Critiquing Mankiw’s Defense of the One Percent

Harvard Economist and former Romney adviser Greg Mankiw has an excellent new essay out defending the one percent. It is, to date, one of the best defenses I have seen of income inequality. That said, there are several places where it falls short.

Mankiw begins with a thought experiment. Imagine a society with equal incomes which is then disrupted by an entrepreneur. Everyone wants to buy the new invention that is being sold by the entrepreneur. If the original position is just, and all the transactions are voluntary, then we have no basis for claiming that the resulting income inequality is unjust or undesirable.

There are three big problems with this line of reasoning. First, as a practical matter, the original position is never just. There’s simply no doubt that there are massive historical inequalities that persist today. The reason blacks are poorer than whites, on average, is based on historical injustices, not on some sort of natural rate of productivity which is then rewarded by a meritocratic economy (the same could be said for gender and also applies to many individuals, it is just easier to demonstrate with reference to groups).

Second, market transactions don’t take place in a vacuum. Much to his credit, Mankiw acknowledges this, and argues (correctly) that the degree to which an individuals income reflects their value to society is a question for empirical economics, and one that is not currently settled. (Mankiw and I differ on how we expect it to be settled, Mankiw intuiting that pay mostly reflects value, while I believe it has significantly more to do with social norms and the way in which we have chosen to set up the labor market.)

Third, Mankiw is wrong about the role individual entrepreneurs play.  He cites as examples, Steve Jobs, Steven Spielberg, and J.K. Rowling. First, he uses only individuals who have benefited from a superstar economy. Second, as The Economist points out,

But now let’s imagine that just before these geniuses are able to bring their creations into the world, they die. No iPod, no Harry Potter, no Jaws. What happens then?

Here’s what happens then. Instead of Apple dominating the market for MP3 players in the early 2000s, Sony and Samsung do; a little later, when smartphones come along, the battle for mobile operating ecosystems revolves around BlackBerry, Samsung/Google and Nokia/Microsoft. Instead of Harry Potter, some other children’s fantasy book becomes the dominant franchise of the 2000s. And instead of “Jaws”, some other movie becomes the first immense blockbuster of the 1970s, and a different brilliant director’s career is launched. All of the money that was spent over the past few decades to make Mr Jobs, Ms Rowling and Mr Spielberg immensely wealthy would instead have gone to three other hard-working creative geniuses, of which the world has no shortage. There would be just as much inequality as there is now.

The examples are also interesting because they all highlight entrepreneurship that took place in times (1970s,1980s) or places (England) where marginal tax rates on the wealthy were much higher than they currently are in the U.S. Indeed, the idea that any of those three people would have failed to work hard if tax rates were higher strikes me as silly. While tax rates might affect people who hate their jobs and only work for the money, it seems quite clear that Jobs, Spielberg, and Rowling are motivated primarily by the satisfaction they derive from work. (The economic assumption that work is undesirable compared to leisure simply doesn’t hold equally true for all types of work).

Mankiw then goes on to tackle inter-generational inequality. He argues that while some of it is based on parents income, much of the correlation between generations is a result of heritable characteristics like intelligence, work ethic, creativity, etc. The one study he cites actually shows that we don’t really know what causes most inter-generational inequality. That said, even if as a poor child you are smart enough and talented enough to go to college, your rich peer who didn’t bother with college is still 2.5 times more likely to wind up wealthy than you are! Considering that only the best and brightest poor kids wind up in college, it’s dubious at best to suggest that this difference is due to genetics.  (Miles Corak has a rebuttal to Mankiw specifically on inter-generational inequality as part of the Journal of Economic Perspectives symposium that includes Mankiw’s article).

Mankiw does object to rent-seeking, he just thinks it doesn’t exist outside of farm subsidies. The fact that traders pay millions of dollars to get consumer confidence index information 2 seconds before their competitors apparently doesn’t dissuade him. While we agree on rent-seeking, Mankiw just decides to ignore its presence, rather than acknowledge it as a real part of the story of growing inequality. As The Economist noted last October:

In the rich world the cronyism is better-hidden. One reason why Wall Street accounts for a disproportionate share of the wealthy is the implicit subsidy given to too-big-to-fail banks. From doctors to lawyers, many high-paying professions are full of unnecessary restrictive practices. And then there is the most unfair transfer of all—misdirected welfare spending. Social spending is often less about helping the poor than giving goodies to the relatively wealthy. In America the housing subsidy to the richest fifth (through mortgage-interest relief) is four times the amount spent on public housing for the poorest fifth.

Mankiw’s consistent theme is that individuals should be paid based on their value to society. He writes, “A well-functioning economy needs the correct allocation of talent. The last thing we need is for the next Steve Jobs to forgo Silicon Valley in order to join the high-frequency traders on Wall Street. That is, we shouldn’t be concerned about the next Steve Jobs striking it rich, but we want to make sure he strikes it rich in a socially productive way.” In 2007, prior to the recession, 47 percent of Harvard graduates were going to Wall St.  It’s fairly safe to say that’s a huge misallocation of talent. While the numbers dropped during the recession it is now beginning to tick back up rapidly.

There are still more problems with Mankiw’s ‘just deserts’ theory of wages (This is, by the way, the title he applies to his own theory, I am not imposing an outside label).

…the dirty secret of these kinds of “just deserts” approaches is that they conflate “what a person produces and what is produced by resources that he happens to own.” The problematic nature of this conflation becomes especially easy to see when you consider the kinds of passive capital income streams that exist in modern capitalism, e.g. those earned on the stock market. On Mankiw’s view, if you fell into a coma and immediately afterwards your parents died and bequeathed you a $100 million dollar fortune in trust, and then while you remained in that coma for 20 years that $100 million dollar fortune grew to $200 million, your marginal product while lying in a coma for 20 years was $100 million. That is, you contributed $100 million to the nation’s output in your decades-long slumber.

After assuming away any mismatch between wages and value to society, Mankiw then attacks utilitarianism as the basis for social planning, arguing that it leads to outcomes that fail to reward merit. Mankiw points out that following utility theory consistently leads to several odd conclusions that cannot be ignored, including a justification for taxing people on the basis of their height. In one of my favorite lines from the piece, he argues that, “If you take from a theory only the conclusions you like and discard the rest, you are using the theory as a drunkard uses a lamp post—for support rather than illumination.” I agree with Mankiw that utility should not be used as the basis for social decisions, although as discussed below I also disagree with his meritocratic approach.

Finally, Mankiw attacks the liberal social insurance argument, the idea that given we don’t know when we ourselves might benefit from the social safety net, it is in our interest to set up a tax system that provides a reasonable safety net. Mankiw objects that by this logic one could set up a system with mandatory kidney donation, since one never knows whether or not one might suddenly need a kidney. But my rights over my own body are stronger than my rights over other property. A broken window is vandalism while a broken nose is assault.

I’ve already written about the problems with meritocracy, but the short version is that genetic luck is not a great basis for determining what each person is due. I find it quite baffling that Mankiw considers utility and meritocracy, two consequentialist approaches to ethics, without ever stopping to consider human rights theory. While Mankiw seems to support utility in suggesting that we can justify provision to the poor as a public good (if the the public is bothered by poverty, which is a morally neutral question of the preferences of society), he later dismisses utility in favor of ‘just deserts.’ It’s unclear what would be provided for children, the elderly, and the disabled under this theory. Perhaps he only wants just deserts theory to apply to those who are capable of work? At any rate, he seems to be using the theory the way a drunk uses a lamppost, to support his prior beliefs without fully examining the theory’s implications.

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