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Jul 24th 2008 From The Economist print edition

The long-term rise in American inequality may have been smaller than it appeared

POPULISTS and professors rarely see eye to eye. But on at least one fact of economic life, they agree: wage inequality has increased in America since the mid-1980s. Many studies outline the same broad shifts. Workers at the bottom of the wage scale have seen their incomes fall relative to those at the top. Within the top decile, the super-rich have left the merely well-off far behind.
Indeed increases in national income this decade have been so skewed towards the rich that, allowing for headline inflation, the spending power of a large chunk of the population has apparently stagnated or even declined. Yet this finding is at odds with the impression of spreading prosperity. Increasing numbers of Americans watch DVDs, rely on dishwashers, enjoy air-conditioning and display other signs of increased material wealth. Are the poor really falling so far behind?
A challenge to the conventional wisdom is set out in a recent research paper* by Christian Broda and John Romalis, both of the University of Chicago’s business school. They argue that standard measures of inequality do not reflect differences in the way that the rich and poor spend their money. A person’s demand for a particular good or service does not rise in exact proportion to his income. As he grows richer, the pattern of his spending changes, as well as the amount. In particular, high-wage households spend a greater share of their income on services and a smaller share on “non-durable” items, such as food, clothing, footwear and toiletries.
For most of the past three decades, the price of non-durable goods has been falling relative to the price of the services—investment advice, personal care, domestic help and so on—that the rich spend more of their money on. If these differences between the inflation rates faced by the rich and the poor are taken into account, the rise in inequality is reduced and may even vanish.
To back these claims up, the authors constructed price indices for 12 income groups, using official figures and detailed private information on the spending habits of different households. This data set, created by shoppers themselves using in-store scanners, records the type of goods bought by various income groups between 1994 and 2005, as well as the prices paid for them.
The Chicago economists found that the share of non-durable spending for the very poorest households was 12 percentage points higher than for the richest households. Because the price of services rose by more than the price of goods during this period, the inflation rate for the rich was far higher than that for the poor. Rich households also buy dearer versions of the same goods than poor consumers. For each product category—a 16-ounce carton of milk, say—well-off households paid an average of 25% more than poor households. This is not because the rich are gullible shoppers but rather, say the authors, because they tend to buy goods of better quality (such as organic milk), the prices of which are higher and tend to rise more quickly.
These differences matter when considering inequality. One standard measure compares the income of a household just below the top 10% of earners with one just above the bottom 10%. The richer household earned 10.6 times more than the poorer one in 1994; that multiple rose to 11.2 in 2005 (see left-hand chart). But according to the authors, this ratio exaggerates how far the poor have been left behind because it does not account for different inflation rates. A fuller picture would consider shifts in relative prices as well as in relative incomes.

Mr Broda and Mr Romalis reckon that around two-thirds of the increase in the standard inequality gauge since 1994 is offset by the poor’s lower inflation rate. They find a similar result when they extend their analysis on spending patterns to price and income figures dating back to 1984. That is not all. Their data on shopping habits show that the range of goods consumed by poor households increased by far more than for rich households. The benefit of this extra variety is not captured in income or inflation, but it can be quantified. If that gain is expressed as an addition to real income, the remaining increase in inequality vanishes.
The authors matched their figures on non-durable spending with equally detailed import data, and discovered that increased trade with China (see right-hand chart) helped lower prices and widen variety. “The poor tend to shop in the aisles of the supermarket where the presence of Chinese goods has increased most,” says Mr Broda. These are also the aisles where prices have fallen fastest. The authors reckon that low-cost imports from China alone offset more than a quarter of the measured rise in income inequality since 1994.
Let them drink organic milk
One obvious rejoinder to these findings is, as Mr Broda concedes, that the recent surge in oil and food prices has hit the poor hardest. Yet to acknowledge this is also to recognise that price changes affect income groups in different ways, depending on how they dole out their money. The run-up in commodity prices has reversed only a small part of the trend of the previous two decades, when the prices of services rose relative to those of non-durable goods. Another possible objection is that if the price of goods that the poor do not habitually consume, but may aspire to, goes up, many will still think them worse off, because those goods are farther out of reach. Nevertheless, if what they typically buy becomes cheaper, they are surely still better off.
The analysis could also be challenged on its own turf. The research focuses on falling goods prices. But the rising price of some services—health care, for example—may partly reflect quality improvements which, if correctly adjusted for, would bring down the inflation rate of the rich. At the very least, however, the research makes a provocative case that income inequality needs to be thought through carefully; and that the increase in Chinese imports offers some clear benefits to low-wage Americans