10/26/2010 05:01 pm ET Updated May 25, 2011

The Difficulties of Judging Income Inequality

Last week's Bloomberg Businessweek opens with a piece by Drake Bennett on how Americans perceive growing income inequalities. The answer, surprising to Businessweek, is that Americans "broadly" favor "the need for a more equal distribution of wealth," but that they consistently overestimate how equitable American society is -- and by rather striking numbers. "On average, those surveyed estimated that the wealthiest 20 percent of Americans own 59 percent of the nation's wealth; in reality the top quintile owns around 84%. The respondent further estimated that the poorest 20 percent own 3.7 percent, when in reality they own 0.1 percent." A survey of economists also found they got it wrong too, though by less, which establishes some realism to the cries for economic literacy as the solution for our woes.

"In part," concludes the magazine, "this work fits into a proud tradition of social science research demonstrating the basic ignorance of the average American." One might add that this fits into another tradition as well: the media eagerly publicizing social scientists pointing out the ignorance of Americans. Indeed, toward the end of the piece, the magazine quotes George Mason University professor Bryan Caplan on the paradoxical claim that it's good that Americans don't realize how unequal things are, because "they tend not to understand the ways that wealth inequality is good." Businessweek fails to tell us that Caplan is the author of the provocative "The Myth of the Rational Voter: Why Democracies Choose Bad Policies," which focuses on the economic illiteracy of the citizenry.

So what does all this really mean? Well, it's not terribly surprising. You can still be economically or financially expert and still be unable to judge the degree of inequality around you. It's not some symptom of creeping Yahoo-dom. It's a big country. Wealth is relative and more importantly often invisible. Wealth in Oklahoma or Iowa certainly differs from wealth in Westchester County or Palm Beach. Much of wealth is abstract: You can see the mansion or the shack, the Bentley or the Civic. But you can't see financial assets in a bank (and you can't see the debt either). The display of wealth may have more to do with social norms than real, tangible financial assets; conspicuous consumption waxes and wanes. Some of these issues arose recently in the tempest that ensued after University of Chicago law professor Todd Henderson complained about how hard it was to live on $250,000 a year. The difficulties of knowing exactly your relation with the Smith family next door, and with Smiths all across the country, grows even tougher when you try to compare different eras: this age of high inequality versus the so-called golden ages of the '50s and '60s.

This inherent difficulty of judging inequality speaks to the fallacies of economic doctrines like rational expectations: If you can't decide where you fit in a complex, shifting economy, how can you generate much more than rough-and-ready expectations about the future of anything, including what you'll need in retirement? There are several explanations flying around about American attitudes toward income inequality. There's the notion that Americans have traditionally been "bought off," both (in a crass way) by the promise of ample credit and consumer goods, which takes the sting from inequality, and (less crass, more patriotic) by the promise of freedom and opportunity. Americans, in this theory, have traditionally not chosen the path of class warfare or socialism (or communism) because at some level they believe they too can be rich (and if they're not, they can still buy that iPhone). Businessweek seems confused by the fact that Americans underestimate inequality but say they favor broad equality. That may stem from the fact that most people do not see any contradiction between equality and opportunity, which only co-exists happily in a high-growth economy.

This core belief appears to be more at home in the U.S. than, say, Europe. Historically, the U.S. had a large continent to fill, ample natural resources and the always-shimmering possibility of reinvention. Today, while physical frontiers are no longer quite as open as they were once, we have another frontier: affluence and its sibling, celebrity. Of course, you can have a highly affluent -- relatively affluent -- economy and still be highly unequal. (The markets also share some of the virtues of the frontier: You're on your own, it's risky, no one cares what you've been in the past, and potentially it's very profitable.) While the U.S. suffers from patches of terrible poverty, both in the cities and in the countryside, not to say historically high unemployment and a national real estate disaster, the presence of once-unheard-of credit (yes, even now) masks impoverishment. You can still buy stuff. Other policies reduce visible poverty as well. The homeless are kept off the streets. There are no wandering armies of train-hopping hobos, no veterans marching on Washington, no apple sellers or widespread famines or epidemics that are apparent for all to see. There is, albeit tattered and frayed, a safety net -- and Europe, of course, has a much more extensive welfare system. The visible scandal of inequality, which was apparent in the U.S. during the Great Depression, and in Europe after the war, barely exists, particularly if you choose not to look. (There are exceptions, mostly involving natural disasters: Katrina-devastated New Orleans, for instance, which revealed underlying poverty and despair. But think about Las Vegas, which was hammered by the housing downturn. Blocks of empty houses is a lot different than neighborhoods literally under water, then left to rot away.)

Again, this is not to say there's not poverty and a terrific squeeze on middle-class and lower-class incomes, which is destructive. It's just that affluence and credit disguise the pain -- and allow the extension of hope and the retention of something resembling your former lifestyle (foreclosure delays help too). Implicit in Businessweek's discussion of inequality is the notion that if people knew the full extent of the problem, they would seek policies to return to the more equal society they seem to want. That might be a stretch. The golden age of the '50s did arrive in part because of the class warfare of the '30s. But it was mostly driven by the pent-up demand and high growth of the postwar industrial economy, which no one planned; indeed, most economists anticipated a return to depression or recession when the GIs came home. The key to the '50s was growth, which then allowed other policies to shape a broad middle class. Our situation is very different. We've made any number of policy changes to fuel growth, from deregulation to bailouts. Policies to create greater equality tend to dampen growth, as Businessweek says. While Americans may have all kinds of confused ideas about income inequality, they do seem to know growth, or the lack of growth, when they see it.

Robert Teitelman is editor in chief of The Deal.