For whom exactly is inequality good?

According to a clip from Richard Epstein, inequality benefits everyone. His appearance on PBS, linked by Mankiw’s blog, gives the standard free-market trickle-down argument about income inequality. According to Epstein, when 1% of the people own ⅓ of the wealth, it gives the rest of us poor 99%'ers incentive to work hard, innovate, and strive for success, in the end creating an even bigger overall “pie” to distribute. Unequal distribution makes everyone is better off, so we should stop complaining about the haves and have-nots. But what is missing in Epstein’s rosy free-market idealist picture about the merits of inequality?

Decline of Real Wages

Epstein’s argument that all incomes have risen under neoliberal capitalism is wrong. Real wage data suggests that in fact real wages have stagnated over the last several decades, despite substantial increases in productivity and wealth. While the pie may indeed be bigger, certainly not everyone is better off. Further, the segment of the population most stricken by inequality and poverty are children and the elderly, who may be even worse off than originally estimated. 

Importance of Relative Income

Behavioral economists have been good at showing that what matters is not the absolute level of income, but rather how we earn relative to others. If more folks are falling at the bottom end of the income distribution, with lower and lower relative standing, then how are we all better off? In fact, some very influential behavioral economists from Mankiw's own institution and down the road at MIT, Michael Norton and Dan Ariely, have shown that most citizens would prefer a more equal society.

Political Power

It’s no news that income inequality undermines democracy. With resources concentrated at the top, some portions of the population can buy their way into political power and create major barriers to entry into elite circles. Epstein however idealizes perfect mobility in an unequal society. Even the Freakonomics blog was able to explain this point a while back, quoting Daron Acemoglu:

"First, people’s well-being may directly depend on inequality, for example, because they view a highly unequal society as unfair or because the utility loss due to low status of the have-nots may be greater than the utility gain due to the higher status of the haves. Second and more importantly, equality of opportunity may be harder to achieve in an unequal society … Third and most importantly, inequality impacts politics. Economic power tends to beget political power even in democratic and pluralistic societies. "

A Response to Mankiw and His Defenders

Mankiw seems genuinely concerned that his protesting students ironically had to miss his lecture on income inequality.   It is important to give Mankiw and his EC 10 text-of-choice (presumably his own “Principles of Economics 6e”) the credit deserved: he mentions income inequality and says it may be a problem depending on one’s political or philosophical persuasion.   Unfortunately, that is about the extent of the credit one can extend.

We take two broad issues with Mankiw’s NPR interview response to his students’ walkout:

1.  Mankiw’s coverage of income inequality is inadequate for an economics course(s)
2. Mankiw misses the broader point that he and his textbooks do not promote plurality of discussion on a wide range of topics beyond income inequality and its relation to economic activity

It’s clear what Mankiw’s lecture on income inequality is all about by looking at his official lecture notes.  He spends some time comparing the poor and the rich in the United States and across countries, and then quickly moves to discussing problems with measurement of income inequality.  And here’s where the bias kicks into overdrive.  According to Mankiw, measures of income inequality are drastically biased upward due to 4 things:

1. The values of in-kind transfers are often ignored when measuring inequality.  The problem is that that is not necessarily true.  For example, the US Census, in its measures of inequality began valuing in-kind government transfer programs back in 1982. 
2. People can borrow and save, therefore ‘smoothing out’ their incomes over time.  The problem with that is that poor persons, almost by definition, have little means of borrowing on credit as they often lack collateral. Second, they have little ability to save since living closer to the poverty line means dedicating just about all of income to subsistence.
3.  If what we really care about measuring is inequality of living standards, then one should compare wealth or permanent income, not transitory income levels.  Again, that is all fine and good except for the statistic is unlikely to improve for poor persons who have limited resources.  
4. Income measures fail to account for the fact that the poor have opportunities to lift themselves up.  Unfortunately, Mankiw fails to mention any barriers to doing so that exist in our society, political power, institutional limitations, or otherwise.  

The rest of Mankiw’s discussion of the income distribution can basically be summed up in 1 sentence:

The problem of income inequality is important, but something more for politicians and philosophers to further a discussion on after comparing the cost of improving income equality, at the expense of economic efficiency.

There is no discussion as to how economics (and students of the discipline) can contribute to the discussion other than as a distant, silent observer.  That is likely why it is nearly the last chapter in this microeconomics textbook – for Mankiw the discussion is an afterthought in economics, as opposed to an integral part of it – so it’s ok if instructors that use his textbook skip the chapter entirely.  Perhaps more importantly, Mankiw’s chapter on income inequality is, to the degree it is discussed, entirely from a microeconomic perspective.  He completely ignores the macroeconomic links between the income distribution and wages, profits, and economic growth.  In his GDP chapter (the macroeconomic measure of living standards) he fails to discuss other measures of income inequality that many nations use because of GDP’s inadequacies (like the Human Development Index, or the Genuine Progress Indicator) which largely stem from the lumping profit (rich) and wages (middle class / poor) into one aggregated measure of supposed well-being. 

All this said, it is disappointing that the protesting Harvard students focus so much of their attention on income inequality and fail to really focus in on the broader problem- that Mankiw and his textbooks perpetuate an ahistorical, assumption laden, non-complex market based dialog, often times ignoring other schools of thought that may have something interesting or useful to say on a topic.

Behavioral economics often points out how unrealistic some of the assumptions of textbook economics truly are, and in fact perfectly rational economic actors are more or less sociopathic.  Some heterodox schools of economics discuss how income inequality is directly related to boom/bust cycles of capitalism and therefore are not just explained by a human capital premium.  Environmental economics also discusses the relationship between economic growth, business cycles and environmental degradation beyond simply discussing market-based tax solutions.   Finally, Mankiw largely ignores the relationship that politics and economics have – and specifically the relationship between political power and economic power of which political scientists are all too familiar with understanding.  Were he to truly recognize the issue, he might have an answer for one of the biggest concerns of the Occupy Wall Street movement: why, essentially, rich people  were given preferential financial/political treatment over poor people when it was the rich people who were in large part responsible for the recent economic calamity that directly hurt the poor.

At the end of the day according to EC 10, economics is about being able to explain only a small part of individual and national choice behavior – the unrealistic perfectly ‘rational’ part - and applying only one kind of solution – a kind of economic bandage (taxes etc.), in the rare instance choice behavior isn’t so perfect or in equilibrium.  For Mankiw, economics can be boiled down to brief, vague principles.  Students around the globe are brainwashed with this limited kind of homo-economicus thinking that would make Adam Smith roll over in his grave.   Luckily, some students are waking up from the haze.  

-anti-mankiw