I am in the process of submitting a proposal to a university for a phd thesis in economics, and after having experienced the power of brainstorming with people outside the economics profession I would be interested in hearing your thoughts on the topic. I will appreciate input from people from any ideological persuasion, and I believe it may stimulate a nice discussion.
In political economics a number of theoretical models predict that in a democracy an increase in pre-tax inequality will result in an increase in the redistribution of wealth by Government (or, alternatively, social expenditure by Government). This is due to heightened inequality giving the majority of voters in a democracy an incentive to demand higher taxation and redistribution (this is not an ideologically driven statement, financially they would be better off and a cornerstone of economic theory is that economic agents pursue their self-interest).
However, econometric models based on historical data show that this prediction does not hold. While results are very mixed in the literature, generally speaking there is not a strong correlation between inequality and Government redistribution in democracies. This is often called the redistribution puzzle. A number of papers have attempted to extend the basic model in order to explain the lack of correlation between the two variables. In my proposed thesis I will introduce a number of extensions to the model that have not previously been considered, and place a strong emphasis on the econometric testing of explanations in order to give empirical evidence on whether the explanations presented actually explain the redistribution puzzle or not.
What I am interested in reading:
I would like to hear your thoughts on what factors of modern democracies sever this predicted link between inequality and redistribution. The answer is likely to be a number of things, I have quite a few ideas myself but I am sure there are many others out there that I have yet to consider.
Inequality is good, redistribution is bad! Vote Ron Paul! Anything else?
Okay, so here’s a conjecture: Voting habit depends not strictly on expected personal gain but is filtered through cultural preferences, and those same preferences are at work to determine the span of pay scales within companies, the probability that people prefer getting rich over other goals, etc.
So if there’s a lot of wealth inequality in a democracy it stands to reason that this inequality came about in the first place because voters think greed is good (as a driving force for a capitalist society) and the ensuing inequality is fine, and therefore will not vote for redistribution even if it benefits them. Conversely, if there’s not a lot of inequality it’s because voters already think greed is bad and nobody should attempt to become much richer than others, and therefore will vote for redistribution even though there’s not much to redistribute.
One important factor which can be seen in American politics today is the ability of political lobbies to convince voters to vote outside of their own financial interests, whether out of patriotism (“the country needs to tighten its belt on spending, I’ll do my part”), enlightened self-interest (“I should pay more taxes, I can afford it”) or aspiration (“we shouldn’t tax millionaires because I might be a millionaire someday”).
I would take this one step further: Even if redistribution benefits those people in the short term, you also have to account for mobility between income brackets. Heavy redistribution may end up being a long-term detriment if those people have a reasonable expectation to move up in pay, as they would (theoretically) spend more of their life paying into redistribution than benefitting from it.
Hope is probably the main problem :) Hope and perhaps also a general ignorance of boring economic reality.
90% of people believe that they are much closer to earning the mean/median wage than they actually are, personal inequality is not perceived strongly by voters so they tend to vote on things that are easier to grasp like unemployment, gas prices, healthcare and abortion which may or may not be having as much an impact on their lives. A lot of the real problems thought to be caused by inequality (rather than the on the face unfairness of it) are non-obvious.
A large proportion of people believe that they have a fair chance of ‘making it’ ‘living the american dream’ and finally becoming rich. The statistics tell a different story (your income in the vast majority of cases will be highly correlated with the earnings of your parents and this correlation increases the higher the inequality in the economy). There is a huge belief that in general the poor are the poor because they didn’t work hard enough and the rich are the rich because they worked harder than anyone else. The basic impossibility of a million dollar wage earner being able to work 500 times harder than a street cleaner on $20,000 doesn’t seem to penetrate the general public mind very well. I suspect this is because hope sells a lot better than truth, and hope creates far better narratives (See the Obama election campaign).
Why can’t we create a hope narrative of fixing inequality? I think it’s a much harder sell as it requires political or societal change - huge movements of people challenging dominant economic models in a complicated way. Meanwhile ‘the american dream’ is a personal, selfish hope that one can easily strive towards without needing to rally a mass movement and educate them in economic minutae. As an analogous example, recently in the UK we had a referendum on improving the voting system, unfortunately it was a fairly complex technocratic tweak which only improved the system in a small (though significant) way. The current system produces worse results and all the experts agree it is unsuitable for fair elections of greater than two parties and yet it still won mostly because it was a little bit simpler.
I’m thirty-one and I’ve earned less than $25,000 a year for my entire life. Over the next ten years, I’m likely to reach $40,000 or even $50,000 a year, but I doubt my wages will ever go over that.
It doesn’t bother me. I have access to more food than I could ever eat. My apartment is well-insulated enough that I barely notice if it’s raining or snowing. Last time I checked, the Mongols weren’t due to stop by to split my head open and rape my family.
If someone gave me a billion dollars tomorrow, it wouldn’t change my life. I don’t care that people with a fraction of my education make hundreds of times more money than I do. I have enough, and while I’m not content, the primary barrier between me and eudaimonia is myself, not other people with more money.
It’s a very diffuse and hard to grasp problem so I’m not surprised you might feel indifferent.
Since those people earning vastly more than you are often doing so by free riding on the productivity of those earning less (median wages haven’t risen while productivity and higher wages have) another way of looking at it that probably would bother you is if you were being paid a true reflection of your labour worth in the gross column of your paycheck and over in the deductions was a substantial transfer to, say, your companies CEO that gets bigger every year. A lot of people resent the government for just such a reason.
Also, as you wisely point out people can easily be content on $25,000 a year so why not transfer some of the wealth from the top down the the bottom to help more people reach that $25,000 a year comfort zone?
It’s a pretty big assumption on your part to think that the well-paid individuals of the world are getting a free ride on my productivity, and not the other way around. Honestly, I have no idea which of us is producing more, relative to our wages. I don’t even know how you would measure such a thing.
Not really. It’s simply beyond the laws of physics that any one individual could be producing 50 to 500 times more productive effort than the average day in day out. Three times as much? Yes. Even up to ten times as much? perhaps.
Yet the rewards are such these days that the highest paid are renumerated in the millions or tens of millions a year.
Nevertheless, people do measure productivity and labour productivity all the time to produce international comparison tables and comparisons over time. People also measure wages over time so you can make the comparison yourself. CEO level pay has risen dramatically in real terms in the last thirty years meanwhile wages for the average worker have remained close to stagnant. Productivity surveys report increased worker productivity per hour and longer hours being worked but the change in rewards has all been at the top.
CEOs’ pay as a multiple of the average worker’s pay, 1960-2007
Anyway the consequences of this would be that the typical feedback loop between economic outcomes & public policy is short circuited.
People do vote generally with their economic interests, but the political system doesn’t care. I’m not as up to date on the theory supporting this view. I know that somewhat recently a study was released showing that the US political system is indifferent to the policy concerns of anyone outside the top income decile. For the life of me I cannot remember where I saw it though so the odds are at least fifty/fifty I’m making that up.
Sub-area to investigate:
People are voting in their economic interest, but the structure of our political system somehow mutes this feedback. Think: electoral college, filibuster, the nitty gritty of Congressional representation, etc. You will want to pick up the book Veto Players, which examines political systems in terms of who can say no and theorizes that the people who can say no are the ones who wield a lot of power. The US political system has a lot of veto players, compared to say the British political system.
We’ve been down this path before. Income inequality basically rose steadily from Reconstruction through the Gilded Age. It wasn’t until the Great Depression and WWII that things evened out and we enjoyed thirty or so years of more equal incomes. Starting in the 70s the rich began to pull away. What happened during those timeframes? Tyler Cowen offers one explanation in The Great Stagnation (forum thread: here): that the postwar boom was the result of picking off low-hanging economic fruit and we’re now out of low-hanging fruit to pick. Other economists and political scientists differ; Red State, Blue State argues that increasing inequality is the result of deliberate policy decisions. If that’s the case, then what made the political system switch gears circa 1970 to start making those decisions?
In the aftermath of the Great Depression we saw all sorts of aggressive government action for about 18 months that seems to have set the stage for a flattening of the income distribution curve. Why did the political system, at this point, abandon its typical mission of protecting the rich? For 18 months Congress basically abdicated its role in government and signed whatever FDR put in front of them. Why was Congress so willing to do this? I’ve heard it theorized that the likely alternative to FDR & the New Deal was a populist uprising and Huey Long as dictator for life, but I’m not certain how surefooted that scenario is, historically speaking.
Anyway I hope this helps at least give you some avenues to explore. Keep us posted on how your dissertation is going. I’d especially like to see what the process is like, a pHD in economics is a path I’m considering pursuing in a couple of years.
What does increased income inequality look like? Specifically:
How much of it is increased returns on financial assets?
How much of it is wall street banker types?
How much of it is CEO pay?
How much of it is high-level exec pay. Subtype here: IT workers basically didn’t exist circa 1970.
What does income inequality look like when you slice and dice by educational attainment? How about categorizing by degree type? Maybe certain types of college degrees (business, engineering) have a higher return than stuff like say dance or psych?
I don’t remember where I read all this, but something along the lines of “republics (not democracies; are there any actual democracies outside of switzerland?) are run by competing sets of elites, not the general public” combined with “rural and income-biased political institutions” combined with “50%+1 vote winner take all” electoral systems combined with the very, very dominating influence of money on modern politics explains an awful lot.
In the US right now I’d say you have a very well-funded, unified, and organized set of elites and related party infrastructure on the right edge that have the reliable loyalties of something like 30% of the public. In a direct democracy or parliamentary system they’d be a major player, but they wouldn’t dominate everything, but in the US thanks to having just about every institution favor them it’s tremendously difficult for the rest of the public to outvote them. Similarly, the media’s agenda setting power isn’t as overwhelming as it was in say, 1965 but it’s far, far more dominant (and vulnerable to cash-fueled elite opinion) than in 1890.
If you’re talking about two guys working at a factory then yes, but not when it comes to knowledge work like running a company or improving a product. I’d expect some people to be five-hundred times as productive as others in those situations.
CEO level pay has risen dramatically in real terms in the last thirty years meanwhile wages for the average worker have remained close to stagnant. Productivity surveys report increased worker productivity per hour and longer hours being worked but the change in rewards has all been at the top.
But that doesn’t tell us whether that increase in productivity per hour is due to more effective workers, or improvements in technology, or better policies developed by the people at the top.
Hi Jason, thanks for your thoughts. Your assessment of the US seems fair, it’s just a matter of identifying each systemic factor that is causing this outcome, and then determine a way to place it into a model of the economy and test using data the validity of it. I also need to consider if the experience is different for a number of other countries, the dataset i’ll have will ideally put 10+ democratic and developed countries into the scope of analysis.
Hi Jeff. This is my one concern with the topic.
Will do. Thanks for posting the material. Regarding 1, I think this is essentially a more general expression of the redistribution puzzle. The outcome of the democratic process is not one that is in the self-interest of a majority of the voters; why is this. As you mentioned in two, the number of veto points is a possible explanation. Your material on pre-WW2 US history is interesting, thanks.
A number of other factors I have been considering: the role of the media (voters have bounded rationality and imperfect information, and rely on the media to inform their vote. This does not happen due to a number of structural factors related to the media industry, the end result being the public in general underestimate the level of inequality in their economy. This is backed up by data), the role of money (or more specifically, campaign contributions) in the political process, lack of compulsory voting, and the concentration of political parties.
I agree. We moved beyond the idea of equating someones worth to how hard they shovel coal some time ago.
If a company has profits of $10million with CEO A and 11 million with CEO B, then (all else being equal) the CEO is worth $999,999 more than the previous CEO. Thats just a harsh economic fact.
As a computer programmer, I earn over 10 times my salary as a boatbuilder. That doesnt make me an evil moustache twirling villain who profits from the sweat of others. It just means i’ve developed skills that produce greater economic benefit. There is no loser in that scenario.
But that starts with the assumption that the CEO is solely and directly responsible for the changes in the company’s fortunes. It’s very rare for that to actually be the case. A CEO who happens to preside over an economic upswing that lifts his company’s profits may not have actually contributed meaningfully to that rise.
Certainly a CEO takes on more responsibility than most, and should be compensated more, but IMO there’s something beyond simple market forces at work in compensation at the top.
How many millions of people can a single musician entertain simultaneously now?
How about three hundred years ago?
A CEO is paid to think real hard about how to make sure everyone else in the company still has their job tomorrow. And the day after. And the day after. As globalization heated up, and as people could start poaching talent more effectively, competition for quality leaders got real heated because not so many folks have the talent and experience necessary to run a multinational corporation spread across dozens of countries and employing hundreds of thousands of people.
My boss, for example, is constantly shocked by how much I don’t know about what I do that he takes for granted, even though I’ve got a couple years in sales and was familiar enough about the intarwebs to have a discussion on the plumbing of it with his staff. I don’t know a hundredth of the people he knows, or have the slightest inkling about what matters which way or the other when he’s making decisions about things. And how the heck should I? I’ve been working here a few months, he’s been doing this for a decade.
Shit, I don’t even know what my CEO does on a daily basis, but I’ll bet you a years salary it’s worth a lot more to the company than me filing reports and selling the occasional port. And if that means he gets paid orders of magnitude more, well, that’s cool. I can’t do what he does (yet) and that means I can’t command that salary.
What does piss me off is they won’t give me health insurance. Even though I’ve already sold enough to cover three salaries my size for the next three years, I’m apparently not worth the few hundred extra bucks a month yet. Damn it.
So, basically, bosses are paid the big bucks because they know how to not fuck up and leave schmucks like me begging on the street. Yay. Would I like more money? Hells yeah. Would I have this job if it was paying more on base terms? Likely no.
First of all I am not sure how you are determining how much credit to give the CEO in thus or any other scenario, second all I have worked for companies who had clearly incompetent executives who nevertheless commanded multimillion dollar scenarios and were let go with golden parachutes, and went on to become executives at other hapless corporations.
It’s all bunch of BS, no one is worth these ridiculous salaries execs get now. And who does all the real work? The rank and file employees. CEOs are glorified salesmen.
Switzerland has lower taxes than Europe’s representative parliamentary democracies (see here for example). So if you think that plebiscites or the absence of powerful political elites cause more redistribution you’re totally on the wrong track.