figure 3).

What was particularly surprising about the results was that when we examined the ideal distributions for Republicans and Democrats, we found them to be quite similar (see Figure 4). When we examined the results by other variables, including income and gender, we again found no appreciable differences. It seems that Americans -- regardless of political affiliation, income, and gender -- want the kind of wealth distribution shown in Figure 3, which is very different from what we have and from what we think we have (see Figure 2). (read more)

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