Sunday, August 10, 2014

What's wrong with inequality?

Um, it's not fair?
Fafner the dragon and his hoard: Excessive savings stopping a jump start in the economy. Image by Arthur Rackham, 1911.
James Pethokoukis of the American Enterprise Institute (an institute of great pith and moment) boldly takes on the "center-left" in the form of Standard & Poor's intelligence agency, who if you didn't know about how leftist they are well, poor you. Or standard you, perhaps. They were showing their leftist cred, anyway, in a report by their economist Beth Ann Bovino on
How Increasing Income Inequality Is Dampening U.S. Economic Growth, And Possible Ways To Change The Tide
Pethokoukis thinks that income inequality is not dampening growth, and not for the reasons I would have thought of first. That would be the famous Piketty and Saez results, according to which the causality works the other way around: it's slow growth that causes inequality: where the rate of return on capital r is greater than the rate of growth g over the long term, r > g, there is concentration of wealth. But couldn't inequality affect growth in the short run, after all, in a kind of feedback effect, through the so-called paradox of thrift? Where all that money in the hoards of the one percent isn't doing anything and the economy stagnates as a result?

Pethokoukis, on the other hand, does not wish to bring Piketty and Saez into the discussion, but to think resolutely in the terms of when he was in grad school, along the following lines:
(1) if rising inequality were actually holding back the economy, you would expect to see the household savings rate rising over the past few decades and consumption accounting for a smaller share of overall GDP. 
Well, for starters, why would you expect to see the household savings rate rise? Rising inequality as we are experiencing it means an increase in the range of people living paycheck to paycheck, from the traditional poor to include the stalwarts at $200 or $300K who have trouble making their payments on the mortgage and the private school tuition, more and more who can't save a dime. Pethokoukis seems to think that since the very rich, who are appropriating all the money, definitely can afford to save, and do, they should by themselves be raising the mean per capita savings rate—the more money he has, the more goes into the CDs and municipal bonds, and that should even things out.

Only in the first place this is thinking like Mitt Romney, that the very wealthy must be about 53% of the population instead of 1% or 0.1% or however you want to define it, because to Romney or Pethokoukis those are normal people, like all their friends, but in fact they are extremely unusual. There are hardly any of them at all. The amount of money they are enabled to save, huge as it is in absolute terms, just isn't enough to move the averages. As the raw number of people who are unable to save increases, the savings rate is bound to go down, and that's certainly what I personally would expect, but then I'm not a famous economist.

Pethokoukis suggests the savings rate is going down because rich people are spending all their money too:
Luxury markets are booming: and it may not be to a good liberal’s taste, but demand for chauffeurs and butlers creates employment just like that for apparel and electronics. Indeed, to the extent richer people consume at the margin on non-tradable services, the leakage is also lower.
That is really the argumentum ad Fairylandium. An increasing demand for butlers does not lift all boats because it is just not large enough. In May 2013, when 170,030 people were employed in the taxi and limousine trade in the United States, 8,350 or 0.6% of them were personal or family drivers, i.e. chauffeurs (BLS). And they didn't make all that much money either (mean annual wage of $22,650, quite a bit less than a taxi driver; and compare the 157,830 transit or intercity bus drivers with a mean annual wage of $38,750).
(2) S&P suggests rising inequality and the “imbalances” it creates can lead to “a boom/bust cycle such as the one that culminated in the Great Recession.” This comes very close to blaming inequality for downturn.
So now we're in danger of hurting inequality's feelings? Not exactly. Pethokoukis explains that there is research showing
“strong evidence linking credit booms to banking crises, but no evidence that rising income concentration was a significant determinant of credit booms.”
Piketty and Saez would not contest those findings (by Bordo and Meisner, 2012). Indeed, they argue that the huge correlation between rising inequality and rising household debt in 1928 and 2007
is partly a coincidence - a correlation rather than a causal impact. That is, a booming stock market contributes both to the rise of top incomes (in particular via capital gains, which were very large both in the 1920s and in the 2000s) and to the rise of financial fragility - but this does not imply that there is causal relationship between rising inequality and financial fragility. Modern financial systems are very fragile and can probably crash by themselves - even without rising inequality.
This does not imply that rising inequality played no role at all. In our view it is highly plausible that rising top incomes did contribute to exacerbate financial fragility. The fact that household debt rose so much and so fast in the US during the 1990s-2000s (especially in the 2000s) and that the crash eventually occurred in the US rather than in Europe is probably not a coincidence. Again the key point that needs to be stressed from our viewpoint is the magnitude of the aggregate income shift that has occurred in the US since the early 1980s.
So that when the levels of income concentration among the wealthiest are as high as they are in the US today, they do contribute to instability.
David Moss, 2010.
(3) S&P blames rising income inequality for reducing social mobility.
The source to which the Bovino paper refers on this, a Brookings report of June 2013 on "Thirteen Economic Facts about Social Mobility and the Role of Education", seems to have vanished from the Web. Its findings were that
investments in education and skills, traits that increasingly decide job market success, are becoming more stratified by family income, threatening the earning potential of the youngest Americans
and this development might cause a decrease in social mobility in the future. It's not a very important part of the argument, anyway. One reason social mobility hasn't gotten any worse over the past several decades, according to the work Pethokoukis cites by Raj Chetty, Nathaniel Hendren, Patrick Kline, Emmanuel Saez, and Nicholas Turner, is that it was pretty low to start with; the American dream hasn't been functioning all that well for those born beween 1950 and 1982 (for kids born later, it's really too early to judge) in the gradual build-down of the Great Society beginning a few years after the Boomers started graduating from college. Also that burgeoning inequality has been so focused on the gains of the top one percent, and therefore has as little an effect on general mobility as it does on the savings rate.

Incidentally, Pethokoukis is being worse than disingenuous in suggesting the study by Chetty et al. means general social mobility is OK in the US:
Raj Chetty, a professor of economics at Harvard and one of the authors, said in an interview that he and his colleagues still believed that a lack of mobility was a significant problem in the United States. Despite less discrimination of various kinds and a larger safety net than in previous decades, the odds of escaping the station of one’s birth are no higher today than they were decades ago. (David Leonhardt, New York Times)
(4) There is plenty of research showing no correlation between rising inequality and slower economic growth in advanced economies.
I actually wrote about his evidence for that one (collected by a Manhattan Institute hack called Scott Winship) back in April. I don't have anything to add.
(5) S&P’s discussion of potential solutions to the inequality “problem” almost entirely concern those pushed by the left: higher minimum wage, raising taxes on capital income such as through the Buffett rule, limiting executive pay, more public investment. 
As an alternative I would suggest wage subsidies to boost low-end incomes and reward work, helping startups by reducing crony capitalist regulation, lower or ending corporate taxation to boost take-home pay for middle-class America.
An alternative? For what? I thought you said there wasn't a problem!


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