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Inequality is Not the Problem
on October 25, 2014
Joseph Stiglitz is one of the greatest economists of our time, a Nobel Prize winner, former head of the World Bank and Chairman of the President’s Council of Economic Advisors. He is also seriously concerned about poverty and inequality in America. I remember well hearing him on NPR radio being interviewed on the day he was informed that he was awarded the 2001 Nobel Prize in Economics: he spoke passionately and almost exclusively about the need for eradicating poverty in America and around the world.
The economic argument for policies that favor the poor over the rich are very simple, being based on the universally accepted principle of the declining marginal utility of income. What that means is that one dollar is worth a lot more to a person who makes $20,000 a year than it is to a person who makes $200,000 a year. Thus a policy that gives $1 to the poorer and reduces the income of the richer by the same amount will increase general social welfare. Some people have argued that this is a value judgment rather than a fact, but that is just wrong. It is a fact, pure and simple.
The bottom half of the income distribution in America earns only 12% of total income. Why don’t they just vote to take money from the top 1% of earners, who capture about 20% of total income? If voters took away half of the earnings of the top 1% and gave it to the bottom 50%, each recipient household would receive about $14,000, a not insignificant sum.
I do not know why voters do not expropriate the rich (both supporters and opponents in the Eighteenth and Nineteenth centuries certainly expected that to happen upon the advent of democracy with universal suffrage), but there is one strong arguments against expropriating the rich: to the extent that high incomes motivate the talented to acquire and exercise skills and to take risks, excessive taxation will lead to economic stagnation.
In fact, my observation of American politics leads me to a very simple understanding of voter sentiments: people care about injustice but not about inequality. The current wave of anger at the top 1% is not fueled by resentment against inequality, but rather against the injustice of the people at the top gaining while others are losing jobs and houses due to the economic elite’s anti-social and greedy machinations.
There are of course societies where people care about inequality per se. But those are invariably relatively poor, clannish societies. For instance, in hunter-gatherer societies without forms of material wealth, when one family is very successful, others who are less successful will demand sharing the bounty. This of course eliminates the incentive to be successful and entails enduring social poverty of the group. In rich societies such as our own, people are used to congratulating the successful, whether sports stars, movie stars, real estate wheeler-dealers, and other celebrities. People object only when they feel success was based on some form of injustice, or the well-off are behaving uncharitably. Inequality per se is simply not something people think is wrong (except, of course, for a fringe of super-liberals, who are politically irrelevant).
Stiglitz draws precisely on this sentiment in this spirited call to action for income redistribution towards the less well off. Recounting the well-established fact that the very rich have done extremely well in the past few decades while the fortunes of those below the top 10% have stagnated, Stiglitz argues that the good fortune of the winners is indeed unjust, being a reward for their inveterate rent-seeking rather that their contributions to society. Stiglitz writes: “This book is not about the politics of envy: the bottom 99 percent by and large are not jealous of the social contributions that some of those among the 1 percent have made, of their well-deserved incomes. This book is instead about the politics of efficiency and fairness. The central argument is that the model that best describes income determination at the top is not one based on individuals’ contributions to society… Much of the income at the top is instead what we have called rents. These rents have moved dollars from the bottom and middle to the top…In the United States the “Occupy Wall Street” movement echoed the same refrain. The unfairness of a situation in which so many lost their homes and their jobs while the bankers enjoyed large bonuses was grating.”
Stiglitz recognizes that because the increase in inequality is due to rent-seeking rather than inexorable “market forces,” it can be reversed by ending the rent-seeking---in effect by changing tax laws. He writes “while we may be able to do only a little to change the direction of market forces, we can circumscribe rent seeking. Or at least we could, if we managed to get our politics right.” Much of the book consists of suggestions to this end. These include curbing the financial sector, stronger pro-competition and anti-trust laws, limiting the power of CEOs, eliminate “corporate welfare” in the form of subsidies to privileged sectors of the economy, improve access to education, institute comprehensive and universal health care, follow a vigorous full-employment fiscal policy, expand affirmative action for minorities, and restore the power of workers’ unions.
Perhaps Stiglitz’ most ambitious suggestion is his proposal for curbing the inegalitarian effects of globalization. He writes, “Globalization and technology both contribute to the polarization of our labor market, but they are not abstract market forces that just arrive from on high; rather, they are shaped by our policies. We have explained how globalization— especially our asymmetric globalization—is tilted toward putting labor in a disadvantageous bargaining position vis-à-vis capital. While globalization may benefit society as a whole, it has left many behind— not a surprise given that, to a large extent, globalization has been managed by corporate and other special interests for their benefit. Too often, the response to the threat of globalization is to make workers even worse off, not just by cutting their wages but also by lowering social protections. The growth of the antiglobalization movement is, under these circumstances, totally understandable. There are myriad ways in which globalization could be brought back into a better balance.”
It strikes me that Stiglitz’ analysis and his policy recommendations are closely tailored to what progressive Democrats in America are thinking, and to what seasoned politicians believe it is possible to attain politically. However, and while I fully agree with many of his policy recommendations, I disagree with some crucial recommendations, and there are important policy options that he does not discuss.
Most important, I think it is likely that the increase in before-tax inequality that we have experienced in the past few decades is in fact market-driven rather than rent-seeking-driven. This is because there are similar trends in all the advanced market economies, the increases in income accrue to members of high-skilled professions, such as law, medicine, and management, and the most income-skewed sector, finance, as grown exponentially through increased public demand for financial services. I should note that Stiglitz himself admits that his rent-seeking thesis is more or less untenable, and he accepts it for reasons of personal taste. He writes: “It is essentially impossible to single out any one factor’s relative contribution, given how intertwined the various forces shaping inequality are; there can be honest differences of opinion. But… markets don’t exist in a vacuum. They are shaped by our politics, often in ways that benefit those at the top. Moreover, while we may be able to do only a little to change the direction of market forces, we can circumscribe rent seeking. Or at least we could, if we managed to get our politics right.”
This admonition reminds me of the old saw about the economist looking for his lost keys one evening under a lamppost despite the fact that he dropped them in the bushes, explaining that there is more light under the lamppost. More to the point: if the problem isn’t rent-seeking, then you can’t reverse it by curbing rent-seeking! It would be more plausible to say that before-tax income inequality has been caused by market forces, but could be corrected by higher taxes on the rich (think of avoiding taxation as a form of rent-seeking). The problem is that the well-off already pay most of the taxes. The top 5% of the income distribution, who receive 45% of national income, pay 71% of all federal income taxes, while the bottom 50%, who receive 12% of national income, pay only 2% of all federal income taxes. There is not likely much leeway for increasing tax rates on the rich much more without generating very strong tendencies for tax avoidance and reduced economic participation of the economic elite.
Another indication of Stiglitz’ adherence to the agenda of the Democratic Party is his pandering to unions. Public sector unions are especially great contributors to the Democratic Party coffers, but it is not clear that they are in any way a force for the mitigation of inequality. Take for instance the teachers’ unions, which are inveterately hostile to competition in education, and which must be pulled kicking and dragging even to allow the firing of incompetent teachers. Stiglitz repeats several times in the book that teachers are underpaid, but never mentions the fact that incentive pay is virtually impossible without serious educational reform. He does not include charter schools or education voucher plan in his recommendation for progressive policy reform.
I have an alternative vision for progressive reform in America. It is not predicated on redistribution through tax laws, strong unions, or crippling the power of business and banking leaders. It is through what Samuel Bowles and I have called “productivity enhancing redistributions” (PEDs) These are policies that both improve the productivity of the economy and at the same time materially benefit the less-well-off. To the extent that a more competitive educational system contributes to the work skills and attitudes of poor youth, it is a productivity enhancing redistribution. The Earned Income Tax Credit (EITC) is a productivity enhancing redistribution, as are on-the-job apprenticeship programs, support for some forms of job retraining, and support for community health programs. Probably most such policy endeavors can be implemented without increasing tax rates.
Perhaps the political types are correct in believing that productivity enhancing redistribution are not politically feasible, but I cannot imagine why not.