Lawrence H. Summers: The Inequality Puzzle: “I have serious reservations about Piketty’s theorizing as a guide…
…to understanding the evolution of American inequality…. Piketty[‘s]… rather fatalistic and certainly dismal view… presumes, first, that the return to capital diminishes slowly, if at all, as wealth is accumulated and, second, that the returns to wealth are [nearly] all reinvested…. Neither of these premises is likely correct as a guide to thinking about the American economy today….
Most economists would attribute both it and rising inequality to the working out of various forces associated with globalization and technological change…. Piketty… recognizes that at this point the gains in income of the top 1 percent substantially represent labor rather than capital income… a separate issue from processes of wealth accumulation…. So why has the labor income of the top 1 percent risen so sharply relative to the income of everyone else? No one really knows. Certainly there have been changes in prevailing mores regarding executive compensation… plenty to criticize in existing corporate-governance arrangements…. I think… those like Piketty who dismiss the idea that productivity has anything to do with compensation should be given a little pause…. The executives who make the most money are not for most part the ones running public companies who can pack their boards with friends. Rather, they are the executives chosen by private equity firms…. This is not in any way to ethically justify inordinate compensation-—only to raise a question about the economic forces that generate it…. And there is the basic truth that technology and globalization give greater scope to those with extraordinary entrepreneurial ability, luck, or managerial skill. Think about the contrast between George Eastman, who pioneered fundamental innovations in photography, and Steve Jobs…. Eastman Kodak Co. provided a foundation for a prosperous middle class in Rochester for generations, no comparable impact has been created by Jobs’s innovations…
In this excerpt from his review of Thomas Piketty’s Capital in the Twenty-First Century, Larry Summers makes three points:
That superstar incomes are paid by private-equity firms to their top managers in what are genuinely arms-length transactions creates a presumption that institutional corporate corruption is not at the heart of other superstar earnings, even those “negotiated” between a CEO and the tame Board members he has appointed.
That there are decision makers willing to voluntarily pay an absolute fortune to hire you in a genuinely arms’-length transaction does not mean that you have in any relevant sense “earned” or “deserve” your fortune.
A substantial component of the past generation’s rise in inequality among the top 20%, in America at least, is due to deep structural changes in technology and organization: witness the different effects of the fundamental innovations of George Eastman and Steve Jobs.
(2) involves standard issues of moral philosophy: If you win the lottery–and if the big prize in the lottery that is given to you is there in order to induce others to overestimate their chances and purchase lottery tickets and so enrich the lottery runner–do you “deserve” your winnings? It is not a win-win-win transaction: you are happy being paid, the lottery runner is happy paying you, but the others who purchase lottery tickets are not happy–or, perhaps, would not be happy in their best selves if they understood what their chances really were and how your winning is finely-tuned to mislead them, for they do voluntarily buy the lottery tickets and you do have a choice. Do you have an obligation to spend your post-winning life telling everyone that what they really ought to do is put their daily lottery ticket purchases in an equity-heavy IRA–something in which they are the house to the tune of the 5%/year real equity earnings yield–as if you were the Ancient Mariner? I would say that you certainly do so. And the same applies to tournaments generally: if, given risk aversion, tournaments are good incentivizing mechanisms and thus sensible for the payers it is because they impose cognitive distortions on the typical tournament entrant, and thus do them (or at last their best and most rational selves) injury.
Moreover, even if you are paid your genuine marginal product to society the fact that you are lucky enough to be in a position in which you are able to extract said marginal product is a matter of, well, luck. Others find that their bargaining power is limited to what their standard of living would be if they moved to the Yukon and lived off the land, and thus cannot extract their marginal product. Do you deserve your luck. And what do you owe those who would be in position to get what they deserve if you had not been lucky enough to get their first?
Plus this whole “mixing your labor with unclaimed natural resources and it becomes yours” business is a crock. We never have to face the question of whether the fruits of your justly-acquired property are deservedly yours because no chain of title is clean. And the argument that even though my chain of title is not clean I still deserve it because I would have equivalently-valuable property in the counterfactual in which the chain of property was clean. We are not on that planet, are we? Your grandmother does not have wheels, does she? So the argument that if she had wheels she would be a bus is not relevant, is it?
(1) is really an extension of (3). And seems to me to be clearly correct. But I do not understand why it is so. Globalization, yes. But there seems to be more to it than that. What is it, precisely, about Apple technology and today’s economy that gives it much more of a winner-take-all nature than Eastman-Kodak technology? And why was the same true of Andrew Carnegie-age technology and organization, but not of Alfred P. Sloan-age technology and organization? Deep questions. (1) simply points out that these deep questions extend well beyond high-tech where you can tell an easy non-rivalry increasing-returns knowledge-spillovers story. And (1) misses what I believe to be three facts: (a) Private-equity senior managers have much less secure tenure and are different people than public-company CEOs. (b) Because everybody thinks that they are the cream, every public-company CEO thinks he is just as good as private equity senior managers. I think most of them are wrong. And (c) when public-company CEOs fail to deliver the results that would have triggered their options bonanzas, their tame directors appear often happy to reconfigure their contracts to make it up to them. The princes of private equity are less willing to spend their own money to do so. So while (1) is true and is a great challenge to “entrenchment” theories of the CEO pay bonanza, I do not think that it is as true as Larry thinks it is.
As for me? My guess is that the big difference between the First Gilded Age, the Social-Democratic Age, and our Second Gilded Age as far as the distribution of the surplus from sophisticated-technology increasing-returns mass-production value chains lies mostly in union threat: political, organizational, legal, and technological–how easy would it be for the workers to organize and destroy the organization as a profit-generating institution while still leaving it largely-intact as a production organization? And how easy would it be to recruit and keep scabs? Where the first is easy and the second is hard, union threat is mighty and we get the Eastman Kodaks and General Motorses of yore. Where the first is hard and the second is easy, we get Carnegie and Apple.
Not, mind you, that I think that there was necessarily or clearly a better economic development strategy than the one the Chinese Communist Party as reformed by Deng Xiaoping has followed. But I would like to hear what Marx, Engels, Lenin, and Mao would say about its historical role as straw boss for America’s plutocratic entrepreneurs and yuppie and non-yuppie consumers…