According to Tyler Cowen (general director of the Mercatus Center at George Mason University, and coauthor of the Economics blog marginal revolution), “most of the worries about income inequality are bogus”. That is the thesis of his recent article, “The Inequality That Matters”, in which Professor Cowen argues that much of the recent fervour about the growing gap between the haves and the have-nots is much-ado-about nothing. That growing inequality is somewhere between “a mere bump in the road, a statistical blip along the path to greater wealth for virtually every American” and that it may even be “partially desirable, reflecting the greater productivity of society’s stars”. I was first taken aback by the idea that the growing gap between the wealthy and those living in poverty would in anyway be perceived as a desirable outcome. However, it seems there is a major disconnect between what those who warn of the potentially grave consequences of excessive income inequality have on their mind, and what others like Cowen are focused on when they dismiss such fears as misplaced or exaggerated. It is a misunderstanding based on conflating concerns over some of the more pernicious causes of the income gap (e.g. unequal opportunity and political influence) with aesthetic displeasure at the income gap in and of itself. This disconnect may explain why some on the left are astounded with what they perceive as conservatives’ apparent indifference to social ills, and why many on the right perceive liberals in a perpetual hurry to spending billions of dollars fending off their own private bogeymen, while razing the hard earned gains of hard working, creative Americans.
Prof. Cowen reaches his conclusions after conducting an analysis that begins with the observation that “income inequality does matter—for both politics and the economy. To see how, we must distinguish between inequality itself and what causes it.” This promising observation precedes an analysis of income trends that leads him to the view that though there is a widening spread of incomes, the primary driver of overall inequality is the explosive income growth in the very top percentiles. He quickly dismisses the apparent growth in income inequality beneath the highest earners as either a red herring, based in America’s shifting demographics, (“there is usually greater inequality of income among both older people and the more highly educated, if only because there is more time and more room for fortunes to vary. Since America is becoming both older and more highly educated, our measured income inequality will increase pretty much by demographic fiat”) or illusory, based on a consideration of differing consumption patterns between the poor and wealthy (“real incomes are measured using a common price index, yet poorer people are more likely to shop at discount outlets like Wal-Mart, which have seen big price drops over the past twenty years. Once we take this behavior into account, it is unclear whether the real income gaps between the poor and middle class have been widening much at all”). This view ignores the fact that the poor may only shop at discount outlets out of necessity, and tacitly embraces the poverty trap (which keeps sons shopping a the discount outlets their fathers shopped at before them) as evidence that the poor are no worse off now than in the past, since their real purchasing power has not changed (even if thanks only to Walmart). That said, the numbers do support the view that the greatest sphere of income divergence is between the top 1% and the bottom 99% of Americans.
Having acknowledged this state of affairs, Cowen turns his attention to the top earners responsible for the majority of the growth in income inequality. He observes that while income inequality has grown, so has the gap in terms of hours worked: “The top earners worked a lot more and most other Americans worked somewhat less“. He then observes that some Americans are content to just “‘get by’ in terms of absolute earning power in order to experience other gains in the form of leisure“. While I agree that there is indeed nothing morally wrong with income growth driven by top earners’ industry, creativity and entrepeneural efforts (indeed, such income growth is desirable), I’m not convinced by Prof. Cowen’s assumption that income stagnation at the lower end of the heap is driven by people who will respond to rising wages by seeking less work or by working less hard or less often. There may indeed be such people, but without offering any data to support that view, it seems like pie in the sky. Cowen supports his assumption that growth in single occupancy household supports the view that there are a growing number such “threshold earners” with the claim that “it seems reasonable to suppose that the more single-occupancy households there are, the more threshold earners there will be, since a major incentive for earning money is to use it to take care of other people with whom one lives“. The reasons for an increasing number of single-occupancy households are likely quite complex. Numerous reasons have been advanced for this trend, including children leaving the family nest at younger ages, more people deferring marriage to further their careers, a greater number of single people living alone following divorce or bereavement, divorces among couples that have deferred or decided against having children resulting in two single occupancy homes rather than one, and myriad potential other reasons, not least of which may be the growing independence of 21st century living. To overlook these varied factors in a rush to conclude that “threshold earners” now make up a significant enough percentage of Americans to influence measures of income inequality seems odd. I doubt there are even a significant minority of Americans who would fit this category, but the idea that unemployed figures and deflated earnings are exaggerated by those people who choose not to work because they prefer leisure to gainful employment, seems like at best a gross exaggeration, and at worst a convenient fiction to justify Cowen’s stance.
Cowen then turns his attention to the top earners, to determine what it is about these high incomes that fuels those who claim income inequality warrants political action. Professional athletes and entertainers account for some of the highest earners, and today “Tiger Woods earns much more, even adjusting for inflation, than Arnold Palmer ever did. J.K. Rowling, the first billionaire author, earns much more than did Charles Dickens“. I concur with Cowen that this is merely the result of a broader range of communication and marketing, and that few would find “these earnings so morally objectionable as to suggest that they be politically actionable“. (This view of Tyler’s, that such moral sentiments lay behind the demands to curb excessive income inequality is at the root of the disconnect between his views and those of others who see growing income inequality as a signal of greater problems requiring our attention. I will return to this later).
The majority of Prof. Cowen’s remaining analysis focuses on the role the financial sector plays in driving income concentration at the very top:
“[F]or 2004, nonfinancial executives of publicly traded companies accounted for less than 6 percent of the top 0.01 percent income bracket. In that same year, the top 25 hedge fund managers combined appear to have earned more than all of the CEOs from the entire S&P 500. The number of Wall Street investors earning more than $100 million a year was nine times higher than the public company executives earning that amount… Many of the other high earners are also connected to finance. After Wall Street, Kaplan and Rauh identify the legal sector as a contributor to the growing spread in earnings at the top. Yet many high-earning lawyers are doing financial deals, so a lot of the income generated through legal activity is rooted in finance. Other lawyers are defending corporations against lawsuits, filing lawsuits or helping corporations deal with complex regulations. The returns to these activities are an artifact of the growing complexity of the law and government growth rather than a tale of markets per se. Finance aside, there isn’t much of a story of market failure here, even if we don’t find the results aesthetically appealing…
We may or may not wish to tax the wealthy, including wealthy celebrities, at higher rates, but there is no need to “cure” the structural causes of higher celebrity incomes. If we are looking for objectionable problems in the top 1 percent of income earners, much of it boils down to finance and activities related to financial markets. And to be sure, the high incomes in finance should give us all pause“.
Again, while the story behind these high earnings is indeed as Cowen states it to be, his view that those concerned by growing income inequality are first, opposed to the high incomes in and of themselves, and second, basing that opposition on the aesthetics of these salaries completely ignores some of the issues of greater concern. He phrases their concerns, almost as a witch-hunt: “looking for objectionable problems”, rather than a concern that such great inequality may be caused by certain fundamental distortions to access to education, or political and lobbying power.
One thing I agree with Mr. Cohen on: simply railing against income inequality doesn’t get us very far. That said, focusing on inequality in and of itself merely without considering how that inequality skews opportunities and outcomes away from a significant proportion of Americans is akin to hiding one’s head in the sand. Where there are externalities that create barriers to upward mobility, stifle access to education (or create unequal educational opportunities), increase the poverty trap, and otherwise hamper the poor and lower-to-middle class americans from increasing their earning potential, there is an opportunity for policy to craft solutions to these obstacles. To the extent that such solutions will require increased sources of funding, then the question becomes one of determining the optimal level of taxation (especially for the wealthiest among us) that will increase revenue without creating a significant disinsentive towards the creation of wealth. These are serious questions that need to be addressed and Prof. Cowen’s willingness to dismiss these concerns, insisting that the growing inequality in America is merely an inevitable aspect of modern society strikes me as too much of a cop-out.
In this week’s economist, the question of the significance of inequality is again raised. Of the three reasons cited by the author as reasons for inequality being perceived as a problem, only the third seems compelling, and then, indirectly: “that inequality perverts politics, with Wall Street’s influence in Washington often cited as exhibit A of the unhealthy clout of a plutocratic elite.” I say indirectly because it is not the growing gap in incomes which is the cause of this problem, so much as the unequal political representation and domination of Washington by the haves’ interests over those of the have-nots’ that is the problem. Allowing private money to influence our political debates, through lobbies and special interest funding, such that politicians find themselves with no choice but to appease wealthy and influential donors – that is the problem. It also doesn’t help that many of the policies advanced are funded by wealthy lobbies with their own private axes grinding. Limiting the dependency of politicians on private cash, increasing the role of public funding, and putting caps on campaign spending would move some way towards addressing these shortcomings. Limiting the influence of lobbyists would also go a long way. Of course the Supreme Court’s recent Citizen’s United decision to allow corporations to spend money from their general treasuries on political lobbying didn’t help things much at all. Growing income inequality is more of a problem in an environment when wealth buys political influence and policies often reflect the interests of those who lobby and fund the politicians the greatest. If despite income inequality, political representation was actually more equal and not skewed in favour of the wealthy, income inequality would be less of an issue, all else being equal.
I’m also not convinced by the view that inequality was a root cause of the financial crisis: rather, the political response to this inequality (pushing poor people towards home ownership by creating distortions that pulled the rug out from under the credit rating system) was the a greater contributor. This created a distortion which the greed and wrecklessness of wall street quickly magnified into a bubble, and the failure of the credit rating agencies (a result of the conflict of interests with the shepherds dependent on the wolf) naturally exarcerbated the problem. The poor political response to inequality lit the spark, and the greed and failures of Wall Street poured on the gas. Inequality was then not the primary cause.
However, the argument that countries with greater inequalities fair worse on many social indicators than those that are flatter presents an interesting econometric question. The problem is there are so many variables that influence how a country rates on any one social indicator. Take health outcomes. I’m not sure how best to control for the great variability between countries’ healthcare systems and the efficiency/inefficiency and presence or absence of healthcare safety nets for the poor. Even if one limits the analysis to the developed world, health outcomes may be more strongly influenced by such variables than the levels of inequality. The U.S is currently embroiled in a great healthcare debate, and while the growing inequality may be cited by some as a factor in the U.S lagging behind other developed nations in measures of healthcare, I’d argue that the significant uninsured and underinsured population and the lack of access to preventive care (and hence dependency on emergency care for high severity health problems) is a far greater problem than income inequality in and of itself. Again, as with access to effective political representation, income inequality is only a driving factor to healthcare outcomes to the extent that ones access to basic preventive healthcare and routine medical attention is limited by poverty. Income inequality comes more into focus when such root problems are ignored.
The article accurately concludes: “the best way to fight income inequality and increase mobility is… [for] governments… to keep their focus on pushing up the bottom and middle rather than dragging down the top: investing in (and removing barriers to) education, abolishing rules that prevent the able from getting ahead and refocusing government spending on those that need it most…[such] reforms would strike at the most pernicious, unfair sorts of income disparity and allow more people to move upwards. They would also boost growth and leave the world economy more stable.”
This makes perfect sense. But a key element of this approach is the “refocusing government spending on those that need it most“. Inequality becomes the focus of people’s attention more so when in the face of growing wealth, there remain shocking outcomes for the poor – primarily in wealthy countries like the U.S. In a country with as much wealth as the U.S, it is shocking that basic access to healthcare ought to be such a divisive and contentious debate. It is disappointing that the absence of basic health services for the poor, the unequal political representation, inferior access to education and the gulf in health outcomes – all of which culminate in low mobility and a greater poverty trap, are not seen by more Americans as constituting a blight on this great nation’s record of progress and achievement.
With problems like these hampering a significant proportion of Americans, it’s surprising that Prof. Cowen concludes that income inequality is much ado about nothing. The focus on income inequality is in reality a proxy for these greater social ills that are presently tethered to ones ability to buy solutions. Reforms that boost growth and development while focusing government spending on such areas of great need are what is really called for, rather than a direct focus on minizing income inequality for the sake of it.
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