Monday, November 8, 2010

Thoughts on Income Inequality

I was reading this interesting post by Dartmouth College economics professor Andrew Samick at Capital Games and Gains concerning income inequality. Here are my thoughts in response:

I am in agreement with Andrew Samwick in theory. It seems what is most important to me is that the well-being of the everyday citizens is good in terms of food, shelter, clothing, education, medical care, leisure, and other things that improve well-being. Companies like Wal-Mart and Apple clearly make life better for most people to the extent that they deliver good products at lower prices or innovate and invent product categories that never existed before. There should be some reward for these activities.

I mean, certainly there are reasons to object to inequality. It is possible, for example, that someone who is wealthy can harm someone who is less so by driving up the prices of goods so that the person with average income could not afford them. But happily, for most goods, this isn't too much of a problem. Wealthy people do not consume unlimited numbers of tooth brushes or iPads or computers. They are generally satiated after buying a few of these goods. Thus, their consumption does not drive up the price. There are some problems with gentrification, of course, as when people find that they are no longer able to live in neighborhoods where their parents lived, as richer neighbors move in. So, there are certainly some negative stories with inequality, but for most goods and services, the consumption of the rich do not make people worse off.

I suppose it should be mentioned that there are also psychological aspects to inequality that shouldn't be entirely discounted either. We should certainly take critiques of accumulation, which perhaps originated with Veblen, seriously as well. When you have, as in modern America, all of this marketing and a commercial culture that glorifies wealth, many people seem to become unhappy because they do not have "things" that they really do not need and probably would not desire except in a social context. Corporate America spends countless dollars bombarding people with commercials that convince many people that they need things that they really do not, and I think a considerable amount of unhappiness results. I have seen this happen. I think we all have. So, there may be something to be said for a culture that glorifies people for their unique qualities more and for what they happen to own or possess less. I think such a cultural change could be facilitated, perhaps, by higher tax rates which would discourage accumulation beyond a certain level.

Now, acknowledging that there are some harms to inequality, is it worth combatting them? I certainly would not want to do anything that would discourage Steve Jobs from innovating, for example. But, is your average high-income CEO really a Steve Jobs? I happen to think that the truly innovative people are driven by passion, not merely money. Especially since I am quite sure that Steve Jobs would not even know how to begin to spend his money on personal consumption. Steve Jobs is driven by a passion for computing and innovating and seeing his creations turned into reality. It is much more than money that motivates him. So, we shouldn't necessarily assume that the costs in terms of innovation of curtailing inequality to some degree would be overwhelming. Indeed, it seems likely that if we took tax revenue used from taxing "conspicuous consumption" and used it to finance research and development, we could have more innovation on net.

All that said, if these were the only risks arising from inequality, I would agree with Andrew Samwick. I think people need to try to put their more superficial and usually unrealistic desires for ever more "things" in check and learn to pursue excellence using their own special talents. Maybe I and Andrew Samwick are holding people to an unrealistic standard when we expect them to not be unhappy because they cannot indulge in the conspicuous consumption that they see others indulging in... Not everyone has my personality, people are social animals, and corporations spend countless millions glorifying conspicuous consumption. But still, at least for now, this is the standard we should hope that people strive too. Of course, there may be some serious negative externalities when people fail in this. When people buy more house than they can really afford, doesn't this contribute to financial crises that affects those who do have the inclination and/or self-discipline to consume beyond our incomes?

Anyway, the case is not a complete slam dunk, but I am in agreement. We should all pursue our own lives and interests and not worry so much about what other people have or do not have. It is true that people who desire more than they can afford and spend accordingly cause negative externalities (i.e. by bidding up the price of housing and contributing to a housing bubble for example) or when they go bankrupt or fail to pay their debt, which increases the price of credit for those more responsible with their credit to some degree. But, I am frankly not sure we should  accommodate such imperfections. Not being able to control your desires, even if such desires are in part created by our commercial culture which constantly barrages us with images making conspicuous consumption seem desirable and identity affirming, is a sort of flaw. People would be better off if they learned to simply resist such imagery. Should the unhappiness that people experience because they are flawed "count" for policy purposes? I am not sure.

But here is my real argument against what I infer to be Andrew Samwick's position that we should be concerned only with absolute measures of income rather than relative measures. I believe that those with wealth naturally tend to buy influence in our political system. I guess when it comes to our civic system, I think we should all be considered "equal." We do not give people more votes just because they have more income or wealth. We used to have minimum property requirements for voting or holding office, but we have long ago abandoned such distinctions between citizens. A rich person and an average citizen each get just one vote. The ideal, I think, is that the interests of the average citizen in our civic system is just as important as the interests of the wealthy citizen. But this ideal seems to be violated on a regular basis as those with more wealth have more influence in our political life, just as they have more power to get what they want from our market economy.

But, obviously, much worse is rent-seeking. That is, when someone has a stream of income somehow tied to government policy, and those people then take a portion of that income to protect that income stream. For example, companies who lobby for wasteful agricultural subsidies that distort our markets. Or companies that try to extend copyrights to unreasonable periods in order to protect Mickey Mouse. I could go on. I think instances of rent-seeking are legion, and their are constituencies on both the left and the right. I think that Andrew Samwick and I would agree that rent-seeking is the much more pernicious problem than the wealthy having a somewhat disproportionate influence. It seems to me that there are wealthy people on both the left and right side of aisle, and they tend to cancel each other out to some degree. But, when a company or industry has an iron grip on an unjustified stream of income at public expense, there is often no countervailing force. The interests of the "special interest" are concentrated; the interest of the general public is diluted. The special interest has the incentive, the money, and the time to monitor political developments concerning their rent-seeking. The general public does not have the time or money to effectively monitor such nitty gritty political developments.

While Andrew Samwick also sees rent-seeking as pernicious, I think he hasn't considered the ultimate motive. The ultimate motive often is "conspicuous consumption." Why would those who control an industry insist on trying to corrupt the system in order to extract rents? These people are not poor. They would not generally live in poverty if they lost their income from rent-seeking. This sort of rent-seeking has a lot to do with the people in control of these industries and companies trying to construct their identity around earning as much money as possible. If you raised marginal tax rates on such people, they would have less incentive to engage in rent-seeking.

Overall, I think a lot of what motivates people in their economic lives is disconnected from anything remotely necessary for survival. It is always wanting more. One does not feel adequate, except as measured by stuff that they do not really need. I am not sure that curtailing this through higher tax rates would be a bad thing. I suspect that the truly passionate and dedicated (like Steve Jobs) are not really in it for the money. I don't think the truly best people in any field are in it primarily for the money. I therefore think that the horrors that are predicated by higher marginal tax rates are overstated.

Also, when we have out-sized rewards for certain professions, we have graduates flocking to those graduates even if this is not the socially most valuable place for them to be. For example, a huge percentage of Harvard graduates have majored in economics with the intention of going to Wall Street in order to get rich. But to what extent is what happens on Wall Street productive? Are these very smart people with tons of intellectual potential making the best use of their talents working in such positions, or would we be socially better off if they used their talents as engineers or teachers or social workers or cancer researchers? It seems to me that another high cost of status competitions based on conspicuous consumption is the potential of a "brain drain" from more valuable but less profitable activities to activities that are perhaps less valuable but more profitable. It seems that higher marginal tax rates on higher incomes would dampen some of this status competition and cause people to consider their profession more on their own ability to contribute and less on the financial awards. Of course, I suppose the thought that a Harvard graduate with crazy good math skills might make a more valuable contribution as a cancer researcher than a Wall Street executive is somewhat speculative. How do you measure relative contributions from the two career paths? Still, my sense is that the incomes on Wall Street are quite inflated relative to the social contribution of those earning those incomes.

Here is what makes me think twice about this. It seems that there are a lot of rich people who devote themselves to doing things that governments do not do nearly as well. I am thinking of the Gates Foundation, as an example. I am certainly glad that Bill Gates has made every dollar he has made, but that is because he has decided to do something truly worthy with it and because I believe that he is likely to be much more effective than any government would be, given that a government is likely to be tied down by bureaucracy.

The bottom-line is that with increased inequality, we may get a lot of wasted energy wasted in pointless and zero sum status games associated with conspicuous consumption. But then we also get those who, like Bill Gates, have moved beyond conspicuous consumption and who direct their resources in a public-spirited manner more efficiently and effectively than any government would probably do. (I am not saying that government cannot do these missions; only that given the way we tend to smother our governments with red tape, it is very difficult for people working for these institutions to be as effective as they could be, dollar for dollar.)

So, I guess my bottom-line position is actually ultimately the same as Andrew Samwick's position. But I think the case is much more complicated and contingent. I think there is a reason to be concerned about increased economic inequality. I also think that the idea that you can really take many steps to lessen influence peddling without tackling the problem of economic inequality and the associated culture of conspicuous consumption is very questionable.

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