Welcome to Empirical Research on Economic Inequality

This textbook developed out of a class I taught at Harvard, and subsequently at IHS Wien and at the University of Zurich. The purpose of this textbook is twofold. First, to teach you about economic inequality, some of its causes, and how it is affected by policy. Second, to teach you econometric methods that have been used in the literature on economic inequality, so as to help you conduct your own research on these topics.

The intended audience for this textbook are advanced undergraduate, master, and PhD students, as well as applied researchers who wish to work on one of the topics covered. Some background in economics and statistics at the undergraduate level is assumed. This textbook can be read sequentially, but it can also be used as a handbook, where each chapter can be read on its own. This textbook is intended to accompany the reading of the original articles referenced in each chapter and listed below. The purpose of this book is to give you a compact overview of formal definitions and derivations and the econometric methods used, but often left implicit, in the papers discussed.

In terms of the topics covered, we will focus on mechanisms affecting income inequality, such as racial discrimination, (de)unionization, minimum wages, shifts in labor demand due to changes in technology and trade, shifts in labor supply due to migration, intergenerational transmission of economic status, and taxation. We will briefly talk about the historical evolution of income and wealth inequality, as well as about international inequality; mostly, however, we will focus on mechanisms affecting the distribution of incomes in the United States.

I would also like to emphasize what topics we will not cover in this book — particularly as these are arguably important topics:

• We will not talk about inequality along non-economic dimensions, such as health, education, political participation, or recognition. All of these are important, but I am not in a position to say much about them.
• Inequality within other countries matters too, of course, but the economics literature which we will discuss is focused on the United States. International inequality matters hugely — the citizenship you are assigned at birth is the single most important determinant of your life chances. International inequality is even more complicated than domestic inequality and involves many additional considerations, so we will mostly focus on the "simpler questions" of within-country inequality.
• We will not talk about indices of economic inequality and their axiomatic justifications, which were central to an older literature on economic inequality, nor about issues of measurement

This textbook can be thought of as having three parts. In the first part, chapter 2, we will discuss normative theories of justice and their implications for empirical research on economic inequality. In the second and largest part, chapters 3 – 8, we will discuss empirical research on inequality along various dimension, including gender, race, education, and parental background. In the third part, chapters 9 and 10, we will discuss welfare economics and the theory of redistribution through taxation.

Chapters 4 – 10 are complementing the following external readings; links to each of these can be found in the corresponding chapters:

• Chapter 3
Topic: The long run evolution of inequality as measured by top income shares
Method: Pareto distribution, maximum likelihood, (interval) censored data

Atkinson, A. B., Piketty, T., and Saez, E. (2011). Top incomes in the long run of history. Journal of Economic Literature, 49(1): 3 – 71.

• Chapter 4
Topic: The long run evolution of gender inequality
Method: Cohort analysis

Goldin, C. (2006). The quiet revolution that transformed women's employment, education, and family. American Economic Review, 96(2):1 – 21.

• Chapter 5
Topic: Racial discrimination
Method: Potential outcomes, treatment effects, randomized experiments

Bertrand, M. and Mullainathan, S. (2004). Are Emily and Greg More Employable Than Lakisha and Jamal? A Field Experiment on Labor Market Discrimination. American Economic Review, 94(4): 991 – 1013.

• Chapter 6
Topic: The effect of de-unionization on inequality
Method: Distributional decompositions, reweighting

Fortin, N. M. and Lemieux, T. (1997). Institutional changes and rising wage inequality: Is there a linkage? The Journal of Economic Perspectives,11(2): pp. 75 – 96. Firpo, S., Fortin, N., and Lemieux, T. (2011). Decomposition methods in economics. Handbook of Labor Economics, 4:1 – 102.

• Chapter 7
Topic: Labor demand and labor supply, technical change, immigration
Method: Estimation of demand systems

Card, D. (2009). Immigration and inequality. The American Economic Review, 99(2): 1 – 21. Boustan, L. P. (2009). Competition in the promised land: Black migration and racial wage convergence in the north, 1940 – 1970. The Journal of Economic History, 69(03): 755 – 782. Autor, D. H., Katz, L. F., and Kearney, M. S. (2008). Trends in US wage inequality: Revising the revisionists. The Review of Economics and Statistics, 90(2): 300 – 323.

• Chapter 8
Topic: Intergenerational mobility
Method: Measurement error
• Chetty, R., Hendren, N., Kline, P., and Saez, E. (2014). Where is the land of opportunity? The geography of intergenerational mobility in the United States. Quarterly Journal of Economics, 129(4): 1553 – 1623. Black, S. and Devereux, P. (2011). Recent developments in intergenerational mobility. Handbook of Labor Economics, 4: 1487 – 1541.

• Chapter 9
Topic: The welfare impact of changing prices and wages
Method: Equivalent variation, conditional causal effects
• Deaton, A. (1989). Rice prices and income distribution in Thailand: a non-parametric analysis. The Economic Journal, pages 1 – 37. Kasy, M. (2014). Who wins, who loses? Tools for distributional policy evaluation. working paper.

• Chapter 10
Topic: Redistributive taxation
Method: Computing optimal income tax schedules

2. Why research economic inequality?

A textbook on economic inequality raises the question: why should we care about inequality, and why should we do research on it? There are a number of distinct justifications which might be given.

First, for normative reasons. We will discuss these normative arguments in more detail in chapter 2. The normative relevance of distributional questions follows from the fact that, in general, economists evaluate societal outcomes and the policies that affect them based on the welfare of individuals, however defined. Formally, if $$v_i$$ is a measure of the welfare of individual $$i$$, social welfare evaluations are a function of all the $$v_i$$, $$F(v_1, \ldots, v_n)$$. From this it follows that any such normative evaluation of the status quo has to start by evaluating who is doing how well. That is, how large is the welfare $$v_i$$ of different individuals? Correspondingly, any normative evaluation of policy changes has to start by evaluating who wins and who loses, and by how much. That is, how much does the welfare $$v_i$$ of different individuals increase or decrease? Such evaluations are the task of the kind of research considered in this class.

Any statement on whether a policy change is desirable must then take a stance on how to trade off the welfare of different individuals — e.g., how much do you care about an additional dollar for a rich person versus an additional dollar for a poor person?

Second, there is a long-standing line of ethical reasoning which suggests that we should put the bulk of normative weight on those who are worst off and aim for an equalization of welfare, which amounts to picking functions $$F(v_1, \ldots, v_n)$$ of a particular form. Such prescriptions of normative symmetry or ethical equality go back as far as the biblical "golden rule;" similar prescriptions seem to appear in almost any religion. A contemporary philosophical version of such a reasoning can be found in John Rawls's "Theory of justice" (Rauls, 1973). Rawls argues that we should evaluate societies by imagining that we are behind a "veil of ignorance," which prevents us from knowing who we actually are. In such a setting of uncertainty regarding who we are, we should try to make the worst-off person as well off as possible, ensuring a minimum standard of living for ourselves should we happen to be among the worst-off. There has been much subsequent debate on this argument; a good reference is (Sen 1995).

Third, we might be worried about the consequences of inequality, which we might consider important in their own right. Various literatures in sociology, political science, and economics are concerned with these consequences; possible consequences that have been discussed are:

• Political consequences: An increasing concentration of income and wealth, and the rising influence of campaign donations and lobbying, might undermine democratic institutions predicated on the principle of "one person, one vote."
• Social consequences: Increasing inequality might further social segregation (residential, educational, etc.), thus reducing knowledge of how others live and undermining social cohesion and solidarity.
• Economic consequences: Rising inequality might destabilize the economy. The increase in mortgage lending as a substitute for income growth of the bottom half of the distribution, for example, was at the origin of the financial crisis starting in 2008.

Whether rising inequality has these and other effects is a hard empirical question which we will not discuss in this class.

Fourth and finally, by studying economic inequality we learn (i) how much it has changed over time and across countries, and (ii) how much it is affected by policy decisions and other social factors. Recognizing these two facts puts into question explanations of inequality that are a-historical and a-social. These include biological explanations (such as biological racism, sexism, or justifications of inequality based on genetic differences in IQ) or explanations that reduce inequality to a matter of individual responsibility.

3. Acknowledgments

I thank Susanne Kimm and Ellora Derenoncourt for many helpful discussions and suggestions, and Lynn Kiang for designing this webpage.