A friend from Manhattan visited Cambridge last week. He was thrilled that President Obama won reelection, but told me that the main economic and social problem facing the U.S. currently is wealth disparity. It is not hard to see how rubbing elbows with the billionaires of Wall Street would make one envious (I remember walking down Madison Avenue a few years with with a millionaire friend; neither of us could afford anything that we saw in any of the shop windows (e.g., $20+ million apartments, $400,000+ Maybach automobiles, women’s shoes, etc.)). And indeed my visiting friend mentioned the absurd wealth accumulation on Wall Street as Prime Example #1 of our problem with wealth disparity.
On the other hand, from a functional on-the-ground point of view I can’t see how chipping away at wealth disparity would help grow the economy. Consider the most obvious way of reducing disparity: halting immigration. The U.S. has approximately 1 million legal immigrants each year. Many of these folks show up without any wealth and without the ability to speak English. Plainly they are not going to be wealthy any time soon. On the other hand, since many of these immigrants work hard, turning them away would shrink the overall GDP.
The second most obvious way of reducing disparity would be a tax on wealth. Indeed we have such a tax already: property tax. It does serve a wealth redistribution function as the owners of valuable property fund schools, police, fire departments, and government worker health care and pensions. However, the money from property taxes is kept within city or a state and not sent from a wealthy region of the U.S. to a poorer region. My friend was apparently against this idea, however, because he said that it was the federal government’s responsibility to shower New York City with tens of billions of dollars to help pay for cleaning up after Hurricane Sandy. Essentially after complaining that people in New York, New Jersey, and Connecticut (i.e., Wall Street) had misappropriated hundreds of billions if not trillions of dollars in wealth from comparatively poor residents of Arkansas, my friend was advocating that folks in Arkansas pay additional federal taxes (or that their children and grandchildren be saddled with additional federal debt) to help out the owners of $100 million beach houses in the Hamptons and $2 billion office buildings in Manhattan. So the idea of transferring wealth from property tax revenues in a rich-to-poor direction is apparently politically unpalatable, even to a person for whom wealth disparity is America’s #1 problem. In any case, it is difficult to see how such a property tax transfer would help the overall economy. California has a system in place where local taxes are sent to Sacramento and then sent back down to local schools before being used to fund classroom instruction (i.e., it is illegal for a wealthy town to tax its residents and spend the money directly on schools). Despite this pioneering effort at wealth redistribution, the state has an unemployment rate that is substantially higher than the national average. An argument could be made that taxing away Wall Street wealth to fund schools in poorer states could improve educational quality nationwide and that would benefit the economy in the long run, but at least with public schools there is no known correlation between funding levels and educational outcomes.
On a “what happens when you wake up and make a decision about what to do today” level, it is difficult to see why the presence of absence of billionaires on Wall Street affects the willingness for those who aren’t currently working to start working. The easiest way to grow the economy is to give people who don’t currently work sufficient incentive that they start or resume working. I’m writing this post in Cambridge, Massachusetts, where roughly 8 percent of the housing is city-owned and much of the rest is dedicated for occupancy by low-income families. A friend pays $3000 per month for a two-bedroom apartment in a newly constructed luxury full-service building. This is her reward from studying assiduously during roughly 20 years of schooling, culminating at an Ivy League university, and working a demanding job. One of her neighbors is a family of five. The father is observed to spend his days drinking and chatting with friends in Central Square. The mother stays home to care for the three children. The family receives a $4000 per month three-bedroom apartment at no cost. The family receives free health care via Medicaid and a City of Cambridge program that supplements Medicaid. The family receives food stamps from the USDA. They get a free cell phone with 250 minutes per month of service paid for by the U.S. government (details). Each child will receive a free K-12 education from the City of Cambridge (funded with over $26,000 of taxpayer money per student (source; the true spending is probably well over $40,000 per year because the official budget does not include the capital expenses of the buildings, the value of the land, or the likely pension and retiree health care costs)). This family’s basic needs are met, but if they want luxury items, however, one of the adults will have to earn some cash. That would result in GDP growth and the government collecting some payroll tax (if done via a W2 job) or at least some sales tax. How would their decision to participate in the labor market be affected by whether or not someone in New York City is rich? How would that decision be influenced by the degree of richness enjoyed by the New York City fatcat?
Economists have published papers showing some correlation between wealth disparity and economic growth but I haven’t seen an explanation for causation. People have been observed to work more hours when tax rates are reduced. At least in the absence of the Welfare State, people have been observed to work harder when they need to support children. People have been observed to work fewer hours when their financial needs have been met, e.g., due to a trust fund, pension, welfare checks, child support payments that exceed the cost of rearing a child, or alimony. But is there any evidence that anyone looks at East Hampton beach house values on zillow.com in the morning before deciding whether or not go out and look for a job? If not, what is it about wealth disparity that causes an economy to shrink or stagnate?
Just for fun, here are two possible directions for a correlation (low growth, inequality)
1. Nina looks at the Robb report, finds out that there are 170m-long superyachts, decides that her income as a dentist will never be enough to build a 172m yacht, drops out of the rat-race and therefore stops contributing to GDP.
2. Bob decides, for personal reasons, to live a simpler life and drop out of the rat-race; Bob’s choice leads to lower growth for sure and, if Bob’s new life is cheap enough, to more wealth disparity (Bob’s one more person in a lower income category).
Now, which story is more likely?
J
I see the wealth inequality as a symptom, not a cause. If the income tax rates were truly progressive and applied equally to all types of income we would have less money flowing to the upper class and maybe the rates could be reduced on the middle and lower classes. At least this would reduce the wealth disparity. As it is now the system has been rigged to allow the super wealthy to pay a lower percentage of their income as taxes than the average upper middle class person (doctors, lawyers, etc).
I work for a produce distributor that services restaurants in San Diego. If there was a choice before me about a change in tax policy such that either:
a) $200,000 ends up in the pocket of a single family, or
b) $1,000 ends up in the pockets of 200 families.
I think “b” leads to greater economic growth since it seems likely that 200 families with some extra cash will eat out at more often than a single family. That’s more of my produce sold and for that matter, I could go out to eat more often and the workers the restaurants hired to service more customers could eat out more often. I prosper all the more. Even if it is *my* family that is the one in choice “a”, I would be fine with that. While I would be taking home less as a percent, I’d still be making more money overall since my business is up.
[Yes, yes, government, waste, taxes, blah blah. We agree that we need *some* government and it has to be paid for *some* way. Also, please don’t take my simple thought experiment to some extreme where the 200 families pay *no* taxes…]
Redistribution has everything to do with social engineering and very little to do with overall (country) level outcomes (e.g., maximization of country wealth). Most supporting redistribution talk about “fairness” and “justice.” The redistribution goal seems to be equal outcomes while (partially) ignoring individual inputs.
I believe humans partially respond to incentives and your example can be considered exhibit A in demonstrating the problem with ignoring inputs. I am concerned that our democracy is turning into system of bribes rather than providing opportunity.
Inequality has been correlated with economic growth *and* national happiness/satisfaction.
On the happiness/satisfaction front, if one were to assume a certain disparity is “natural” (e.g,. 100/1 executive to shopworker earnings) then a state could tax/socialize that disparity away. The Scandavian nations are often cited as an example.
On the economic growth front, one might look at disparity as an indicator of market distortions (rather than a cause) and hence taxing/socializing it away would be ineffective — as you imply. That is, the fact that firm management is screwing their share-holders, quants are distorting stock markets, firms are too big to fail (i.e., privatize gain, socialize risk) might be the causes. Permitting them and then taxing/socialization disparity would be ineffective in terms of growth and only lead to a more complex tax system.
[btw: in Chrome (cookies off) when I tried to leave this I was told I’m posting comments too fast.]
Nina thinks again, figures out that if she wants that kind of luxury toy she can try to earn more. She thinks of a business idea. She tries and succeeds. She commisions and builds 173 m long yacht. GDP goes up. She pays extra taxes.
One obvious factor is spending, both in terms of quantity and quality. Extremely wealthy individuals probably only spend a small fraction of their incomes to purchase products. But the development and sale of products is probably the strongest driving force in the economy. For example a person making $1M per year doesn’t buy 10x as many smartphones as one making $100K. Therefore the more peaked the income distribution the fewer smartphones will be sold for a given global GNP.
Wealthy individuals may buy very expensive products that are out of reach of the majority of the population, such as yachts, business jets and $20M luxury apartments but I suspect the economic stimulating effect of such purchases is lower than that of consumer goods. The number of jobs that building a $20M yacht creates, directly and indirectly, is probably much less than the number created by building and selling 100000 smartphones.
An interesting look at why the wealth that is concentrated at the top is not as useful to the economy as wealth spread out at the bottom: http://www.interfluidity.com/v2/3487.html
I think the best argument that income disparity is a problem is that growing disparity is a synonym of increasing crony capitalism. I am personally not convinced there is a growing disparity and if there is it is not really a concern if everyone is still better off. I am somewhat concerned if income mobility is decreasing which is a different concern.
However, to humor the argument. I think you can make a good case that crony capitalism is an important issue and that could be leading to income disparity. The rich and power could be getting more powerful with super pacs and more complicated legislation that the public can provide real oversight on. It makes sense that this could lead to more of the tails they win and heads the taxpayer loses situations like the bailouts.
Maybe my view oversimplified but for me growth is strictly tied to demand. If more people want stuff more stuff gets created or it becomes more expensive and either way you get GDP growth. When people who can not afford things get more money they generally spend them – it might be on iTunes gift cards and Warcraft expansion packs that you don’t see but they do. That is why I generally support the democratic view. The supply side economics make zero sense to me particularly in a global investment world.
I’ll also leave you with this quote:
Arthur Laffer: And let me use an example if I may, Warren Buffett. He was sitting there asking my friends and I need to have higher tax rates, and I looked at his letter to the New York Times, and he said he paid a little less than 7 million in taxes, and he said his tax rate was 17.4 percent, which I did the math, hold back, I’m a wiz, but I divided it. He had adjusted gross income of $40 million in that year.
I then went to Forbes. His wealth increased from 40 billion to 50 billion. I went to the Bill and Melinda Gates Foundation, and what you found there is he gave 1.75 billion to the Bill and Melinda Gates Foundation, not counting his sons’ foundations or his daughter’s foundation. Now, as a definition of “income,” to me income is what you spend, what you give away, and your increase in your wealth. It’s called the Simon definition of income. If you look at Bill Gates — I mean — if you look at Warren Buffett, his income that year was $12 billion, and he paid 7 million in taxes. That is a tax rate of six 1/100th of 1 percent on his true income. That is obnoxious.
You’ve missed an important point.
Why are rich countries richer than poor countries?
Because of the human capital investments rich countries make – free education, transport networks, and the like – aka wealth redistribution. Would going in that direction further help? The people of Denmark (happiest country on earth) are happy having gone in direction, so maybe yes.
If you tax the wealthy in and put more in the hands of low income people, they spend it all immediately.
Total money is a cake, unlike the republican talking points. The slice you get is a claim on the resources of the world. If you get a bigger slice, you might just end up gambling it on speculative investments built on thin air, which when they implode, you force the rest of the economy to compensate you for (because you bribed it’s leaders).
Phil, Anthony and others – I have gotten a lot out of reading Jared Bernstein’s blog. He does a nice job explaining and is very good about linking to source materials, which is important to me.
He has talked a lot about this very subject. A particularly relevant post about inequality and growth, titled “Inequality and Growth”(!), can be found at
http://jaredbernsteinblog.com/inequality-and-growth/
“Inequality” is a category tag unto itself on his blog…
Phil, you’re puzzled over this because you’re trying to understand it from a rational point of view. Take a look at what Obama said a few years ago about raising the tax on capital gains:
“GIBSON: And in each instance, when the [capital gains tax] rate dropped, revenues from the tax increased; the government took in more money. And in the 1980s, when the tax was increased to 28 percent, the revenues went down.
So why raise it at all, especially given the fact that 100 million people in this country own stock and would be affected?
OBAMA: Well, Charlie, what I’ve said is that I would look at raising the capital gains tax for purposes of fairness.”
I find it useless to try to argue with anybody who thinks the same way. A rational discussion is simply impossible.
Chris: Thanks for the link. I looked at the Boushey and Hersh link briefly. I’m not convinced of the argument about inequality leading to underinvestment in human capital or infrastructure. The U.S. has been spending like crazy on public schools for the past 30 years and we have plenty of infrastructure (recently topped up with $1 trillion in “stimulus” spending plus our usual $1-1.5 trillion annual budget deficits). I look more to the fact that we can’t implement congestion pricing on the roads that we have, thus making the infrastructure mostly useless for commerce during large portions of every day.
dude: The Scandinavian countries have been discussed here before. It turned out that Scandinavians in the U.S. are much more successful than the average American. So the secret of the 5.5 million Danes may be that they are Danes and not that they have a secret that can be applied by non-Danes. (Separately, a friend of mine who is recent emigre from Denmark (he is a young university professor here) says that the happiness survey from Denmark should be disregarded. “The last thing that a Dane would ever admit to you is that he is unhappy.”)
I’m also not sure that the rich/poor country distinction is so simple. There are some countries that are rich almost solely due to natural resources. There are plenty of countries with free universal education that are nonetheless poor. The U.S. was well on its way to becoming the world’s richest country at a time before the advent of free government-run schools.
http://lmgtfy.com/?q=science+of+income+inequality+economic+growth#seen
IMF Report quoted by the Washington Post:
– “a 10 percentile decrease in inequality… increases the expected length of a growth spell by 50 percent.”
– “…inequality tends to be associated with financial crises. When inequality runs rampant, people on the lower end tend to borrow more to keep up, which increases the risk of a major crisis. (Earlier IMF research suggested that this may have contributed to the 1929 and 2008 financial crashes in the United States.)”
Avoiding deep financial crises seems to be a good way to get better growth.
Wikipedia:
– Better health
– Better social cohesion and trust
– Less crime
“… it is evident that any transference of income from a relatively rich man to a relatively poor man of similar temperament, since it enables more intense wants, to be satisfied at the expense of less intense wants, must increase the aggregate sum of satisfaction. The old “law of diminishing utility” thus leads securely to the proposition: Any cause which increases the absolute share of real income in the hands of the poor, provided that it does not lead to a contraction in the size of the national dividend from any point of view, will, in general, increase economic welfare”
“The view that income inequality harms growth—or that improved equality can help sustain growth—has become more widely held in recent years. … The main reason for this shift is the increasing importance of human capital in development. When physical capital mattered most, savings and investments were key. Then it was important to have a large contingent of rich people who could save a greater proportion of their income than the poor and invest it in physical capital. But now that human capital is scarcer than machines, widespread education has become the secret to growth.”[68]
“Our empirical study concludes that income inequality has significant negative effect on the rate of GDP growth. Among the channels suggested by recent literature, we find that the most important one is the transfer channel while the least important one is the human capital channel. However, the direct impact of income inequality on the rate of productivity growth accounts for more than 55 percent of its overall total effect. This indicates that the effects of income inequality on economic growth are much more complicated than what we have perceived or modeled.”
etc.
Slightly better link: http://lmgtfy.com/?q=science+of+income+inequality+economic+growth
Grmph.
Marcel: Thanks for the link/quote. I’m not convinced, though, by the “better health” and “less crime” arguments. I grew up in the 1960s and 1970s when the U.S. was a comparative paradise of income/wealth equality. Yet the crime rate was much higher then than now.
As for health, at least if we measure by spending we are spending far more than we did in the 1960s and 1970s. This is in absolute terms as well as in percentage of GDP. And much of that is spent on people regardless of income, e.g., by Medicare (for all Americans 65 and over) and Medicaid (for poor Americans).
So while we may have become more unequal in terms of ability to buy a beach house in the Hamptons (mere millionaires will never be able to afford one!), it seems as though we’ve become more equal, as a society, in terms of freedom from crime and access to fancy health care.
The FIRE (finance, real estate, insurance) sector of the economy is outpacing and outsizing the real productive sector that it is obstensibly exists to support. This is only made possible by printing more money to fuel non-productive speculation. If history is to be believed, eventually the ponzi economy will collapse, followed by social unrest and then a slow rebuild. Meanwhile, here is a video show how remarkably similar our economic situtation is to that of 18th century France: http://www.youtube.com/watch?v=U4aRuiO1OuQ#t=45s
Extremely wealthy individuals probably only spend a small fraction of their incomes to purchase products.
Macroeconomists call this “consumption.” It’s useful. But even better is “investment.”
The US economy is probably too over-balanced towards consumption. It is very easy for push it up in the short-term, though. Successful stimulus plans will try to get consumption up as big as possible as fast as possible (this tends to be even more important than spending it on something “useful”) but this does not mean it is a good long-term plan.
Really, what do you think rich people who aren’t spending their money are doing with it? Hiding it in their mattresses? No, it ends up invested somewhere, reducing capital costs for people who want investment dollars.
You want to encourage investment over consumption where you can.
There may be other reasons to want to reduce inequality, but “so people consume more” isn’t one of them, economically speaking.
Dan,
Please explain why would an ultra rich invest in the US compared to the gazillion backwards places that have the potential for great growth rates. How does that help anybody here.
Phil: are you questioning the effect or trying to understand the causes?
As far as I can tell, the existence of the effect is empirically quite well established: less inequality leads to more growth.
It also leads to all sorts of other beneficial effects, see http://www.equalitytrust.org.uk/why
(you can also watch Richard Wilkinson’s amazing Ted Talk: http://www.ted.com/talks/richard_wilkinson.html?awesm=on.ted.com_Wilkinson&utm_campaign&utm_medium=on.ted.com-static&utm_source=conferences.ted.com&utm_content=awesm-publisher )
In short, even the wealthiest are better off in more equal societies on just about every metric you can possibly imagine, despite being slightly less wealthy. I find this an absolutely startling effect, and I couldn’t believe it at first, but the numbers seem clear.
I don’t quite understand the objections you raised: first, these are not ‘arguments’ for the existence of an effect, they are various explanations for an effect that exists. Second, they are multi-causal, not mono-causal, meaning there are many effects that lead from less inequality to more growth (usually via some sort of more well-being). Some of the studies I listed disagree about which order these effects come in, but their causal relevance does not seem to be in question. So even if one or two might not be applicable in a particular case, that doesn’t mean that they aren’t generally applicable, and even less that there is no connection.
Third, spending on health-care is only marginally correlated with outcomes, which are what’s relevant here, and the US health-care system is well-documented as having both high spending and generally bad outcomes: #1 in spending, #37 in outcomes. I am also not sure wether you are arguing that because medicare and medicaid exist, health-care in the US is egalitarian, because that would be just ludicrous on the face of it.
Fourth, although crime has decreased in the US (and as far as I know most of the rest of the western world), it is still high relatively speaking, the murder rate for example is 4 times what it is in western europe and the crime index is way up there (higher than pakistan, russia, ukraine, the iran,…). However, inequality is not the only factor affecting crime rates, and crime rates are not the only factor affecting growth, so an observed decrease in crime rates with an observed increase in inequality in one case does not invalidate the link unless you have done the work to isolate other effects (which is what scientific studies of these effects tend to do, which is why these studies are generally more useful than anecdotal evidence)
Income inequality is lower when economic growth is high, not the other way around. One very basic cause is unemployment, which rises when economic growth stalls. Another basic cause is that the rich garner more of their income from capital gains, and these are less sensitive to the state of the economy than wages. In bad times, the supply of labor outstrips demand for labor and wages (and career mobility) tend to be soft. In good times, though a billionaire’s wealth may increase, he may not increase his consumption much, since he consumes quite a lot even in bad times.
Phil,
I believe you are asking the right question but from the wrong perspective.
Though the issue is a disparity in wealth the solution is not taxation/redistribution.
The wealth disparity has more to do with the destruction of the middle class’s ability to earn than tax/redistribution policy changes.
Just look at General Aviation. Up until 1979 the middle class was able to absorb 19,000 new light airplanes a year. The people who bought these airplanes were able to do so because of their high middle class wages. Adjusted for inflation these airplanes were not fantastically more expensive than today’s new airplanes.
We now can only sell 600 to 900 new light airplanes a year.
This is not because taxes have gone up it’s due to the balkanization of our economy.
Dan: investment is good as long as it is invested in the actual economy and connected to real output. However, as Henry Ford famously realized, you need consumers to actually buy your goods for those investments to pay off:
“Ford’s policy proved, however, that paying people more would enable Ford workers to afford the cars they were producing and be good for the economy. ” (Wikipedia)
Investment only helps growth if there is demand for the goods or services created (or if it’s for infrastructure that helps sufficiently). If there is no demand, the investment either has no return, or, if the investor is smart, is simply not made.
As income inequality rises, investing in the real economy makes less and less sense, because there are fewer consumers to actually buy products. So instead the money is “invested” in purely financial “products” with no real economic backing, which not only do not lead to economic growth (they are zero sum games), but also lead inexorably to financial crises, especially when combined with borrowing from those trying to maintain their status of living…and I think we can all agree that those don’t help economic growth.
http://lmgtfy.com/?q=income+inequality+financial+crisis
http://www.imf.org/external/pubs/ft/fandd/2010/12/pdf/kumhof.pdf
Inequality also leads to deficits and external debt:
http://www.imf.org/external/pubs/ft/wp/2012/wp1208.pdf
In the US, it seems to me you had the worst of both worlds: rising inequality, credit-based consumption by the middle class trying to maintain their standard of living, crumbling infrastructure due to lack of investment, and “investment” going into an oversize financial system that not only doesn’t add anything to the economy (when things are going well), but then goes on to tank the economy when it goes bust, as it must.
Not that we’re doing all that much better here in Europe, mind you, but the problems are slightly different (financial sector also a big problem, though)
tekumse,
easy to explain: It’s save. When investing in the US (and other western countries)
you can be relatively sure that you’ll get your money back even so the potential return is lower. And you can go to court with a somewhat predictable outcome (as long as there are no patents involved…) This is much less sure in countries like Russia or China .
The rental figure of $3k/mo. for the mother of 3 is not in compliance with the Cambridge Housing Auth. FMR (fair market rent/Payment Standards & Utility Rates 2011)
http://www.cambridge-housing.org/For-Property-Owners/Fair-Market-Rents-and-Utility-Rates
The choice in regard to the housing equation is to consider the cost of neighborhoods becoming slums. Areas where nobody would ever choose to live let alone drive to, or park a car.
Frederick Christ “Fred” Trump (October 11, 1905 – June 25, 1999)
http://en.wikipedia.org/wiki/Fred_Trump
Business career
Trump embarked on a career as an entrepreneur through real estate development, building, and operating affordable rental housing via large apartment complexes in New York City, including more than 27,000 low-income multifamily apartments and row houses in the neighborhoods of Coney Island, Bensonhurst, Sheepshead Bay, Flatbush, and Brighton Beach in Brooklyn and Flushing and Jamaica Estates in Queens.[3]
MH: I think it is actually closer to a $4000/month apartment. The link that you cite does not apply, I don’t believe, because this is a newer building and I think that a requirement to include low-income housing was imposed on the developer in exchange for permission to build. Thus the transfer of money from working Cambridge residents to non-working Cambridge residents is not done through taxes and government spending, but by an agreement with a private developer that accomplishes the same thing in a way that is not transparent.
Maine State Housing Auth. has a similar program for real estate developers as the Cambridge non-working program. The catch is working while renting a low income unit. The rental value is then pro-rated to income level(s) until the subsidy is terminated. A different incentive however, is to grant the rent subsidy to the family in the form of home ownership. For now, they’re both stuck in Cambridge, while she is raising three kids, and he likely has the capacity to work, only not the earning power to carry the load. As long as the developer is locked in as a landlord with not any intention of selling the units it essentially guarantees the low income/non-working family a place to live. In contrast, to an agreement where the developer is free to sell the units including to those whose incentive to work and live in the area is given as a social program to assist with home ownership. One of the most critical problems with the H.U.D. program is incorrectly matching tenants, or developers, with programs they should not belong. It is counter-productive when the identical problem is multiplied to become government largess.
Please explain why would an ultra rich invest in the US compared to the gazillion backwards places
Yes, people in America — “ultra rich” or just with normal amounts of money, dunno why that matters — invest both domestically and overseas. And people overseas invest in their home markets as well as in America.
But if high returns are guaranteed from (say) China, then the price has already been bid up.
However, as Henry Ford famously realized, you need consumers to actually buy your goods for those investments to pay off
The idea that Ford paid his workers so that his workers could buy his products is as silly as a self-licking ice cream cone. It’s a nice feel-good story, but you aren’t meant to actually believe it.
(Seriously, replacement costs for employees were high, and Ford wanted to push them down by keeping employees. He was still paying the normal pay rate as the Detroit market demanded. He boosted it with a bonus that was conditional on a whole bunch of things, including continued employment, speaking English, and not letting your wife work outside the home.)
If there is no demand
Yes, as I said, that’s the way any competent stimulus is set up: to boost AD as much and as fast as possible.
This is not a long-term plan. If your long-term is a liquidity trap, you should just start hoarding guns and butter now.
Closely related to the shrinking middle class is an article in today’s (11-13-12) Wall Street Journal about the latest “pilot shortage”.
Now that pilot wages have been depressed to the point where few are showing an interest in entering the profession the Regional Airline Association is now lobbying the government for help in the form of tax credits or government subsidized pilot training.
This happened to engineers over the last three decades as well. Wages go down to where no-one is interested in making the investment required to enter the bottom of the field and industry starts complaining they need government assistance, be it H1B visas, tax credits or outright subsidies.
The “invisible hand of the free market” apparently is only supposed to operate in favor of those already at the top of the financial pyramid. If you are a middle class professional and your wages have gone down to the point where you’re not interested in doing the job wages aren’t supposed to go up, the government is supposed to step in so the free market won’t apply.
Phil,
Bragging on you here: Your post on this subject was the best testimony I’ve ever read for the use of common sense over the high-brow economics that many educated, left-leaning citizens argue for.
I challenge anyone here who truly thinks wealth redistribution is a positive move for our country to get out of their comfortable existence and actually meet and converse with the average person who survives on myriad Federal and state subsidies. Hear what they have to say about their situation and listen to their ambitions!
I’d wager that after a little discourse, many of the well-meaning folks here who really want to see more wealth “redistributed” would quietly change their tune.
There is nothing more educative than putting boots in the ground and seeing the situation in reality, instead of in the clinical environs of a cushy office or board meeting room.
My relatives own quite a portfolio of investment real estate, with many apartments dedicated to the poor and the vast majority of these folks DO NOT EVER want to find a job. Ever.
A few years ago, during Daimler’s purchase of Chrysler, I was struck by the fact that the head of the German company was making 6-7 (I don’t remember exactly) times *less* than the American CEO.
My guess would be, the closer the salaries of the assembly-line worker; the engineer; and the CEO are, the better correlated their efforts would be. For example, the CEO would be less interested in outsourcing, offshore tax avoidance etc., and more concentrated on the ‘get-rich-slowly’ approach such as improving the cars.
David: Cutting top management salaries to something reasonable would not necessarily reduce wealth disparity dramatically. Most of what the CEOs are stealing is stolen from shareholders, not other employees. A company hires workers (except for the top managers who play golf with the Board) at market-clearing wages. If the CEO gets paid $3 million per year instead of $50 million, the extra $47 million would most likely be paid out as a dividend or used for stock repurchase or maybe to build a factory. It would not directly translate into another $47 million in bonuses for other employees. I guess you can argue that the average shareholder in a public company does not earn $50 million or even $3 million per year and therefore paying shareholders instead of mediocre CEOs (see http://en.wikipedia.org/wiki/Robert_Nardelli and his $500 million stolen from Home Depot shareholders).
Well if the average salary in a company is say 120K then reducing the outlier from $50m to $3m will cut the std-dev quite a bit, even if $47m simply disappeared into thin air. Although I agree it’s probably not a magic button.
I think that while innovation should have its rewards, today’s huge disparity possibly stifles innovation rather than foster it. Referring to the latest Technology Review, today’s climate is good for giving us 140 characters; whereas the high-tax years have brought the Interstate highway system, the Moon landings and Arpanet.
I think you make a strong case for why income disparity is not, per se, a bad thing and why, therefore, reducing disparity through tax should not in itself be an objective.
Many of the arguments against disparity are patently false and self-serving. However I think there is an argument that some types of super-wealth are symptoms of a bad thing. For example:
– drug barons in Columbia
– oligarchs in Russia
– kleptocrats in various African states
– party chiefs in China.
This wealth probably trickles down somewhere, for example in the purchase of yachts and cars. But it also clearly has a direct negative effect on other people’s lives and prosperity.
So the question is, to what extent the super-wealth of some people, such as hedge fund managers, is based on free markets or on flaws in the free market. Much of the super-wealth in Western economies has come about because of lax credit conditions. Knowledgeable people have legitimately exploited the conditions created by foolish politicians to accumulate super-wealth. There is a similarity (though not exact) to the way Boris Yeltsin created the oligarch class by trying to open up Russian industry to competition.
So the damage has been done. Credit conditions are now tighter, but a few people have extracted super-wealth while a majority have to pay through higher taxes, lower spending, smaller industries etc. The only way to correct this would be to tax retrospectively the profits of financial services firms. This would be legitimate if you think that credit conditions were too loose (like a windfall tax), but it is almost impossible to do. Do you tax the lawyer who profited from the hedge fund? Do you tax the pool attendant who profited from the lawyer who profited from the hedge fund? Even in Russia they have not managed to take the money back from the oligarchs. If you just tax wealth, then you punish all the people who have profited with merit, like entrepreneurs and actors.
At the moment I think there is a confusion between tax as punishment (or retribution) and tax as revenue. It would be better if people did not frame their argument as though tax were a punishment, but instead as the least damaging way of raising revenue.
Anecdotal evidence does not prove the overall case. How about the fact that the average or median income has not grown over the last 30 plus years when adjusted for inflation? How about the fact that a huge amount of light manufacturing has been sent overseas and please note it was good for us because it kept the prices down at WalMart? There are any number of economic indicators but anecdotally I will say that nobody in their right mind is going to stop from making more money because the top marginal tax rate was raised from 35% to 39.5%. If they’re damn dumb they don’t deserve to be rich…anecdotally I would say.
The trouble with inequality is that rich people don’t spend money, they invest it.
Up to a point, investment is a good thing. Once the amount of investment exceeds the ability of the economy to process it, it becomes a problem instead of a solution. Real interests rates below zero is the market’s way of saying your capital is worthless and it doesn’t want it.
Consider the housing bubble and the government debt. Large amounts of pernicious debt could not accumulate if there wasn’t somebody with capital to invest and no better place to put it. If the US quit running a deficit, capital markets would collapse… what would all the treasury bond investors do with their trillions?
Unsustainable wealth and unsustainable debt are two sides of the same coin. Our system is always inventing things like health insurance, student loans, and baloon mortgages to trick people into spending more than they would if they thought rationally.
If prosperity was pushed downwards, people would have money to spend. Investment for business expansion would become proftiable. The key is “definancialization”; people need to borrow less and save less too.
Although it makes sense for an individual to save money, saving by groups is actually harmful to society when it forces the financial system to make promises that it can’t keep.