Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 18 April 2017

Inequality or poverty

Tony Blair famously said:
“[It’s] not that I don’t care about the gap [between high and low incomes], so much as I don’t care if there are people who earn a lot of money. They’re not my concern. I do care about people who are without opportunity, disadvantaged and poor.”

Most people, including the Labour government, interpreted that as focusing on poverty rather than inequality. For an excelllent discussion of historic trends in inequality and how they were influenced, among other things, by poverty reduction programmes pushed by Labour (as well as how that may unwind in the near future) see this excellent discussion by Rick. 

I recently saw a very clear defence of the position that poverty mattered more than inequality from Miles Kimball. His argument comes from surveys that quantify a basic principle of economics, which is diminishing marginal utility. He quotes results which suggest that a dollar of income means an awful lot more to someone earning half the average wage than someone who earns double the average wage. He suggests the results come close to validating the second principle of justice suggested by John Rawls. To put the idea at its most simple, we should not worry about the rich too much because their extra money buys them very little extra happiness, but instead focus on reducing poverty.

Now of course this point is irrelevant if we are talking about reducing poverty by taxing the rich. The rich are a very good source of money, because they will not miss it very much. The importance comes if we compare two societies. One has no poverty, but a significant number of very rich people. The other has no rich people, but still has poverty. Miles’s argument is that we should prefer the society with no poverty to the one with no super-rich. In a static sense I think that is right, but I have dynamic concerns that I will now come to.

Right at the start of Miles’s discussion is an interesting paragraph:
“Before going on, let me concede first of all that the amount of wealth held by the ultra-rich is truly astonishing, and that making sure that the ultra-rich do not convert their wealth into total control of our political system is important. Documenting and studying in detail all of the ways in which the ultra-rich influence politics is crucial. But short of the ultra-rich subverting our political system, the focus of our concern about inequality should be how well we take care of the poor; whether money needed to help the poor comes from middle-income families or the rich is an important issue, but still of secondary importance to how well we take care of the poor.”

I want to explore a point that Miles does not pursue. If money matters so little to the very rich, why would they want to become ultra-rich to an astonishing degree, and go on to try and control the political system to ensure they get even more? The answer comes from exactly the same logic as Miles uses. If £1000 means nothing to you because you are very rich, if opportunities arise you put effort into making that £1000 into £10,000 or £100,000. The fact that the ultra-rich have wealth that is truly astonishing may not be an accident, but may be a result of exactly the same principle that Miles explores: diminishing marginal utility. The rich are no different from everyone else in wanting more utility, except for them it requires huge amounts of money to get it. [1]

To see why this can matter, consider an argument put forward by Piketty, Saez and Stantcheva that I discussed here. Why has pre-tax income for the 1% risen so much in the two countries, the UK and US, that in the 1980s saw large reductions in top income tax rates? The argument these authors put forward is that with punitive tax rates, there was little incentive for CEOs or finance high-flyers to use their monopoly power to extract rent (take profits away) from their firms. It would only gain you a few thousands after tax, which as they were already well paid would not increase their utility very much. However once top tax rates were cut, it now became worthwhile for these individuals to put effort into rent extraction.

As I discussed here, the bonus culture may be the means of rent extraction that was incentivised by cutting top tax rates. If you want to see the kind of thing I have in mind in action, read this article by Ben Chu on what happened to Theresa May’s wish to see annually binding votes by shareholders on executive pay. That kind of lobbying takes effort. It worked, and as a result top executives at the builder Crest Nicholson can ignore a shareholder vote against changes to their compensation rules. No wonder executive pay seems to rise even when a company’s fortunes turn sour.

So it seems to me that I could take the same basic principle that Miles explores and write a very different conclusion. Once we allow those at the top the opportunity to earn very high incomes, and the only way these individuals can see to get additional utility is to embark on rent seeking, we can at the very least divert their effort from socially enhancing activities (i.e improving the company). When those efforts extend to influencing the political system, we are in serious trouble. These activities may culminate in taking over the political system, which after all is what has happened in the US, with potentially disastrous consequences. For that reason alone, inequality matters as well as poverty.

[1] Of course status linked to competitive consumption is also important.


16 comments:

  1. of course concern with poverty implies concern about inequality if you think that great wealth results from zero-sum bargaining. So the rich get rich by making the rest of us poorer. IMO that's an important question I see relatively little attention paid to.

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    1. I think Adam Smith resolved that conundrum a while ago.

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    2. Well he had a view. But I wouldn't say he resolved it in the sense of everybody now agreeing with him.

      Smith believed the interests of profit-seekers were structurally and thus permanently “directly opposite to that of the great body of the people,”

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  2. Let me send some water to your mill.

    There was a public problem recently in Canada regarding the pay of CEOs: the federal government bailed out Bombardier and, despite very questionable performances from the part of the high ends of the administration, the board has decided to raise the income of top executives by 50%. Needless to say, people went nuts (have you ever seen a public survey get over 90% of respondents saying something was wrong?)

    What struck me about this episode is the stupidity of Trudeau's reply. Apparently, it is not a problem to get involved in private business when you spare idiots from sinking themselves using public funds, but it is a problem if you attach strings to the money you send them. This was a common line of defense, that we ought to let the "market" decide how to use those funds (but it wasn't up to the "market" to decide which business should go under).

    It seems to be very obvious to me that with only a handful of people with the connections, habits and skills to do a good job at managing huge firms, you might have a problem with them being left with the opportunity to decide how much they should be paid. Apparently, people do not learn soon enough about rent seeking and the principal-agent problem in economics course. We probably spend too much time in introduction courses explaining what happens when there are rainbows and flowers everywhere. It also seems to me very obvious that a government shouldn't hand money to businesses without any strings attached: socializing the risks while privitatizing the profits is a recipe that can only encourage recklessness.

    In this context, it's hard not to see the government's decision as petting friends on the back.

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  3. Someone suggested recently - I think it was in the New Statesman - that a policy of means-testing benefits was actually more left-wing than universality, because means-testing ensured that the benefits went to the poor (and hence, presumably, made it possible to raise the level of benefits by redistributing the money that would have been wasted on people who didn't need it). I described this at the time as an impoverished idea of leftism - poverty as localised market failure to be compensated through organised altruism. Miles Kimball seems to be thinking in similarly cramped terms.

    It's interesting that he invokes Rawls; I can't see the idea that "the focus of our concern about inequality should be how well we take care of the poor" surviving a serious encounter with the 'veil of ignorance', predicated as it is on distinguishing between what 'we' are and need and what 'the poor' are and need.

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    1. In the US, means-testing is a pretty sure way to lose a welfare program and to stigmatize recipients. AFDC, by the board. Food stamps, being cut. Medicaid, always a target, and frequently cut at the state level. I am anti-means testing. I think that is the resiliency of social security and Medicare.

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  4. Paul Krugman blog DEC 28 2016 'Greed Springs Eternal'

    'Jonathan Chait catches Larry Kudlow praising the Orange One for choosing a cabinet of billionaires, because rich men are incorruptible — after all, they don’t need even more money. As Chait says, this is ludicrous on its face; consider, for example, Russia’s oligarchs.

    What Chait doesn’t note is the special irony of seeing this argument from Kudlow, or indeed any right-wing advocate of supply-side economics.

    Remember, their whole worldview is based around the claim that cutting taxes on rich people will work economic miracles, because of incentives: let a plutocrat keep more of an extra dollar in income, and he’ll innovate, create jobs, lead us to an earthly paradise in order to get that extra income.

    To belabor what should be obvious: either the wealthy care about having more money or they don’t. If lower marginal tax rates are an incentive to produce more, the prospect of personal gain is an incentive to engage in corrupt practices. You can’t go all Ayn Rand/Gordon Gekko on the importance of greed as a motivator while claiming that wealth insulates a man from temptation.'

    Keith Joseph Edgbaston speech 19 OCTOBER 1974

    "Yes, we have to get economics back into proportion, as one aspect of politics, important but never really the main thing. This may be unfashionable, indeed anti-fashionable, because it is the current intellectual fashions which have wrought so much havoc in this country.

    During the elections, discussion focused almost exclusively on economics; and we lost the election. Were these two facts unconnected? I don't think so. The voter has faced three parties all of who claimed that they alone had the secret of fighting inflation, of achieving economic growth, of keeping down prices and providing benefits. This was the kind of auction in which Labour was bound to outbid us, because they are quite unhibited [sic], in promising the earth."

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  5. Why just CEO?
    There is a bunch of top earners: in my opinion it's globalization that gives visibility, and so money, just at the very top, in all fields. All the top earners have a lot of bargain power, while medium and low earners are fungible worldwide, hence they haven't bargain power.

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  6. Regarding note [1], the few very wealthy people I've spoken to (hedge fund) about this have freely admitted that competition with other high net worth individuals was their MAIN driver for acquiring "more"—and not as you suggest something as objectively measurable as "competitive consumption."

    Increasing wealth is pure scorekeeping (and not consumption) for the top echelon; "bigger-yacht-ism" per se isn't a driving factor. Of course, this differs greatly across cultures, e.g., golden toilets and other oligarch status symbols...

    My suggestion is that when calculating utility, we should effectively neglect consumption among the very wealthy and focus on relative status; the 1950s super-rich were not demonstrably less sated than the 1980s super-rich, and I've seen no evidence that today's billionaires have any advantage in consumptive utility. And since relative status is, well, relative, it shouldn't weigh at all heavily in discussions of poverty, deprivation and social welfare.

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    1. Michael, that is exactly the argument Diamond and Saez make more formally in their well known 2011 JEP article arguing that the top tax rate in the US should be set at the Laffer point of about 73 cents in the dollar.

      And it is not original with them - I know the UK Labour government of the 1960s used to argue it with analytic support from John Hicks.

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    2. If super-rich people are motivated mainly by relative rather than absolute wealth, then shouldn't they not oppose higher taxation too strongly (as long as the taxation doesn't change their position in the rankings)?

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    3. George, I don't believe this follows; your perspective seem (at a minimum) to be contingent upon a world of perfect adherence to/enforcement of the tax regime—where each individual is certain that none of his status competitors could successfully game the system. I suppose you could also view low top marginal rates as a hedge against gains by the lower deciles that could lead to increased competition in the top ranks. The greater their relative distance to the broad field, the less chance of ever being overtaken from below.

      There is a lot of precedence for this interpretation in the enduring complexity of tax law: none of the real players is pushing for simplicity and transparency, although this would clearly and significantly reduce their accounting burden, for the simple reason that they see more benefit in intransparency.

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    4. And thanks derider, for the more quantitative / analytical references.

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  7. Yes, good point. And any thoughts on how we can help to ensure that the views of economists - experts dare I say - can be disseminated in the election campaign. It shouldn't be much to ask for - a higher quality of public debate than the first time round.

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  8. If EITC could somehow be used to restore the 10% overall income share lost by the bottom 45% over a couple of generations -- IOW could be used to double (!) their incomes -- that would come in at something like $1.4 trillion a year, not today's $70 billion (equals 1/2 of 1% of overall income). Before we tear out hair out figuring out how we would distribute that -- it would obviously upend the whole (consumer) market-based direction of production.

    I'm not nearly as interested in the min wage as I am in rebuilding labor union density. That would sort out production by the max the consumer would put up with rather than the minimum labor will up with (starting with the most vulnerable workers and working up).

    I'm guessing if the mid 54% pay 14% more of their incomes through higher prices (10% of overall income) -- they in turn with their new union generated political power can just confiscatory-tax back the 10% overall the top 1% squeezed out over the last two generations.

    Their moral question there could be phrased as do they want to keep the 54% in penury (may not be a choice if the 45% refuse to show up for work [strike]) or do they want pro quarterbacks to work for a million a year instead of ten million. When faced with questions like this I ask myself: what would Jimmy Hoffa do? :-)

    Finally occurred to me that the bottom 45% will heartily encourage the mid 54% to lay that confiscatory-tax (90% on all income over say $2 million?) on the 1% -- so they can get at some of that money! :-O

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  9. For an American, it's unsettling and a bit shocking to read the completely offhand recognition that the rich taking over the political system "is what has happened in the U.S." Many of us know this, of course, but our media—save for the occasional voice in the wilderness like Bill Moyers—simply don't dwell on it much.

    Always good to have perspective from outside our borders!

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