“Is Income Volatility Really Rising?”

I’ve presented quite a bit of Jacob Hacker’s work here, so it’s only fair that I also present intelligent responses to it. Justin Wolfers has the details, and I added a few comments at the end:

Is Income Volatility Really Rising? For Whom?, by Justin Wolfers: Jacob Hacker’s Great Risk Shift described rising income risk over recent decades as an important and quite general phenomenon. While there’s been plenty of controversy around that claim, the most careful analysis I have seen roughly supports Hacker’s contention. …

What Hacker actually shows is that the average level of income volatility is rising. But we know that an average can hide as much as it reveals. And this is the point brilliantly developed in a provocative new working paper by my Wharton colleague Shane Jensen, and my former colleague Stephen Shore (full paper available here; warning, there are some econometric pyrotechnics involved).

Income volatility is not a single number — some people’s incomes move around over time more than others. And while Hacker and others have documented a rise in the average level of income volatility, Jensen and Shore document changes in the entire distribution of different people’s income volatilities.

A stock market analogy might be useful: some stocks are more volatile, some are less, and it is interesting to see what is happening to the volatility of different types of stocks, and not just some mythical “average stock.”

The Jensen-Shore findings are pretty stark and are sure to stir the policy debate: Despite sharp growth since the 1970’s in the average level of income volatility, median income volatility is basically unchanged. (There are some differences in samples and methods…, but I would be surprised if that explains much.)

hacker1.jpg Indeed, there’s been no change in income volatility for most of the distribution: hacker2.jpg Here’s the punch line:The key driver of rising average levels of income risk is that life among the already risky has become even riskier. Indeed, you really need to look to the riskiest 5 percent of the distribution to find the rise in income risk. And this rise in risk among the already risky is so great as to be responsible for nearly all the rise in average income volatility. And who are these riskiest 5 percent? Jensen and Shore find that they are particularly likely to be self-employed. hacker3.jpg The Jensen-Shore analysis yields an interesting scorecard: Hacker was right on average, but wrong for 95 percent of us. …Perhaps the debate about the Great Risk Shift isn’t such a big deal after all: the best argument for a social safety net is that there is too much risk, not that risk has grown.Full details, including technical wizardry, here.

I’ll keep an eye out for any response from Jacob Hacker, but let me anticipate what he might say. This is from an email he sent in response to earlier questions about his work (the email addresses questions raised by a CBO report that comes to different conclusions about income volatility, something Justin Wolfers discusses in parts of the post above that I didn’t include, and something that Jacob Hacker and Elisabeth Jacobs discuss and attempt to resolve here). I think Jacob Hacker would argue that income volatility is just one dimension of the risk shift he was talking about:

[F]amily income volatility is scarcely the only measure of economic insecurity or the “risk shift” that I and others have discussed. Only one chapter in my book is about family income instability. The rest are about pensions, health care, the decline in traditional job security, the increasing debt burdens reflected in families’ financial balance sheets—in short, about the whole range of economic risks that Americans face. Many of these risks, such as health costs, retirement insecurity, bankruptcy, and mortgage foreclosure, either do not show up in the incomes of working-age people or show up only weakly.

As I put it in The Great Risk Shift, “The up-and-down movement of income among working-age families is a powerful indicator of the economic risks faced by Americans today. Yet economic insecurity is also driven by the rising threat to families’ financial well-being posed by budget-busting expenses like catastrophic medical costs, as well as by the massively increased risk that retirement has come to represent, as more and more of the responsibility of planning for the post-work years has shifted onto Americans and their families. When we take in this larger picture, we see an economy not merely changed by a matter of degrees, but fundamentally transformed—from an all-in-the-same boat world of shared risk toward a go-it-alone world of personal responsibility.”

Originally posted at Economist’s View and reproduced here with the author’s permission.

2 Responses to "“Is Income Volatility Really Rising?”"

  1. Guest   July 1, 2008 at 9:33 am

    The Winter Of Our Discontent?Right now America is passing through one of those profound times in its economic history. Yet you would never know it based upon th comments in the financialmedia. Apparently the Powers-That-Be on Wall St and in Washington DC don’t want Americans to think too hard about what is really taking place.Today as we check the makor index for banking stocks in the USA (see $BKX on http://www.stockcharts.com) we see that this index continues to decline very steadily. Currently it is below 58, and still sinking like a rock.But what’s in a number, you ask? Well first, this is a critical range because $BKX has just dropped through a very important long-term support level. The numbers 60-66 should have held this index – if there was any hope ofa buy-in to support the banks. So apparently many people feel that America’s banks are indeed in deep trouble.As a sideline, there is an interesting dynamic taking place here. Clearly many major hedge funds are shorting the banks right now. It is unlikely that $BKX would be dropping quite as rapidly as it is – withoutsome strong downwards pressure from major short positions. But there is a certain irony – and financial struggle – in these developments.The hedge funds seek to profit from the dilemma of the banks. Yet clearly a massive deleveraging must also occur amongst the hedge funds sooner or later. So today the "hedgies" may be laughing, but at some time in the future things will not be so rosy for them either.The much bigger question facing America is this … what are we going to do for an encore? The demise of the banking sector really marks the collapse of a major paradigm for the US economy. It was said bysome that America could forsake her role as a world leader in manufacturing and industry. Key jobs were exported overseas, and a major employment shift caused many US workers to move into service sector jobs.America entered – and profited from – the era of financial wizardry. Could this be the new nirvana? Well perhaps it was for a while … whileAmerica gorged itself upon debt in every conceivable form. But today as we watch the sun set on $BKX, we see that the financial nirvana is rapidly receding. Americans now ask themselves what new industrywill arise that could possibly provide the kind of wages that would support a profligate lifestyle? Unfortunately, it’s not clear that there is one.The auto industry in the USA is now in serious trouble, and it’s very possible that one of the major car companies in Detroit could go bust. Othersectors like technology and software have prospered in America. But these sectors are wide open to outsourcing and foreign competition as well.So there is a real danger that the USA is moving to permanent levels of higher unemployment. In the immediate future we face the carnage of a very vicious cyle which operates as follows:Rising unemployment causes higher home foreclosures and delinquencies in consumer debt, which leads to even tighter credit from banks, which leads to rising spreadsin corporate bond yields, which causes further layoffs and higher unemployment. And so on.Of course, these cycles are always seen in a recession. But is this a standard recession? For a glimpse at the futue, go to http://www.stockcharts.com and plot $INDU over the last 30 years. You will need at least a basicsubscription to perform this exercise – or you can follow what I’m saying here. You will find that a very nice straight line can be drawn against the lowersupport of the Dow Jones index over this long-term bull run. At least up to now. Very clearly over the last few months this long-term resistance has been broken, and the Dow is headed decisively downwards into unknown territory. It is this kind of observation – a major violation of long-term technicals – thatis causing alarm. For example, the Royal Bank of Scotland (RBS) recently warned investors of a possible major calamity in the global stock markets. And RBS is not alone in these warnings.Some commentators such as Mike Shedlock have already observed that we appear to have passed the point of "Peak Credit" in the USA. America has finally reached the point where the US consumer just cannot handle any further debt load. Very likely this is true. But I would also add that we appear to have reached the point of Peak Derivatives in the globaleconomy. According to the latest count, total derivatives deals in the world now add up to a staggering 1,000 trillion dollars. We actually haveto search for a new word – quadrillion – to describe this enormous number. Is this absurd? Of course it is. How could it be otherwise – when some ourmajor banks are already insolvent (if all assets are marked to market), and asset prices are still decreasing? Reasonable estimates of the UShousing market indicate that prices will fall at least as much in the next 2-3 years as they have already. So there is no way that America can avoid a major depreciation of house prices and equities. Yet these same assets are ulimately backing up derivatives deals that have exploded beyond any reasonable proportion.Looking out from the bow of the ship of state, it appears much more likely that America is headed towards an iceberg – rather than towards open water. The world may experience a recession, but the USA could verywell be headed for a depression (perhaps joined by the UK, Spain, and some other countries). If so, it is an economic disclocation that Americans are ill prepared to face. With savings accounts at zero, andhousehold bills escalating, the US consumer has little ability to absorb further economic pain. Truly we could be heading towards the winter of our discontent. PeteCA

  2. SK   July 1, 2008 at 2:41 pm

    Well put together PeteCA