Monday, December 22, 2014

Inequality at WSJ -- the oped

This is a Wall Street Journal oped on inequality. With 30 days passed, I can post it here. It's a much edited version of my evolving "Why and How we Care About Inequality" essay.

What the ‘Inequality’ Warriors Really Want

Progressives decry inequality as the world’s most pressing economic problem. In its name, they urge much greater income and wealth taxation, especially of the reviled top 1% of earners, along with more government spending and controls—higher minimum wages, “living” wages, comparable worth directives, CEO pay caps, etc.

Inequality may be a symptom of economic problems. But why is inequality itself an economic problem? If some get rich and others get richer, who cares? If we all become poor equally, is that not a problem? Why not fix policies and problems that make it harder to earn more?

Yes, the reported taxable income and wealth earned by the top 1% may have grown faster than for the rest. This could be good inequality—entrepreneurs start companies, develop new products and services, and get rich from a tiny fraction of the social benefit. Or it could be bad inequality—crony capitalists who get rich by exploiting favors from government. Most U.S. billionaires are entrepreneurs from modest backgrounds, operating in competitive new industries, suggesting the former.

But there are many other kinds and sources of inequality. The returns to skill have increased. People who can use or program computers, do math or run organizations have enjoyed relative wage increases. But why don’t others observe these returns, get skills and compete away the skill premium? A big reason: awful public schools dominated by teachers unions, which leave kids unprepared even to enter college. Limits on high-skill immigration also raise the skill premium.

Americans stuck in a cycle of terrible early-child experiences, substance abuse, broken families, unemployment and criminality represent a different source of inequality. Their problems have proven immune to floods of government money. And government programs and drug laws are arguably part of the problem.

These problems, and many like them, have nothing to do with a rise in top 1% incomes and wealth.

Recognizing, I think, this logic, inequality warriors go on to argue that inequality is a problem because it causes other social or economic ills. A recent Standard & Poor’s report sums up some of these assertions: “As income inequality increased before the [2008 financial] crisis, less affluent households took on more and more debt to keep up—or, in this case, catch up—with the Joneses. ” In a 2011 Vanity Fair article, Columbia University economist Joe Stiglitz wrote that inequality causes a “lifestyle effect . . . people outside the top 1 percent increasingly live beyond their means.’’ He called it “trickle-down behaviorism.”

I see. A fry cook in Fresno hears that more hedge-fund managers are flying in private jets. So he buys a pickup he can’t afford. They are saying that we must tax away wealth to encourage thrift in the lower classes.

Here’s another claim: Inequality is a problem because rich people save too much. So, by transferring money from rich to poor, we can increase overall consumption and escape “secular stagnation.”

I see. Now we need to forcibly transfer wealth to solve our deep problem of national thriftiness.

You can see in these examples that the arguments are made up to justify a pre-existing answer. If these were really the problems to be solved, each has much more natural solutions.

Is eliminating the rich, to eliminate envy of their lifestyle, really the best way to stimulate savings? Might not, say, fixing the large taxation of savings in means-tested social programs make some sense? If lifestyle envy really is the mechanism, would it not be more effective to ban “Keeping Up With the Kardashians”?

If we redistribute because lack of Keynesian “spending” causes “secular stagnation”—a big if—then we should transfer money from all the thrifty, even poor, to all the big spenders, especially the McMansion owners with new Teslas and maxed-out credit cards. Is that an offensive policy? Yes. Well, maybe this wasn’t about “spending” after all.

There is a lot of fashionable talk about “redistribution” that’s not really the agenda. Even sky-high income and wealth taxes would not raise much revenue for very long, and any revenue is likely to fund government programs, not checks to the needy. Most inequality warriors, including President Obama, forthrightly advocate taxation to level incomes in the name of “fairness,” even if those taxes raise little or no revenue.

When you get past this kind of balderdash, most inequality warriors get down to the real problem they see: money and politics. They think money is corrupting politics, and they want to take away the money to purify the politics. As Berkeley economist Emmanuel Saez wrote for his 2013 Arrow lecture at Stanford University: “top income shares matter” because the “surge in top incomes gives top earners more ability to influence [the] political process.”

A critique of rent-seeking and political cronyism is well taken, and echoes from the left to libertarians. But if abuse of government power is the problem, increasing government power is a most unlikely solution.

If we increase the top federal income-tax rate to 90%, will that not just dramatically increase the demand for lawyers, lobbyists, loopholes, connections, favors and special deals? Inequality warriors think not. Mr. Stiglitz, for example, writes that “wealth is a main determinant of power.” If the state grabs the wealth, even if fairly earned, then the state can benevolently exercise its power on behalf of the common person.

No. Cronyism results when power determines wealth. Government power inevitably invites the trade of regulatory favors for political support. We limit rent-seeking by limiting the government’s ability to hand out goodies.

So when all is said and done, the inequality warriors want the government to confiscate wealth and control incomes so that wealthy individuals cannot influence politics in directions they don’t like. Koch brothers, no. Public-employee unions, yes. This goal, at least, makes perfect logical sense. And it is truly scary.

Prosperity should be our goal. And the secrets of prosperity are simple and old-fashioned: property rights, rule of law, economic and political freedom. A limited government providing competent institutions. Confiscatory taxation and extensive government control of incomes are not on the list.

Mr. Cochrane is a professor of finance at the University of Chicago Booth School of Business, a senior fellow at the Hoover Institution, and an adjunct scholar at the Cato Institute.


  1. Here the socialists have a feeling something is wrong, but they can't pin down the cause of that feeling. But, I think they have a point, as masses often do when describing the problem.
    Variance in wealth is a sub-optimal outcome. Markets are supposed to distribute utility optimally, and motivate people to perform. Variance in wealth, given Jensen's inequality and declining marginal utility of wealth, is a sub-optimal distribution of wealth.

    Libertarians will retort that this inequality is necessary to motivate people. Yes, the more inequality there is, the more motivated people will be, and the system should balance itself.

    But it is worth: 1) admitting that inequality of wealth does not maximize utility 2) Economists haven't determined an optimal variance of wealth that would balance state-utility-maximization with motivational-inequality. So, there might be an imbalance here.

    1. Be careful with the world "optimal." In economics forums, optimal has a precise definition. An optimal allocation of resources is one where no one can better their situation by trade.

      By this definition, if I had all of the money, that would be an optimal allocation.

      I am not sure I buy into "declining marginal utility of wealth." I know it is standard doctrine. I think it people gain satisfaction when they see there ecnomomic circumstances improve (or dissatisfaction when they see it crater). It is changes in income that creates utility.
      Income is the first derivative of wealth
      Change in income is a second derivative of wealth.

      more on the utility of wealth... savers must have higher utility from wealth. That is why they save rather than spend. So, by utilitarian logic, we should give more money to natural savers.

    2. Douglas...

      Optimal does not necessarily mean Pareto efficient. Optimal can also mean the best allocation using some social utility function. I believe that is how Fish is using the word.

      Also, if you don't buy into declining marginal utility of wealth, then you don't buy into nearly every modern economic model.

      Finally, savers are usually modeled as agents with more patience. This does not imply they have a higher marginal utility from wealth, but only that, if they are consuming a given fraction of wealth, the ratio of marginal utility from wealth and marginal utility from consumption will be relatively high.

    3. Jose Romeu RobazziJanuary 1, 2015 at 12:29 PM

      Some defend that utility is ordinal and subjective, so, how to define a utility function that is not "optimal" because of inequality ?

  2. Cochrane: "If we increase the top federal income-tax rate to 90%, will that not just dramatically increase the demand for lawyers, lobbyists, loopholes, connections, favors and special deals?"

    Cochrane seems to be inviting us to make tax policy judgments informed primarily by thought experiment: "let's imagine what things will be like if income-tax rate were raised thus ...".

    But there is another way to inform our judgments: empirically, by examining history. We know that in the 1950's the top U.S. income-tax bracket was 91%. In the 1960's it was 70%. Were the economic conditions of the 1950's and 1960's not to your liking?

    1. Comparing nominal tax rates before and after the Tax Reform Act of 1986 is apples and oranges. Rates are lower today, but the tax code itself is much different. Look at total taxes paid (federal, state, and local) as a percentage of gdp- It wasn't any higher in the 50's and 60's than in recent years. I can't speak for Dr. Cochrane but this sounds like exactly the type of thing he's referring to. Also, keep in mind that government spending was consistently lower in those years.

  3. The data from the Hoover conference show that upward mobility of the lowest quintile is very low in the US compared to other countries. Why? One reason is that we keep subsidizing dysfunctional behavior -- the disincentives to family formation induced by the welfare programs are well known. Poor women are "trapped" in intergenerational welfare dependency, they have high birth rates and keep producing more dysfunctional offspring, and there are no incentives to form intact families. Another reason is the low HS graduation rates in the lowest quintile, and the low labor force participation rates of poor males. That is related to poor educational choices -- we need more early occupational training, see Germany for example -- as well as too high minimum wages. As long as we trap people by giving them poor incentives and bad labor market tools to ascend, income inequality will persist. As an old Chicago hand might say, if you subsidize poverty, you will see more of it. We are doing that, and then use the results to argue for more of the same. How long can a society keep doing what is not working and refuse to acknowledge the implications of that political behavior? We have the poverty rates the political system approves of. The problem is not the top 1%, it's the 100% in the political class that seems totally dysfunctional.

    1. Well put. Can we call it "social moral hazard"?

  4. Having come to this after reading the Krugtron parts 2 and 3 post from last October, where Cochrane states the academic world should "try to understand the other side's view", this post kind of falls flat. It smacks more of a straw man factory than a careful commentary of opposing ideas.

    I'd like to share a comment posted elsewhere which I found thought provoking that people more intelligent than I might pick it apart.

    "Redistributive taxation is a good idea if your concern is the efficient operation of markets. Free markets are most efficient when there is an even distribution of wealth, and they become less efficient as wealth is concentrated. Unfortunately, markets also tend to concentrate wealth. Redistributive taxation counteracts that tendency and helps keep markets efficient, but it must [be] somewhat limited so there is still incentive to compete. All this is trivial to prove mathematically with market models."

    Someone posted this years ago before inequality was en vogue, but it always stuck with me. That last part I know is a bugger; nothing is "trivial to prove" in economics (or about anything). I'm sure using redistributive and good idea in the same sentence makes Cato advocates cringe & in my view such policies do have a real moral/ethical problem in using brute force transfers. Still, the idea that those with more money have greater ability to stifle competition seems to track with history. Markets certainly seem to concentrate wealth and while I sympathize with the idea that government cronyism can facilitate the process it seems to work fine without them as well. Overall I feel there must be some inequality reflecting the difference in value and availablity of skills among people, but there's also room for public works and regulation to promote market efficiency. How to do it "right" is a far longer discussion.

    That said, I have a few questions for those so inclined:

    Do markets in fact tend to concentrate wealth? It seems like they do & that it may even be desirable in that it (theoretically) puts wealth in the hands of those who will use it best.

    If capital is concentrated in a minority of market participants, does this tend to make the market less efficient? Asking at the risk of repeating myself because, like markets concentrating wealth, I don't want to assume my way to certainty & it feels like a point Cochrane didn't address (at least in this post).

    Is an "efficient" market synonymous with a "competitive" market? Maybe this is obvious, but in speaking of free markets it seems the goal is actually competitive markets. If so how the rule of law should be structured to facilitate this end is the real battle ground between these economic personalities.

    Sorry for the length & thanks for making it this far. At this point I'll just shut up and wish you a Merry Christmas! :)

    1. An efficient market is one that quickly incorporates new information.

    2. Efficiency in economics means marginal cost equals marginal benefit. An efficient market is one where the marginal benefit to new information is equal to its marginal cost. When information is costlessly available, it has no value.

    3. I'm not aware of any reasonable models or theories that conclude that "free markets are most efficient when there is an even distribution of wealth." It is also well understood that a broad range of markets function less and less efficiently in response to policies that try to assure that.

      With regard to using wealth to try to stifle competition, it is notoriously difficult to accomplish absent an assist from government -- which often can be purchased much more cheaply than trying to corner some market, erect meaningful entry barriers or the like.

  5. "Why? One reason is that we keep subsidizing dysfunctional behavior -- the disincentives to family formation induced by the welfare programs are well known."

    Nope. Income mobility is low because education is not publically funded. Scandinavian countries who exceed the US by far in terms of any welfare measure (basically GDP plus health, crime and pollution indicators) as well as income and wealth equality feature public tertiary education. YOur blaming of the victim plus your welfare queen nonsense is just Reaganite racist propaganda.

    1. Throwing around unwarranted accusation of racism is the mark of a scoundrel, and should properly be ignored. But I'll make three points. One, there was nothing about race in my original post, and the remarks hold for all races, all times. Second, the central point was that all poverty programs have behavioral implications, and that has been stated by a number of social scientists repeatedly. The implication is that poor people are just as rational as everyone else, i.e., they respond to incentives and behave predictably. Third, my original post was really just a restatement of something that the Democratic Senator from New York, Daniel Patrick Moyniahan, said about 40 years ago. So there.

    2. I've been letting all comments through for the past few days -- why not share the lunacy of my inbox with the rest of the world? But I cut off this racism thread and did not allow Anonymous I a snarky reply. We're just not going there.

    3. Understanding the difference between symptoms and underlying causes is pretty sophisticated stuff. So let's forget the symptoms argument and concentrate on causes. I see 2 biggies: 1. China and others have engineered the largest labor migration in world history - low skill people from subsistence farming into the cities and manufacturing - hence a big wage disturbance 2. Robots. It looks to me like the 'K' in production is now both complimenting and displacing the 'L." These two factors, i think, have a lot to do with local inequality coupled with world-wide equalization. Point 1 will go away. Point 2 will not. The models I use have trouble with point 2.

    4. Great post. In the last 20 years 300 million Chinese peasants moved from the farm to the factory. That is larger than the entire U.S. labor force. Should we be surprised then that low-skilled wages in the U.S. have stagnated or fallen? One could argue, I suppose, that taxing away some of the gains from trade to high-skill U.S. labor and transferring to low-skilled labor is exactly the kind of policy economists have been advocating as superior to restrictions on trade itself.

      It is true that this China effect is transitory, but I suspect that means at least 50 more years of direct U.S. labor market impacts and many decades of indirect or second order effects on U.S. labor.

  6. "We limit rent-seeking by limiting the government’s ability to hand out goodies." - JHC

    This is the fundamental idea that really needs to be incorporated into macro models, i.e. that government spending (or transferring for that matter) comes with a big negative for the economy. I suspect that there is a government spending Laffer-style curve where the Keynesian multiplier effects compete with the rent-seeking and cronyism effects such that at low levels of total spending the Keynesian effects dominate. But as G gets bigger and the crapitalist policies start to multiply... it's all bad.


Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.