I don't really want to be writing about this now. I had hoped to spend today theorizing obscurely about liquidity. But, after reading (via Felix Salmon) the apologetics of a bunch of prominent economists for inequality (here, here, and especially here — or here via Mark Thoma, to get around Times Select), I just have to go off half-cocked a bit.
Earth to Economics Professors! Earth to Economics Professors! In this, the real world that we inhabit, There Is No Such Thing As A Pareto Improvement. An increase in inequality (or an increase in equality for that matter) always helps some people and hurts others in a variety of ways. Period.
You can claim, if you like, that the harms people experience by increased inequality are outweighed by other benefits, even to the harmed. But the dimensions along which people are harmed and helped are incommensurable. Conventional economic simplifications like "real income" do not capture the full effect of the changes. And we need not and should not, resort to emotional fairy tales like "spite and envy" (as in a previous blogospheric inequality controversy) or "inequality of happiness" (an unfortunate addition today by the usually excellent Tyler Cowen).
Increases in wealth to the wealthy can harm the less wealthy in many ways that don't show up in "real income" stats. Here are two important but often overlooked examples:
1) Inaccessibility of public goods for which superior private substitutes can be purchased
Consider almost anything that is arguably a "public good" — parks, well-paved roads, transportation in general, schools, medical care, social insurance, personal security. Private substitutes are available for nearly all of these goods, to those who are sufficiently wealthy. Who needs a park, when one can buy a home with a lovely back yard? Is it worth paying high taxes to keep the roads smooth, when one can purchase an SUV, or a helicopter, that is not bothered by potholes, and is more comfortable and functional than an economy car anyway? Speaking of cars, should we just invest in an excellent streetcar and/or subway system, and not spend so much money on roads? Should we accede to higher taxes to support well appointed public schools, or do we prefer strictly private education? Should I support taxes to fund the police, when in any case I am going to require expensive private security?
Rational individuals will answer these sorts of questions very differently, depending on their circumstances. To those for whom the marginal utility of a dollar is low, buying superior private substitutes for public goods will appear to worthwhile. They will oppose government purchase of these goods and the taxation required to support it. But, poorer people will find the dollar cost of private substitutes to be burdensome, and will rationally choose less expensive state provision via inferior public goods. Choices have to be made. We build a comprehensive subway system, or we don't; we buy and maintain a new park, or we don't; we tax to fund more policing, or we don't. Increases in inequality (particularly increases in the numbers and the political influence of the relatively wealthy) shift the likelihood that we opt for private provision of what could be provided in an inferior manner, but at lower cost-per-person, as a public good. Poorer people are forced to pay more for a service than they would have under the policy they would have chosen, or to do entirely without services that might have been provided them inexpensively by the state.
2) Goods and services become expensive, or fail to be produced at all, under inequality, due to reduced economies of scale and increased resource prices.
The mix of goods and services produced by a society is affected by the distribution of wealth in that society. It is easy to see that luxury goods might fail to be produced in very equal societies. Suppose, counterfactually, that we could have an economy in which goods and services are produced as efficiently as they are currently, but with no inequalities in wealth or income, everyone earns the same, current US-average income. The market for Lamborghinis would dry right up. But the converse holds as well. Suppose that the same society is divided into two groups, one wealthy enough such that the superior performance of a Lamborghini is clearly worth the extra expense, and another group whose wealth is roughly the current US-average. The poorer group will be adversely affected by the sudden good fortune of their neighbors. As the market for economy cars will be cut in half, economies to scale in auto production will be adversely affected. Car companies might be the first to take a hit, as they will have already sunk costs based on now violated scale expectations. But new lines of economy cars will have to be designed more sparely, or else priced more expensively, in order for car companies to build profitable econoboxes. The scale effect is exacerbated if, plausibly, Lamborghini production utilizes more non-human resources (metal, energy, etc.) than econobox production. Goods prices will be bid up by the wealthy half of the world, and price and quality of the econoboxes will thereby suffer as well. There may be dynamic effects that mitigate the ill effects of half the world's sudden good fortune on the other half, but even in this most contrived case, you can't claim a simple "Pareto improvement".
The above is not to suggest that inequality is inherently bad. On the contrary, my intuition is that most societies I'd want to live in would tolerate a great deal of inequality. But "a great deal" does not mean unlimited, and tolerance does not imply unconditional cheerleading. At this moment in the United States (and throughout the world), a lot of people (myself included) see a disturbing degree of inequality whose growth, we believe, is insufficiently attached to the kind of positive effects that sometimes persuades us that inequality is a good thing. We may be mistaken. But today's crop of justifications, by authors whom I usually admire, struck me as shallow, glib, and unserious.
|Steve Randy Waldman — Friday January 26, 2007 at 12:35am||permalink|