Do differing work efforts imply that there is less inequality and poverty than we think?

One often hears that high incomes are simply the reward for greater effort, and poverty reflects laziness. Here, for example, is what Ben Stein has said (In The American Spectator, April 4. 2014): “There is an immense amount of income inequality here [in the US] and everywhere. I am not sure why that is a bad thing. Some people will just be better students, harder working, more clever, more ruthless than other people”. Stein goes on to claim that long-term poverty reflects “poor work habits”.

Is there any truth to the claim that there is less inequality and poverty than we think, once one allows for the differing degrees of work effort that people make? My paper “Inequality and poverty when effort matters,” argues that it is far from obvious that allowing for heterogeneity in effort implies less inequality or poverty.

If one takes seriously the idea that effort comes at a cost to welfare then it is clear that prevailing approaches are not using a valid monetary measure of welfare. While this much is obvious enough, the heterogeneity in effort must also be brought into the picture. Then the distributional outcome is far from obvious. It may be granted that average effort rises with income, but there is also a variance in effort at given income. The implications for measuring inequality and poverty stem from both the vertical differences (in how mean effort varies with income) and the horizontal differences (in how effort varies at given income).

It is unclear on a priori grounds what effect adjusting for effort in a welfare-consistent way will have on standard measures. There are both empirical and conceptual issues. The implications for measurement of taking effort seriously depend crucially on the behavioral responses to unequal opportunities, and not all of those responses are readily observable. Measures with a clearer welfare-economic interpretation call for data on efforts, for which existing surveys are limited to a subset of the dimensions of effort.

The paper provides illustrative calculations for American working adults without disabilities. A positive income gradient in labor supply is evident in the data. This gradient accounts for very little of the income gap between the poorest third (say) and the overall mean. The fact that poorer workers work less appears to contribute rather little to overall inequality in observed incomes. However, the considerable heterogeneity in effort at given incomes imparts a large horizontal element to inequality measures that adjust for effort consistently with behavior.

On calculating distributions of welfare-consistent equivalent incomes to allow for this heterogeneity, I find higher measures of inequality than for observed (unadjusted) incomes. Contrary to the common view, the prevailing practice of ignoring differences in effort understates inequality.

It can be acknowledged, however, that some of the apparent heterogeneity in leisure preferences seen in the data is deceptive given likely rationing and measurement errors. When I use predicted leisure shares based on covariates I find a modest drop in the measured levels of inequality on adjusting for effort. Adjusting for effort does not appear to make much difference in the structure of inequality, as indicated by regressions using a set of circumstances related to gender, age, race and place of birth.

The implications for measures of poverty depend crucially on whether one sets the poverty line consistently with the welfare metric. If one does not do so, then poverty rates are lower using equivalent incomes although this essentially vanishes when one smooths the data. However, these comparisons are arguably deceptive since one is not setting the poverty line consistently with how one is assessing welfare. To correct for this, one needs to include a normative allowance for leisure as a basic need in setting the poverty line.

On introducing even a modest allowance for leisure as a basic need (valued at a low wage rate) I finds higher poverty rates when one adjusts for effort. If half the average amount of leisure taken by American adults is deemed to be a basic need then the poverty rate based on equivalent incomes, adjusted for effort, is nearly twice as high as that based on observed incomes.

In short: allowing for effort in a way that is broadly consistent with behavior does not attenuate the disparities suggested by standard data sources on income inequality or poverty. Indeed, one can reasonably argue the opposite: there is even more inequality and poverty than current measures suggest.