Inequality

French economist Thomas Piketty has put growing income and wealth inequality center stage, publishing a well researched book full of data that pretty conclusively shows what many of us have been arguing for sometime: there is a growing gap between the rich and poor and this could be dangerous to democracy and modern society.

I plan to read the book and will blog more on the details/arguments.  For now, I offer only a general reflection about the subject matter and the importance of taking inequality seriously.

His book isn’t a radical appeal to the masses.  It is a lengthy academic tome with a target audience that includes economists, political scientists, and other scholars.   Among this audience his argument is neither new nor earth shattering – economists and political scientists have been pointing out how the centralization of wealth has been increasing, creating a real threat to democracy and capitalism itself.    However, perhaps because the public is waking up to this fact, his work has suddenly became a best seller and is perhaps one of the most important books of our era.

Pointing out the dangers of out of control capitalism is not an argument for socialism; quite the contrary, thoughtful supporters of market capitalism should take it seriously and ask themselves: is the growing power and influence of the very rich a result of hard work and initiative, or are they able to rig the game in their favor?   If the very wealthy are rigging the game, then they are undermining capitalism and democracy.

Libertarian thinkers sometimes have an understanding of economics that is skin deep.  They have learned the basics of how the market works, and thus have an understanding that, all things being equal, the market does better than anything else at communicating demand and using price to allocate goods and services.  Government policy simply distorts that mechanism and thus creates inefficiencies.   So, they conclude, government is the problem, less government is better.

But that’s only if reality operates as pure market theory says it should, and if you take economics beyond the first year you know that is not the case.   Markets are distorted by a myriad of factors: imperfect information, misinformation, inside deals, connections, the capacity to use wealth to influence others, and the utter lack of knowledge many have about the way the system operates.

A good example is in Michael Lewis’ new book, Flash Boys.  The rigging of the game there is rather minor – big banks can use lags in time to make trades to figure out what trade is coming and make an offer that will earn them a few extra pennies on every trade.  No big deal; no 401K investor notices the slight variations.  Yet a few pennies off of hundreds of millions of trades and it adds up!   That’s just an example of what you can do if you are on the inside.   Of course, the way the big banks took investors to the cleaners over derivative bonds during the housing bubble (and in fact caused the housing bubble) is a more dramatic example – described in Lewis’ earlier book The Big Short.

Now one might say that this is nothing new.   Throughout history the wealthy, elite class has always assumed they deserved privilege while the poor were looked down upon as being lower in character or worth.  In the 19th century the British tried to make any form of social welfare painful and difficult so as to avoid anyone wanting to stay on it.   Yet workers have defied that notion of the poor as lazy for centuries.  After all, when in Britain millions of factory workers endured horrific conditions during the industrial revolution, they still worked.   They put up with sustenance wages, filth, squalor, child labor 80 hour work weeks, and numerous work related deaths and injuries to keep earning.

Compared to then, workers have it pretty good now.   So does that mean inequality doesn’t matter?

It does matter.  Consider the two charts here.  Above, the share of wealth that the top 0.1% have is shown, and it has doubled in the last thirty years to the point that they control a over a fifth of the country’s capital.   Below, the graph shows the income of the top 10%.  Again, the share going to the very wealthy has increased dramatically over the last 30 years, to levels from the early 20th Century.

This matters for a number of reasons.   First, such a distribution of wealth and income makes bubbles more likely.  In theory, the very wealthy should be investing their money to create jobs for the poor, allowing that wealth to “trickle down.”  In practice, when too much capital is centralized to the very few, bubbles become more likely as they are looking for “easy money” rather than investing in jobs.    And when they do invest, overseas investment is common.   That money does not go into improving our economy.   It would be more efficient to tax it and use it to build infrastructure and support the economy.

The key to long term growth is demand from the middle class.  Money earned by the middle class does not usually flow into bubbles; rather, it creates demand for goods and services that require domestic jobs.    When a higher proportion of the wealth flows to average folk, the economy grows.  Moreover, social mobility in the US as become very low – where you were born has become the best predictor of where you will end up.

That is contrary to the American dream – and the value that individual initiative and effort matter.  The best way to assure that people can achieve all they are capable of is to assure access to education, health care, and the things needed to overcome obstacles caused by poverty or lack of status.  That means government programs to promote equal opportunity are good for capitalism and freedom; by expanding the capacity of people to achieve all they can we avoid becoming an oligarchy.

If this trend is not reversed, the economy will stagnate and America’s best days will be behind us.   The good news is that it appears the anti-tax anti-government sentiment that has been the norm for the last 35 years is starting to fade.   Despite the fights over Obamacare, it was passed and implemented; public opinion is shifting.   For now it’s important that the conversation about inequality continue – the future of market capitalism depends upon avoiding or reversing today’s inertia to oligarchy.