Mercator Blog

Fed Research Says Income Gap Okay Because the Poor Skip School and Buy Cheap Stuff
Date: April 9, 2015
Research Team

Income inequalities are okay, according to two economists at the St. Louis Fed because the poor buy cheaper goods, which means that they aren’t really suffering a loss in buying power. In an article titled “Changes in Income Gaps Might Overstate Changes in Welfare Gaps,” Juan Sanchez and Lijun Zhu write the following:

Overall the findings suggest the increase in the income gap between rich and poor households might overstate the welfare differences. The reason is that the rich and poor generally consume a different basket of goods, and the goods consumed by predominantly richer householders have risen faster in price.

This would be a reasonable analysis if we were comparing Teslas with Ford Focuses, for example. But the horrifying blind spot in the analysis done by Sanchez and Zhu is the complete lack of recognition of the relative value of the spending. They write:

A casual observation of the change in prices and income elasticities suggest that the goods consumed more by richer households, such as education, have become more costly over the past three decades.

In an accompanying chart, they show how the costs of education and medical care rise significantly, but women’s apparel holds relatively steady. So if you’re a poor woman in need of a shirt, you are okay, but if you need an operation, or want to get a better job—well the implication is that you should know your place and stick to your basket of goods.

The following is highlighted in a recent New York Times article about the stagnation of real wages for low-income people.

For Ms. Almodovar, 36, acquiring new credentials and skills is a big obstacle.

When she talked with her employer’s human resources department about how to increase her long-frozen salary, their advice was to go back to school. Although Ms. Almodovar took the G.E.D. test and earned the equivalent of a high school diploma in her late 20s, taking classes would be a tough proposition now.

“I’m living with roommates, and if I don’t go to work, I don’t get paid,” she said. “Even one day makes a big difference.”

Is the welfare of these workers really the same because their shirts don’t cost any more?

Ben Blog image

This analysis is an excellent example of knowing the price of everything and the value of nothing. The benefits of education and health care are not discrete and carry far more weight than the value of clothing, for example. Suggesting that the poor households are fine because they buy the same stuff while at the same time accepting that they would be shut out from education and health care is inhumane analysis.

Financial services companies cannot afford to have an economic structure that encourages income and wealth concentrations because it shrinks their customer base and reduces their profitability. While banks, credit unions, and other financial services companies cannot control prices or income, they can do more to help their customers manage their money more effectively and build assets, which will lead to a more profitable customer base.

The key is not to accept income inequality or unprofitable customers as a fait accompli. Instead, those financial service providers who deploy their assets to help customers build their own wealth will be the ones to survive. Start-ups such as Betterment and Wealthfront have begun doing this on the investment front, companies like Digit and SmartyPig on the savings front, and Penny, Mint, and Simple on the budgeting front. Very few offer a complete suite of products, so opportunities remain to capture the market.