Evening Must-Read: Robert M. Solow: Greg Mankiw and the One Percent

Robert M. Solow: The One Percent:

The cheerful blandness of N. Gregory Mankiw’s “Defending the One Percent” (Summer 2013, pp. 21–34) may divert attention from its occasional unstated premises, dubious assumptions, and omitted facts. I have room to point only to a few such weaknesses; but the One Percent are pretty good at defending themselves, so that any assistance they get from the sidelines deserves scrutiny.

First, the paper starts off by invoking an iconic Steve Jobs and, without making an explicit claim, carries on tacitly as if the One Percent consists mainly of entrepreneurs whose innovations generate a lot of consumer surplus for the world. There would be less alarm if that were so. But a large and–before the crisis–increasing part of the income of the One Percent arises in the financial services industry, and a large and increasing part of that has come from trading profits. Much of the income in question must therefore be the payoff to asymmetric information, and generates precious little in the way of aggregate consumer surplus. Consider this history (for details see Murphy 2012, especially pp. 307–8): from 1970 to about 1995, the median realized compensation for chief executive officers in Standard and Poor’s 500 broker-dealer firms was essentially indistinguishable from that of Standard and Poor’s 500 banks and industrials. Rather suddenly, between 1996 and 2006, the median broker-dealer chief executive officer started to collect anywhere between 7 and 10 times the median compensation of the other two groups. This does not smell like the Goldin and Katz (2008) story. I’ll swallow “innovation,” but socially productive innovation, no thanks. Extreme inequality is not primarily about useful entrepreneurs. On financial profits and inequality, Mankiw waffles uncomfortably.

Second, Mankiw refers at best tangentially to what may be the most dangerous adverse consequence of extreme inequality at the top: the rich, with a large assist from the Citizens United v. Federal Election Commission (558 US 310 [2010]) decision, can buy political influence, and not only influence but power. An immediate example is the millions of dollars spent by the financial services industry to weaken regulation under the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010. Mankiw’s partial reference is in connection with the contribution of rent-seeking to inequality. There his response is that the proper remedy is not to attack extreme inequality but to suppress rent-seeking. Presumably he would give the same answer here: if inequality corrupts politics, go after the corruption, not the inequality. But this would be, willfully or not, naive: it is precisely the power of great wealth that makes it difficult or impossible to eradicate corruption.

Third, Mankiw’s conception of rents is too narrow; he refers mainly to monopoly rents. But economic rents are pervasive. He mentions the close correlation between height and income. It seems unlikely that height is correlated with true productivity, outside the NBA. More likely height confers an interpersonal advantage, so the return to height is a rent, at the expense of others. (Our culture has produced a song with the line: “Short people got no right to live.”) Taxing height would indeed be odd (Greg Mankiw is pretty tall, by the way); but it is too nonchalant to presume that all market incomes reflect true productivity, let alone social productivity.

Fourth, evidence has accumulated that the degree of intergenerational income mobility in the United States is less than it used to be, less than in some other advanced economies, and less than the American self-image requires. These changes and differences are unlikely to be genetic in origin. (If they were, they would be rents!) Mankiw ignores or skates over this evidence in favor of an anecdote: he thinks his children do not have significantly better opportunities than his own, although they grew up in a much more affluent family than he did. This is a rather small sample, of course. Besides, Professor Mankiw’s success came in what must be one of the more meritocratic occupations around. I wonder if he would have had as good a shot at a bank presidency as his children could have.

Fifth, you don’t have to be a card-carrying utilitarian to believe that taking a (lump-sum) dollar from a random rich person and giving it to a random poor person would lead to a better social state. Mankiw’s attempts to undermine this intuition fall pretty far short: a) Yes, rich countries are pretty cheap with aid to poor countries, and might be so even if they were surer that aid was effective. But this only says something about the limits of human solidarity: greater within a family than outside it, greater within a nation than outside it, etc. So what? b) No, we don’t try to equalize the marginal value of kidneys across the population. But this does not deny that some people need a kidney more than others, it merely reflects the fact that most people regard kidneys and other body parts as somehow less fungible than bank accounts. Does it follow from the fact that we do not redistribute spare kidneys that we should not redistribute some spare cash? As for the actual progressiveness of the federal tax code, if we take the group averages given in the paper as points on the tax function, the marginal tax rate between incomes of $223,500 and $1,219,700 appears to be slightly lower than that between $64,300 and $223,500.

Sixth, who could be against allowing people their “just deserts?” But there is that matter of what is “just.” Most serious ethical thinkers distinguish between deservingness and happenstance. Deservingness has to be rigorously earned. You do not “deserve” that part of your income that comes from your parents’ wealth or connections or, for that matter, their DNA. You may be born just plain gorgeous or smart or tall, and those characteristics add to the market value of your marginal product, but not to your just deserts. It may be impractical to separate effort from happenstance numerically, but that is no reason to confound them, especially when you are thinking about taxation and redistribution. That is why we may want to temper the wind to the shorn lamb, and let it blow on the sable coat.