Personal income minus transfer payments (like Social Security)

Manufacturing and trade sales

Nonagricultural employees on payrolls

Industrial production

Why You Should Care

You may want to keep track of these indexes and the general movement of indicators, especially leading economic indicators. It is possible to track some of the leading indicators yourself, like the stock market and Consumer Confidence indexes, before seeing them compiled into this “big picture.” Investors, in particular, find the LEI/CEI/LAG indexes to come late in the reporting cycle, too late to buy or sell on the news. But to get the big picture, and to understand the news as it comes at you, these measures can be helpful.

14. DISTRIBUTION OF INCOME AND WEALTH

If everything were perfect in today’s economy, it would perform in line with a slogan rooted, ironically, in Socialist ideals: “From each according to his abilities; to each according to his needs.” That is to say, in this perfect world, income and wealth distribution are natural and track economic contributions exactly. You work and you’re paid the exact value of what you produce, and so is everyone else. You reap what you sow. You spend what you earn, or preferably a little less, as you save for the future. Your investments grow exactly in line with the economy. The economy grows, you grow, and everyone prospers.

Unfortunately, it doesn’t work that way. While the United States and many Western economies are capitalistic and free and the so-called “invisible hand” doles out benefits largely commensurate with contributions, the largest income and greatest wealth don’t always accrue to those who produce the most.

What You Should Know

Economists concern themselves with the inequality of income and wealth distribution. In terms of household income, the U.S. median in 2009 was $47,637, meaning that 50 percent of all households earned more, 50 percent earned less. The 20th percentile level was $20,453, while the 80th percentile and 95th percentile were $100,000 and $180,001 respectively. That’s a large gap, and that gap has been growing in recent years. Between 1980 and 2009, the gain in income for the top 5 percent of Americans was 43 percent, or 4.3 times the 10 percent gain experienced by the lowest 20th percentile over the same period. Since the income base at the high levels is larger, the disproportionate size in percentage gains is even more significant. While some of this is explained by the growth in double-income households, one basic fact cannot be denied: the wealthy are getting wealthier, while the poor are getting poorer.

However, there is a difference between income and wealth.

In financial terms, wealth is the items of value a person owns, whereas income is the economic value a person receives as a result of work or investing, but does not necessarily retain. It’s helpful to remember that income is a cause; wealth is an effect.

So some economists also focus on the distribution of wealth. As a matter of brevity, rather than sharing wealth statistics, I direct you to the fascinating study done by the U.S. Federal Reserve every three years known as the Survey of Consumer Finances. This survey not only points out the characteristics of wealth distribution and asset ownership, it also provides a fabulous benchmark for you to see where you stack up against other citizens. You can view the survey at www.federalreserve.gov/pubs/oss/oss2/scfindex.html.

Finally, it is sobering to examine worldwide data on this subject. According to statistics published by the United Nations University World Institute for Development Economics Research (UNU-WIDER) back in 2006 but still quite relevant:

North America represents 5.2 percent of the world’s population and 34.4 percent of the world’s net worth

Europe represents 9.6 percent of the population and 29.2 percent of the net worth

Asia represents 52.2 percent of the population and 25.6 percent of the net worth

Africa represents 10.7 percent of the population and 0.54 percent of the net worth

Why You Should Care

The distribution of wealth and income at a national level are interesting topics, especially for policymakers and social scientists. Efforts to redistribute wealth, for good or bad, become part of tax policy.

For individuals, it’s important to know where you stand and to make sure your income—cause—is creating some wealth for you—effect. It’s also important to make sure what you’re calling “wealth” is truly wealth—not a fiction in a pretty wrapper known as the “wealth effect” (see #15 The Wealth Effect). Finally, it’s good to appreciate the advantages you have compared to others in the United States and the world. As stressful and depressing as things seem at a given point in time, understanding income and wealth distribution on the U.S. and worldwide stages will make you realize how much better off you really are.

15. THE WEALTH EFFECT

Have a lot of dough in the bank? Stocks been doing well? House has gone up (or recovered) $100,000 in value in the last two years? You might feel like spending money even if your income hasn’t gone up a bit. Why? Because of the wealth effect.

What You Should Know

Wealth effects can happen when people actually are richer (when their incomes rise) or when people feel richer—as they did in a big way twice this past decade—because of the increase in the value of stocks, real estate, or other assets. The latter effect is dangerous because asset prices don’t always match asset values, and things can change quickly.

The wealth effect created in the 2005–2007 real estate boom became doubly dangerous as people not only felt wealthier but used that wealth—their home values—to borrow money to buy things they couldn’t otherwise afford. They used their homes as ATM machines. When prices came back to earth, not only were these unfortunate citizens less wealthy, they also had a lot of new debts to pay. The subsequent deleveraging (see #9 Deleveraging) caused a steep drop in economic activity and a vicious circle of unemployment, falling asset values, and still more unserviceable debt we all became familiar with.

Two scenarios can get people to spend more: (1) They are actually richer, be it through a raise, bonus, or some other form of increased income; (2) They perceive themselves to be richer, for example with an increase in their portfolio or assessed home value.

Interestingly, the wealth effect can turn on a dime. A January 2008 Gallup Poll reported that 56 percent of Americans thought their standard of living was getting better, while only 26 percent thought it was getting worse. By February 2009, those figures had reversed: 33 percent of Americans thought their standard of living was getting better while 44 percent thought it was getting worse. As we emerged from the Great Recession, people became once again more optimistic, and a resurgence in the stock markets has helped make people more comfortable with their finances—but it didn’t cause a huge boom. As economist Robert Samuelson put it: “Careless optimism has given way to stubborn cautiousness.”

Why You Should Care.

For starters, never equate the accumulation of “stuff” with being rich, and never count your asset chickens—particularly noncash assets—before they’re hatched. You should never expand your lifestyle based on such asset values, but rather income and real worth after current and future obligations (like a college education or retirement) are met. Once people attain a standard of living they cannot afford, it is devilishly difficult to go back. The tendency is to expand further, borrow more, and become even more vulnerable.