Income volatility strongest for poorest 25% of the income ladder
A version of this commentary appeared in the Globe and Mail, Hamilton Spectator and the Vancouver Sun
The government of Canada has remained conspicuously silent on a topic of growing concern: income inequality. While the International Monetary Fund, the OECD and the Conference Board of Canada have all expressed concern about the trends in recent years, there remain — as in the climate change debate — some deniers. Enter the Fraser Institute.
The Fraser Institute’s recent study on income mobility claims it is turning conventional wisdom on its head. In a nutshell, they say income inequality in Canada is not a problem because more people have incomes that have been going up than down, particularly among the poorest earners.
This reasoning, if it were conceptually and empirically correct, would certainly provide an important caution to the Occupy Wall Street concerns about the dramatic growth in incomes of the top 1 per cent. The Fraser Institute study does use the best data available to examine income mobility in Canada — a large Statistics Canada sample of individuals’ income tax returns linked from one year to the next.
Unfortunately, its results are misleading.
The key that something is amiss is that, while the study claims to be examining relative mobility, the average proportion of individuals moving up the earnings ladder — 47 per cent — is much larger than the proportion moving down the earnings ladder — 14 per cent. Of course, if we look at dollars, the majority of workers have rising earnings, partly due to inflation, and partly general economic growth. But the kind of mobility the Fraser Institute purports to be examining is how one income group in 1990 is doing over time relative to another.
It is well known that there is a broad life cycle pattern to earnings — lower entry-level wages in your early 20s, generally rising to a career maximum in your 50s, and then declining essentially to zero after age 70 when fully retired. So of course, we should expect that a great many people will see rising earnings as they move from newly minted to mid-career workers.
The Fraser study focused on younger workers in 1990, but defined its income groups based on the entire population of earners, which is generally older, and therefore has higher average earnings.
While they have not published the details of their income groups, this likely accounts for more than three times as many earners looking like they are moving up the income ladder rather than moving down.
If the analysis had been done fairly, looking at relative mobility as it claims, it would have used income groups for the specific population being studied – younger earners. Then, for every person moving up a relative position on the income ladder (e.g. from the bottom 20 per cent to the top 20 per cent, as in the Fraser analysis), someone else must have moved down, there being a fixed number of rungs (or 20 per cent income groups in this case).
Fortunately, there is an analysis of the question of income mobility in Canada based on a more careful methodology which I co-authored a few years ago, using exactly the same income tax data base. Our results lead to quite different conclusions.
While the Fraser Institute divided earners into five broad groups, using income points bound to result in more upward than downward income mobility, we looked at much more detailed and properly relative income groups, including the bottom 10 per cent up to the top 1 per cent, and even the top 0.01 per cent.
As part of our study, we assessed rationales for income inequality put forward by Milton Friedman, also cited by the Fraser Institute. One of his arguments is that high income inequality need not be ethically troublesome, because high incomes go together with more volatile incomes, and are justified, therefore, because they represent compensation for the greater risks of a volatile income.
Income mobility and income volatility are clearly linked — both relate to how much incomes move up and down over time. And if the Fraser Institute had done its analysis properly, the same number of individuals would be moving up as moving down the income ladder.
The interesting question in light of Mr. Friedman’s argument is whether those with the highest incomes actually experience the highest income volatility.
Our analysis showed that yes, the elite earners in the top 1 per cent (and up) do have more volatile incomes than those at the middle and upper-middle rungs of the income ladder. But those in the bottom 25 per cent of the income spectrum faced even higher income volatility.
In other words, the top 1 per cent and even the top 0.01 per cent had incomes that bounced around less than the incomes of the 25 per cent at the poorest end of the income ladder. A major reason: low earnings are often the result of “precarious” jobs which not only pay low wages, but are unstable.
Life at the top may be risky, but the real risks in life lie at the bottom of the income spectrum..
This reality of precarious jobs amongst the poor, and current research standards for unbiased analysis of income mobility, are ignored by the Fraser Institute as it tries to perpetuate the Horatio Alger, ‘rags to riches’ myth.
Michael Wolfson is an adviser with EvidenceNetwork.ca, and Canada Research Chair in population health modeling/populomics at the University of Ottawa. He is a former assistant chief statistician at Statistics Canada, and has a PhD in economics from Cambridge.