Mankiw on the 1%

Greg Mankiw has an intereting new article draft, titled "Defending the 1%"  It's mistitled really, as the main point I got out of it is the more interesting question, "Can transfers really help the bottom 50%?"

It's a very well written (as one would expect) and survey of economic issues surrounding the idea of greatly expanded taxation of upper income people to fund transfers. Go read it, I won't do it justice in a summary.

As Greg notes, much of the success of the 1% is not rent-seeking, nor inherited wealth, but entrepreneurs who innovated and got spectacularly wealthy in the process.

It's not clear how Steve Jobs getting hugely rich hurts the rest of us. (Greg makes a few jabs at financial profits, but readers of this blog know that's a more nuanced issue.) It's not clear how any of us even know if Jobs had $100 million, $1 billion, or $1 Gazillion when he died, though it makes a huge difference to measured inequality.  And I like Greg's emphasis that it doesn't make much philosophical or moral sense to draw national borders around income-transfer moral philosophy.  Look for the kidney story too.

Greg chose not to argue with the very tricky measurement issues, instead just quoting Pikkety and Saez' numbers.  That's a good issue for another day -- other measures give very different results.

One of Greg's main points is that our inequality is the result of an interplay between supply and demand for talented skilled people.

I am more persuaded [than by Stiglitz] by the thesis advanced by Claudia Goldin and Lawrence Katz (2008) in their book The Race between Education and Technology. Goldin and Katz argue that skill biased technological change continually increases the demand for skilled labor. By itself, this force tends to increase the earnings gap between skilled and unskilled workers, thereby increasing inequality. Society can offset the effect of this demand shift by increasing the supply of skilled labor at an even faster pace, as it did in the 1950s and 1960s. In this case, the earnings gap need not rise and, indeed, can even decline, as in fact occurred. But when the pace of educational advance slows down, as it did in the 1970s, the increasing demand for skilled labor will naturally cause inequality to rise. The story of rising inequality, therefore, is not primarily about politics and rent-seeking but rather about supply and demand.

Having stated it this way, I'm disappointed Greg didn't explore supply more. Why is it that America has not responded this time by increasing the supply of skilled workers? The obvious suspects are easy to name, and do not bode well for the left's suggestion that permaent confiscatory taxation plus transfers are the answer to the "problem."

Greg does a good job of painting the standard incentive problem with tax and transfer redistribution. However, he states it in its classic, static form. More transfers means less work effort. In reality, hours of work don't really respond that much, as there are only so many hours in a day and income and substitution effects offset. To make this come alive, we need to think harder about the margin of working vs. not working.

And investing. Here the two points come together, and I don't think Greg's article nor the literature put the pieces in one place. We need a dynamic perspective. If inequality comes from a mismatch between supply and demand for skill, then keeping the incentives in place to acquire skill is vital. If there is a strong income-based transfer scheme in place, yes, there  is less incentive to work overtime. And yes, there is less incentive to work at all at least legally. But most of all, there is less incentive to go to school, to pick hard courses (face it, art history is a lot more fun than python and Java 101), pursue expensive advanced graduate education or innovate. One can imagine a spiral, or inequality laffer curve: Demand for skill outpaces supply, inequality rises, we put in place an income based transfer scheme, less people acquire skils, inequality rises...

Greg has a great section, "listening to the left" which I will now invite as well. Forget about the 1%. Pretend wealth grows on trees. Let's just think of the fortunes of the bottom 50%. Can we actually help them? Is there any historical precednent of a successful society that pays large means-tested amounts to young and working-age men and women, without destroying their incentives to gain skills and become middle class, to say nothing of the next Steve Jobs?

Social security doesn't count; the question is sending checks to young, healthy, but low-skilled working age people.  Short-term doesn't count. I want to know of an instance in which, maintained over a generation or two, such a system did anything more than perpetuate an unskilled largely dysfuncitonal underclass, which achieved much more than reliably voting for politicians who endorse its transfers. (The model "send money to Democratic voters" does explain the proposed policies pretty well!) The reputed wonders of living in Sweden or other welfare states don't count: their benefits are in kind, and not means tested.

It's easy to come up with incentive-destruction horror stories, American welfare, European dole, and so on.  Small cash transfers coupled with restricted educational opportunities and large labor market wedges, as faced by refugees and many European immigrants, seem particularly destructive. Tom Sowell writes whole books of examples.  But it's too easy to listen to the choir. To those of you advocating large cash transfers, when has this ever worked?   I'm curious to hear a clear historical precedent for the policies you advocate for the US.