Sacrificing for the undeserving

From The Wealthy-Hand-to-Mouth by Greg Kaplan, Giovanni Violante and Justin Weidner.

In “The Wealthy-Hand-to-Mouth,” authors Greg Kaplan of Princeton University, Giovanni Violante of New York University and Justin Weidner of Princeton University find that both the wealthy hand-to-mouth (those with little or no liquid wealth but substantial holdings of illiquid assets – those that carry a transaction cost to access, such as housing, large durables, or retirement accounts, as opposed to liquid cash, checking, and saving accounts), and the “poor-hand-to-mouth” behave similarly: both groups have “large marginal propensities to consume out of small income changes – a key determinant of the macroeconomic effects of fiscal policy,” they write. The wealthy-hand-to-mouth choose to weather income fluctuations rather than dipping into their assets to smooth shocks , because smoothing shocks would entail holding large balances of cash and foregoing the high return on their illiquid assets.

The research shows that around one-third of all US households live hand-to-mouth (around 38 million households in 2010, based on 117 million households in 2010, Census Bureau), and of that group, over two-thirds are indeed wealthy-hand-to-mouth.

Interesting because it introduces an ethical dilemma of the sort economists would prefer not to address.

The implications from the research are, that in order to juice demand in the economy (which benefits everyone), then you need to target your stimulus policies towards those with the highest propensity to consume. Makes sense. But what the research reveals is that of those with the highest propensity to consume, 65% are not poor. They are temporarily income poor but they are asset rich. They could continue to cover their consumption expenditures by liquidating some of their illiquid assets even though this is financially suboptimal to them individually.

The upshot of this research is that, in order to stimulate the economy, you have to take money from the productive and cautious to generate consumption. 35% of that consumption will occur among individuals who are agreed by all to be poor (they have no income and no assets). However, 65% of consumption will occur by giving money from the productive and cautious to the wealthy and careless. Essentially you are subsidizing the already wealthy in their further wealth accumulation. This raises the prospect of the productive and cautious going John Galt if they perceive their sacrifice as being on behalf of the undeserving.

One study does not a conclusion make, but it is an interesting insight.